APPLIED VOICE TECHNOLOGY INC /WA/, 10-K, 1998-03-30

APPLIED VOICE TECHNOLOGY INC /WA/
10-K, 1998-03-30
PREPACKAGED SOFTWARE

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

FORM 10-K

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

For the fiscal year ended: December 31, 1997

[_] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from TO
-------------- ---------------

Commission file number: 0-25186

APPLIED VOICE TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)

Washington 91-1190085
(State or other jurisdiction of (IRS EMPLOYER
incorporation or organization IDENTIFICATION NO.)

11410 N.E. 122nd Way
Kirkland, WA. 98034
(Address of principal executive offices) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (425) 820-6000

SECURITIES REGISTERED PURSUANT TO SECTION 12(d) OF THE ACT: None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, $.01 PAR VALUE PER SHARE
--------------------------------------
(TITLE OF CLASS)

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceeding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]

Aggregate market value of voting stock held by non-affiliates of the registrant
as of March 6, 1998 was $160,140,080 (based upon the closing sale price of
$33.25 per share on the Nasdaq National Market on such date).

Number of shares of Common Stock outstanding as of March 6, 1998 was 5,939,344

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's Proxy Statement for the 1998 Annual Meeting of
Shareholders to be held May 6, 1998 are incorporated by reference in response to
Part III, Items 10-13 (Directors and Executive Officers of the Registrant)
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TABLE OF CONTENTS

<TABLE>
<CAPTION>
PART I
<S> <C>
Item 1. BUSINESS...................................................... 1
Industry Background........................................... 1
The AVT Solution.............................................. 1
Strategy...................................................... 2
Products...................................................... 3
Distribution.................................................. 6
Product Support............................................... 8
Product Development........................................... 8
Proprietary Rights............................................ 9
Competition................................................... 9
Manufacturing................................................. 10
Employees..................................................... 10
Item 2. PROPERTIES.................................................... 10
Item 3. LEGAL PROCEEDINGS............................................. 10
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 10

PART II

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS........................................... 11
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA.......................... 11
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................... 12
RISK FACTORS.................................................. 18
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 23
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................... 36

PART III

Item 10-13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 37

PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K...................................................... 38
</TABLE>

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PART 1

Item 1. BUSINESS

The Company is a leading provider of software-based computer-telephony
solutions for medium-sized enterprises. The Company provides flexible, cost-
effective products that address the voice messaging, call center, fax server and
production fax markets, and distributes these products primarily through
independent distributors and value-added resellers. The Company's products run
on off-the-shelf hardware, support Window NT and OS/2, and interface with a wide
variety of telephony and computer equipment.

INDUSTRY BACKGROUND

Businesses are increasingly using information technology to improve customer
service, increase employee productivity, decrease costs and more efficiently
disseminate information. As the amount of information exchanged between
organizations increases, and the diversity of the delivery formats and
combinations used by organizations to exchange this information becomes more
complex, there is a growing need for organizations to find new ways to manage
information in a more timely and cost-effective manner.

In response to the growth in voice communications, organizations are
increasingly using voice messaging, call centers with automated intelligent
routing and IVR systems that provide voice-prompted access to data. These
computer-telephony solutions allow employees to more effectively manage
communications, significantly improve call center efficiency, and allow easy
access by telephone to large amounts of information that resides on computer
databases.

The growth in data communications presents additional opportunities for
accessing and sending information. For example, organizations are deploying LAN-
based fax servers to store, forward and broadcast their growing volume of
facsimile traffic in an efficient manner. Electronic messaging over LANs, the
Internet and corporate intranets has emerged as another way to access data and
disseminate information. This rapid increase in multiple forms of voice and data
communication has further accentuated the need for organizations to optimize
their information management capabilities and integrate voice and data
communications.

Large corporations have been the first to implement systems that provide
enhanced voice and data integration. These large systems typically have been
based on proprietary hardware and software and are not cost-effective for
medium-sized organizations or smaller offices of large organizations. However,
to remain competitive these medium-sized entities require systems with the same
functionality to provide a comparable level of interaction with customers and
vendors and to reduce operating costs. These organizations do not typically have
the resources or the number of users required to purchase, customize and
maintain proprietary solutions. Rather, they require cost-effective computer-
telephony solutions that provide open standards-based interfaces to a broad
range of voice and data equipment, flexibility to add new functionality and
scaleable capacity to add new users, and that operate on readily available
hardware.

THE AVT SOLUTION

The Company is a leading provider of software-based computer-telephony
solutions for medium-sized enterprises. These solutions are designed to enhance
individual and work group productivity, improve customer service, reduce
business operating costs and simplify information access and dissemination. The
Company's products provide enhanced voice and data integration through
applications such as unified voice and data messaging, call center management,
IVR and document distribution. The Company's products run on off-the-shelf
server hardware, support Windows NT and OS/2, and interface with a wide variety
of telephony and computer equipment.

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STRATEGY

The Company's mission is to provide cost-effective, innovative computer-
telephony software products that operate on industry-standard computer
platforms, and market those products throughout the world. Key components of the
Company's strategy include:

Provide Complete Software-based Computer-telephony Solutions. The Company is
focused on providing a comprehensive and affordable set of software-based
computer-telephony solutions designed to enhance productivity, improve customer
service, reduce business operating costs and simplify access to data and
dissemination of information. The Company's products provide enhanced voice and
data integration through applications such as unified voice and data messaging,
call center management, IVR and document distribution.

Focus on Medium-sized Enterprise Market. The Company currently targets
enterprises with 100 to 2,000 employees, including divisions and subsidiaries of
Fortune 1000 companies. The Company's strategy is to continue to invest in new
product development and marketing initiatives to gain market share and further
meet the computer-telephony needs of medium-sized enterprises.

Leverage Telephony and Data Expertise. The Company has established a knowledge
base in the development of call processing, voice processing and call switching
applications, as well as LAN, Internet and corporate intranet software
applications. The Company believes that its expertise in these areas enables it
to efficiently bring to market innovative software products that unify and
exchange information on and between the telephone and computer. While the
Company's product lines all provide computer-telephony functionality, the
Company tailors its products to take advantage of the distinct telephony-
oriented and computer-oriented distribution channels. The Company intends to
leverage its expertise to continue to develop channel-specific products and to
introduce new products that further integrate its telephony and computer
capabilities.

Capitalize on Installed Base. The Company intends to capitalize on its
installed base by offering add-on modules, software upgrades and new products,
all of which provide increased capacity and functionality. Moreover, the Company
believes the migration of many of its customers to the Windows NT operating
system will present it with a significant opportunity to sell Windows NT product
upgrades.

Utilize Capabilities of Multiple Distribution Channels. The Company targets
medium-sized enterprises primarily through telephony-oriented distributors and
computer-oriented value-added resellers. The Company believes that some
enterprises will evaluate computer-telephony solutions from a telephony
perspective while others will focus on data-centric solutions. The use of
multiple distribution channels that target many of the same potential customers
increases the likelihood that the Company's products will be sold to a
particular customer. The Company intends to broaden its distribution channels by
expanding its direct sales efforts and by continuing to enter into distribution
agreements with private label OEMs and other strategic partners, such as the
recently signed agreement with Ericsson Enterprise Networks AB.

Grow Through Strategic Acquisitions. The Company believes that growth through
strategic acquisitions of complementary technologies, products and distribution
channels offers the potential for significant competitive advantage. The
Company's open-systems technology facilitates the rapid integration of and
linkage to other complementary open-systems technologies. The Company believes
it is therefore able to accelerate introduction of new technologies to the
market through acquisition, and to respond rapidly to industry changes and
opportunities.

Pursue International Opportunities. The Company believes that the markets for
CTI products outside the United States will experience accelerated growth in the
next few years. To pursue these opportunities, the Company intends to continue
to localize its products for specific markets and to actively recruit new
dealers, distributors and strategic partners internationally.

2
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PRODUCTS

The Company's product lines include both telephony-oriented and computer-
oriented products. The Company's telephony-oriented product lines serve the
messaging and call center markets and focus on voice and call processing,
unified messaging, IVR, personal and workgroup call management and call center
productivity applications. The Company's computer-oriented product lines target
the fax server and production fax markets and focus on high-performance fax
processing and unified messaging, as well as Internet, corporate intranet and
phone-based information access. The following table provides an overview of the
Company's products in each of these markets.

<TABLE>
<CAPTION>
PRODUCT LINE Description
<S> <C>
Message Products:

CallXpress for Windows NT A multi-application platform for medium-sized to large enterprises that supports
(Introduced 1997) 4 to 64 ports and runs on Windows NT.

CallXpress3 A multi-application platform that has the same capabilities as CallXpress for
(Introduced 1991) Windows NT and runs on the OS/2 operating system.

PhoneXpress A call answering, routing and voice messaging system for small to medium-sized
(Introduced 1993) enterprises that supports 4 to 16 ports.

Call Center Products:

AgentXpress for Windows NT A high-performance ACD system for medium-sized call centers that runs on
(Introduced 1997) Windows NT and supports up to 144 inbound trunk lines and up to 96 agents.

Enhanced Agent Computer-telephony interfaces and applications that support integration of
(Introduced 1997) AgentXpress with CallXpress and RightFAX servers.

RightFAX Products:

RightFAX 5.0 A high-performance LAN-based fax server that runs on Windows NT and supports
(Introduced 1997) up to 32 fax channels.

RightFAX Enterprise An enhanced version of the RightFAX 5.0 software designed for complex, enterprise
(Introduced 1997) -wide fax server environments.

RightFAX 4.5 A high-performance LAN-based fax server that has the same capabilities as
(Introduced 1991) RightFAX 5.0 and runs on the OS/2 operating system.

CommercePath Products:

CommercePath for Windows NT A high-volume, production-oriented server that enables fax and other forms of
(Introduced 1997) electronic transmission for electronic commerce applications, supports up to
48 ports and transmits or receives up to 2,800 pages per hour.

HOST-FAX for Unix A high-volume, production-oriented line of fax servers based on the Unix operating
(Introduced 1991) system with many of the same capabilities found in CommercePath for Windows NT.
</TABLE>

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MESSAGING PRODUCTS

CallXpress Line

The CallXpress family of products consists of CallXpress3 and CallXpress for
Windows NT. CallXpress3, introduced in early 1991, is a multi-application
computer-telephony platform that runs on the OS/2 operating system. Succeeding
CallXpress3 as the Company's premier telephony-oriented product offering,
CallXpress for Windows NT was introduced in early 1997. CallXpress for Windows
NT is designed to take advantage of the advanced capabilities of the Windows NT
operating system, and includes significant improvements to the system's
installation and administrative capabilities and increased fax functionality.
The CallXpress line is designed to support from 4 to 64 telephone ports and can
serve the needs of small to large enterprises.

The Company's CallXpress messaging products are either sold as software kits
to dealers who obtain their own hardware, or sold fully integrated on Company-
provided PC hardware platforms. Software kits consist of software,
documentation, a hardware security key, voice cards and fax cards. Fully
integrated systems include all the components supplied in the software kits,
plus fully integrated and tested PCs, disk drive storage devices of various
sizes and configurations, modems, monitors and keyboards. While CallXpress was
developed with a telephony orientation, it is designed to link with computer-
oriented solutions through its standard LAN-connection and software-modular
packaging.

CallXpress application modules consist of software programs that operate in an
integrated, multi-tasking environment and are not dependent on secondary
hardware processors. Modules may be purchased either at the time of initial
installation or as subsequent add-ons. CallXpress software modules are divided
into three application categories: call processing, unified messaging, and call
center productivity.

Call Processing Applications

Automated Attendant/Voice Mail. The Automated Attendant/Voice Mail module
answers calls on the first ring and invites the caller to enter an extension
number, wait on the line for a receptionist or leave a voice mail message. The
Audiotext feature of the Automated Attendant/Voice Mail module acts as a "spoken
bulletin board."

Digital Networking. With the Digital Networking module, a company with
multiple locations can link its offices together, thereby allowing subscribers
at each location to send and receive voice and fax messages to and from any
other office in the network using the Internet or corporate intranet.

Unified Messaging Applications

Desktop Message Manager. Desktop Message Manager provides a visual interface
to the subscriber's unified mailbox, letting the subscriber know who sent a
message, the type of message sent, when it arrived, whether it is urgent and its
length. The module will play back voice mail messages on the subscriber's
telephone or voice-enabled PC, as well as display fax messages on the computer
screen. A related module provides the subscriber with a visual interface to
manage his or her CallXpress unified mailbox from Microsoft Outlook.

E-Mail Access. E-Mail Access provides a subscriber with the option to hear
electronic mail text messages through text-to-speech capabilities or convert
them into faxes through text-to-fax capabilities. E-Mail Access integrates with
Lotus cc:Mail, Lotus Notes, Microsoft Mail and Microsoft Exchange.

Fax Mail. The Fax Mail module provides store and forward capabilities for fax
documents identical to those provided for voice messages. The Company's Fax
Server supported under CallXpress for Windows NT extends the capabilities of Fax
Mail to include the full feature set, performance and capacity of the RightFAX
fax server.

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Call Center Productivity Applications

Automated Agent. Automated Agent is an interactive voice response module that
enables complete application solutions to be designed for specific business
functions such as catalog ordering and college registration. Automated Agent can
be connected to the corporate database through a variety of host computer and
LAN-based interfaces.

Fax Response. The Fax Response module provides documents such as order
acknowledgments or printouts of customer accounts requested by callers through
the Automated Agent module.

Desktop Call Manager. Desktop Call Manager provides intelligent, real-time
management of incoming calls, allowing the subscriber or member of a workgroup
to take the call, take a message, or redirect the call. Incoming calls are
identified by Caller ID, prompting the system to display the caller's identity
on the subscriber's PC. Desktop Call Manager can be a very cost-effective
application for smaller, informal call centers where an ACD system cannot be
cost-justified.

Faxtext. The Faxtext module provides callers 24-hour access to requested
information such as product literature, specification sheets, rate sheets,
technical bulletins or other types of information a company may want to quickly
and easily communicate via fax.

PHONEXPRESS

PhoneXpress is designed to meet the requirements of small- to medium-sized
enterprises that require full-featured automated attendant and voice mail
functions. PhoneXpress is based on the same core technology as CallXpress3, but
does not provide the application interfaces to support all the advanced
computer-telephony applications of unified messaging and call center
productivity. PhoneXpress is designed to support from 4 to 16 ports and can be
configured with faxtext and networking capability to provide a cost-effective
branch voice processing system for enterprise-wide networks. PhoneXpress, like
CallXpress messaging products, is available as a software kit or as a completely
integrated system.

CALL CENTER PRODUCTS

AgentXpress for Windows NT

AgentXpress for Windows NT is the Company's first product resulting from the
acquisition of selected assets and liabilities of Telcom Technologies in early
1997. AgentXpress for Windows NT, launched in the second quarter of 1997, brings
a high-performance ACD offering to the Company's advanced computer-telephony
application product line targeted at the call center. AgentXpress is an open
systems-based platform, supporting up to 144 incoming trunk lines, including
analog T1 or ISDN connections, and up to 96 agents utilizing either analog or
digital display phone sets. Designed for the medium-sized call center, the
system contains a variety of features and functions at a price point below
comparable proprietary systems. Up to 16 AgentXpress systems can be networked
together to form a distributed call center environment capable of supporting up
to 1,536 agents and 2,300 incoming calls at any one time.

AgentXpress is sold as a complete turnkey system with fully integrated and
tested PCs, disk drive storage devices of various sizes and configurations,
voice cards, trunk cards, modems, monitors, keyboards and digital display
phones.

ENHANCED AGENT

Enhanced Agent is a set of computer-telephony interfaces and applications
designed to extend the capabilities of AgentXpress to support integration with
CallXpress and RightFAX computer-telephony servers. Features provided by
Enhanced Agent include seamless transfers of callers to voice mail, the use of
IVR scripting for sophisticated caller interrogation, the ability for agents to
transmit fax-based information to callers while on the line, and the
simultaneous delivery through screen pops of computer-based caller information
to the agent assigned the call.

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RIGHTFAX PRODUCTS

The RightFAX high-performance, LAN-based fax servers are designed for
businesses with high fax traffic, with many fax users, or that require secure
and confidential fax management. The RightFAX products consist of server
software, fax cards and desktop clients. Desktop clients can fax documents
directly from any Windows application on their LAN-connected PC. All fax
processing is performed on the server, thereby eliminating the need for a fax
modem or telephone line connected directly to each user's PC. In addition,
because the fax processing is performed on the server, the user's application
sends the information to be faxed to the server, where all the conversions to
fax format and outbound calling and transmission are managed. RightFAX products
are sold in software kit form with or without fax cards.

Like the Company's telephony-oriented products, RightFAX provides a mailbox to
receive incoming faxes, which can be routed to the user's mailbox in a variety
of ways, including OCR (optical character recognition) of a cover page. The fax
is digitally stored and can be viewed on a PC connected to the LAN or from any
web browser on a PC connected to the Internet. Faxes can then be printed on any
printer connected to the LAN or the user's PC, forwarded to other users on the
RightFAX server, or re-faxed to any other fax machine in the world. Since the
fax has been stored digitally, there is no further degradation due to multiple
scannings through standalone fax machines.

RightFAX 4.5 runs on the OS/2 operating system and RightFAX 5.0 runs on the
Windows NT operating system. The newly announced RightFAX Enterprise product
offers more advanced features, including least-cost routing, Internet and
corporate intranet capabilities and load-sharing features for multiple server
environments. RightFAX servers can be configured from 1 to 32 simultaneous
inbound/outbound fax channels, supporting analog or digital T1 connectivity.
Capacity is added by installing voice/fax cards and by purchasing port licenses.
RightFAX servers are compatible with all major network operating systems and are
sold as either software licenses or software kits (including fax cards).

COMMERCEPATH PRODUCTS

CommercePath offers a high-volume, production-oriented line of servers that
attach to mainframe, midrange or network "host" computers and enable fax and
other forms of electronic transmission for applications on specific host
computers. Sold most often into high-volume business-to-business electronic
commerce environments, these servers are used to convert, transmit or receive
thousands of production documents such as purchase orders, order
acknowledgments, invoices or statements per hour.

CommercePath software is licensed for either Unix or Windows NT environments
starting with a base set of software known as the CommercePath environment.
Functions are purchased in individual module sets. These modules include
Hostfax, Responsefax, EDI-Interpoint, Internetlink and a set of desktop
applications know as Workstation. Capacity is added by installing voice/fax
cards and by purchasing port licenses.

CommercePath servers support up to 48 simultaneous inbound/outbound channels
per server, and analog or digital T1 connectivity, plus simultaneous attachments
to multiple hosts and printers. Each system is scaleable to transmit/receive
faxes at a rate of up to 2,800 pages per hour. CommercePath servers are sold as
complete turnkey systems with fully integrated and tested PCs, disk drive
storage devices of various sizes and configurations, voice and fax cards,
modems, monitors and keyboards.

DISTRIBUTION

The Company sells its products primarily through an indirect channel of
resellers and distributors, as well as through direct sales and OEM and private
label agreements. The Company believes that some enterprises will evaluate
computer-telephony solutions from a telephony perspective while others will be
more data-focused. The use of multiple distribution channels that access many of
the same potential customers increases the likelihood that the Company's
products will be sold to a particular customer. The Company has built large
telephony-oriented and computer-oriented distribution channels in the United
States and is developing its international distribution channels. The Company
recently took a significant step toward expanding its international distribution
channels by forming a strategic relationship with Ericsson Enterprise Networks
AB ("Ericsson"). See "--OEM/Strategic Accounts." No single customer represented
10% or more of the Company's net sales during 1996 or 1997. See "Risk Factors--
Dependence on Indirect Distribution."

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Telephony-Oriented Distribution

The Company currently derives a substantial percentage of its U.S. telephony-
oriented sales revenues from over 400 wholesale dealers and distributors
comprised of customer premise telephone equipment dealers and voice processing
specialists. This channel consists primarily of national telephone equipment
dealers and regionally focused organizations and is serviced by 20 employees.
The Company continues to selectively recruit additional dealers, focusing on
those capable of marketing and servicing advanced computer-telephony application
products.

Dealers are required to attend Company-sponsored training sessions on system
usage, installation, maintenance and customer support. Advanced training is also
available from the Company on an ongoing basis. All dealers are subject to
agreements with the Company covering matters such as payment terms, protection
of proprietary rights and nonexclusivity of sales territories, but these
agreements generally do not restrict the dealer's ability to carry competitive
products.

Computer-Oriented Distribution

In the United States, the Company's computer-oriented sales force sells most
of the Company's computer-oriented products through an indirect channel of
value-added resellers, independent software vendors, and professional services
companies specializing in custom systems development. These computer-oriented
resellers are small- to medium-sized regionally-focused organizations. In
addition, the Company markets its computer-oriented products directly to end-
user customers through trade shows and journal advertisements. As of December
31, 1997, this sales force consisted of 29 employees.

The Company's CommercePath products are marketed exclusively through its
CommercePath subsidiary using a direct, in-house sales force, which, as of
December 31, 1997, consisted of 19 persons.

OEM/Strategic Accounts

To broaden its access to certain markets, the Company has entered into
distribution and private label/OEM agreements with Dictaphone Corporation and
Fujitsu Business Communications Systems Inc. to sell private label versions of
the Company's CallXpress3 and PhoneXpress products, and has an arrangement with
Cardiff Software, Inc. to sell a private label version of its RightFAX products.
The Company expects to pursue additional OEM and private label agreements in the
future. As of December 31, 1997 the Company had three employees focused on OEM
and strategic accounts. In December 1997, the Company entered into an OEM
agreement with Ericsson. The agreement provides for the integration of the
Company's CallXpress for Windows NT application into certain Ericsson systems
that will be distributed and marketed by Ericsson worldwide. The agreement also
provides for certain joint product development initiatives.

International Distribution

The international market for computer-telephony products is not as developed
as the market in the United States. The Company believes that over the next few
years the market for both telephony-oriented and computer-oriented computer-
telephony products will grow faster internationally than in the United States.
To address this opportunity, the Company is developing broad coverage of
international markets through a variety of dealer, distributor, and strategic
relationships. To date, the majority of the Company's international sales have
been in English-speaking countries: Canada, Australia, the United Kingdom, South
Africa and New Zealand. The Company expects its accelerated distribution
development and product localization efforts of the past few years will result
in a higher growth rate in non-English-speaking countries than in English-
speaking countries. The Company is actively recruiting new dealers and
distributors in international markets. The Company has sales offices in Canada,
the United Kingdom, Germany, Hong Kong and Dubai. Although the Company's sales
to date have generally been denominated in U.S. dollars, the Company expects
that in the future an increasing portion of its international sales will be made
in local currencies. See "Risk Factors--Risks of International Markets" and Note
1 to the Consolidated Financial Statements.

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PRODUCT SUPPORT

The Company's dealers and distributors are primarily responsible for
supporting end-users of the Company's products. The Company provides telephone-
based technical support to its dealers and distributors. Telephone support
service hours to dealers have been expanded to more effectively service non-U.S.
customers. The Company has also expanded its technical training offerings of
both telephony-oriented and computer-oriented products to its dealers. The
Company provides limited warranties on its RightFAX products and certain
hardware components distributed in conjunction with its products.

The majority of product support is provided by the Company within three months
of product shipment, and the estimated cost of such support is recognized as
product revenues are recorded. The Company generally charges its customers
separately for post-sale updates and upgrades.

PRODUCT DEVELOPMENT

The Company has established a knowledge base in the development of call
processing, voice processing and call switching applications, as well as in the
development of LAN and Internet software applications. The Company believes that
its expertise in these areas enable it to efficiently bring to market innovative
software products that unify and exchange information on and between the
telephone and computer.

The Company maintains four product development centers: CallXpress and
PhoneXpress products are developed in Kirkland, Washington; AgentXpress products
in Montclair, California; RightFAX products in Tucson, Arizona; and CommercePath
products in Portland, Oregon. In total, the Company employed, as of December 31,
1997, 108 engineers, technicians and quality assurance specialists in its
development centers. While development efforts in the past have been separate,
the convergence of technologies is allowing the Company to collaborate and
leverage development efforts among these groups. An example of such
collaborative efforts is the incorporation of the RightFAX fax server into the
CallXpress for Windows NT products. The Company expects these cross-development
efforts to increase in the future.

The Company internally develops its core technology, but believes that it is
more cost-effective to license from third parties certain components of its
products, such as database software, screen viewers, voice and fax cards and
network connectors. Whenever practical, the Company will license and integrate
such technology into its product offerings in order to decrease the cost of
development and shorten the time to market. In addition, the Company also
believes that the acquisition of new technology and new product offerings is
consistent with its strategic initiatives and will continue to pursue such
opportunities as they become available.

The Company believes that, for its product offerings to continue to achieve
acceptance, it will be necessary to continue to develop enhanced versions of its
computer-telephony applications. Over the past year the Company has released
major new versions of its products which operate in the Windows NT environment.
The Company expects to continue to expend significant research and development
efforts in developing new technology, but does not expect to introduce as many
new product lines in future years as in 1997. See "Risk Factors--Rapidly
Changing Technology and Customer Needs."

Additionally, with international markets expected to grow at a faster rate
than the North American market over the next several years, the Company intends
to continue to develop versions of its products that have been localized for
foreign markets. Localization includes converting client screens, documentation,
and voice-prompt sets into foreign languages. The Company anticipates expending
significant research and development resources to develop localized versions of
its products.

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PROPRIETARY RIGHTS

AVT relies on a combination of patents, copyright, trademark and trade secret
laws, nondisclosure and other agreements and technical measures to protect its
proprietary technology. The Company has received a patent in the area of unified
messaging. There can be no assurance that the Company's efforts to protect its
proprietary rights will be successful. AVT has periodically received letters
from third parties asserting patent rights. Following analysis, the Company
generally has not believed it necessary to license any of the patent rights
referred to in such letters. In those cases in which the Company has determined
a license of patent rights was necessary, it has entered into a license
agreement. The Company believes that any necessary licenses or other rights
under patents to products or features could be obtained on conditions that would
not have a material adverse effect on its financial condition, although there
can be no assurance in this regard. See "Risk Factors--Limited Intellectual
Property Protection; Potential Infringements."

The Company licenses certain portions of its technology from third parties
under written agreements, some of which contain provisions for ongoing royalty
payments. As of December 31, 1997, the Company had license agreements with Octel
Corporation, Syntellect Inc., Intelligent Environments, Inc. and International
Business Machines Corporation.

COMPETITION

The computer-telephony market is highly competitive and the Company believes
that the competitive pressures it faces are likely to intensify, particularly as
new offerings based on the Windows NT operating system emerge. System features,
product pricing, ease of use and installation, sales engineering and marketing
support, and product reliability are the primary bases of competition. The
Company believes that it competes favorably with respect to these factors in its
target markets. See "Risk Factors--Competition."

The Company's principal competitors in the telephony-oriented market for voice
messaging and unified messaging systems are independent suppliers, including the
Octel Messaging Division of Lucent Technologies, Inc., Centigram Communications
Corporation, Active Voice Corporation, Voysys Corporation and Callware
Technologies, Inc. The Company's principal competitors in the call center
systems market are manufacturers such as Aspect Telecommunications Corporation
and Rockwell International Corporation. PBX and key telephone systems
manufacturers such as Lucent Technologies, Inc., Northern Telecom Ltd., Siemens
Business Communication Systems, Inc., Executone Information Systems, Inc.,
Panasonic Communications and Systems Co., NEC America, Inc. and Toshiba America
Information Systems, Inc. also compete with the Company by offering integrated
voice messaging systems, unified messaging systems and ACD systems of their own
design or under various OEM agreements.

In the market for LAN-based facsimile systems, the Company's principal
competitors are Omtool, Ltd., Optus Software, Inc., Alcom Corporation and
Computer Associates International, Inc. The Company's fax server products also
compete with vendors offering a range of alternative facsimile solutions,
including operating systems containing facsimile and document transmission
features, low-end fax modem products, desktop fax software, single-platform
facsimile software products and customized proprietary software solutions. In
the market for production facsimile systems, the Company's principal competitors
are Biscom, Inc., Teubner & Associates and Topcall International AG.

9
<PAGE>

MANUFACTURING

The Company's manufacturing operations consist primarily of diskette
duplication, documentation fulfillment, final assembly and quality control
testing of materials, subassemblies and systems. Some limited hardware
fabrication is performed by third parties for the Company on certain telephone
switch integration modules, for which the Company has designed a proprietary
device to emulate a particular manufacturer's telephone station set, and for
certain internal "switching" components and digital hand sets used in the
Company's ACD products. The Company is dependent on third-party manufacturers
and vendors for certain critical hardware components such as PC chassis,
keyboards, disk drives, monitors, memory modules and other miscellaneous
components.

The Company's products incorporate a number of commercially available
application cards, fax cards, voice cards and circuit boards that enable
integration with certain telephone switches. The Company currently purchases
voice cards from Dialogic, Natural Microsystems Corp. and Mitel Corp. The
Company purchases fax cards from Brooktrout and Dialogic. See "Risk Factors--
Dependence on Suppliers."

EMPLOYEES

As of December 31, 1997, the Company had 285 full-time employees, including 39
in administration, 24 in manufacturing, 108 in engineering and product
development, and 114 in sales, marketing and technical support. The Company's
employees enter into agreements containing confidentiality restrictions. The
Company has never had a work stoppage and no employees are represented by a
labor organization. The Company considers its employee relations to be good.

ITEM 2. PROPERTIES

The Company's headquarters and its telephony-oriented administrative,
engineering, manufacturing and marketing operations are located in approximately
58,000 square feet of space in Kirkland, Washington under a lease that expires
in January 2003. The Company also conducts telephony-oriented operations in
approximately 10,000 square feet of leased space in Montclair, California. The
Company's computer-oriented operations are primarily located in approximately
14,000 square feet of leased space in Tucson, Arizona and approximately 8,570
square feet of leased space in Portland, Oregon.

The Company believes that these facilities are adequate to meet its current
needs and that suitable additional or alternative space will be available, as
needed, in the future on commercially reasonable terms.

ITEM 3. LEGAL PROCEEDINGS

The Company is not a party to any material pending legal proceedings.

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

There were no matters submitted to a vote of security holders during the
fourth quarter of 1997.

10
<PAGE>

PART II

Item 5. MARKET FOR REGISTRATION'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

The information required by this Item is incorporated by reference to
information contained in Note 9 to the Consolidated Financial Statements:
Quarterly Financial Data and Market Information (unaudited).

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Statement of Income Data:
Net sales............................................................ $21,253 $28,761 $31,284 $44,127 $58,091
Cost of sales........................................................ 9,623 12,391 13,364 16,895 21,066
------- ------- ------- ------- -------
Gross profit......................................................... 11,630 16,370 17,920 27,232 37,025
------- ------- ------- ------- -------
Operating expenses:
Research and development.......................................... 2,421 2,671 2,732 4,149 6,719
Selling, general and administrative............................... 6,795 8,357 8,458 14,509 19,212
Write-off of purchased, in-process research and
development(1)................................................... -- -- -- 4,140 11,025
------- ------- ------- ------- -------
Total operating expenses.......................................... 9,216 11,028 11,190 22,798 36,956
------- ------- ------- ------- -------
Operating income..................................................... 2,414 5,342 6,730 4,434 69
Other income, net.................................................... 68 294 1,116 919 1,070
------- ------- ------- ------- -------
Income before income tax expense..................................... 2,482 5,636 7,846 5,353 1,139
Income tax expense(2)................................................ -- 1,398 2,512 3,419 410
------- ------- ------- ------- -------
Net income........................................................... $ 2,482 $ 4,238 $ 5,334 $ 1,934 $ 729
======= ======= ======= ======= =======
Diluted earnings per common share(3)................................. $0.69 $1.04 $0.95 $0.33 $0.12
Net income excluding nonrecurring items(4)........................... $ 2,482 $ 4,238 $ 5,334 $ 6,074 $ 7,785
Diluted earnings per common share excluding nonrecurring
Items(3)(4)......................................................... $0.69 $1.04 $0.95 $1.03 $1.24
Weighted average common and common equivalent shares
outstanding(3)...................................................... 3,621 4,071 5,611 5,874 6,299
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------
1993 1994 1995 1996 1997
------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and short-term investments.................... $1,817 $22,685 $24,446 $27,679 $22,233
Working capital...................................................... 3,948 24,294 29,670 30,870 27,926
Total assets......................................................... 7,639 28,944 36,932 46,127 54,410
Long-term debt, less current portion................................. -- -- 899 313 --
Total shareholders' equity........................................... 4,795 24,998 32,889 38,883 43,010
</TABLE>

(1) Reflects nonrecurring charges of $4,140,000, $3,898,000 and $7,127,000
for the write-off of purchased, in-process research and development
associated with the acquisition of RightFAX in January 1996, Telcom
Technologies in January 1997 and CommercePath in October 1997,
respectively.
(2) The Company utilized all its remaining net operating loss carryforwards in
the year ended December 31, 1993, and therefore recognized no income tax
expense in that year.
(3) Computed on the basis described in Note 1 to the Consolidated Financial
Statements.
(4) Excludes the effect of the nonrecurring charges in 1996 and 1997 referred
to above.

11
<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW

The Company is a leading provider of software-based computer-telephony
solutions for medium-sized enterprises. These solutions are designed to enhance
individual and work group productivity, improve customer service, reduce
business operating costs and simplify access to data and dissemination of
information. The Company's products provide enhanced voice and data integration
through applications such as unified voice and data messaging, call center
management, IVR and document distribution. The Company's key products are multi-
application computer-telephony platforms that run on off-the-shelf hardware,
support Windows NT and OS/2, and interface with a wide variety of telephony and
computer equipment. The Company also offers add-on modules and software upgrades
that provide increased capacity and functionality.

The Company sells its products primarily through an indirect channel of
resellers and distributors, as well as through direct sales and OEM and private
label agreements. The Company expanded its product offerings significantly in
1997 by releasing Windows NT-based products in each of its main product
categories. The Company's telephony-oriented products include: CallXpress for
Windows NT and CallXpress3, the Company's premier multi-application, high-
capacity computer-telephony product lines; PhoneXpress, a full-featured voice
messaging system for small- to medium-sized enterprises; AgentXpress for Windows
NT, a high-performance Windows NT-based ACD system for medium-sized call
centers; and Enhanced Agent, a set of interfaces and applications designed to
extend the capabilities of AgentXpress. The Company's computer-oriented products
include RightFAX 5.0 and RightFAX Enterprise, the Company's LAN-based fax server
lines for Windows NT, and RightFAX 4.5, which runs on the OS/2 operating system.
With the completion of its acquisition of CommercePath in October 1997, the
Company added the CommercePath line of production document delivery systems for
Unix and Windows NT to its computer-oriented product line.

The Company's products address the needs of four segments of the computer-
telephony market: advanced computer telephony integration ("CTI") applications,
CTI-ready systems, basic messaging systems, and installed base add-ons and
service. Advanced CTI application products include CallXpress for Windows NT and
CallXpress3 systems sold with at least one advanced CTI application module (in
addition to voice mail/automated attendant), AgentXpress for Windows NT, the
RightFAX line of fax servers and the CommercePath line of production fax
systems. CTI-ready systems are CallXpress for Windows NT and CallXpress3 systems
sold initially with voice mail/automated attendant capabilities only, but which
can be easily upgraded to include advanced computer-telephony features. The
basic messaging market is addressed by the PhoneXpress product. Sales to the
installed base of non-CTI capability-enhancing add-ons, capacity-increasing
upgrades, maintenance, training and service parts represent the fourth market
segment.

Since January 1996, the Company has made three strategic acquisitions, each of
which was accounted for as a purchase. The Company acquired RightFAX, a
developer of LAN-based fax server software, in January 1996. In January 1997,
the Company acquired selected assets and liabilities of Telcom Technologies, a
developer of NT-based open-architecture ACD systems. In October 1997, the
Company acquired CommercePath, a developer of high-volume production-oriented
fax servers. In connection with the RightFAX, Telcom Technologies and
CommercePath acquisitions, the Company recorded nonrecurring charges of $4.1
million, $3.9 million and $7.1 million, respectively, in January 1996, January
1997 and October 1997 for the write-off of purchased, in-process research and
development, and recorded additional amounts of goodwill that are being
amortized over future years. See "--Liquidity and Capital Resources" and Note 8
to the Consolidated Financial Statements.

12
<PAGE>

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage of
net sales represented by certain items in the Company's consolidated statements
of income.

<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1995 1996 1997
-------------- ------------ ------------
<S> <C> <C> <C>
Net sales......................................................................... 100.0% 100.0% 100.0%
Cost of sales..................................................................... 42.7 38.3 36.3
----- ----- -----
Gross profit...................................................................... 57.3 61.7 63.7
Operating expenses:
Research and development........................................................ 8.7 9.4 11.6
Selling, general and administrative............................................. 27.1 32.9 33.1
Write-off of purchased, in-process research and development..................... -- 9.4 18.9
----- ----- -----
Total operating expenses........................................................ 35.8 51.7 63.6
Operating income.................................................................. 21.5 10.0 0.1
Other income, net................................................................. 3.6 2.1 1.9
----- ----- -----
Income before income tax expense.................................................. 25.1 12.1 2.0
Income tax expense................................................................ 8.0 7.7 0.7
----- ----- -----
Net income........................................................................ 17.1% 4.4% 1.3%
===== ===== =====
</TABLE>

NET SALES

The Company derives net sales primarily from initial sales of software kits
and licenses and fully integrated systems, as well as follow-on sales of add-on
software modules and product upgrades. Sales to dealers and distributors are
recognized when the products are shipped. The sales mix among the Company's four
market segments and between software kits and fully integrated systems affects
both net sales and gross margin. Because of their hardware components, fully
integrated systems generate higher revenue per unit and lower margins than
comparable software kits. Advanced CTI application systems generally are sold at
a higher unit price and with a higher gross margin than basic messaging systems
due to the additional software modules purchased and the higher mix of software
kits and software licenses as compared to fully integrated systems. Over the
past two years, sales have shifted toward higher-margin advanced CTI products
and software kits from lower-margin CTI-ready systems and basic messaging
products, but there can be no assurance that this trend will continue. See "Risk
Factors--Fluctuations in Quarterly Operating Results; Limited Backlog" and
"--Declining Average Sales Prices."

Years ended December 31, 1997 and 1996. Net sales increased 32% to $58.1
million in 1997 from $44.1 million in 1996. The increase resulted primarily from
sales of advanced CTI application systems, which increased 63% in 1997, and
represented 60% of net sales, as compared to 49% of net sales in 1996. This
trend is consistent with the Company's strategic emphasis on advanced CTI
applications rather than on lower-margin basic messaging sales. The Company
introduced new, Windows NT-based, advanced CTI-oriented product lines in the
first half of 1997 and included CommercePath's results of operations beginning
in November 1997. Sales of CTI-ready systems decreased 8% in 1997 from 1996, and
represented 9% of net sales in 1997, as compared to 13% of net sales in 1996.
The lower-margin basic messaging market continued to be affected by price
pressures from competitive offerings. Basic messaging sales declined 18% in 1997
from 1996, and represented 17% of net sales in 1997 compared to 26% of net sales
in 1996. Sales to the installed base increased 59% in 1997 from 1996 due to
accelerated marketing efforts of telephony-oriented products and the inclusion
of maintenance and spare parts sales related to the January 1997 acquisition of
selected assets of Telcom Technologies. Sales to the installed base represented
14% of net sales in 1997, an increase from 12% of net sales in 1996.
International sales for 1997 increased 50% from 1996, and represented 21% of net
sales.

Years ended December 31, 1996 and 1995. Net sales increased 41% to $44.1
million in 1996 from $31.3 million in 1995, due primarily to the growth in sales
of advanced CTI applications. Advanced CTI application product sales increased
163% and represented 49% of 1996 net sales as compared to 26% of 1995 net sales.
In addition to the inclusion of RightFAX sales for the first time, the Company
introduced major enhancements to both the CallXpress3 and RightFAX product lines
during 1996, which contributed to this significant growth. In 1996 a higher
percentage of CallXpress3 systems

13
<PAGE>

were sold with advanced CTI application modules (as compared to voice
mail/automated attendant functions only) than in 1995, resulting in CTI-ready
sales declining to 13% of 1996 net sales from 22% of 1995 net sales. Sales of
basic messaging products were essentially unchanged and represented 26% of net
sales in 1996, down from 37% in 1995. Add-on and service sales increased 11%,
representing 12% of 1996 net sales. International sales increased 83% in 1996
over 1995 and represented 18% of net sales, due primarily to growth in Europe.
The Company significantly increased its efforts in 1996 to develop distribution
outside the United States to gain a foothold in the emerging international CTI
marketplace.

GROSS PROFIT

Years ended December 31, 1997 and 1996. Gross profit as a percentage of net
sales improved to 63.7% in 1997, as compared to 61.7% in 1996, due primarily to
the favorable sales mix of advanced CTI applications as compared to basic
messaging systems. Gross profit on basic messaging system sales in 1997
continued to be negatively affected by price erosion and a higher ratio of fully
integrated systems as compared to advanced CTI application systems.

Years ended December 31, 1996 and 1995. Gross profit as a percentage of net
sales improved to 61.7% in 1996 from 57.3% in 1995 due to the continued product
mix shift toward software kits and software licenses, as opposed to fully
integrated systems, and the growth in advanced CTI application products.

RESEARCH AND DEVELOPMENT

Years ended December 31, 1997 and 1996. Research and development expenses
increased 62% to $6.7 million in 1997 from $4.1 million in 1996, due primarily
to increased personnel costs relating to acceleration of certain development
projects, the inclusion of the recently formed call center development group,
which was acquired from Telcom Technologies, and research and development
expenses associated with CommercePath. As a percentage of net sales, research
and development expenses represented 11.6% in 1997, as compared to 9.4% in 1996.

Years ended December 31, 1996 and 1995. Research and development expenses
increased 52% to $4.1 million in 1996 from $2.7 million in 1995 due to the
addition of software development and quality assurance personnel associated with
the computer-oriented RightFAX product line and the accelerated development of
CallXpress3 version 4.0, several CallXpress3 advanced CTI modules, and other
advanced development projects. Accordingly, research and development expenses as
a percentage of net sales increased to 9.4% in 1996 from 8.7% in 1995.

SELLING, GENERAL AND ADMINISTRATIVE

Years ended December 31, 1997 and 1996. Selling, general and administrative
expenses increased 32% to $19.2 million in 1997 from $14.5 million in 1996, due
primarily to increased personnel-related costs of domestic and international
development of both the telephony-oriented and computer-oriented distribution
channels, the new product launches of CallXpress for Windows NT and AgentXpress
for Windows NT, and the inclusion of CommercePath expenses for the last two
months of 1997. Selling, general and administrative expenses for 1997 included
amortization of $0.7 million of goodwill relating to acquisitions. Selling,
general and administrative expenses represented 33.1% of net sales in 1997, as
compared to 32.9% in 1996.

Years ended December 31, 1996 and 1995. Selling, general and administrative
expenses increased 72% to $14.5 million in 1996 from $8.5 million in 1995, due
primarily to the Company's expanded distribution efforts in the computer-
oriented channel resulting from the RightFAX acquisition, as well as significant
increases in its telephony-oriented worldwide sales management organization and
expanded marketing programs. Selling, general and administrative expenses
accordingly increased to 32.9% of net sales in 1996 from 27.1% of net sales in
1995.

14
<PAGE>

WRITE-OFF OF PURCHASED, IN-PROCESS RESEARCH AND DEVELOPMENT

In connection with the acquisitions of Telcom Technologies and CommercePath,
the Company recognized nonrecurring charges of $3.9 million and $7.1 million in
the first and fourth quarters of 1997, respectively, for the write-off of
purchased, in-process research and development. The Company recognized a
nonrecurring charge of $4.1 million in the first quarter of 1996 for the write-
off of purchased, in-process research and development associated with the
acquisition of RightFAX. The Company did not record any such charges in 1995.

OTHER INCOME, NET

For the year ended December 31, 1997, other income increased to $1.1 million
from $0.9 million for 1996. Other income decreased to $0.9 million in 1996 from
$1.1 million in 1995 because cash and investment balances declined in early 1996
as a result of payments made related to the RightFAX acquisition.

INCOME TAX EXPENSE

Years ended December 31, 1997 and 1996. The effective income tax rate in both
1997 and 1996 was 36%, excluding acquisition-related charges. The acquisitions
of Telcom Technologies and CommercePath in 1997 were taxable transactions, and,
therefore, the resulting excess of purchase price over net tangible assets
acquired is deductible for income tax purposes. By contrast, the excess of the
purchase price over net tangible assets acquired associated with the acquisition
of RightFAX in 1996 is not tax deductible. Primarily as a result of the
differing tax treatment of these acquisitions, the Company recognized an income
tax expense of $0.4 million in 1997, as compared to an income tax expense of
$3.4 million in 1996.

Years ended December 31, 1996 and 1995. The Company's effective tax rate
increased to 36% in 1996 from 32% in 1995, excluding the effect of the
nondeductible, nonrecurring charge for the write-off of purchased, in-process
research and development discussed above. The increase was due primarily to the
effect of federal, state and foreign income and franchise taxes.

NET INCOME AND NET INCOME PER SHARE

Years ended December 31, 1997 and 1996. The Company recognized net income in
1997 of $0.7 million as compared to $1.9 million in 1996. Excluding the
nonrecurring charges related to the RightFAX, Telcom Technologies and
CommercePath transactions discussed above, net income for 1997 would have
increased 28% to $7.8 million, from $6.1 million in 1996. Diluted net income per
share, excluding the nonrecurring charges, increased to $1.24 per share in 1997
from $1.03 per share in 1996.

Years ended December 31, 1996 and 1995. Net income excluding the nonrecurring
charge increased 14% to $6.1 million in 1996 from $5.3 million in 1995. Diluted
net income per share, excluding the nonrecurring charge, increased to $1.03 in
1996 from $0.95 in 1995. Including the nonrecurring charge, net income in 1996
was $1.9 million and diluted net income per share was $0.33.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents and short-term investments decreased to $22.2
million at December 31, 1997 from $27.7 million at December 31, 1996 and from
$24.4 million at December 31, 1995, due primarily to the 1997 acquisitions of
Telcom Technologies and CommercePath. Cash flow generated from operating
activities was $10.6 million, $8.2 million and $2.3 million in the years ended
December 31, 1997, 1996 and 1995, respectively. The increases resulted primarily
from profitable operations.

In February 1995, the Company prepaid the remaining balance due under a
royalty agreement associated with a 1989 business combination. See Note 6 to the
Consolidated Financial Statements. The cash disbursement, which amounted to $1.8
million, was recorded as an intangible asset and has been amortized over the
remaining term of the original royalty agreement, approximately six years. In
addition, the Company amended a license agreement in September 1995, prepaying

15
<PAGE>

its remaining royalty obligation by issuing a note in the amount of $1.9 million
payable in 12 equal quarterly installments of $161,417 each, including imputed
interest at 8.75% per annum. The Company amended an additional license agreement
in July 1996, prepaying its remaining royalty obligation by issuing a non-
interest-bearing note for $450,000 that was fully paid prior to December 31,
1996. For each of these license agreement amendments, the related intangible
asset is being amortized on a straight-line basis over the average remaining
lives of the patents, which are approximately 12 years in the case of the
license amended in September 1995 and approximately seven years in the case of
the license amended in July 1996.

In January 1996, the Company acquired RightFAX for $4.2 million in cash plus
163,000 shares of Common Stock. The business combination was accounted for as a
purchase. Approximately $4.1 million of the purchase price was recognized as a
nonrecurring charge in the first quarter of 1996, representing the value of
purchased, in-process research and development. The remaining intangible assets
are being amortized over seven years from the date of acquisition. In addition,
the Company paid $1.4 million in cash and issued 95,000 shares of Common Stock
in 1997 relating to the 1996 earn out and guaranteed value of the Common Stock.
As a result of the earn out, the Company recorded additional goodwill of $1.3
million and $2.0 million at December 31, 1997 and 1996, respectively. The former
shareholders of RightFAX are entitled to receive additional consideration of up
to $0.5 million in a combination of cash and Common Stock if certain revenue and
profit margin goals are achieved by RightFAX during 1998.

In January 1997, the Company acquired selected assets and liabilities of
Telcom Technologies. The purchase price for the acquisition was $3.5 million in
cash, plus warrants to purchase 100,000 shares of Common Stock exercisable at
$13.36 per share, which may be exercised any time prior to January 3, 2002. The
Company accounted for the business combination as a purchase and recognized a
nonrecurring charge of $3.9 million in the first quarter of 1997, representing
the value of the purchased, in-process research and development.

In October 1997, the Company acquired all the outstanding capital stock of
CommercePath from Forest City Trading Group, Inc. for $10.4 million in cash. In
connection with the acquisition, the Company also granted options to purchase
120,000 shares of Common Stock, at an exercise price of $28.09 per share, to two
of CommercePath's executive officers. The Company has accounted for the
acquisition as a purchase and recorded a nonrecurring charge of $7.1 million for
the write-off of purchased, in-process research and development. In addition,
the Company will record additional amounts of goodwill that will be amortized
over future years. See Note 8 to the Consolidated Financial Statements.

At December 31, 1997, the Company had a $4.0 million unsecured revolving line
of credit, none of which was outstanding. The Company's line of credit expires
in May 1999 and contains certain financial covenants and restrictions as to
various matters. The Company is currently in compliance with all such covenants
and restrictions. Borrowings under the line of credit bear interest at the
bank's prime rate or its interbank offering rate plus 1.50%, at the Company's
option.

The Company invested $1.1 million, $0.9 million and $0.7 million in equipment
and leasehold improvements in the years ended December 31, 1997, 1996 and 1995,
respectively. Equipment purchases in such years consisted primarily of computer
hardware and software.

The Company expects that its current cash, cash flow from operations and
available bank line of credit, will provide sufficient working capital for
operations for the foreseeable future.

IMPACT OF THE YEAR 2000 ISSUE

The Company has developed a plan to ensure its systems and products are
compliant with the requirements to process transactions in the year 2000. The
Company believes that with upgrades to existing software the impact of the Year
2000 Issue can be mitigated. However, if such upgrades, modifications and
conversions are not made, or are not made in a timely manner, the Year 2000
Issue could have a material impact on the Company's operations.

The Company is currently in the process of completing all necessary updates to
its programs and equipment to ensure they will continue to be effective in the
year 2000. Amounts incurred are being expensed as incurred and are not expected
to be material. The Company plans to complete the Year 2000 project not later
than December 31, 1998.

16
<PAGE>

The costs of the Year 2000 project and the date on which the Company plans to
complete Year 2000 modifications are based on managements' best estimates, which
were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans.

CERTAIN TRENDS AND UNCERTAINTIES

When used in this discussion, the words "believes," "anticipates" and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to certain risks and uncertainties that could cause actual results
to differ materially from those projected. Factors which could affect the
Company's financial results are described below under "Risk Factors" and in Item
1 (Business) of this Annual Report on Form 10-K. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date hereof. The Company undertakes no obligation to publicly release the
results of any revisions to these forward-looking statements that may be made to
reflect events or circumstances after the date hereof or to reflect the
occurrences of unanticipated events.

17
<PAGE>

RISK FACTORS

Fluctuations in Quarterly Operating Results; Limited Backlog. The Company's
quarterly results of operations are subject to significant fluctuations due to a
variety of factors, including the timing of customer orders, changes in the
Company's mix of products and distribution channels, the announcement or
introduction of new products by the Company or its competitors, pricing
pressures and general economic conditions. For example, mix shifts between fully
integrated systems and software kits result in fluctuations in gross margins
because fully integrated systems generate higher revenue per unit but have lower
margins due to their hardware component. The Company's results of operations
also may fluctuate as a result of seasonal factors. Specifically, due to typical
year-end dealer sales patterns and end-user buying patterns, net sales in the
Company's first quarter, without taking into account the effect of acquisitions,
have in the past declined from the fourth quarter of the previous year. Because
substantially all of the Company's revenues in each quarter result from orders
received in that quarter, the Company has historically operated with little or
no backlog. The Company establishes its expenditure levels for product
development and other operating expenses based on its expected revenues, and
expenses are relatively fixed in the short term. As a result, variations in the
timing of sales can cause significant variations in quarterly results of
operations. Accordingly, the Company's results of operations for any period are
not necessarily indicative of results for any future period.

Dependence on Indirect Distribution. A substantial majority of the Company's
net sales depends on a network of independent telephone equipment dealers and
computer-oriented value-added resellers. There is intense competition for the
attention of these independent dealers and resellers from both the Company's
competitors and from providers of other products normally distributed through
these channels. In addition, many of these dealers and resellers do not have the
financial resources to withstand a downturn in their businesses. The lack of
active effort or interest on the part of these dealers and resellers in selling
the Company's products, the loss of a major dealer or reseller, or any other
event or condition negatively affecting the distribution network could have a
material adverse effect on the Company's business, results of operations and
financial condition. There can be no assurance that the Company will be able to
maintain or expand its network of dealers and resellers in the future or that
such dealers and resellers will maintain or expand their present level of
efforts to sell the Company's products. See "Business--Distribution."

Risks Associated With Recent and Future Acquisitions. Since January 1996, the
Company has made three strategic acquisitions. While there are currently no
specific commitments with respect to any future acquisitions, the Company's
management frequently evaluates potential acquisitions of products, technologies
and businesses. Acquisitions by the Company may result in the diversion of
management's attention from the day-to-day operations of the Company's business
and may include numerous other risks, including difficulties in the integration
of operations, products and personnel. Efforts to integrate CommercePath are
still ongoing as the acquisition was recently completed in October 1997. The
failure of efforts to integrate CommercePath or future acquisitions could have a
material adverse effect on the Company's business, results of operations and
financial condition. In addition, acquisitions by the Company have the potential
to result in dilutive issuances of equity securities, the incurrence of debt,
write-offs of purchased, in-process research and development and amortization
expenses related to goodwill and other intangible assets.

Rapidly Changing Technology and Customer Needs. The market for the Company's
products is subject to rapid technological change, changes in customer
requirements and frequent new product and feature introductions. Customer needs
and expectations will require the Company to continue to identify, develop and
market new products and features that satisfy those needs and keep pace with
technological developments, including evolving industry standards and
competitive offerings. Such activities will require the Company to make
substantial expenditures on product development. In addition, the Company has
devoted significant expenditures to technologies that it anticipates will become
widely adopted, such as Windows NT and the Internet. There can be no assurance
that new products or product enhancements developed by the Company will achieve
market acceptance or that the Company will successfully develop new products or
product enhancements on a timely basis. Any failure by the Company to anticipate
or respond adequately to technological developments, customer requirements or
evolving industry standards, or any significant delays in product development or
introduction, could have a material adverse effect on AVT's business, results of
operations and financial condition. See "Business--Product Development."

Competition. The computer-telephony market is highly competitive and the
Company believes that the competitive pressures it faces are likely to
intensify, particularly as new offerings based on the Windows NT operating
system emerge.

18
<PAGE>

The Company's principal competitors in the telephony-oriented market for
messaging systems are independent suppliers, including the Octel Messaging
Division of Lucent Technologies, Inc., Centigram Communications Corporation,
Active Voice Corporation, Voysys Corporation and Callware Technologies, Inc. The
Company's principal competitors in the call center systems market are
manufacturers such as Aspect Telecommunications Corporation and Rockwell
International Corporation. In addition to these independent suppliers of
computer-telephony solutions, private branch exchange ("PBX") and key telephone
systems manufacturers such as Lucent Technologies, Inc., Northern Telecom Ltd.,
Siemens Business Communication Systems, Inc., Executone Information Systems,
Inc., Panasonic Communications and Systems Co., NEC America, Inc. and Toshiba
America Information Systems, Inc. also compete with the Company by offering
integrated voice messaging systems, unified messaging systems and automatic call
distribution ("ACD") systems of their own design or under various OEM
agreements.

The Company believes that further acceptance of open systems architectures and
the development of industry standards in the call processing market will
eliminate some of the technical barriers to entry, allowing additional
competitors to enter the market. Many of the Company's existing competitors have
substantially greater technical, financial and marketing resources, as well as
larger customer and installed bases and greater name recognition, than the
Company. Further, some of the Company's competitors are able to achieve
marketing advantages by bundling their call processing equipment or competitive
facsimile solutions as part of their broader product offerings. The Company
expects its competitors to continue to offer improved product technologies and
capabilities, the availability of which could cause a significant decline in
sales of the Company's existing products. There can be no assurance that the
Company will be able to compete successfully or that such competition will not
have a material adverse effect on the Company's business, results of operations
or financial condition. See "Business--Competition."

Declining Average Sales Prices. The Company has experienced declining average
sales prices in its basic voice messaging products as a result of competitive
pressures and in the future may experience declining prices in some of its other
product lines. Declining average sales prices of the Company's more significant
product lines could lead to a decline in the Company's overall gross margins. To
offset and forestall declining average sales prices, the Company believes that
it must continue to develop product enhancements and new products with advanced
features that are likely to generate higher-margin incremental revenue. If the
Company is unable to develop new products and enhancements in a timely manner or
if such products do not achieve significant customer acceptance, the Company's
business, results of operations and financial condition could be materially
adversely affected. See "--Competition".

Limited Intellectual Property Protection; Potential Infringements. The
Company's success depends in part on its ability to protect its proprietary
technology. The Company has received a patent in the area of unified messaging,
but there can be no assurance that the claims in the patent will not be
successfully challenged or circumvented by competitors, or that the patent will
provide competitive advantages for the Company's products. In addition, the
Company relies on a combination of copyright, trademark and trade secret laws,
nondisclosure and other agreements and technical measures to protect its
proprietary technology. There can be no assurance that the Company will be able
to obtain any meaningful patent protection for its technology in the future, or
that the measures taken by the Company will be adequate to prevent or deter
misappropriation of its technology or the development of technologies having
similar performance characteristics. The Company's use of open systems
architecture in the design of its products may make it easier for competitors to
misappropriate or replicate the Company's designs and developments. The
computer-telephony software industry has historically been characterized by
numerous allegations of patent infringement among competitors, and considerable
related litigation. The Company has received claims of patent infringement from
several parties and likely will receive additional claims in the future.
Although none of these claims has led to litigation to date, the Company's
investigation into some of these claims has been limited by, among other things,
lack of sufficient information regarding the claims. These claims may yet result
in the Company's incurring substantial legal expenses and being required to
obtain licenses, pay damages for infringement, or cease offering products that
infringe such patents. There can be no assurance that a license under patents

19
<PAGE>

or other intellectual property that the Company is allegedly infringing would be
available to the Company on reasonable terms, if at all. The inability of the
Company to obtain necessary licenses or other rights or to protect its
proprietary technology could have a material adverse effect on the Company's
business, results of operations and financial condition. See "Business--
Proprietary Rights."

Risks of International Markets. The Company's future growth depends in part on
continued expansion of its international sales, which accounted for
approximately 14%, 18% and 21% of net sales in the years ended December 31,
1995, 1996 and 1997, respectively. This expansion requires significant
management attention and financial resources, and has resulted in a significant
portion of the Company's revenues being subject to the risks associated with
international sales. Such risks include necessary product adaptations to local
languages and telephone system technology, changes in regulatory requirements,
special standards requirements, exposure to exchange rate fluctuations, tariffs
and other trade barriers, difficulties in staffing and managing international
operations, potentially adverse tax consequences, and uncertainties arising from
local business practices and cultural considerations. Although substantially all
of the Company's international sales currently are denominated in U.S. dollars,
as the Company continues to expand its international operations, it expects its
non-dollar-denominated sales and its exposure to gains and losses on
international currency transactions to increase. The Company does not currently
engage in transactions to hedge against the risk of currency fluctuations.
Because most sales are U.S.-dollar denominated, exchange rate fluctuations may
make the Company's products noncompetitive in certain markets. Furthermore,
continued growth in international markets for the Company's products depends in
part on the pace at which various foreign countries are upgrading their
telephone systems. There can be no assurance that these factors will not have a
material adverse effect on the Company's business, results of operations or
financial condition. See "Business--Distribution--International Distribution."

Dependence on Key Personnel; Management of Growth. The Company's success
depends on its ability to attract and retain key personnel involved in
engineering, research and development, marketing, sales, finance and
administration. In particular, the Company depends to a significant degree on
the efforts of its senior management team. The Company does not maintain
material key person life insurance. The competition for skilled personnel is
intense and the loss of the services of key persons in any functional area could
have a material adverse effect on AVT's current operations and on new product
development efforts. There can be no assurance that the Company will be able to
hire or retain sufficient qualified staff to meet its goals. The Company's
success also depends on the ability of its officers and key employees to manage
growth successfully and to continue to successfully develop product enhancements
and new products. The growth in the Company's business has placed, and is
expected to continue to place, significant demands on the Company's management
and operations. To manage its growth, the Company must continue to implement and
improve its operational, financial and management information systems and
expand, train and manage its employees. The Company's failure to manage growth
effectively could have a material adverse effect on the Company's business,
results of operations or financial condition.

Dependence on Suppliers. The Company uses standard computer hardware for its
products. While most components utilized by the Company are readily available,
voice processing circuit boards ("voice cards") and facsimile processing circuit
boards ("fax cards") are available in quantity only from three domestic
suppliers of voice cards and two domestic suppliers of fax cards. The Company
has historically relied almost exclusively on Dialogic Corporation ("Dialogic")
for its voice cards, and on Dialogic and Brooktrout Technologies, Inc.
("Brooktrout") for its fax cards, primarily because of volume price discounts
and the cost and effort required to develop software for an alternate voice or
fax card. If the Company were to experience significant delays, interruptions or
reductions in its supply of voice or fax cards, or unfavorable changes to price
and delivery terms, the Company's business, results of operations and financial
condition would be materially adversely affected. See "Business--Manufacturing."

20
<PAGE>

Possible Volatility of Stock Price. The market price of the Company's Common
Stock has been, and is likely to continue to be, volatile. Factors such as new
product announcements or changes in product pricing policies by the Company or
its competitors, quarterly fluctuations in the Company's operating results,
announcements of technical innovations, announcements relating to strategic
relationships or acquisitions, changes in earnings estimates by securities
analysts and general conditions in the computer-telephony market, among other
factors, may have a significant effect on the market price of the Company's
Common Stock. The market prices of securities issued by many companies,
particularly in high-technology industries, experience volatility for reasons
unrelated to the operating performance of the specific companies. These broad
market fluctuations may adversely affect the market price of the Company's
Common Stock.

21
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

APPLIED VOICE TECHNOLOGY, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
December 31,
---------------------
1996 1997
- ------------------------------------------------------------------------------------------------ ---------- ---------
ASSETS (in thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents..................................................................... $12,195 $ 7,965
Short-term investments........................................................................ 15,484 14,268
Accounts receivable, less allowance of $606,000 and $787,000 6,106 10,098
.....................................
Inventories................................................................................... 2,458 4,908
Deferred income taxes......................................................................... 861 1,119
Prepaid expenses and other.................................................................... 502 968
------- -------
Total current assets....................................................................... 37,606 39,326
Equipment and leasehold improvements, net....................................................... 1,479 2,364
Intangibles, net................................................................................ 6,847 8,815
Deferred income taxes........................................................................... 195 3,905
------- -------
$46,127 $54,410
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable.............................................................................. $ 2,033 $ 2,352
Other current liabilities..................................................................... 3,967 6,114
Note payable--current portion................................................................. 586 313
Income taxes payable.......................................................................... 345 2,621
------- -------
Total current liabilities.................................................................. 6,931 11,400
------- -------
Note payable.................................................................................... 313 --
Commitments.....................................................................................
Shareholders' equity:
Preferred stock, par value $.01 per share, 1,000,000 shares authorized; none
outstanding................................................................................. -- --
Common stock, par value $.01 per share, 30,000,000 shares authorized;
5,425,713, and 5,761,279 outstanding........................................................ 54 58
Additional paid-in capital.................................................................... 28,267 31,661
Retained earnings............................................................................. 10,562 11,291
------- -------
Total shareholders' equity................................................................. 38,883 43,010
------- -------
$46,127 $54,410
======= =======
</TABLE>

See the accompanying notes to these consolidated financial statements.

22
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
---------- ---------- ---------
<S> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
Net sales............................................................ $31,284 $44,127 $58,091
Cost of sales........................................................ 13,364 16,895 21,066
------- ------- -------
Gross profit....................................................... 17,920 27,232 37,025
------- ------- -------
Operating expenses:
Research and development........................................... 2,732 4,149 6,719
Selling, general and administrative................................ 8,458 14,509 19,212
Write-off of purchased, in-process research and development........ -- 4,140 11,025
------- ------- -------
Total operating expenses........................................ 11,190 22,798 36,956
------- ------- -------
Operating income..................................................... 6,730 4,434 69
------- ------- -------
Other income:
Interest income.................................................... 1,063 909 808
Other.............................................................. 53 10 262
------- ------- -------
Other income.................................................... 1,116 919 1,070
------- ------- -------
Income before income tax expense..................................... 7,846 5,353 1,139
Income tax expense................................................... 2,512 3,419 410
------- ------- -------
Net income........................................................... $ 5,334 $ 1,934 $ 729
======= ======= =======
Basic earnings per common share...................................... $1.05 $0.36 $0.13
Weighted average common shares outstanding........................... 5,096 5,376 5,682
Diluted earnings per common share.................................... $0.95 $0.33 $0.12
Weighted average common and common equivalent shares outstanding..... 5,611 5,874 6,299
</TABLE>

See the accompanying notes to these consolidated financial statements.

23
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
---------------- PAID-IN DEFERRED RETAINED SHAREHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS EQUITY
---------------- ---------- ------------- --------- --------------

(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994....................... 4,903,592 $49 $21,774 $(119) $ 3,294 $24,998
Unrealized gain on investments..................... -- -- -- -- 22 22
Exercise of overallotment option
from initial public offering...................... 168,750 1 2,039 -- -- 2,040
Exercise of stock options.......................... 71,698 1 409 -- -- 410
Stock compensation expense......................... -- -- -- 85 -- 85
Net income......................................... -- -- -- -- 5,334 5,334
--------- --- ------- ------------ ------- -------
Balance at December 31, 1995....................... 5,144,040 51 24,222 (34) 8,650 32,889
Unrealized loss on investments..................... -- -- -- -- (22) (22)
Exercise of stock options.......................... 118,374 1 617 -- -- 618
Stock compensation expense......................... -- -- -- 34 -- 34
Stock issued in acquisition........................ 163,299 2 3,428 -- -- 3,430
Net income......................................... -- -- -- -- 1,934 1,934
--------- --- ------- ------------ ------- -------
Balance at December 31, 1996....................... 5,425,713 54 28,267 -- 10,562 38,883
Stock issued in acquisition........................ 95,516 1 667 -- -- 668
Warrants issued in acquisition..................... -- -- 700 -- -- 700
Exercise of stock options.......................... 240,050 3 1,465 -- -- 1,468
Tax benefit of stock options
exercised......................................... -- -- 562 -- -- 562
Net income......................................... -- -- -- -- 729 729
--------- --- ------- ------------ ------- -------
Balance at December 31, 1997....................... 5,761,279 $58 $31,661 $ -- $11,291 $43,010
========= === ======= ============ ======= =======
</TABLE>

See the accompanying notes to these consolidated financial statements.

24
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
(IN THOUSANDS)
Cash flows from operating activities:
Net income........................................................................ $ 5,334 $ 1,934 $ 729
-------- ------- --------

Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization..................................................... 809 1,395 2,083
Write-off of purchased, in-process research and development....................... -- 4,140 11,025
Stock compensation expense........................................................ 85 34 --
Deferred income taxes............................................................. 2 (137) (3,406)
Changes in current assets and liabilities:
Accounts receivable............................................................ (1,732) 5 (1,944)
Inventories.................................................................... (332) (551) (1,239)
Prepaid expenses and other assets.............................................. (539) (237) (340)
Accounts payable............................................................... 60 241 16
Accrued compensation and benefits.............................................. (80) 514 (52)
Income taxes payable........................................................... (859) 546 2,278
Other accrued liabilities...................................................... (460) 271 1,124
-------- ------- --------
Total adjustments.............................................................. (3,046) 6,221 9,545
-------- ------- --------
Net cash provided by operating activities...................................... 2,288 8,155 10,274
-------- ------- --------

Cash flows from investing activities:
Purchase of equipment and leasehold improvements.................................. (691) (930) (1,112)
Cash paid in acquisition, net of cash acquired.................................... -- (3,318) (15,426)
Purchase of short-term investments................................................ (12,175) (3,309) --
Net proceeds from the sale of investments......................................... -- -- 1,216
Other intangibles and long-term assets............................................ (1,807) -- (64)
-------- ------- --------
Net cash used in investing activities.......................................... (14,673) (7,557) (15,386)
-------- ------- --------

Cash flows from financing activities:
Net proceeds from overallotment exercise.......................................... 2,040 -- --
Repayment of long-term debt....................................................... (289) (983) (586)
Proceeds from sale of common stock................................................ 198 331 1,468
-------- ------- --------
Net cash provided by (used in) financing activities............................ 1,949 (652) 882
-------- ------- --------
Net decrease in cash........................................................... (10,436) (54) (4,230)
Cash and cash equivalents at beginning of period.................................... 22,685 12,249 12,195
-------- ------- --------
Cash and cash equivalents at end of period.......................................... $ 12,249 $12,195 $ 7,965
======== ======= ========
Cash paid for interest.............................................................. $ 44 $ 129 $ 57
</TABLE>

See the accompanying notes to these consolidated financial statements.

25
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Nature of Business and Summary of Significant Accounting Policies

Nature of Business

Applied Voice Technology, Inc. (the Company), a Washington corporation,
provides software-based computer-telephony products for medium-sized
enterprises. The Company's products address the voice messaging, call center,
fax server and production fax markets and are distributed primarily through
independent distributors and value-added resellers. The consolidated financial
statements include the accounts of all subsidiaries, all of which are wholly
owned, from the date of acquisition, including RightFAX, Inc., as of January 2,
1996, and CommercePath, Inc., as of October 22, 1997. All intercompany accounts
have been eliminated.

Cash and Cash Equivalents

The Company's policy is to invest cash in excess of operating requirements in
income-producing investments. For purposes of the consolidated statements of
cash flows, the Company considers all highly liquid debt instruments purchased
with a maturity of three months or less to be cash equivalents. Cash and cash
equivalents include all cash balances and highly liquid investments in a money
market fund. Investments are recorded at cost, which approximates market prices.

Inventories

Inventories consist primarily of computer assemblies, components and related
equipment, and are stated at the lower of cost (first-in, first-out) or market
(net realizable value). Inventories consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
(IN THOUSANDS)
Raw materials and service parts................ $2,193 $4,629
Finished goods................................. 265 279
------ ------
$2,458 $4,908
====== ======
</TABLE>

Equipment and Leasehold Improvements

Equipment and leasehold improvements are stated at cost and are depreciated on
the straight-line method over the estimated useful lives of the assets, which
range from three to five years. Equipment and leasehold improvements consist of
the following:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1997
-------------- ------------
<S> <C> <C>
(IN THOUSANDS)
Computers and other equipment.................. $ 4,015 $ 5,758
Leasehold improvements......................... 339 427
Furniture and fixtures......................... 372 584
------- -------
4,726 6,769
Less accumulated depreciation.................. (3,247) (4,405)
------- -------
Equipment and leasehold improvements, net...... $ 1,479 $ 2,364
======= =======
</TABLE>

26
<PAGE>

APPLIED VOICE TECHNOLOGY, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)

Intangibles

Goodwill is being amortized using the straight-line method over its estimated
useful life of seven years. License agreements are amortized using the straight-
line method over the remaining lives of the related patents, which range from
approximately 6 to 12 years.

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------- ------------
<S> <C> <C>
(IN THOUSANDS)
Goodwill on CommercePath acquisition.......... $ -- $ 1,793
Goodwill on RightFAX acquisition.............. 4,070 5,406
License agreements............................ 4,068 4,516
------- -------
8,138 11,715
Less accumulated amortization................. (1,291) (2,900)
------- -------
Intangibles, net.............................. $ 6,847 $ 8,815
======= =======
</TABLE>

Other Current Liabilities

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1997
----------- ----------
<S> <C> <C>
(IN THOUSANDS)
Accrued compensation and benefits............... $1,252 $1,485
Acquisition costs............................... 1,408 1,336
Deferred maintenance revenue.................... 519 1,891
Other........................................... 788 1,402
------ ------
Other current liabilities....................... $3,967 $6,114
====== ======
</TABLE>

Use of Estimates

The preparation of the Company's consolidated financial statements, in
conformity with generally accepted accounting principles, requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Certain prior period balances have been reclassified to conform with the current
period presentation.

Revenue Recognition

Revenues from sales to dealers are recognized when the products are shipped.
When the Company has an installation obligation, revenues are recognized when
product installation is complete. Revenues from extended warranty agreements are
recognized over the lives of the related service contracts on the straight-line
method. The Company accrues estimated costs of technical support to customers as
related revenues are recognized.

Research and Development Costs

Research and development costs are expensed as incurred. The Company has not
capitalized any software development costs, as technological feasibility is not
generally established until substantially all development is complete.

27
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Earnings Per Share

Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the year.
Diluted earnings per common share were computed by dividing net income by the
sum of the weighted average number of shares of common stock outstanding during
the year plus the net additional shares that would have been issued had all
dilutive options been exercised less shares that would be repurchased with the
proceeds from such exercise. Dilutive options are those that have an exercise
price which is less than the average stock price during the year. In 1997, the
Company adopted SFAS No. 128, "Earnings per Share." As a result, the Company's
reported earnings per share for the years presented has been restated.

The computation of diluted earnings per common share is as follows:

<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1995 1996 1997
----------- ---------- -----------
(in thousands, except per share
amounts)
Diluted earnings per common share:
<S> <C> <C> <C>
Net income.............................................................. $5,334 $1,934 $ 729
------ ------ ------
Weighted average common shares outstanding.............................. 5,096 5,376 5,682
Plus: dilutive options assumed exercised................................ 731 796 1,395
Less: shares assumed repurchased with proceeds from exercise............ (216) (393) (812)
Plus: other common stock equivalents.................................... -- 95 34
------ ------ ------
Weighted average common and common equivalent shares outstanding........ 5,611 5,874 6,299
------ ------ ------
Diluted earnings per common share....................................... $0.95 $0.33 $0.12
====== ====== ======
</TABLE>

Concentration of Credit Risk; Export Sales

The Company achieves broad U.S. market coverage for its products primarily
through a nationwide network of telephony-oriented dealers and computer-oriented
value-added resellers. For the years ended December 31, 1996 and 1997, no
customer represented 10% or greater of the Company's net sales. The Company's
largest customer represented 12.1% of net sales for the year ended December 31,
1995. The Company performs ongoing credit evaluations of its customers'
financial conditions and, generally, no collateral is required.

The Company's export sales were as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
---------- --------- ----------
<S> <C> <C> <C>
(IN THOUSANDS)
Canada............... $2,055 $2,660 $ 3,395
Other................ 2,315 5,338 8,757
------ ------ -------
$4,370 $7,998 $12,152
====== ====== =======
</TABLE>

28
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

2. Income Taxes

Income taxes are provided for in the consolidated statements of income using
the asset and liability method. The difference between the provision for income
taxes and the statutory tax rate applied to income before income tax expense is
due to certain expenses not being deductible for tax purposes and research and
experimentation credits.

The following is a reconciliation from the U.S. statutory rate to the
effective tax rate:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1995 1996 1997
-------------- -------------- ---------------
AMOUNT % AMOUNT % AMOUNT %
------- ----- ------- ----- ------- ------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Tax at statutory rate.................................... $2,667 34.0% $1,820 34.0% $ 387 34.0%
Research and experimentation credit...................... (45) (0.6) (69) (1.3) (105) (9.2)
Write-off of purchased, in-process research and
development............................................. -- -- 1,408 26.3 -- --
Nondeductible goodwill amortization...................... -- -- 101 1.9 230 20.2
Nontaxable interest income............................... (148) (1.9) (217) (4.0) (235) (20.6)
State taxes and other.................................... 38 0.5 376 7.0 133 11.6
------ ---- ------ ---- ----- -----
Income tax expense....................................... $2,512 32.0% $3,419 63.9% $ 410 36.0%
====== ==== ====== ==== ===== =====
</TABLE>

Deferred taxes result from temporary differences relating to bad debt and
obsolescence reserves, depreciation and amortization and other accruals that are
expensed for financial reporting, but are not currently deductible for income
tax purposes.

Income tax expense and cash paid for income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997
----------- ------------ ------------
<S> <C> <C> <C>
(IN THOUSANDS)
Current................................... $2,510 $3,556 $ 4,378
Deferred.................................. 2 (137) (3,968)
------ ------ -------
Total income tax expense............... $2,512 $3,419 $ 410
====== ====== =======
Cash paid for income taxes................ $3,677 $3,010 $ 1,539
====== ====== =======
</TABLE>

Significant components of the Company's deferred tax asset as of December 31,
1996 and 1997 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1997
----------- ----------
<S> <C> <C>
(IN THOUSANDS)
Deferred tax assets:
Accounts receivable allowances................... $ 244 $ 283
Inventories...................................... 118 75
Depreciation and amortization.................... 195 64
Accrued compensation and benefits................ 137 171
Purchased research and development............... -- 3,841
Other............................................ 362 590
------ ------
Deferred tax assets................................. $1,056 $5,024
====== ======
</TABLE>

29
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

3. Shareholders' Equity

The Company has stock option plans under which employees, directors, officers
and other agents may be granted options to purchase common stock. The Company
has reserved approximately 1,860,000 shares of common stock for issuance
pursuant to these plans upon exercise of outstanding options and upon exercise
of options to be granted in the future. Options generally vest over three to
four years and expire 10 years from the date of grant. The options are
exercisable at prices determined at the discretion of the Board of Directors.
The Company accounts for these plans under Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," under which no compensation
cost has been recognized and is based on the difference between the exercise
price and fair market value at the date of grant, if any. Had compensation cost
for stock option grants made in 1995, 1996 and 1997 been determined using the
fair value method consistent with Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C> <C>
Net Income: As Reported...... $5,334,000 $1,934,000 $ 729,000
Pro Forma........ $5,324,000 $ 793,000 $(441,000)
Basic EPS: As Reported...... $ 1.05 $ 0.36 $ 0.13
Pro Forma........ $ 1.04 $ 0.15 $ (0.08)
Diluted EPS: As Reported...... $ 0.95 $ 0.33 $ 0.12
Pro Forma........ $ 0.95 $ 0.14 $ (0.08)
</TABLE>

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants during the year ended December 31, 1997: risk-free
interest rates of 6.85%; expected lives of five years; expected volatility of
49%; and $0 dividends. For 1996 and 1995 the following assumptions were used:
risk-free interest rates of 6.25%; expected lives of five years; expected
volatility of 45%; and $0 dividends.

Stock Option Plans

A summary of the status of the Company's stock option plans at December 31,
1995, 1996 and 1997, and the changes during the years then ended, is presented
in the table and narrative below:

1995 1996 1997
------------------- --------------------- ---------------------
WTD. AVG. WTD. AVG. WTD. AVG.
SHARES EX. PRICE SHARES EX. PRICE SHARES EX. PRICE
-------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of period..................... 809,175 $ 2.74 738,284 $ 2.95 1,450,365 $ 8.87
Granted................................................ 16,487 $15.56 891,900 $13.26 241,800 $21.72
Exercised.............................................. (71,699) $ 2.76 (118,374) $ 2.82 (240,051) $ 6.11
Canceled............................................... (15,679) $ 5.86 (61,445) $13.02 (32,009) $13.89
------- --------- ---------
Outstanding at end of period........................... 738,284 $ 2.95 1,450,365 $ 8.87 1,420,105 $11.41
------- --------- ---------
Exercisable at end of period........................... 657,619 $ 2.61 598,236 $ 2.76 736,347 $ 6.93
Weighted average fair value of options granted......... $ 7.50 $ 5.77 $11.01
</TABLE>

Options outstanding have exercise prices ranging from $1.00 to $30.88 per
share, with weighted average remaining contractual lives of 7.2 and 6.9 years at
December 31, 1996 and 1997, respectively. At December 31, 1997, 332,492 shares
of the Company's common stock were available for future grant under the
Company's stock option plans.

30
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Warrants

At December 31, 1997, there were outstanding warrants to purchase 100,000
shares of the Company's common stock at $13.36 per share. The warrants were
issued in connection with the Telcom Technologies Inc. acquisition discussed in
Note 8 below.

4. LINE OF CREDIT

At December 31, 1997, the Company had a $4.0 million unsecured revolving line
of credit, none of which was used during the years ended December 31, 1996 and
1997. The Company's line of credit expires in May 1999, and contains certain
financial covenants and restrictions as to various matters, including the
Company's ability to pay cash dividends without the bank's prior approval. The
Company is currently in compliance with such financial covenants and
restrictions. Borrowings under the line of credit bear interest at the bank's
prime rate or, at the Company's option, its interbank offering rate plus 1.50%.
At December 31, 1997, the bank's prime rate was 8.5%, and its interbank offering
rate was 5.7%.

5. SHORT-TERM INVESTMENTS

The Company has classified its investments as "available-for-sale" and
recorded these investments at estimated fair value, with unrealized gains and
losses, when material, reported as a component of shareholders' equity.

Interest income is recorded using an effective interest rate, with the
associated premium or discount amortized to interest income over the term of the
investment. The cost of securities sold is based upon the specific
identification method. Available-for-sale securities as of December 31, 1996 and
1997 consisted of municipal notes and bonds whose amortized cost approximates
estimated fair value. The average maturity for these investments is four months.

6. COMMITMENTS

Leases

The Company leases its office space under noncancelable operating leases. Rent
expense under the noncancelable leases amounted to $520,000 in 1995, $654,000 in
1996 and $1,048,000 in 1997. Future minimum lease payments under noncancelable
operating leases are as follows (in thousands):

Retirement Savings Plan

The Company offers a 401(k) profit-sharing plan to substantially all of its
employees. Company contributions are determined annually and are at the
discretion of the Board of Directors. Contributions made to the plan were
$40,000 in 1995, $54,000 in 1996 and $165,000 in 1997.

31
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

License Agreements

In connection with the acquisition of a business in 1989, the Company agreed
to make royalty payments from future sales of the Company's products, up to a
maximum of $2,800,000 in total, payable up to $70,000 per quarter, before
adjustment for increases in the consumer price index. In February 1995, the
Company made a prepayment of $1,808,000 to satisfy this royalty commitment. This
intangible is being amortized over the remainder of the original agreement's
term (67 months). Amounts charged to expense under this agreement were $324,000
in each of 1995, 1996 and 1997.

In addition to the agreement mentioned above, the Company has two nonexclusive
licenses to sell products using patented technology. In exchange for the
licenses, the Company has made quarterly payments equal to 6% of net revenues
from sales of components utilized in the Company's products that use the
licensed technology.

In September 1995, the Company renegotiated its royalty obligation for one of
these licenses by issuing a note in the amount of $1,937,000, payable in 12
equal quarterly installments of $161,417 each, with the first installment paid
upon the signing of the agreement. The Company accrues interest expense at an
imputed rate of 8.75% per annum. The Company recorded an intangible for this
prepayment in the amount of $1,725,000. The intangible is being amortized on a
straight-line basis over the remaining average lives of the related patents
(approximately 12 years).

In July 1996, the Company renegotiated its royalty obligation for the second
license by issuing a note in the amount of $450,000, payable over two quarters,
with the first installment paid upon the signing of the agreement. The Company
accrued interest expense at an imputed rate of 8.5% per annum. This note was
satisfied at December 31, 1996. The Company recorded an intangible for this
prepayment in the amount of $446,000. The intangible is being amortized on a
straight-line basis over the remaining average lives of the related patents
(approximately seven years). Amounts charged to expense for the two nonexclusive
licenses were $533,000 in 1995 and $212,000 in each of 1996 and 1997.

7. SUPPLEMENTAL INFORMATION--VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED BALANCE
BEGINNING COSTS AND TO OTHER AT END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS(1) OF PERIOD
- ------------------------------------------------------ ---------- ---------- -------- ------------- ---------
(IN THOUSANDS)
Allowance for doubtful accounts:
<S> <C> <C> <C> <C> <C>
December 31, 1995................................... $495 77 -- 89 $483
December 31, 1996................................... $483 248 -- 125 $606
December 31, 1997................................... $606 208 97 124 $787
</TABLE>
- -----------------
(1) Amounts include write-offs of accounts receivable deemed uncollectable.

8. BUSINESSES ACQUIRED

On January 3, 1997, the Company acquired selected assets and liabilities of
Telcom Technologies Inc., a developer of NT-based open-architecture automatic
call distribution systems. The purchase price for the acquisition was $3.5
million in cash, plus warrants to purchase 100,000 shares of the Company's
common stock at $13.36 per share, which may be exercised at any time prior to
January 3, 2002. The Company accounted for the business combination as a
purchase and recognized a nonrecurring charge of $3.9 million in the first
quarter of 1997, representing the value of the purchased, in-process research
and development.

32
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

On October 22, 1997, the Company acquired all the outstanding capital stock of
CommercePath, Inc. (CommercePath) from Forest City Trading Group, Inc. for $10.4
million in cash. In connection with the acquisition, the Company also granted
options to purchase 120,000 shares of the Company's common stock, at an exercise
price of $28.09 per share, to two executive officers of CommercePath. The
Company accounted for the business combination as a purchase and recorded a
nonrecurring charge of $7.1 million in the fourth quarter of 1997, representing
the value of the purchased, in-process research and development, and recorded
$1.8 million of goodwill that it will amortize over seven years.

The pro forma unaudited consolidated operating results of the Company for the
years ended December 31, 1996 and 1997, assuming the acquisition of CommercePath
had been made as of January 1, 1996 and 1997, respectively, are summarized
below:

<TABLE>
<CAPTION>
1996 1997
----------------------------- ---------------------------
PRO FORMA PRO FORMA
ACTUAL (UNAUDITED) ACTUAL (UNAUDITED)
------------- -------------- ----------- --------------
<S> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales.............................. $44,127 $50,401 $58,091 $63,468
Net income............................. $ 1,934 $ 1,811 $ 729 $ 226
Diluted earnings per share............. $ 0.33 $ 0.31 $ 0.12 $ 0.04
</TABLE>

These pro forma results have been prepared for comparative purposes only and
include certain adjustments such as additional amortization resulting from
allocating a portion of the purchase price to goodwill. They do not purport to
be indicative of the results of operations which actually would have resulted
had the combination been in effect on January 1, 1996 or January 1, 1997, as the
case may be, or future results of operations of the consolidated entity.

33
<PAGE>

APPLIED VOICE TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. QUARTERLY FINANCIAL DATA AND MARKET INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
---------- -------- --------- -------- ---------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS EXCEPT PER SHARE DATA)
Net sales................................. $ 9,556 $10,680 $11,221 $12,670 $12,062 $13,660 $14,781 $17,588
Cost of sales............................. 3,777 4,105 4,202 4,881 4,590 4,958 5,475 6,043
------- ------- ------- ------- ------- ------- ------- -------
Gross profit.............................. 5,779 6,575 7,019 7,859 7,472 8,702 9,306 11,545
Operating expenses:
Research and development.................. 935 1,001 1,093 1,120 1,498 1,571 1,678 1,972
Selling, general and
administrative........................... 3,308 3,538 3,719 3,944 4,183 4,640 4,599 5,790
Write-off of purchased, in-process
research and development................. 4,140 -- -- -- 3,898 -- -- 7,127
------- ------- ------- ------- ------- ------- ------- -------
Total operating expenses.................. 8,383 4,539 4,812 5,064 9,579 6,211 6,277 14,889
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss)................... (2,604) 2,036 2,207 2,795 (2,107) 2,491 3,029 (3,344)
Other income, net......................... 173 225 252 269 240 278 265 287
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before income tax
expense................................... (2,431) 2,261 2,459 3,064 (1,867) 2,769 3,294 (3,057)
Income tax expense (benefit).............. 608 821 886 1,104 (672) 997 1,185 (1,100)
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss)......................... $(3,039) $ 1,440 $ 1,573 $ 1,960 $(1,195) $ 1,772 $ 2,109 $(1,957)
======= ======= ======= ======= ======= ======= ======= =======
Diluted earnings (loss) per common
share (1)................................. $ (0.57) $ 0.24 $ 0.26 $ 0.33 $ (0.21) $ 0.29 $ 0.33 $ (0.34)
Net income excluding nonrecurring
Items..................................... $ 1,101 $ 1,440 $ 1,573 $ 1,960 $ 1,300 $ 1,772 $ 2,109 $ 2,604
Diluted earnings per common share
excluding nonrecurring items(1)........... $ 0.19 $ 0.24 $ 0.26 $ 0.33 $ 0.21 $ 0.29 $ 0.33 $ 0.40
Weighted average common and
common equivalent shares
outstanding............................... 5,305 5,900 5,943 5,940 5,604 6,127 6,343 5,760
Stock price range (2)
High...................................... 14.75 15.63 14.13 15.19 20.13 19.38 30.13 32.50
Low....................................... 8.25 9.00 9.75 10.25 11.75 11.38 17.38 19.00
</TABLE>
- ------------------
(1) Earnings per common share is computed independently for each of the quarters
presented. Therefore, the sum of the quarterly net income per share amounts
will not necessarily equal the total for the year.
(2) The Company's common stock is traded on the Nasdaq National Market under the
symbol "AVTC." As of December 31, 1997, there were approximately 60
stockholders of record of the Company's common stock. The Company has not
paid any cash dividends on its common stock.

34
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

The Board of Directors and Shareholders
of Applied Voice Technology, Inc.

We have audited the accompanying consolidated balance sheets of Applied Voice
Technology, Inc. (a Washington corporation) and its subsidiaries as of December
31, 1996 and 1997, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the 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 Applied Voice Technology, Inc.
and its subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.

ARTHUR ANDERSEN LLP
Seattle, Washington,
January 23, 1998

35
<PAGE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

Item 10-13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Part III (Item 10-13) is incorporated by reference
to information in the Company's definitive proxy statements which will be filed
pursuant to Regulation 14a within 120 days of December 31, 1997.

36
<PAGE>

PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

A. LIST OF DOCUMENTS FILED AS A PART OF THIS REPORT

1. Index financial statements

. Consolidated Balance Sheets--December 31, 1997 and 1996
. Consolidated Statements of Income--Years ended December 31, 1997, 1996
and 1995
. Consolidated Statements of Shareholders' Equity--Years ended
December 31, 1997, 1996 and 1995
. Consolidated Statements of Cash Flows--Years ended December 31, 1997,
1996 and 1995
. Notes to Consolidated Financial Statements
. Report of Independent Public Accountants

2. Index to Financial Statement Schedules

. See Note 8 of Notes to Consolidated Financial Statements--Valuation and
Qualifying--Accounts

3. Index to Exhibits

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ---------------- -------------------------------------------------------------------------------------------------------
<C> <S>
3.1 Restated Articles of Incorporation of Applied Voice Technology, Inc. (A) (Exhibit 3.1)
3.2 Amended and Restated Bylaws of Applied Voice Technology, Inc. (A)(Exhibit 3.2)
4.1 Form of Warrant, dated January 3, 1997, issued by Applied Voice Technology, Inc. to
shareholders of Telcom Technologies, Inc. (E) (Exhibit 4.1)
+10.1 1994 Nonemployee Directors Stock Option Plan (A) (Exhibit 10.1)
+10.2 Restated 1989 Stock Option Plan (F)
+10.3 1986 Incentive Stock Option Plan (A) (Exhibits 10.3)
+10.4 Management Incentive Compensation Plan (A) (Exhibit 10.4)
+10.5 Employment Agreement dated May 1, 1993 between Applied Voice Technology, Inc. and
Richard J. LaPorte (A) (Exhibit 10.5)
+10.6 Form of Indemnification Agreement between Applied Voice Technology, Inc. and each of its
directors and officers (A) (Exhibit 10.6)
10.7 Loan Agreement and Promissory Note dated May 16, 1997 between U.S. Bank of Washington
and Applied Voice Technology, Inc.
10.8 Lease Agreement dated June 30, 1989 between Riggs National Bank of Washington D.C. and
Applied Voice Technology, Inc. as amended (A) (Exhibit 10.11)
10.9 Second Amendment to Lease Agreement dated February 1, 1995 between Riggs National Bank
of Washington D.C. and Applied Voice Technology, Inc. (D) (Exhibit 10.11)
10.10 Third Amendment to Lease Agreement dated May 28, 1997 between Riggs National Bank of
Washington D.C. and Applied Voice Technology, Inc.
10.11 Lease Agreement dated May 28, 1997 between Riggs National Bank of Washington D.C. and
Applied Voice Technology, Inc.
#10.12 Amended Patent License Agreement dated September 29, 1995 between Syntellect
Technology Corp. and Applied Voice, Technology Inc. (B) (Exhibit 10.1)
10.13 Master Software Manufacturing License Agreemented dated June 11, 1992 between Intelligent
Environments Inc. and Applied Voice Technology, Inc. as amended (A) (Exhibit 10.16)
10.14 Agreement and Plan of Merger among Applied Voice Technology, Inc., Cracchiolo & Feder,
Inc., the shareholders of Cracchiolo & Feder, Inc. and CFI Acquisition Corp., dated as of
January 2, 1996. (C) (Exhibit 10.1)
10.15 Registration Rights Agreement among Applied Voice Technology, Inc., Joseph J. Cracchiolo
and Bradley H. Feder, dated as of January 2, 1996 (C) (Exhibit 10.2)
21.1 Subsidiaries of Applied Voice Technology, Inc.
23.1 Consent of Arthur Andersen.
27.1 Financial Data Schedule for Year End 12/31/1997
27.2 Restated Financial Data Schedule for Year End 12/31/1997
27.3 Restated Financial Data Schedule for Year End 12/31/1996
</TABLE>
- --------------

37
<PAGE>

(A) Previously filed with, and incorporated herein by reference to, designated
exhibits to Registration Statement on Form S-1 of Applied Voice Technology,
Inc. File No. 33-85452.
(B) Previously filed with, and incorporated by reference to, designated exhibit
to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1995.
(C) Previously filed with, and incorporated by reference to, designated exhibit
to the Company's Current Report on Form 8-K dated January 2, 1996.
(D) Previously filed with, and incorporated by reference to, designated exhibit
to the Company's 1995 Annual Report on Form 10-K.
(E) Previously filed with, and incorporated by reference to, designated exhibit
to the Company's Current Report on Form 8-K dated January 3, 1997.
(F) Previously filed with, and incorporated by reference to, appendix A to the
Company's definitive Proxy Statement dated April 16, 1996.
+ Management contract or compensatory plan or arrangement.
# Confidential treatment requested for a portion of this agreement.

B. REPORTS ON FORM 8-K

The Company filed a Current Report on Form 8-K on October 23, 1997 relating to
the Company's acquisition of CommercePath, Inc. (formerly American International
Facsimile Products, Inc.). Historical financial information regarding
CommercePath, Inc. and pro forma financial information relating to such
acquisition was filed by amendments to the October 23, 1997 form 8-K, which were
filed on January 5 and January 6, 1998.

38
<PAGE>

SIGNATURES

Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf the undersigned, thereunto duly authorized, in the City of Kirkland,
State of Washington, on the 23rd day of March, 1998.

APPLIED VOICE TECHNOLOGY, INC.

By: /s/ Richard J. LaPorte
-------------------------------------
Richard J. LaPorte
President and Chief Executive Officer

Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed by the following persons in the capacities indicated below on the
23rd day of March, 1998.

<TABLE>
<CAPTION>
SIGNATURE Title
<S> <C>

/s/ Richard J. LaPorte President, Chief Executive Officer and Director
- -------------------------------------------------------- (Principal Executive Officer)
RICHARD J. LAPORTE

/s/ Roger A. Fukai Executive Vice President of Finance and Administration and Chief
- -------------------------------------------------------- Financial Officer (Principal Financial and Accounting Officer)
ROGER A. FUKAI

/s/ James S. Campbell Director
- --------------------------------------------------------
JAMES S. CAMPBELL

/s/ Robert L. Lovely Director
- --------------------------------------------------------
ROBERT L. LOVELY

/s/ William L. True Director
- --------------------------------------------------------
WILLIAM L. TRUE
</TABLE>

39
<PAGE>

EXHIBIT INDEX

<TABLE>
<C> <S>
3.1 Restated Articles of Incorporation of Applied Voice Technology, Inc. (A) (Exhibit 3.1)
3.2 Amended and Restated Bylaws of Applied Voice Technology, Inc. (A)(Exhibit 3.2)
4.1 Form of Warrant, dated January 3, 1997, issued by Applied Voice Technology, Inc. to
shareholders of Telcom Technologies, Inc. (E) (Exhibit 4.1)
+10.1 1994 Nonemployee Directors Stock Option Plan (A) (Exhibit 10.1)
+10.2 Restated 1989 Stock Option Plan (F)
+10.3 1986 Incentive Stock Option Plan (A) (Exhibits 10.3)
+10.4 Management Incentive Compensation Plan (A) (Exhibit 10.4)
+10.5 Employment Agreement dated May 1, 1993 between Applied Voice Technology, Inc. and
Richard J. LaPorte (A) (Exhibit 10.5)
+10.6 Form of Indemnification Agreement between Applied Voice Technology, Inc. and each of its
directors and officers (A) (Exhibit 10.6)
10.7 Loan Agreement and Promissory Note dated May 16, 1997 between U.S. Bank of Washington
and Applied Voice Technology, Inc.
10.8 Lease Agreement dated June 30, 1989 between Riggs National Bank of Washington D.C. and
Applied Voice Technology, Inc. as amended (A) (Exhibit 10.11)
10.9 Second Amendment to Lease Agreement dated February 1, 1995 between Riggs National Bank
of Washington D.C. and Applied Voice Technology, Inc. (D) (Exhibit 10.11)
10.10 Third Amendment to Lease Agreement dated May 28, 1997 between Riggs National Bank of
Washington D.C. and Applied Voice Technology, Inc.
10.11 Lease Agreement dated May 28, 1997 between Riggs National Bank of Washington D.C. and
Applied Voice Technology, Inc.
#10.12 Amended Patent License Agreement dated September 29, 1995 between Syntellect
Technology Corp. and Applied Voice, Technology Inc. (B) (Exhibit 10.1)
10.13 Master Software Manufacturing License Agreemented dated June 11, 1992 between Intelligent
Environments Inc. and Applied Voice Technology, Inc. as amended (A) (Exhibit 10.16)
10.14 Agreement and Plan of Merger among Applied Voice Technology, Inc., Cracchiolo & Feder,
Inc., the shareholders of Cracchiolo & Feder, Inc. and CFI Acquisition Corp., dated as of
January 2, 1996. (C) (Exhibit 10.1)
10.15 Registration Rights Agreement among Applied Voice Technology, Inc., Joseph J. Cracchiolo
and Bradley H. Feder, dated as of January 2, 1996 (C) (Exhibit 10.2)
21.1 Subsidiaries of Applied Voice Technology, Inc.
23.1 Consent of Arthur Andersen.
27.1 Financial Data Schedule for Year End 12/31/1997
27.2 Restated Financial Data Schedule for Year End 12/31/1997
27.3 Restated Financial Data Schedule for Year End 12/31/1996

</TABLE>

<PAGE>

EXHIBIT 10.7

[LOGO OF U.S.BANK]

BUSINESS LOAN AGREEMENT

<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
PRINCIPAL LOAN DATE MATURITY LOAN NO CALL COLLATERAL ACCOUNT OFFICER INITIALS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$4,000,000.00 05-16-1997 05-15-1999 733-67 00012 001 0340178007 38838
- ------------------------------------------------------------------------------------------------------------------
References in the shaded area are for Lender's use only and do not limit the applicability of
this document to any particular loan or item.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>

BORROWER: APPLIED VOICE TECHNOLOGY,INC. LENDER: U.S. BANK
11410 NORTHEAST 122ND WAY SW CORPORATE BKG.
KIRKLAND, WA 98083 1420 FIFTH AVE.
SEATTLE, WA 98101
================================================================================

THIS BUSINESS LOAN AGREEMENT between APPLIED VOICE TECHNOLOGY, INC. ("Borrower")
and U.S. BANK ("Lender") is made and executed on the following terms and
conditions. Borrower has received prior commercial loans from Lender or has
applied to Lender for a commercial loan or loans and other financial
accommodations, including those which may be described on any exhibit or
schedule attached to this Agreement. All such loans and financial
accommodations, together with all future loans and financial accommodations from
Lender to Borrower, are referred to in this Agreement individually as the "Loan"
and collectively as the "Loans." Borrower understands and agrees that: (a) in
granting, renewing, or extending any Loan, Lender is relying upon Borrower's
representations, warranties, and agreements, as set forth in this Agreement; (b)
the granting, renewing, or extending of any Loan by Lender at all times shall be
subject to Lender's sole judgment and discretion; and (c) all such Loans shall
be and shall remain subject to the following terms and conditions of this
Agreement.

TERM. This Agreement shall be effective as of MAY 16, 1997, and shall continue
thereafter until all indebtedness of Borrower to Lender has been performed in
full and the parties terminate this Agreement in writing.

DEFINITIONS. The following words shall have the following meanings when used in
this Agreement. Terms not otherwise defined in this Agreement shall have the
meanings attributed to such terms in the Uniform Commercial Code. All references
to dollar amounts shall mean amounts in lawful money of the United States of
America.

AGREEMENT. The word "Agreement" means this Business Loan Agreement, as this
Business Loan Agreement may be amended or modified from time to time,
together with all exhibits schedules attached to this Business Loan
Agreement from time to time.

BORROWER. The word "Borrower" means APPLIED VOICE TECHNOLOGY, INC.. The
word "Borrower" also includes, as applicable, all subsidiaries and
affiliates of Borrower as provided below in the paragraph titled
"Subsidiaries and Affiliates."

CERCLA. The word "CERCLA" means the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980, as amended.

CASH FLOW. The words "Cash Flow" mean net income after taxes, and
exclusive of extraordinary gains and income, plus depreciation and
amortization.

COLLATERAL. The word "Collateral" means and includes without limitation all
property and assets granted as collateral security for a Loan, whether real
or personal property, whether granted directly or indirectly, whether
granted now or in the future, and whether granted in the form of a security
interest, mortgage, deed of trust, assignment, pledge, chattel mortgage,
chattel trust, factor's lien, equipment trust, conditional sale, trust
receipt, lien, charge, lien or title retention contract, lease or
consignment intended as a security device, or any other security or lien
interest whatsoever, whether created by law, contract, or otherwise.

DEBT. The word "Debt" means all of Borrower's liabilities excluding
Subordinated Debt.

ERISA. The word "ERISA" means the Employee Retirement Income Security Act
of 1974, as amended.

EVENT OF DEFAULT. The words "Event of Default" means and include without
limitation any of the Events of Default set forth below in the section
titled "EVENTS OF DEFAULT."

GRANTOR. The word "Grantor" means and includes without limitation each and
all of the persons or entities granting a Security Interest in any
Collateral for the Indebtedness, including without limitation all Borrowers
granting such a Security Interest.

GUARANTOR. The word "Guarantor" means and includes without limitation each
and all of the guarantors, sureties, and accommodation parties in
connection with any Indebtedness.

INDEBTEDNESS. The word "Indebtedness" means and includes without
limitation all Loans, together with all other obligations, debts and
liabilities of Borrower to Lender, or any one or more of them, as well as
all claims by Lender against Borrower, or any one or more of them; whether
now or hereafter existing, voluntary or involuntary, due or not due,
absolute or contingent, liquidated or unliquidated; whether Borrower may be
liable individually or jointly with others; whether Borrower may be
obligated as a guarantor, surety, or otherwise; whether recovery upon such
Indebtedness may be or hereafter may become barred by any statute of
limitations; and whether such Indebtedness may be or hereafter may become
otherwise unenforceable.

LENDER. The word "Lender" means U.S. BANK, its successors and assigns.

LIQUID ASSETS. The words "Liquid Assets" mean Borrower's cash on hand plus
Borrower's readily marketable securities.

LOAN. The word "Loan" or "Loans" means and includes without limitation any
and all commercial loans and financial accommodations from Lender to
Borrower, whether now or hereafter existing, and however evidenced,
including without limitation those loans and financial accommodations
described herein or described on any exhibit or schedule attached to this
Agreement from time to time.

NOTE. The word "Note" means and includes without limitation Borrower's
promissory note or notes, if any, evidencing Borrower's Loan obligations in
favor of Lender, as well as any substitute, replacement or refinancing note
or notes therefor.

PERMITTED LIENS. The words "Permitted Liens" mean: (a) liens and security
interests securing Indebtedness owed by Borrower to Lender; (b) liens for
taxes, assessments, or similar charges either not yet due or being
contested in good faith; (c) liens of materialmen, mechanics, warehousemen,
or carriers, or other like liens arising in the ordinary course of business
and securing obligations which are not yet delinquent; (d) purchase money
liens or purchase money security interests upon or in any property acquired
or held by Borrower in the ordinary course of business to secure
indebtedness outstanding on the date of this Agreement or permitted to be
incurred under the paragraph of this Agreement titled "Indebtedness and
Liens"; (e) liens and security interests which, as of the date of this
Agreement, have been disclosed to and approved by the Lender in writing;
and (f) those liens and security interests which in the aggregate
constitute an immaterial and insignificant monetary amount with respect to
the net value of Borrower's assets.

RELATED DOCUMENTS. The words "Related Documents" mean and include without
limitation all promissory notes, credit agreements, loan agreements,
environmental agreements, guaranties, security agreements, mortgages, deeds
of trust, and all other instruments, agreements, and

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05-16-1997 BUSINESS LOAN AGREEMENT PAGE 2
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documents, whether now or hereafter existing, executed in connection with
the Indebtedness.

SECURITY AGREEMENT. The words "Security Agreement" mean and include without
limitation any agreements, promises, covenants, arrangements, understands
or other agreements, whether created by law, contract, or otherwise,
evidencing, governing, representing, or creating a Security Interest.

SECURITY INTEREST. The words "Security Interest" mean and include without
limitation any type of collateral security, whether in the form of a lien,
charge, mortgage, deed of trust, assignment, pledge, chattel mortgage,
chattel trust, factor's lien, equipment trust, conditional sale, trust
receipt, lien or title retention contract, lease or consignment intended as
a security device, or any other security or lien interest whatsoever,
whether created by law, contract, or otherwise.

SARA. The word "SARA" means the Superfund Amendments and Reauthorization
Act of 1986 as now or hereafter amended.

SUBORDINATED DEBT. The words "Subordinated Debt" mean indebtedness and
liabilities of Borrower which have been subordinated by written agreement
to indebtedness owed by Borrower to Lender in form and substance acceptable
to Lender.

TANGIBLE NET WORTH. The words "Tangible Net Worth" mean Borrower's total
assets excluding all intangible assets (i.e., goodwill, trademarks,
patents, copyrights, organizational expenses, and similar intangible items,
but including leaseholds and leasehold improvements) less total Debt.

WORKING CAPITAL. The words "Working Capital" mean Borrower's current
assets, excluding prepaid expenses, less Borrower's current liabilities.

CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make the initial
Loan Advance and each subsequent Loan Advance under this Agreement shall be
subject to the fulfillment to Lender's satisfaction of all of the conditions set
forth in this Agreement and in the Related Documents.

LOAN DOCUMENTS. Borrower shall provide to Lender in form satisfactory to
Lender the following documents for the Loan: (a) the Note, (b) Security
Agreements granting to Lender security interests in the Collateral, (c)
Financing Statements perfecting Lender's Security Interests; (d) evidence
of insurance as required below; and (e) any other documents required under
this Agreement or by Lender or its counsel.

BORROWER'S AUTHORIZATION. Borrower shall have provided in form and
substance satisfactory to Lender properly certified resolutions, duly
authorizing the execution and delivery of this Agreement, the Note and the
Related Documents, and such other authorizations and other documents and
instruments as Lender or its counsel, in their sole discretion, may
require.

PAYMENT OF FEES AND EXPENSES. Borrower shall have paid to Lender all fees,
charges, and other expenses which are then due and payable as specified in
this Agreement or any Related Document.

REPRESENTATIONS AND WARRANTIES. The representations and warranties set
forth in this Agreement, in the Related Documents, and in any document or
certificate delivered to Lender under this Agreement are true and correct.

NO EVENT OF DEFAULT. There shall not exist at the time of any advance a
condition which would constitute an Event of Default under this Agreement.

REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as
of the date of this Agreement, as of the date of each disbursement of Loan
proceeds, as of the date of any renewal, extension or modification of any Loan,
and at all times any Indebtedness exists:

ORGANIZATION. Borrower is a corporation which is duly organized, validly
existing, and in good standing under the laws of the state of Borrower's
incorporation and is validly existing and in good standing in all states in
which Borrower is doing business. Borrower has the full power and authority
to own its properties and to transact the businesses in which it is
presently engaged or presently proposes to engage. Borrower also is duly
qualified as a foreign corporation and is in good standing in all states in
which the failure to so qualify would have a material adverse effect on its
businesses or financial condition.

AUTHORIZATION. The execution, delivery, and performance of this Agreement
and all Related Documents by Borrower, to the extent to be executed,
delivered or performed by Borrower, have been duly authorized by all
necessary action by Borrower; do not require the consent or approval of any
other person, regulatory authority or governmental body; and do not
conflict with, result in a violation of, or constitute a default under (a)
any provision of its articles of incorporation or organization, or bylaws,
or any agreement or other instrument binding upon Borrower or (b) any law,
governmental regulation, court decree, or order applicable to Borrower.

FINANCIAL INFORMATION. Each financial statement of Borrower supplied to
Lender truly and completely disclosed Borrower's financial condition as of
the date of the statement, and there has been no material adverse change in
Borrower's financial condition subsequent to the date of the most recent
financial statement supplied to Lender. Borrower has no material contingent
obligations except as disclosed in such financial statements.

LEGAL EFFECT. This Agreement constitutes, and any instrument or agreement
required hereunder to be given by Borrower when delivered will constitute,
legal, valid and binding obligations of Borrower enforceable against
Borrower in accordance with their respective terms.

PROPERTIES. Except as contemplated by this Agreement or as previously
disclosed in Borrower's financial statements or in writing to Lender and as
accepted by Lender, and except for property tax liens for taxes not
presently due and payable, Borrower owns and has good title to all of
Borrower's properties free and clear of all Security Interests, and has not
executed any security documents or financing statements relating to such
properties. All of Borrower's properties are titled in Borrower's legal
name, and Borrower has not used, or filed a financing statement under, any
other name for at least the last five (5) years.

HAZARDOUS SUBSTANCES. The terms "hazardous waste," "hazardous substance,"
"disposal," "release," and "threatened release," as used in this Agreement,
shall have the same meanings as set forth in the "CERCLA," "SARA," the
Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq.,
the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et
seq., or other applicable state or Federal laws, rules, or regulations
adopted pursuant to any of the foregoing. Except as disclosed to and
acknowledged by Lender in writing, Borrower represents and warrants that:
(a) During the period of Borrower's ownership of the properties, there has
been no use, generation, manufacture, storage, treatment, disposal, release
or threatened release of any hazardous waste or substance by any person on,
under, about or from any of the properties. (b) Borrower has no knowledge
of, or reason to believe that there has been (i) any use, generation,
manufacture, storage, treatment, disposal, release, or threatened release
of any hazardous waste or substance on, under, about or from the properties
by any prior owners or occupants of any of the properties, or (ii) any
actual or threatened litigation or claims of any kind by any person
relating to such matters. (c) Neither Borrower not any tenant, contractor,
agent or other authorized user of any of the properties shall use,
generate, manufacture, store, treat, dispose of, or release any hazardous
waste or substance on, under, about or from any of the properties; and any
such activity shall be conducted in compliance with all applicable federal,
state, and local laws, regulations, and ordinances, including without
limitation those laws, regulations and ordinances described above. Borrower
authorizes Lender and its agents to enter upon the properties to make such
inspections and tests as Lender may deem appropriate to determine
compliance of the properties with this section of the Agreement. Any
inspections or tests made by Lender shall be at Borrower's expense and for
Lender's purposes only and shall not be construed to create any
responsibility or liability on the part of Lender to Borrower or to any
other person. The representations and warranties contained herein are based
on Borrower's due diligence in investigating the properties for hazardous
waste and hazardous substances. Borrower hereby (a) releases and waives any
future claims against Lender for indemnity or contribution in the event
Borrower becomes liable for cleanup or other costs under any such laws, and
(b) agrees to
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05-16-1997 BUSINESS LOAN AGREEMENT PAGE 3
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================================================================================

indemnify and hold harmless Lender against any and all claims, losses,
liabilities, damages, penalties, and expenses which Lender may directly or
indirectly sustain or suffer resulting from a breach of this section of the
Agreement or as a consequence of any use, generation, manufacture, storage,
disposal, release or threatened release occurring prior to Borrower's
ownership or interest in the properties, whether or not the same was or
should have been known to Borrower. The provisions of this section of the
Agreement, including the obligation to indemnify, shall survive the payment
of the Indebtedness and the termination or expiration of this Agreement and
shall not be affected by Lender's acquisition of any interest in any of the
properties, whether by foreclosure or otherwise.

LITIGATION AND CLAIMS. No litigation, claim, investigation, administrative
proceeding or similar action (including those for unpaid taxes) against
Borrower is pending or threatened, and no other event has occurred which
may materially adversely affect Borrower's financial condition or
properties, other than litigation, claims, or other events, if any, that
have been disclosed to and acknowledged by Lender in writing.

TAXES. To the best of Borrower's knowledge, all tax returns and reports of
Borrower that are or were required to be filed, have been filed, and all
taxes, assessments and other governmental charges have been paid in full,
except those presently being or to be contested by Borrower in good faith
in the ordinary course of business and for which adequate reserves have
been provided.

LIEN PROPERTY. Unless otherwise previously disclosed to Lender in writing,
Borrower has not entered into or granted any Security Agreements, or
permitted the filing or attachment of any Security Interests on or
affecting any of the Collateral directly or Indirectly securing repayment
of Borrower's Loan and Note, that would be prior or that may in any way be
superior to Lender's Security Interests and rights in and to such
Collateral.

BINDING EFFECT. This Agreement, the Note, all Security Agreements directly
or indirectly securing repayment of Borrower's Loan and Note and all of the
Related Documents are binding upon Borrower as well as upon Borrower's
successors, representatives and assigns, and are legally enforceable in
accordance with their respective terms.

COMMERCIAL PURPOSES. Borrower intends to use the Loan proceeds solely for
business or commercial related purposes.

EMPLOYEE BENEFIT PLANS. Each employee benefit plan as to which Borrower may
have any liability complies in all material respects with all applicable
requirements of law and regulations, and (i) no Reportable Event nor
Prohibited Transaction (as defined in ERISA) has occurred with respect to
any such plan, (ii) Borrower has not withdrawn from any such plan or
initiated steps to do so, (iii) no steps have been taken to terminate any
such plan, and (iv) there are no unfunded liabilities other than those
previously disclosed to Lender in writing.

LOCATION OF BORROWER'S OFFICES AND RECORDS. Borrower's place of business,
or Borrower's Chief executive office, if Borrower has more than one place
of business, is located at 11410 NORTHEAST 122ND WAY, KIRKLAND, WA 98083.
Unless Borrower has designated otherwise in writing this location is also
the office or offices where Borrower keeps its records concerning the
Collateral.

INFORMATION. All information heretofore or contemporaneously herewith
furnished by Borrower to Lender for the purposes of or in connection with
this Agreement or any transaction contemplated hereby is, and all
information hereafter furnished by or on behalf of Borrower to Lender will
be, true and accurate in every material respect on the date as of which
such information is dated or certified; and none of such information is or
will be incomplete by omitting to state any material fact necessary to make
such information not misleading.

SURVIVAL OF REPRESENTATIONS AND WARRANTIES. Borrower understands and agrees
that Lender, without independent investigation, is relying upon the above
representations and warranties in extending Loan Advances to Borrower.
Borrower further agrees that the foregoing representations and warranties
shall be continuing in nature and shall remain in full force and effect
until such time as Borrower's indebtedness shall be paid in full, or until
this Agreement shall be terminated in the manner provided above, whichever
is the last to occur.

AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, while
this Agreement is in effect, Borrower will:

LITIGATION. Promptly inform Lender in writing of (a) all material adverse
changes in Borrower's financial condition, and (b) all existing and all
threatened litigation, claims, investigations, administrative proceedings
or similar actions affecting Borrower or any Guarantor which could
materially affect the financial condition of Borrower or the financial
condition of any Guarantor.

FINANCIAL RECORDS. Maintain its books and records in accordance with
generally accepted accounting principles, applied on a consistent basis,
and permit Lender to examine and audit Borrower's books and records at all
reasonable times.

FINANCIAL STATEMENTS. Furnish Lender with, as soon as available, but in no
event later than ninety (90) days after the end of each fiscal year,
Borrower's balance sheet and income statement for the year ended, audited
by a certified public accountant satisfactory to Lender, and, as soon as
available, but in no event later than forty five (45) days after the end of
each fiscal quarter, Borrower's balance sheet and profit and loss statement
for the period ended, prepared and certified as correct to the best
knowledge and belief by Borrower's chief financial officer or other officer
or person acceptable to Lender. All financial reports required to be
provided under this Agreement shall be prepared in accordance with
generally accepted accounting principles, applied on a consistent basis,
and certified by Borrower as being true and correct.

ADDITIONAL INFORMATION. Furnish such additional information and statements,
lists of assets and liabilities, agings of receivables and payables,
inventory schedules, budgets, forecasts, tax returns, and other reports to
Borrower's financial condition and business operations as Lender may
request from time to time.

FINANCIAL COVENANTS AND RATIOS. Comply with the following covenants and
ratios:

TANGIBLE NET WORTH. Maintain a minimum Tangible Net Worth of not less
than $25,000,000.00.

NET WORTH RATIO. Maintain a ratio of Total Liabilities to Tangible Net
Worth of less than 0.50 to 1.00.

WORKING CAPITAL. Maintain Working Capital in excess of $10,000,000.00.

CASH FLOW REQUIREMENTS. Maintain Cash Flow at not less than the
following level: A RATIO OF 1.20 TO 1.00, DEFINED AS THE RATIO OF
INCOME PLUS DEPRECIATION AND AMORTIZATION PLUS INTEREST LESS UNFUNDED
CAPITAL EXPENDITURES LESS DIVIDENDS TO CURRENT PORTION OF LONG TERM
DEBT PLUS INTEREST.

The following provisions shall apply for purposes of determining compliance
with the foregoing financial covenants and ratios: BORROWER'S COMPLIANCE
WITH THE FINANCIAL COVENANTS IN THIS AGREEMENT WILL BE TESTED ON A
QUARTERLY BASIS. Except as provided above, all computations made to
determine compliance with the requirements contained in this paragraph
shall be made in accordance with generally accepted accounting principles,
applied on a consistent basis, and certified by Borrower as being true and
correct.

INSURANCE. Maintain fire and other risk insurance, public liability
insurance, and such other insurance as Lender may require with respect to
Borrower's properties and operations, in form, amounts, coverages and with
insurance companies reasonably acceptable to Lender. Borrower, upon request
of Lender, will deliver to Lender from time to time the policies or
certificates of insurance in form satisfactory to Lender, including
stipulations that coverages will not be cancelled or diminished without at
least ten (10) days' prior written notice to Lender. Each insurance policy
also shall include an endorsement providing that coverage in favor of
Lender will not be impaired in any way by any act, omission or default of
Borrower or any other person. In connection with all policies covering
assets in which Lender holds or is offered a security interest for the
Loans, Borrower will provide Lender with such loss payable or other
endorsements as Lender may require.

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05-16-1997 BUSINESS LOAN AGREEMENT PAGE 4
LOAN NO 733-67 (CONTINUED)
================================================================================

INSURANCE REPORTS. Furnish to Lender, upon request of Lender, reports on
each existing insurance policy showing such information as Lender may
reasonably request, including without limitation the following: (a) the
name of the insurer; (b) the risks insured; (c) the amount of the policy;
(d) the properties insured; (e) the then current property values on the
basis of which insurance has been obtained, and the manner of determining
those values; and (f) the expiration date of the policy. In addition, upon
request of Lender (however not more often than annually), Borrower will
have an independent appraiser satisfactory to Lender determine, as
applicable, the actual cash value or replacement cost of any Collateral.
The cost of such appraisal shall be paid by Borrower.

OTHER AGREEMENTS. Comply with all terms and conditions of all other
agreements, whether now or hereafter existing, between Borrower and any
other party and notify Lender immediately in writing of any default in
connection with any other such agreements.

LOAN PROCEEDS. Use all Loan proceeds solely for Borrower's business
operations, unless specifically consented to the contrary by Lender in
writing.

TAXES, CHARGES AND LIENS. Pay and discharge when due all of its
indebtedness and obligations, including without limitation all assessments,
taxes, governmental charges, levies and liens, of every kind and nature,
imposed upon Borrower or its properties, income, or profits, prior to the
date on which penalties would attach, and all lawful claims that, if
unpaid, might become a lien or charge upon any of Borrower's properties,
income, or profits. Provided however, Borrower will not be required to pay
and discharge any such assessment, tax, charge, levy, lien or claim so long
as (a) the legality of the same shall be contested in good faith by
appropriate proceedings, and (b) Borrower shall have established on its
books adequate reserves with respect to such contested assessment, tax,
charge, levy, lien, or claim in accordance with generally accepted
accounting practices. Borrower, upon demand of Lender, will furnish to
Lender evidence of payment of the assessments, taxes, charges, levies,
liens and claims and will authorize the appropriate governmental official
to deliver to Lender at any time a written statement of any assessments,
taxes, charges, levies, liens and claims against Borrower's properties,
income, or profits.

PERFORMANCE. Perform and comply with all terms, conditions, and provisions
set forth in this Agreement and in the Related Documents in a timely
manner, and promptly notify Lender if Borrower learns of the occurrence of
any event which constitutes an Event of Default under this Agreement or
under any of the Related Documents.

OPERATIONS. Maintain executive and management personnel with substantially
the same qualifications and experience as the present executive and
management personnel; provide written notice to Lender of any change in
executive and management personnel; conduct its business affairs in a
reasonable and prudent manner and in compliance with all applicable
federal, state and municipal laws, ordinances, rules and regulations
respecting its properties, charters, businesses and operations, including
without limitation, compliance with the Americans With Disabilities Act and
with all minimum funding standards and other requirements of ERISA and
other laws applicable to Borrower's employee benefit plans.

INSPECTION. Permit employees or agents of Lender at any reasonable time to
inspect any and all Collateral for the Loan or Loans and Borrower's other
properties and to examine or audit Borrower's books, accounts, and records
and to make copies and memoranda of Borrower's books, accounts, and
records. If Borrower now or at any time hereafter maintains any records
(including without limitation computer generated records and computer
software programs for the generation of such records) in the possession of
a third party, Borrower, upon request of Lender, shall notify such party to
permit Lender free access to such records at all reasonable times and to
provide Lender with copies of any records it may request, all at Borrower's
expense.

COMPLIANCE CERTIFICATE. Unless waived in writing by Lender, provide Lender
NOT APPLICABLE and at the time of each disbursement of Loan proceeds with a
certificate executed by Borrower's chief financial officer, or other
officer or person acceptable to Lender, certifying that the representations
and warranties set forth in this Agreement are true and correct as of the
date of the certificate and further certifying that, as of the date of the
certificate, no Event of Default exists under this Agreement.

ENVIRONMENTAL COMPLIANCE AND REPORTS. Borrower shall comply in all respects
with all environmental protection federal, state and local laws, statutes,
regulations and ordinances; not cause or permit to exist, as a result of an
intentional or unintentional action or omission on its part or on the part
of any third party, on property owned and/or occupied by Borrower, any
environmental activity where damages may result to the environment, unless
such environmental activity is pursuant to and in compliance with the
conditions of a permit issued by the appropriate federal, state or local
governmental authorities; shall furnish to Lender promptly and in any event
within thirty (30) days after receipt thereof a copy of any notice,
summons, lien, citation, directive, letter or other communication from any
governmental agency or instrumentality concerning any intentional or
unintentional action or omission on Borrower's part in connection with any
environmental activity whether or not there is damage to the environment
and/or other natural resources.

ADDITIONAL ASSURANCES. Make, execute and deliver to Lender such promissory
notes, mortgages, deeds of trust, security agreements, financing
statements, instruments, documents and other agreements as Lender or its
attorney may reasonably request to evidence and secure the Loans and to
perfect all Security Interests.

RECOVERY OF ADDITIONAL COSTS. If the imposition of or any change in any law,
rule, regulation or guideline, or the interpretation or application of any
thereof by any court or administrative or governmental authority (including any
request or policy not having the force of law) shall impose, modify or make
applicable any taxes (except U.S. federal, state or local income or franchise
taxes imposed on Lender), reserve requirements, capital adequacy requirements or
other obligations which would (a) increase the cost to Lender for extending or
maintaining the credit facilities to which this Agreement relates, (b) reduce
the amounts payable to Lender under this Agreement or the Related Documents, or
(c) reduce the rate of return on Lender's capital as a consequence of Lender's
obligations with respect to the credit facilities to which this Agreement
relates, then Borrower agrees to pay Lender such additional amounts as will
compensate Lender therefor, within five (5) days after Lender's written demand
for such payment, which demand shall be accompanied by an explanation of such
imposition or charge and a calculation in reasonable detail of the additional
amounts payable by Borrower, which explanation and calculations shall be
conclusive in the absence of manifest error.

NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this
Agreement is in effect, Borrower shall not, without the prior written consent of
Lender:

INDEBTEDNESS AND LIENS. (a) Except for trade debt incurred in the normal
course of business and indebtedness to Lender contemplated by this
Agreement, create, incur or assume indebtedness for borrowed money,
including capital leases, (b) except as allowed as a Permitted Lien, sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or
encumber any of Borrower's assets, or (c) sell with recourse any of
Borrower's accounts, except to Lender.

CONTINUITY OF OPERATIONS. (a) Engage in any business activities
subsequently different than those in which Borrower is presently engaged,
(b) cease operations, liquidate, merge, transfer, acquire or consolidate
with any other entity, change ownership, change its name, dissolve or
transfer or sell Collateral out of the ordinary course of business, (c) pay
any dividends on Borrower's stock (other than dividends payable in its
stock), provided, however that notwithstanding the foregoing, but only so
long as no Event of Default has occurred and is continuing or would result
from the payment of dividends, if Borrower is a "Subchapter S Corporation"
(as defined in the Internal Revenue Code of 1986, as amended), Borrower may
pay cash dividends on its stock to its shareholders from time to time in
amounts necessary to enable the shareholders to pay income taxes and make
estimated income tax payments to satisfy their liabilities under federal
and state law which arise solely from their status as Shareholders of a
Subchapter S Corporation because of their ownership of shares of stock of
Borrower, or (d) purchase or retire any of Borrower's outstanding shares or
alter or amend Borrower's capital structure.
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05-16-1997 BUSINESS LOAN AGREEMENT PAGE 5
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================================================================================

LOANS, ACQUISITIONS AND GUARANTIES. (a) Loan, invest in or advance money or
assets, (b) purchase, create or acquire any interest in any other
enterprise or entity, or (c) incur any obligation as surety or guarantor
other than in the ordinary course of business.

CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to
Borrower, whether under this Agreement or under any other agreement, Lender
shall have no obligation to make Loan Advances or to disburse Loan proceeds if:
(a) Borrower or any Guarantor is in default under the terms of this Agreement or
any of the Related Documents or any other agreement that Borrower or any
Guarantor has with Lender; (b) Borrower or any Guarantor becomes insolvent,
files a petition in bankruptcy or similar proceedings, or is adjudged a
bankrupt; (c) there occurs a material adverse change in Borrower's financial
condition, in the financial condition of any Guarantor, or in the value of any
Collateral securing any Loan; (d) any Guarantor seeks, claims or otherwise
attempts to limit, modify or revoke such Guarantor's guaranty of the Loan or any
other loan with Lender; or (e) Lender in good faith deems itself insecure, even
though no Events of Default shall have occurred.

STATUTE OF FRAUDS DISCLOSURE. ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY,
EXTEND CREDIT, OR TO FORBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT
ENFORCEABLE UNDER WASHINGTON LAW.

RIGHT OF SETOFF. Borrower grants to Lender a contractual possessory security
interest in, and hereby assigns, conveys, delivers, pledges, and transfers to
Lender all Borrower's right, title and interest in and to, Borrower's accounts
with Lender (whether checking, savings, or some other account), including
without limitation all accounts held jointly with someone else and all accounts
Borrower may open in the future, excluding however all IRA and Keogh accounts,
and all trust accounts for which the grant of a security interest would be
prohibited by law. Borrower authorizes Lender, to the extent permitted by
applicable law, to charge or setoff all sums owing on the Indebtedness against
any and all such accounts.

EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default
under this Agreement:

DEFAULT ON INDEBTEDNESS. Failure of Borrower to make any payment when due
on the Loans.

OTHER DEFAULTS. Failure of Borrower or any Grantor to comply with or to
perform when due any other term, obligation, covenant or condition
contained in this Agreement or in any of the Related Documents, or failure
of Borrower to comply with or to perform any other term, obligation,
covenant of condition contained in any other agreement between Lender and
Borrower.

DEFAULT IN FAVOR OF THIRD PARTIES. Should Borrower or any Grantor default
under any loan, extension of credit, security agreement, purchase or sales
agreement, or any other agreement, in favor of any other creditor or person
that may materially affect any of Borrower's property or Borrower's or any
Grantor's ability to repay the Loans or perform their respective
obligations under this Agreement or any of the Related Documents.

FALSE STATEMENTS. Any warranty, representation or statement made or
furnished to Lender by or on behalf of Borrower or any Grantor under this
Agreement or the Related Documents is false or misleading in any material
at the time made or furnished, or becomes false or misleading at any time
thereafter.

DEFECTIVE COLLATERALIZATION. This Agreement or any of the Related Documents
ceases to be in full force and effect (including failure of any Security
Agreement to create a valid and perfected Security Interest) at any time
and for any reason.

INSOLVENCY. The dissolution or termination of Borrower's existence as a
going business, the insolvency of Borrower, the appointment of a receiver
for any part of Borrower's property, any assignment for the benefit of
creditors, any type of creditor workout, or the commencement of any
proceeding under any bankruptcy or insolvency laws by or against Borrower.

CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or
forfeiture proceedings, whether by judicial proceeding, self-help,
repossession or any other method, by any creditor of Borrower, any creditor
of any Grantor against any collateral securing the Indebtedness, or by any
governmental agency. This includes a garnishment, attachment, or levy on or
of any of Borrower's deposit accounts with Lender.

EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect
to any Guarantor of any of the Indebtedness or any Guarantor dies or
becomes incompetent, or revokes or disputes the validity of, or liability
under, any Guaranty of the Indebtedness.

CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent (25%)
or more of the common stock of Borrower.

ADVERSE CHANGE. A material adverse change occurs in Borrower's financial
condition, or Lender believes the prospect of payment or performance of the
Indebtedness is impaired.

INSECURITY. Lender, in good faith, deems itself insecure.

EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where
otherwise provided in this Agreement or the Related Documents, all commitments
and obligations of Lender under this Agreement or the Related Documents or any
other agreement immediately will terminate (including any obligation to make
Loan Advances or disbursements), and, at Lender's option, all Indebtedness
immediately will become due and payable, all without notice of any kind to
Borrower, except that in the case of an Event of Default of the type described
in the "Insolvency" subsection above, such acceleration shall be automatic and
not optional. In addition, Lender shall have all the rights and remedies
provided in the Related Documents or available at law, in equity, or otherwise.
Except as may be prohibited by applicable law, all of Lender's rights and
remedies shall be cumulative and may be exercised singularly or concurrently.
Election by Lender to pursue any remedy shall not exclude pursuit of any other
remedy, and an election to make expenditures or to take action to perform an
obligation of Borrower or of any Grantor shall not affect Lender's right to
declare a default and to exercise its rights and remedies.

MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of
this Agreement:

AMENDMENTS. This Agreement, together with any Related Documents,
constitutes the entire understanding and agreement of the parties as to the
matters set forth in this Agreement. No alteration of or amendment to this
Agreement shall be effective unless given in writing and signed by the
party or parties sought to be charged or bound by the alteration or
amendment.

APPLICABLE LAW. THIS AGREEMENT HAS BEEN DELIVERED TO LENDER AND ACCEPTED BY
LENDER IN THE STATE OF WASHINGTON. IF THERE IS A LAWSUIT, BORROWER AGREES
UPON LENDER'S REQUEST TO SUBMIT TO THE JURISDICTION OF THE COURTS OF KING
COUNTY, THE STATE OF WASHINGTON. SUBJECT TO THE PROVISIONS ON ARBITRATION,
THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE
LAWS OF THE STATE OF WASHINGTON.

ARBITRATION. LENDER AND BORROWER AGREE THAT ALL DISPUTES, CLAIMS AND
CONTROVERSIES BETWEEN THEM, WHETHER INDIVIDUAL, JOINT, OR CLASS IN NATURE,
ARISING FROM THIS AGREEMENT OR OTHERWISE, INCLUDING WITHOUT LIMITATION
CONTRACT AND TORT DISPUTES, SHALL BE ARBITRATED PURSUANT TO THE RULES OF
THE AMERICAN ARBITRATION ASSOCIATION, UPON REQUEST OF EITHER PARTY. No act
to take or dispose of any Collateral shall constitute a waiver of this
arbitration agreement or be prohibited by this arbitration agreement. This
includes, without limitation, obtaining injunctive relief or a temporary
restraining order; invoking a power of sale under any deed of trust or
mortgage; obtaining a writ of attachment or imposition of a receiver; or
exercising any rights relating to personal property, including taking or
disposing of such property with or without judicial process pursuant to
Article 9 of the Uniform Commercial Code. Any disputes, claims, or
controversies concerning the lawfulness or reasonableness of any act, or
exercise of any right, concerning any Collateral, including any claim to
rescind, reform, or otherwise modify any agreement relating to the
Collateral, shall also be arbitrated, provided however that no arbitrator
shall have the right or the power to enjoin or restrain any act of any
party. Judgment upon any award rendered by any arbitrator may be entered in
any court having jurisdiction. Nothing in this Agreement shall preclude
<PAGE>

05-16-1997 BUSINESS LOAN AGREEMENT PAGE 6
LOAN NO 733-67 (CONTINUED)
================================================================================

any party from seeking equitable relief from a court of competent
jurisdiction. The statute of limitations, estoppel, waiver, laches, and
similar doctrines which would otherwise be applicable in an action brought
by a party shall be applicable in any arbitration proceeding, and the
commencement of an arbitration proceeding shall be deemed the commencement
of an action for these purposes. The Federal Arbitration Act shall apply to
the construction, interpretation, and enforcement of this arbitration
provision.

CAPTION HEADINGS. Caption headings in this Agreement are for convenience
purposes only and are not to be used to interpret or define the provisions
of this Agreement.

CONSENT TO LOAN PARTICIPATION. Borrower agrees and consents to Lender's
sale or transfer, whether now or later, of one or more participation
interests in the Loans to one or more purchasers, whether related or
unrelated to Lender. Lender may provide, without any limitation whatsoever,
to any one or more purchasers, or potential purchasers, any information or
knowledge Lender may have about Borrower or about any other matter relating
to the Loan, and Borrower hereby waives any rights to privacy it may have
with respect to such matters. Borrower additionally waives any and all
notices of sale of participation interests, as well as all notices of any
repurchase of such participation interests. Borrower also agrees that the
purchasers of any such participation interests will be considered as the
absolute owners of such interests in the Loans and will have all the rights
granted under the participation agreement or agreements governing the sale
of such participation interests. Borrower further waives all rights of
offset or counterclaim that it may have now or later against Lender or
against any purchaser of such a participation interest and unconditionally
agrees that either Lender or such purchaser may enforce Borrower's
obligation under the Loans irrespective of the failure or insolvency of any
holder of any interest in the Loans. Borrower further agrees that the
purchaser of any such participation interests may enforce its interests
irrespective of any personal claims or defenses that Borrower may have
against Lender.

COSTS AND EXPENSES. Borrower agrees to pay upon demand all of Lender's
expenses, including without limitation attorneys' fees, incurred in
connection with the preparation, execution, enforcement, modification and
collection of this Agreement or in connection with the Loans made pursuant
to this Agreement. Lender may pay someone else to help collect the Loans
and to enforce this Agreement, and Borrower will pay that amount. This
includes, subject to any limits under applicable law, Lender's attorneys'
fees and Lender's legal expenses, whether or not there is a lawsuit,
including attorneys' fees for bankruptcy proceedings (including efforts to
modify or vacate any automatic stay or injunction), appeals, and any
anticipated post-judgment collection services. Borrower also will pay any
court costs, in addition to all other sums provided by law.

NOTICES. All notices required to be given under this Agreement shall be
given in writing, may be sent by telefacsimile, and shall be effective when
actually delivered or when deposited with a nationally recognized overnight
courier or deposited in the United States mail, first class, postage
prepaid, addressed to the party to whom the notice is to be given at the
address shown above. Any party may change its address for notices under
this Agreement by giving formal written notice to the other parties,
specifying that the purpose of the notice is to change the party's address.
To the extent permitted by applicable law, if there is more than one
Borrower, notice to any Borrower will constitute notice to all Borrowers.
For notice purposes, Borrower will keep Lender informed at all times of
Borrower's current address(es).

SEVERABILITY. If a court of competent jurisdiction finds any provision of
this Agreement to be invalid or unenforceable as to any person or
circumstance, such finding shall not render that provision invalid or
unenforceable as to any other persons or circumstances. If feasible, any
such offending provision shall be deemed to be modified to be within the
limits of enforceability or validity; however, if the offending provision
cannot be so modified, it shall be stricken and all other provisions of
this Agreement in all other respects shall remain valid and enforceable.

SUBSIDIARIES AND AFFILIATES OF BORROWER. To the extent the context of any
provisions of this Agreement makes it appropriate, including without
limitation any representation, warranty or covenant, the word "Borrower" as
used herein shall include all subsidiaries and affiliates of Borrower.
Notwithstanding the foregoing however, under no circumstances shall this
Agreement be construed to require Lender to make any Loan or other
financial accommodation to any subsidiary or affiliate of Borrower.

SUCCESSORS AND ASSIGNS. All covenants and agreements contained by or on
behalf of Borrower shall bind its successors and assigns and shall inure to
the benefit of Lender, its successors and assigns. Borrower shall not,
however, have the right to assign its rights under this Agreement or any
interest therein, without the prior written consent of Lender.

SURVIVAL. All warranties, representations, and covenants made by Borrower
in this Agreement or in any certificate or other instrument delivered by
Borrower to Lender under this Agreement shall be considered to have been
relied upon by Lender and will survive the making of the Loan and delivery
to Lender of the Related Documents, regardless of any investigation made by
Lender or on Lender's behalf.

WAIVER. Lender shall not be deemed to have waived any rights under this
Agreement unless such waiver is given in writing and signed by Lender. No
delay or omission on the part of Lender in exercising any right shall
operate as a waiver of such right or any other right. A waiver by Lender of
a provision of this Agreement shall not prejudice or constitute a waiver of
Lender's right otherwise to demand strict compliance with that provision or
any other provision of this Agreement. No prior waiver by Lender, nor any
course of dealing between Lender and Borrower, or between Lender and any
Grantor, shall constitute a waiver of any of Lender's rights or of any
obligations of Borrower or of any Grantor as to any future transactions.
Whenever the consent of Lender is required under this Agreement, the
granting of such consent by Lender in any instance shall not constitute
continuing consent in subsequent instances where such consent is required,
and in all cases such consent may be granted or withheld in the sole
discretion of Lender.

BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN
AGREEMENT, AND BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF MAY
16, 1997.

BORROWER:

APPLIED VOICE TECHNOLOGY, INC.

By: /s/ Roger A. Fukai
--------------------------
Roger A. Fukai

Title: EXEC VP AND CFO
-----------------------
<PAGE>

LENDER:

U.S. BANK

By: /s/ Maryann Crissey
--------------------------
Maryann Crissey

Authorized Officer
<PAGE>

ALTERNATIVE RATE OPTIONS
PROMISSORY NOTE
(PRIME RATE, IBOR)

$4,000,000.00
Date: May 16, 1997

APPLIED VOICE TECHNOLOGY, INC. ("Borrower")

U. S. BANK ("Lender")

1. TYPE OF CREDIT. This note is given to evidence Borrower's obligation to
repay all sums which Lender may from time to time advance to
Borrower ("Advances") under a:

[ ] single disbursement loan. Amounts loaned to Borrower hereunder will be
disbursed in a single Advance in the amount shown in Section 2.

[X] revolving line of credit. No Advances shall be made which create a
maximum amount outstanding at any one time which exceeds the maximum
amount shown in Section 2. However, Advances hereunder may be
borrowed, repaid and reborrowed, and the aggregate Advances loaned
hereunder from time to time may exceed such maximum amount.

[ ] non-revolving line of credit. Each Advance made from time to time
hereunder shall reduce the maximum amount available shown in Section
2. Advances loaned hereunder which are repaid may not be reborrowed.

2. PRINCIPAL BALANCE. The unpaid principal balance of all Advances outstanding
under this note ("Principal Balance") at one time shall not exceed
$4,OOO,OOO.OO.

3. PROMISE TO PAY. For value received Borrower promises to pay to Lender or
order at 1420 Fifth Ave., Seattle, WA, the Principal Balance of this note, with
interest thereon at the rate(s) specified in Sections 4 and 11
below.

4. INTEREST RATE. The interest rate on the Principal Balance outstanding may
vary from time to time pursuant to the provisions of this note. Subject to the
provisions of this note, Borrower shall have the option from time to time of
choosing to pay interest at the rate or rates and for the applicable periods of
time based on the rate options provided herein; provided, however, that once
Borrower notifies Lender of the rate option chosen in accordance with the
provisions of this note, such notice shall constitute Borrowers irrevocable
request for an Advance hereunder at the rate option specified in such notice.
The rate options are the Prime Borrowing Rate and the IBOR Borrowing Rate, each
as defined herein.

(a) THE PRIME BORROWING RATE.

(i) The Prime Borrowing Rate is a per annum rate equal to Lender's prime
rate plus 0.00% per annum.

(ii) Whenever Borrower desires to use the Prime Borrowing Rate option,
Borrower shall give Lender notice orally or in writing in accordance with
Section 15 of this note, which notice shall specify the requested disbursement
date and principal amount of the Advance, and that Borrower has chosen the Prime
Borrowing Rate option.

(iii) Prepayments of all or any part of the Principal Balance bearing
interest at the Prime Borrowing Rate may be made at any time without penalty.
Upon prepayment of any such principal amount, Borrower also must pay all accrued
interest thereon to the date of prepayment.

(iv) Subject to Section 11 of this note, interest shall accrue on the
unpaid Principal Balance at the Prime Borrowing Rate unless and except to the
extent that the IBOR Borrowing Rate is in effect.

(b) THE IBOR BORROWING RATE.

(i) The following terms shall have the following meanings:

"Business Day" means any day other than a Saturday, Sunday, or other
day that commercial banks in Portland, Oregon or New York City are authorized or
required by law to close.

"IBOR Amount" means each principal amount for which Borrower chooses
to have the IBOR Borrowing Rate apply for any specified IBOR Interest Period.

"IBOR Interest Period" means as to any IBOR Amount, a period of one,
two. three, or six months commencing on the date the IBOR Borrowing Rate becomes
applicable thereto; provided, however, that: (A) no IBOR Interest Period shall
be selected which would extend beyond (NOT APPLICABLE); (B) no IBOR Interest
Period shall extend beyond the date of any principal payment required under
Section 6 of this note, unless the sum of the principal amounts bearing interest
at the Prime Borrowing Rate, plus IBOR Amounts with IBOR Interest Periods ending
on or before the scheduled date of such principal payment, plus principal
amounts remaining unborrowed under a line of credit, equals or exceeds the
amount of such principal payment; (C) any IBOR Interest Period which would
otherwise expire on a day which is not a Business Day, shall be extended to the
next succeeding Business Day, unless the result of such extension would be to
extend such IBOR Interest Period into another calendar month, in which event the
IBOR Interest Period shall end on the immediately preceding Business Day; and
(D) any IBOR Interest Period that begins on the last Business Day of a calendar
month (or on a day for which there is no numerically corresponding day in the
calendar month at the end of such IBOR Interest Period) shall end on the last
Business Day of a calendar month.

(ii) The IBOR Borrowing Rate is Lender's IBOR Rate plus 1,50% per annum.
Lenders IBOR Rate for any IBOR Interest Period is the rate per annum (computed
on the basis of a 360-day year and the actual number of days elapsed) equal to
the arithmetic average (rounded upward to the nearest 1/16 of 1%) of the rates
per annum determined by Lender as of the times specified in Section 4(b)(iii) on
the date two (2) Business Days prior to the first day of such IBOR Interest
Period as the rates offered to Lender by three Eurodollar money market dealers
in such Eurodollar market as may be selected by Lender for U.S. dollar deposits
to be delivered on the first day of such IBOR Interest Period for the number of
months therein; provided, however, that Lender's IBOR Rate shall be adjusted to
take into account the maximum reserves required to be maintained for
Eurocurrency liabilities by banks during each such IBOR Interest Period as
specified in Regulation D of the Board of Governors of the Federal Reserve
System or any successor regulation.

(iii) Borrower may obtain IBOR Borrowing Rate quotes from Lender between
8:00 a.m. and 12:00 noon (Portland, Oregon time) on any Business Day. Any IBOR
Borrowing Rate quoted (A) before 10:00 a.m. shall be based on Lender's IBOR Rate
determined as of approximately 8:00 a.m. on such day, and Borrower may request
an Advance at such rate only by giving Lender notice in accordance with Section
4(b)(iv) before 10:00 a.m. on such day; and (B) between 10:00 a.m. and 12:00
noon shall be based on Lender's IBOR Rate determined as of approximately 10:00
a.m. on such day, and Borrower may request an Advance at such rate only by
giving Lender notice in accordance with Section 4(b)(iv) not later than 12:00
noon on such day.

(iv) Whenever Borrower desires to use the IBOR Borrowing Rate option,
Borrower shall give Lender irrevocable notice (either in writing or orally and
promptly confirmed in writing) between 8:00 a.m. and 12:00 noon (Portland,
Oregon time) two (2) Business Days in advance of the desired effective date of
such rate. Any oral notice shall be given by, and any written notice or
confirmation of an oral notice shall be signed by, the person(s) authorized in
Section 15 of this note, and shall specify the requested effective date of the
rate, IBOR Interest Period and IBOR Amount, and whether Borrower is requesting
a new Advance a the IBOR Borrowing Rate under a line of credit, conversion of
any portion of the Principal Balance bearing interest at the Prime Borrowing
Rate to an IBOR Amount, or a new IBOR Interest Period for an outstanding IBOR
Amount. Notwithstanding any other term of this note, Borrower may elect the IBOR
Borrowing Rate in the minimum principal amount of $100,000.00 and in integral
multiples of $100,000.00; provided, however, that no more than forty separate
IBOR Interest Periods may be in effect at any one time.

Page 1 of 4

8
<PAGE>

(v) Borrower may not prepay all or any part of any IBOR Amount(s).

(vi) If at any time Lenders IBOR Rate is unascertainable or unavailable to
Lender or if IBOR Rate loans become unlawful, the option to select
the IBOR Borrowing Rate shall terminate immediately. If the IBOR Borrowing Rate
is then in effect, (A) it shall terminate automatically with respect to all
IBOR Amounts (i) on the last day of each then applicable IBOR Interest Period,
if Lender may lawfully continue to maintain such loans, or (ii) immediately if
Lender may not lawfully continue to maintain such loans through such day, and
(B) subject to Section 11, the Prime Borrowing Rate automatically shall
become effective as to such amounts upon such termination.

(vii) If at any time after the date hereof (A) any revision in or adoption
of any applicable law, rule, or regulation or in the interpretation or
administration thereof (i) shall subject Lender or its Eurodollar lending office
to any tax, duty, or other charge, or change the basis of taxation of payments
to Lender with respect to any loans bearing interest based on Lender's IBOR
Rate, or (ii) shall impose or modify any reserve, insurance, special deposit, or
similar requirements against assets of, deposits who or for the account of. or
credit extended by Lender or its Eurodollar lending office, or impose on Lender
or its Eurodollar lending office any other condition affecting any such loans,
and (B) the result of any of the foregoing is (i) to increase the cost to Lender
of making or maintaining any such loans or (ii) to reduce the amount of any sum
receivable under this note by Lender or its Eurodollar lending office, Borrower
shall pay Lender within 15 days after demand by Lender such additional amount as
will compensate Lender for such increased cost or reduction. The determination
hereunder by Lender of such additional amount shall be conclusive in the absence
of manifest error. If Lender demands compensation under this Section 4(b)(vii),
Borrower may upon three (3) Business Days' notice to Lender pay the accrued
interest on all IBOR Amounts, together with any additional amounts payable under
Section 4(b)(viii). Subject to Section 11, upon Borrowers paying such accrued
interest and additional costs, the Prime Borrowing Rate immediately shall be
effective with respect to the unpaid principal balance of such IBOR Amounts

(viii) Upon any termination of any IBOR Borrowing Rate (including but not
limited to conversion to another rate) or payment of all or any portion of any
IBOR Amount on a date other than the last day of the then applicable IBOR
Interest Period, including without limitation (A) acceleration under Section 11
or (B) repayment in response to a notice under Section 4(b)(vii), Borrower shall
pay to Lender on demand such amount as Lender reasonably determines (determined
as though 100% of the applicable IBOR Amount had been funded in the applicable
Eurodollar market) is equivalent to all direct or indirect losses, expenses,
liabilities, or reductions in yield to Lender resulting therefrom, whether
incurred in connection with liquidation or reemployment of funds or otherwise.

(ix) If Borrower chooses the IBOR Borrowing Rate, Borrower shall pay
interest based on such rate, plus any other applicable taxes or charges
hereunder, even though Lender may have obtained the funds loaned to Borrower
from sources other than the applicable Eurodollar market. Lender's determination
of the IBOR Borrowing Rate and any such taxes or charges shall be conclusive in
the absence of manifest error.

(x) Notwithstanding any other term of this note, Borrower may not select
the IBOR Borrowing Rate if an event of default hereunder has occurred and is
continuing.

(xi) Nothing contained in this note, including without limitation the
determination or any IBOR Interest Period or Lenders quotation of any IBOR
Borrowing Rate, shall be construed to prejudice Lenders right, if any. to
decline to make any requested Advance or to require payment on demand.

5. COMPUTATION OF INTEREST. All interest under Section 4 and Section 11 will
be computed at the applicable rate based on a 360-day year and applied to the
actual number of days elapsed.

6. PAYMENT SCHEDULE.

(a) Principal. Principal shall be paid:

[X] on demand.
[ ] on demand, or if no demand, on
[ ] on
[ ] subject to Section 7, in installments of
[ ] each, plus accrued interest
[ ] each including accrued interest
beginning on and on the same day of each thereafter until
when the entire Principal Balance plus interest thereon shall be
due and payable.
[ ]

(b) Interest

(i) Interest on all amounts bearing interest at the Prime Borrowing Rate
shall be paid:

[X] on the 15th day of June, 1997, and on the same day of each month
thereafter prior to maturity and at maturity.
[ ] at maturity.
[ ] at the time each principal installment is due and at maturity.
[ ] _____

(ii) Interest on all IBOR Borrowing Rate Amounts shall be paid:

[ ] on the last day of the applicable IBOR Interest Period, and if
such IBOR Interest Period is longer than three months, on the
last day of each three month period occurring during such IBOR
Interest Period, and at maturity.
[X] on the 15th day of June, 1997, and on the same day of each month
thereafter prior to maturity and at maturity.
[ ] at maturity.
[ ] at the time each principal installment is due and at maturity.
[ ] -----

7. CHANGE IN PAYMENT AMOUNT. If the interest rate on this note is subject to
change in accordance with Section 4, the holder of this note may, from time to
time, in holders sole discretion, increase or decrease the amount of each of the
installments remaining unpaid at the time of each change in rate to an amount
holder in its sole discretion deems necessary to continue amortizing the
principal Balance at the same rate established by the installment amounts
specified in Section 6(a) whether or not a "balloon" payment may also be due
upon maturity of this note. Holder shall notify the undersigned of each such
change in writing. Whether or not the installment amount is increased under this
Section 7, Borrower understands that, as a result of increases in the rate of
interest in accordance with Section 4, the final payment due, whether or not a
"balloon" payment, shall include the entire Principal Balance and interest
thereon then outstanding, and may be substantially more than the installment
specified in Section 6.

8. ALTERNATE PAYMENT DATE. Notwithstanding any other term of this note, if
in any month there is no day on which a scheduled payment would otherwise be due
(e.g. February 31) such payment shall be paid on the last banking day of that
month.

9. PAYMENT BY AUTOMATIC CHARGE.

[ ] Please automatically deduct the amount of all principal and interest
payments from account number N/A. If there are insufficient funds in the
account to pay the automatic deduction in full, Lender may allow the account to
become overdrawn, or Lender may reverse the automatic deduction. Borrower will
pay all the fees on the account which result from the automatic deductions,
including any overdraft/NSF charges. If for any reason Lender does not charge
the account for a payment, or if any automatic payment is reversed, the payment
is still due according to this note. If the account is a Money Market Account,
the number of withdrawals from that account is limited as set out in the
agreement. Lender may cancel the automatic deduction at any time in its
discretion.

Page 2 of 4

9
<PAGE>

Provided, however, if no account number is entered above, Borrower does not want
to make payments by automatic charge.

10. LENDER'S PRIME RATE. Lender's prime rate is the rate of interest which
Lender from time to time establishes as its prime rate and is not, for example,
the lowest rate of interest which Lender collects from any borrower or class of
borrowers. When Lender's prime rate is applicable under Section 4(a) or 11(b),
the interest rate hereunder shall be adjusted without notice effective on the
day Lender's prime rate changes, but in no event shall the rate of interest be
higher than allowed by law.

11. DEFAULT.

(a) Without prejudice to any right of Lender to require payment on demand or to
decline to make any requested Advance, each of the following shall be an event
of default: (i) Borrower fails to make any payment when due. (ii) Borrower fails
to perform or comply with any term, covenant or obligation in this note or any
agreement related to this note, or in any other agreement or loan Borrower has
with Lender. (iii) Borrower defaults under any loan, extension of credit,
security agreement, purchase or sales agreement, or any other agreement, in
favor of any other creditor or person that may materially affect any of
Borrower's property or Borrower's ability to repay this note or perform
Borrower's obligations under this note or any related documents. (iv) Any
representation or statement made or furnished to Lender by Borrower or on
Borrower's behalf is false or misleading in any material respect. (v) Borrower
becomes insolvent, a receiver is appointed for any part of Borrower's property,
Borrower makes an assignment for the benefit of creditors, or any proceeding is
commenced either by Borrower or against Borrower under any bankruptcy or
insolvency laws. (vi) Any creditor tries to take any of Borrower's property on
or in which Lender has a lien or security interest. This includes a garnishment
of any of Borrower's accounts with Lender. (vii) Any of the events described in
this default section occurs with respect to any guarantor of this note or any
guaranty of Borrowers indebtedness to Lender ceases to be, or is asserted not to
be, in full force and effect. (viii) Lender in good faith deems itself insecure.
If this note is payable on demand, the inclusion of specific events of default
shall not prejudice Lender's right to require payment on demand or to decline to
make any requested Advance.

(b) Without prejudice to any right of Lender to require payment on demand, upon
the occurrence of an event of default, Lender may declare the entire unpaid
Principal Balance on this note and all accrued unpaid interest immediately due
and payable, without notice. Upon default, including failure to pay upon final
maturity, Lender, at its option, may also, if permitted under applicable law,
increase the interest rate on this note to a rate equal to the Prime Borrowing
Rate plus 5%. The interest rate will not exceed the maximum rate permitted by
applicable law. In addition, if any payment of principal or interest is 15 or
more days past due, Borrower will be charged a late charge of 5% of the
delinquent payment.

12. EVIDENCE OF PRINCIPAL BALANCE; PAYMENT ON DEMAND. Holder's records shall,
at any time, be conclusive evidence of the unpaid Principal Balance and interest
owing on this note. Notwithstanding any other provisions of this note, in the
event holder makes Advances hereunder which result in an unpaid Principal
Balance on this note which at any time exceeds the maximum amount specified in
Section 2, Borrower agrees that all such Advances, with interest, shall be
payable on demand.

13. LINE OF CREDIT PROVISIONS. If the type of credit indicated in Section 1 is
a revolving line of credit or a non-revolving line of credit, Borrower agrees
that Lender is under no obligation and has not committed to make any Advances
hereunder. Each Advance hereunder shall be made at the sole option of Lender.

14. DEMAND NOTE. If this note is payable on demand, Borrower acknowledges and
agrees that (a) Lender is entitled to demand Borrower's immediate payment in
full of all amounts owing hereunder and (b) neither anything to the contrary
contained herein or in any other loan documents (including but not limited to,
provisions relating to defaults, rights of cure, default rate of interest,
installment payments, late charges, periodic review of Borrower's financial
condition, and covenants) nor any act of Lender pursuant to any such provisions
shall limit or impair Lender's right or ability to require Borrower's payment in
full of all amounts owing hereunder immediately upon Lender's demand.

15. REQUESTS FOR ADVANCES.

(a) Any Advance may be made or interest rate option selected upon the request
of Borrower (if an individual), any of the undersigned (if Borrower consists of
more than one individual), any person or persons authorized in subsection (b) of
this Section 15, and any person or persons otherwise authorized to execute and
deliver promissory notes to Lender on behalf of Borrower.

(b) Borrower hereby authorizes any one of the following individuals to request
Advances and to select interest rate options: Richard J. LaPorte or Roger A.
Fukai, unless Lender is otherwise instructed in writing. All requests must be
made in writing.

(c) All Advances made pursuant to this Section 15 shall be disbursed by deposit
directly to Borrower's account number 0287-022289 at the Bellevue Highlands
branch of Lender, or if requested in writing, by cashier's check made payable
solely to Borrower.

16. PERIODIC REVIEW. Lender will review Borrower's credit accommodations
periodically. At the time of the review, Borrower will furnish Lender with any
additional information regarding Borrowers financial condition and business
operations that Lender requests. This information may include but is not limited
to, financial statements, tax returns, lists of assets and liabilities, agings
of receivables and payable, inventory schedules, budgets and forecasts. If upon
review, Lender, in its sole discretion, determines that there has been a
material adverse change in Borrower's financial condition, Borrower will be in
default. Upon default, Lender shall have all rights specified herein.

17. NOTICES. Any notice hereunder may be given by ordinary mail, postage paid
and addressed to Borrower at the last known address of Borrower as shown on
holder's records. If Borrower consists of more than one person, notification of
any of said persons shall be complete notification of all. Notice may be given
either before or reasonably soon after the effective date of the change.

18. ATTORNEY FEES. Whether or not litigation or arbitration is commenced,
Borrower promises to pay all costs of collecting overdue amounts.
Without limiting the foregoing, in the event that holder consults an attorney
regarding the enforcement of any of its rights under this note or any document
securing the same, or if this note is placed in the hands of an attorney for
collection or if suit or litigation is brought to enforce this note or any
document securing the same, Borrower promises to pay all costs thereof including
such additional sums as the court or arbitrator(s) may adjudge reasonable as
attorney fees, including without limitation, costs and attorney fees incurred in
any appellate court, in any proceeding under the bankruptcy code, or in any
receivership and post-judgment attorney fees incurred in enforcing any judgment.

19. WAIVERS; CONSENT. Each party hereto, whether maker, co-maker, guarantor or
otherwise, waives diligence, demand, presentment for payment, notice of non-
payment, protest and notice of protest and waives all defenses based on
suretyship or impairment of collateral, without notice to Borrower and without
diminishing or affecting Lender's rights or Borrower's obligations hereunder,
Lender may deal in any manner with any person who at any time is liable for, or
provides any real or personal property collateral for, any indebtedness of
Borrower to Lender, including the indebtedness evidenced by this note. Without
limiting the foregoing, Lender may, in its sole discretion: (a) make secured or
unsecured loans to Borrower and agree to any number of waivers, modifications,
extensions and renewals of any length of such loans, including the loan
evidenced by this note; (b) impair, release (with or without substitution of new
collateral), fail to perfect a security interest in, fail to preserve the value
of, fail to dispose of in accordance with applicable law, any collateral
provided by any person; (c) sue, fail to sue, agree not to sue, release, and
settle or compromise with, any person.

20. JOINT AND SEVERAL LIABILITY. All undertakings of the undersigned Borrowers
are joint and several and are binding upon any marital community of which any of
the undersigned are members. Holder's rights and remedies under this note shall
be cumulative.

21. ARBITRATION

(a) Either Lender or Borrower may require that all disputes, claims,
counterclaims and defenses, including those based on or arising from any alleged
tort ("Claims") relating in any way to this note or any transaction of which
this note is a part (the "Loan"), be settled by binding arbitration in
accordance with the Commercial Arbitration Rules of the American Arbitration
Associated and Title 9 of the U.S. Code. All Claims will be subject to the
statutes of limitation applicable if they were litigated. This provision is void
if the Loan, at the time of the proposed submission to arbitration, is secured
by real property located outside of Oregon or Washington, or if the effect of
the arbitration procedure (as opposed to any Claims of Borrower) would be to
materially impair Lender's ability to realize on any collateral securing the
Loan.

Page 3 of 4

10
<PAGE>

(b) If arbitration occurs and each party's Claim is less than $100,000, one
neutral arbitrator will decide all issues; if any party's Claim is $100,000 or
more, three neutral arbitrators will decide all issues. All arbitrators will be
active Washington State Bar members in good standing. All arbitration hearings
will be held in King County, Washington. In addition to all other powers, the
arbitrator(s) shall have the exclusive right to determine all issues of
arbitrability. Judgment on any arbitration award may be entered in any court
with jurisdiction.

(c) If either party institutes any judicial proceeding relating to the Loan,
such action shall not be a waiver of the right to submit any Claim to
arbitration. In addition, each has the right before, during and after any
arbitration to exercise any number of the following remedies, in any order or
concurrently: (i) setoff; (ii) self-help repossession; (iii) judicial or non-
judicial foreclosure against real or personal property collateral; and (iv)
provisional remedies, including injunction, appointment of receiver, attachment,
claim and delivery and replevin.

22. GOVERNING LAW.

This note shall be governed by and construed and enforced in accordance with the
laws of the State of Washington without regard to conflicts of law principles;
provided however, that to the extent that Lender has greater rights or remedies
under Federal law, this provision shall not be deemed to deprive Lender of such
rights and remedies as may be available under Federal law.

23. DISCLOSURE.

ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO FORBEAR
FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW,

EACH OF THE UNDERSIGNED HEREBY ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THIS
DOCUMENT.

APPLIED VOICE TECHNOLOGY, INC.
Borrower Name (Corporation, Partnership of other Entity)

By: /s/ Roger A. Fukai
--------------------------
Title Executive VP and CFO

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

For valuable consideration, Lender agrees to the terms of the arbitration
provision set forth in this note.

Lender Name: U.S. Bank

By:
-------------------------------------
Title:
----------------------------------
Date:
-----------------------------------

<PAGE>

EXHIBIT 10.10

THIRD AMENDMENT TO LEASE

THIS THIRD AMENDMENT TO LEASE is made this 28th day of May, 1997, by and between
Riggs Bank N.A., as Trustee for the Multi-Employer Property Trust, successor in
interest to Riggs National Bank of Washington D.G., (the "Landlord") and Applied
Voice Technology, Inc., a Washington Corporation (the "Tenant").

WHEREAS, Landlord and Tenant entered into a Lease Agreement dated June 30,
1989, as amended on August 16, 1990, and amended by the Second Amendment to
Lease dated September 28, 1994 (collectively referred to as the "Lease"), for
Suites 100/200 in Building A-1, located at 11410 NE 122nd Way, Kirkland,
Washington 98034 (the "Premises"), as more fully described in the Lease; and

WHEREAS, the current term of Lease expires January 31, 1998, and Landlord and
Tenant desire to extend the term of the Lease, and to modify the Lease
accordingly;

NOW, THEREFORE, in consideration of the covenants and agreements contained
herein, the parties hereby mutually agree as follows:

1. The Lease Term is hereby extended for a period of Sixty (60) months
commencing February 1, 1998 and terminating January 31, 2003.

2. Effective February 1, 1998 the Monthly Base Rent as provided for in
Paragraph 2 of the Lease shall be increased to Forty Six Thousand Six Hundred
Twenty Six and no/100 Dollars ($46,626.00). Effective February 1, 2001 the
Monthly Base Rent as provided for in Paragraph 2 of the Lease shall be increased
to Fifty One Thousand Two Hundred Eighty Eight and no/100 Dollars ($51,288.00).

3. Tenant agrees to extend the Lease Term as set forth in Paragraph 1 above
and accept the Premises in "as in" condition except that Landlord agrees to
perform certain tenant improvements outlined in ,Exhibit C-4, attached hereto,
which shall replace and supersede Exhibits C-2 and C-3 of the Lease.

4. Effective February 1, 1998, Addendum to Paragraph 2A of the Lease and the
modification to Addendum to Paragraph 2A set for in Paragraph 6 of the Second
Amendment to Lease shall be deleted and replaced with the following:

Tenant agrees to pay to Landlord Base Rent for the Premises in advance,
without demand, deduction or set off, for the entire extended Lease Term hereof
commencing February 1, 1998 at the Monthly Base Rent set forth in Paragraph 2 of
this Third Amendment to Lease, The first such monthly installment shall be due
and payable on February 1, 1998 and a like monthly installment shall be due and
payable on or before the first day of each calendar month thereafter, except
that the Monthly Base Rent payment for any fractional calendar month at the
commencement or end of the Lease Term shall be prorated on the basis of a 30-day
month.

5. Effective February 1, 1998, Addendum to Paragraph 5E of the original Lease
and the subsequent modification to Addendum to Paragraph 5E set forth in
Paragraph 7 of the Second Amendment to Lease shall be deleted and replaced with
the following:

Landlord shall obtain for the benefit of Tenant all customer and usual
warranties from Landlord's contractors, its subcontractors and suppliers in
connection with the construction of the Landlord's Work paid for by Landlord
which are part of the Landlord Allowance, and specified in Exhibit C-4 attached
<PAGE>

hereto. Landlord shall enforce or shall cause Landlord's contractor to enforce
such warranties at Tenant's request. Any repair covered by such a warranty shall
be excluded, for the warranty period only, from Tenant's maintenance
responsibility pursuant to Paragraph 5 of the Lease.

6. Addendum to Paragraph 7A of the Lease shall be amended and replaced with
the following:

Tenant agrees to pay as an additional charge each month for its
proportionate share of the cost of operation and maintenance of the Common Area
which shall be defined from time to time by Landlord. Common Area costs which
may be incurred by Landlord at its discretion, shall include, but not limited to
those costs incurred for lighting; electricity; gas; water; sewage; trash
removal; exterior painting; exterior window cleaning; sweeping; accounting;
policing; inspecting; sewer lines; building exterior plumbing; downspouts;
gutters; paving; landscape maintenance; plant material replacement and other
like charges; elevator contract maintenance; other miscellaneous elevator costs;
general exterior building repairs other than exterior walls; roof repairs; fire
alarm contract; miscellaneous fire protection costs; maintenance, repairs,
janitorial service and supplies for lobby area and common areas, HVAC supplies,
materials, contract maintenance, water treatment and repairs; maintenance and
repairs of building directory and other common area signage; and Landlord's fee
for supervision and administration of the items set forth in this paragraph,
which shall not exceed the lesser of the then current Landlord's percentage fee
with respect to common area charges at the Kirkland 405 Corporate Center or 10%
plus any CPI adjustment in accordance with the provision of Paragraph 13A. for
any subsequent term (with such fee calculated on costs exclusive of tax),
provided that Common Area costs shall not include the following:

(1) costs (including any costs of compliance), fines or penalties incurred
due to violations by Landlord of any governmental statute, regulation, rule or
authority;

(2) expenses reimbursed from another source including, without limitation,
reimbursement by insurance coverages, or by a governmental entity exercising its
right of domain or their governmental power;

(3) costs incurred to lease out space, including, without limitations,
leasing commissions and advertising and promotional expenditures;

(4) interest on debt or amortization payments on any mortgages or deeds of
trust and interest or penalties resulting from delayed or late payments by
Landlord;

(5) costs of refinancing the Premises or any property of which they are a
part;

(6) janitorial service and supplies for Tenant's Premises, which Premises
includes Tenants restrooms and showers;

(7) Tenant security or alarm contract (except fire alarm).

With respect to all sums payable by Tenant as additional Rent hereunder for the
repair or replacement of the air-conditioning and heating equipment servicing
the Premises which is a capital item, and which would be capitalized under
generally accepted accounting principles consistently applied ("GAAP"). Tenant
shall be required to pay only its prorata share of the cost of the repair and
replacement falling due within the Lease Term or any extension thereof based
upon the amortization of the cost of the capital item over the useful life
<PAGE>

of such repair and replacement, as reasonably determined by Landlord in
accordance with GAAP, The Tenant shall be responsible for all costs of repair
and maintenance which are due to Tenant's negligence.

7. Addendum to Paragraph 8A. Alterations of the Lease shall be amended to add
the following at the end of the first paragraph:

"If Tenant elects to perform any alterations, additions or improvements
(individually and collectively "Tenant Alterations") to the Premises, then the
Tenant Alterations shall be performed by contractors employed by Tenant under
one or more construction contracts, in form and content approved in advance in
writing by Landlord (which approval shall not be unreasonably withheld or
delayed) and may include a requirement that the prime contractor and the
respective subcontractors: (a) be parties to, and bound by, a collective
bargaining agreement with a labor organization affiliated with the Building and
Construction Trades Council of the AFL-CIO and (b) employ only members of such
labor organizations to perform work within their respective jurisdictions."

8. Paragraph 9 of the Second Amendment to Lease shall be deleted and replaced
in its entirety with the following:

For the purpose of the extended Lease Term, Landlord agrees to allow Tenant
to replace or relocate its exterior building mounted sign (east side) at its
sole cost and expense. In addition, Landlord will allow Tenant to add a second
Building mounted sign at the west entrance (next to NE 122nd Way) to the
Building. All sign revisions shall be subject to the approval of Landlord,
Owners Association and City of Kirkland. The Landlord agrees to reasonably
assist Tenant in obtaining Owner Association approval and City of Kirkland sign
variance approval, if required. All costs related to signage modifications shall
be at the Tenant's sole cost and expense. Upon the expiration of the Lease or
earlier termination thereof, Tenant agrees to remove any sign and restore the
sign area to its original condition at the time of installation, normal wear and
tear excepted. Tenant may pay for the cost of sign modifications out of the
Landlord's Allowance.

9. Addendum to Paragraph 13 Insurance Fire and Casualty Damage of the Lease
shall be modified as follows:

In line 3 of paragraph A, after the word "Earthquake", the word "Flood"
shall be inserted.

In Line 1 of paragraph B, after the word "fire", the words "lightning,
earthquake and flood, vandalism and malicious mischief" shall be inserted.

10. Paragraph 24C (Notices) of the Lease shall be modified to read as
follows:

Riggs Bank N.A.
as Trustee of the Multi-Employer Property Trust
c/o Trammell Crow Company
1687 114th Avenue SE
Suite 250
Bellevue, WA 98004

with copy to:

1) Riggs Bank N.A./MEPT
808 17th Street N.W.
P.O. Box 96202
Washington, DC 20090-6202
Attn: Leanne Tobias

2) Marc Winters
<PAGE>

McNaul Ebel Nawrot Helgren & Vance
600 University Street, Suite 2700
Seattle, WA 98101-3143

11. The following Paragraph shall be added as EXPANSION # 1. Effective
November l, 1998, the Premises shall be expanded by approximately 4,591 rentable
square feet (referred to as "Expansion # 1") to a total of approximately 47,630
rentable square feet. The Expansion # 1 space is located on Floor 3 and is
outlined on Exhibit A-1 attached hereto which shall replace and supercede
Exhibit A of the Lease. The Lease Term for Expansion # 1 shall be 51 months and
shall be co-terminus with the original Premises on Floors 1 and 2, Effective
November 1, 1998 through January 31, 2001 the Monthly Base Rent for Expansion #
1 per Paragraph 2 of the Lease shall be $ 5,165 per month. Effective February 1,
2001 through January 31, 2003 the Monthly Base Rent per Paragraph 2 of the
Lease shall be $5,605 per month. The Landlord's Allowance for tenant
improvements is set forth in Exhibit C-4.

12. The following Paragraph shall be added as Expansion # 2. Effective
September 1, 2000 the Premises shall be expanded by approximately 4,044 rentable
square feet (referred to as "Expansion # 2") to a total of approximately 51,674
rentable square feet. The Expansion # 2 space is located on Floor 3 and is
outlined on Exhibit A-1 attached hereto which shall replace and supercede
Exhibit A of the Lease. The Expansion # 2 space includes a portion
(approximately 765 rentable sf) of space leased to GTE Mobilnet. The Lease Term
for Expansion # 2 shall be 29 months and shall be co-terminus with the original
Premises on Floors 1 and 2. Effective September 1, 2000 through January 31, 2001
the Monthly Base Rent per Paragraph 2 of the Lease shall be $ 4,634 per month.
Effective February 1, 2001 through January 31, 2003 the Monthly Base Rent per
Paragraph 2 of the Lease shall be $4,937 per month. The Landlord's Allowance for
tenant improvements is set forth in Exhibit C-4.

13. The following Paragraph shall be added as OPTION TO TERMINATE. So long as
there is no event of default then existing under the Lease beyond any applicable
cure period, and subject to the terms and conditions of this Option to Terminate
paragraph, Tenant shall have a one-time Option to Terminate Expansion # 1 and
/or Expansion # 2 without penalty or fee by providing advance written notice to
the Landlord ("Tenant Notice"). For the purpose of this Option to Terminate
paragraph, the Tenant Notice to Landlord to terminate Expansion # 1 must be
received by Landlord no later than 5 p.m. on May 1, 1998. For the purpose of
this Option to Terminate paragraph, the Tenant Notice to Landlord to terminate
Expansion #2 must be received no later than 5 p. m. on December 1, 1999. Failure
to provide Tenant Notice as required for either Expansion # 1 or Expansion # 2
as provided in this paragraph shall render the Option to Terminate null and
void, and of no further force and effect. This Option to Terminate shall be
personal to Tenant and shall not apply to any assignee or subtenant.

14. The following Paragraph shall be added as Right of First Opportunity. So
long as there is not event of default then existing under the Lease beyond any
applicable cure period, and so long as there has not been more than one event of
default under the Lease in the preceding 12 months, and subject to the terms
and conditions of this Paragraph, Tenant shall have a right of First Opportunity
to lease the following
<PAGE>

spaces; (i) approximately 3,229 square feet as outlined in green on Exhibit A-1
("Right of First Opportunity-Suite 310/312"): (ii) approximately 5,158 rentable
square feet outlined in green on Exhibit A-1 ("Right of First Opportunity-Suite
300") and or (iii) approximately 5,083'rentable square feet outlined in green on
Exhibit A-1 ("Right of First Opportunity-Suite 304"). Hereinafter, the spaces in
i-iii above shall be referred to as "ROFO Space". If any of the ROFO Space is
exercised during any applicable cure period following an event which with the
passage of time or giving of notice, or both, would constitute an event of
default, then such exercise shall be void and of no further force or effect
unless the cure is fully completed within the applicable cure period, but in no
event later than the expiration or earlier termination of the Lease. Upon
written notification to Tenant by Landlord ("Landlord's Notice") that the ROFO
Space has become available, Tenant shall have ten (10) business days to notify
Landlord in writing of Tenant's desire to exercise Tenant's Right of First
Opportunity ("Tenant's Notice") on terms and conditions offered by Landlord
("Landlord's Terms"). If Tenant does not accept the Landlord's Terms, or if
Tenant fails to give Tenant's Notice as required above, then Tenant shall have
no further right, title or interest in the ROFO Space offered to Tenant and the
Right of First Opportunity shall terminate and be of no further force and
effect. If, however, the Tenant exercises the Right of First Opportunity in the
manner prescribed and accepts Landlord's Terms, Tenant shall immediately deliver
to Landlord payment for the first month's Monthly Base Rent for the ROFO Space
(in the same manner as provided for in this Lease), and the lease for the ROFO
Space shall be consummated without delay in accordance with the terms set forth
in Landlord's Notice. This Right to First Opportunity shall be subordinate to
any and all renewal options granted to any tenant that occupies the ROFO Space.

Tenant's Right of First Opportunity shall be conditioned upon the following: (i)
at the time of exercise of the Tenant Notice, and at the time of the
commencement of any such ROFO Space, Tenant shall be in possession of and
occupying the Premises for the conduct of its business therein and the same
shall not be occupied by any assignee, subtenant or licensee. This Right of
First Opportunity is personal to Tenant, and shall not apply to any other
assignee, subtenant, or licensee,

15. The following paragraph shall be added as OPTION TO RENEW. So long as
there is no event of default then existing under the Lease beyond any applicable
cure period and so long as there has not been more than one event of default
under the Lease in the preceding 12 months, and subject to the terms and
conditions of this Paragraph, Tenant shall have one (1) Option to Renew the term
of the Lease for a period of five (5) years ("Option Term"). If the Option to
Renew referenced in the preceding sentence is exercised during any applicable
cure period following an event, which with the passage of time or the giving of
notice, or both, would constitute an event of default, then such exercise shall
be void and of no further force or effect unless the cure is fully completed
within the applicable cure period, but in no event later than the expiration or
earlier termination of the Lease. Except as set forth in this Paragraph, all
terms and conditions shall remain the same during the Option Term except the
Monthly Base Rent at the end of the initial term as defined in Paragraph 2 of
the Lease, shall be adjusted to the then current market Rent for the comparable
Class A office
<PAGE>

buildings in the Kirkland, Redmond, or Bothell/Northcreek area of like quality,
size and amenities. In no event will the Rent for the Option Term be less than
the Rent for the month preceding the expiration of the extended Lease Term. For
purposes of this Paragraph the Option to Renew the term for a period of five (5)
years is referred to as the "Option to Renew."

As a condition to the Tenant's right to exercise the Option to Renew, Tenant
shall give Landlord written notice of its intent to exercise its Option to Renew
at least twelve (12) months but not more than fourteen (14) months prior to the
expiration of the extended Lease Term ("Notice Period"), together with Tenant's
determination ("Tenant's Determination") of the Prevailing Fair Market Base
Rental Rate ("PFMBRR"). If Tenant timely delivers notice of its intent to
exercise its Option to Renew but fails to timely deliver Tenant's Determination,
said attempt to exercise the Option to Renew shall be ineffective. If Landlord
does not agree with Tenant's Determination, Landlord shall provide Tenant with
notice of its determination of the PFMBRR ("Landlord's Determination") within
twenty days of Landlord's receipt of Tenant's Determination. If Landlord fails
to provide Landlord's Determination within such time, the PFMBRR for the Option
Term shall be that set forth in Tenant's Determination.

If Landlord and Tenant each timely submit their respective Determinations as set
forth above, said Determinations are different, and the parties are unable to
agree upon the PFMBRR within sixty days of Tenant's receipt of Landlord's
Determination, the parties shall within fifteen days together appoint a mutually
acceptable arbitrator or, if they are unable to agree upon such an arbitrator,
shall apply to the American Arbitration Association for the designation of an
arbitrator (the "Arbitrator") in the Seattle, Washington metropolitan area to
render a final determination of the PFMBRR. Unless otherwise agreed by the
parties, the Arbitrator shall be a real estate appraiser or consultant who shall
be a M.A.I. member and who shall have at least fifteen years continuous
experience in the business of appraising Class A office buildings in the greater
Seattle area. The Arbitrator shall conduct such hearings and investigations as
the Arbitrator shall deem appropriate and shall, with sixty days after having
been appointed, choose either the Landlord's or Tenant's Determination (the
"Option Term Base Rent"), and that choice by the Arbitrator shall be final and
binding upon the parties. The party whose Determination is not chosen shall pay
all the fees and expenses of the Arbitrator and the American Arbitration
Association, if any. The Arbitrator shall not have the power to add to, modify,
or change any of the provisions of this Lease.

In the event that Landlord's and Tenant's PRMBRRs differ by ten percent or less
(based on the higher number) then the PFMBRR shall not be determined by
arbitration, but shall instead be set by taking the average of the parties'
Determinations.

If for any reason the Option Term Base has not been arrived at prior to the
commencement of the Option
<PAGE>

Term, Tenant shall pay each month as Base Rent the lower of the two
Determinations until the Option Term Base Rent is finalized, at which point
Tenant will immediately pay to Landlord any rent differential.

Any determination of the PFMBRR, whether by Tenant or Landlord, shall include a
statement of the elements of rent included in such determination (whether tenant
improvement allowances, free rent, common area cost allowance, or otherwise)
sufficient to permit a calculation of the effective rent of the Premises.

In addition to the provisions set forth above, the Option to Renew shall be
conditioned upon the following: (i) at the time of Tenant's notice to Landlord
of its intent to exercise the Option to Renew, and continuing thereafter until
the commencement of the Option Term, Tenant shall have been in possession of and
occupying the Premises for the conduct of its business therein and there shall
have been no assignment of this Lease or subletting of all of the Premises; and
(ii) the notice of the intent to exercise shall constitute a representation and
promise by Tenant to Landlord effective as of the date of the notice that Tenant
does not intend to assign the Lease in whole or in part, or sublet all of the
Premises, at any time during any remaining initial Lease Term or the Option
Term, the election to extend the term being for purposes of utilizing the
Premises for Tenant's purposes in the conduct of Tenant's business therein. This
Option to Renew is personal to the Tenant and shall not apply to any subtenant,
assignee or licensee.

16. The following paragraph shall be added as HVAC-Hour of Operation/Usage.
The building standard hours for the HVAC System are 7:00 a.m, to 6:00 p.m.,
Monday through Friday and 8:00 a.m. to 12:00 noon on Saturday. After hours usage
will be billed as additional Rent at $20.00/hour.

17. The following paragraph shall be added as ERISA. Additional Paragraph 30,
ERISA. With the exception of this Lease, neither the Tenant nor any affiliate of
the Tenant is a tenant under a lease or any other tenancy arrangement
represents: (1) with: (a) The Riggs N.A., as Trustee of the Multi-Employer
Property Trust; (b) the Multi-Employer Property Trust; (c) The National Bank of
Washington Multi-Employer Property Trust, the previous name of the Multi-
Employer Property Trust; (d)The Riggs National Bank of Washington , D.C., as
trustee of the Multi-Employer Property Trust; (e) the Alameda Industrial
Properties Joint Venture; (f) Harman International Business Campus Joint
Venture; (g) Beaverton-Redmond Tech Properties; (h) Corporate Drive Corporation
as trustee of the Corporate Drive Nominee Realty Trust; (i) Goldbelt Place Joint
Venture; (j) BOCA 1515, joint venture; (k) Arboretum Lakes-1, L.L.C., a Delaware
limited liability company; (l) Village Green of Rochester Hills Associates
L.L.C.; (m) Pine Street Development, L.L.C.; or (n) MEPT Realty L.L.C., or (2)
involving any property in which the entities named in clauses (1)(a) through (m)
are known by the tenant to have an ownership interest.

18. The following Paragraph shall be added as Exculpatory Provision. Landlord
has executed this Lease by its Trustee signing solely in a representative
capacity. Notwithstanding anything contained in this Lease to the contrary,
Tenant confirms that the covenants of Landlord are made and intended, not as
personal covenants of the trustee, or for the purpose of binding the trustee
personally, but solely in the exercise of the
<PAGE>

representative powers conferred upon the trustee by its principal. Liability
with respect to the entry and performance of this Lease by or on behalf of
Landlord, however it may arise, shall be asserted and enforced only against the
Landlord's estate and interest in the Building and Landlord shall have no
personal liability in the event of any claim against Landlord arising out of or
in connection with this Lease, the relationship of Landlord and Tenant or
Tenant's use of the Premises. Further, in no event whatsoever shall any and all
partners, officers, agents, employees, trustees, investment advisors and
consultants of Landlord have any liability or responsibility whatsoever arising
out of or in connection with this Lease, the relationship of Landlord and Tenant
or Tenant's use of the Premises. Any and all personal liability, if any, beyond
that which may be asserted under this paragraph, is expressly waived and
released by Tenant and all persons claiming by, through or under Tenant.

19. Landlord shall be responsible for the payment of any brokerage fees or
commissions associated with this Lease extension to Brent Jackson at Trammell
Crow N.W. Inc., 1687 114th Avenue S.E., Suite 250, Bellevue, WA 98004 and John
Black at John Black and Associates, 777 108th Ave NE Suite 2130, Bellevue, WA
98004. The commissions to be paid by Landlord to the above referenced parties
are outlined in the letter dated May 28, 1997 to John Black and Associates.

20. No trustee, officer, employee, agent or individual partner of Landlord, or
its constituent entitles, shall be personally liable for any obligation of
Landlord hereunder, and Tenant must look solely to the interest of Landlord, or
its constituent entitles in the subject real estate, for the enforcement of any
claims against Landlord arising hereunder.

21. Tenant and Landlord each warrant that all necessary corporate actions have
been duly taken to permit Tenant and Landlord to enter into this Amendment to
Lease and that each undersigned officer has been duly authorized and instructed
to execute this Amendment to Lease.

22. Except as expressly modified above, all terms and conditions of the Lease
remain in full force and effect and are hereby ratified and confirmed.

LANDLORD: TENANT:
Riggs Bank N.A. Applied Voice Technology Inc., a
as Trustee of the Multi-Employer Washington Corporation
Property Trust

By: By: /s/ Richard J. LaPorte
----------------------------- -----------------------------
Leanne Tobias Richard J. LaPorte

Its: Its: President-CEO
---------------------------- ----------------------------
<PAGE>

DISTRICT OF )
---------------------
) ss.

On this day of , 199 , before me personally appeared
, to me known to be the of The Riggs Bank N.A., as Trustee for
the Multi-Employer Property Trust, the corporation that executed the within and
foregoing instrument as its Trustee, and that he/she as such of the
Trustee, acknowledged said instrument to be the free and voluntary act and deed
of said corporation as Trustee for the uses and purposes therein mentioned, and
on oath stated that was authorized to execute the said instrument and
that the seal affixed is the corporate seal of said corporation.

IN WITNESS WHEREOF I have hereunto set my hand and official seal the day
and year first above written.

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

NOTARY PUBLIC in and for the District of
---------
residing at:
-------------------------------------
My appointment Expires
---------------------------

STATE OF WASHINGTON )
) ss.
COUNTY OF KING )

On this 11th day of June 1997, before me a Notary Public in and for the
State of Washington, personally appeared Richard J. LaPorte to me known to be
the individual described in and who executed the within and foregoing
instrument, and acknowledged that he signed the same as his free and voluntary
act and deed, for the uses and purposes therein mentioned.

WITNESS my hand and official seal hereto affixed the day and year first as
above written.

Kathleen G. Leverette
-----------------------------------------
KATHLEEN G. LEVERETTE Name: Kathleen G. Leverette
NOTARY PUBLIC NOTARY PUBLIC in and for the
STATE OF WASHINGTON State of Washington
My Comm. Exp. Oct. 24, 1998 residing at Kirkland

My appointment expires: 10/24/98

<PAGE>

EXHIBIT A-1

[THIRD FLOOR PLAN GRAPHIC]

THIRD FLOOR PLAN

<PAGE>

EXHIBIT A-1 Continued

[MAPS]

FIRST FLOOR PLAN SECOND FLOOR PLAN

Applied Voice Technology
11410 N.E. 122nd Way
Kirkland, WA
43,049 sf

This plan is conceptual in nature, and while it shows
intended uses, it does not show the exact scope of
construction to take place on any portion of the
property. The buildings, parking and site plan
<PAGE>

EXHIBIT C-4

WORK LETTER AGREEMENT

RIGGS BANK N.A., AS TRUSTEE OF THE
MULTI-EMPLOYER PROPERTY TRUST
AND
APPLIED VOICE TECHNOLOGY, INC.

Basic Information:

Tenant agrees to Lease the Premises in "as-is" condition provided all existing
conditions such as base electrical service and distribution, lighting, HVAC or
heating equipment, plumbing systems and any other existing building systems are
in good working order, all of which shall be reused and modified as part of the
Landlord's Work.

1. At Landlord's cost and expense, Landlord shall, on a schedule mutually
approved by Tenant and Landlord, furnish and install in a good and
workmanlike manner within the Premises those improvements as shown on the
mutually approved space plan outlined on Exhibit C-5 attached hereto. Such
improvements are referred to herein as the "Landlord's Work." The total
cost of the Landlord's Work for space occupied on Floor 1 and 2 shall not
exceed $225,000 ("Landlord's Allowance"). The Landlord's Allowance for
Expansion # 1 space ("Landlord Allowance Expansion # 1") shall not exceed
$46,000. The Landlord's Allowance for Expansion # 2 space ("Landord
Allowance Expansion # 2") shall not exceed $32,352. The Landlord's Work
shall include, but is not limited to the costs associated with space
planning, construction drawing, mechanical or engineering drawings, permit
fees, all tenant improvements, demolition, signage, code upgrades within
the Premises, sales tax, construction management fees (5%) and fire and
life safety system modifications. If the cost of the Landlord's Work
exceeds the Landlord's Allowance, Landlord's Allowance Expansion #1 or
Landlord's Allowance Expansion #2 then Tenant shall pay such amount as
additional Rent within fifteen (15) days of receipt of an invoice from the
Landlord.

2. Tenant and Landlord shall mutually agree upon the general contractor and
all subcontractors (collectively referred to as "Contractors") for the
Landlord's Work and the form of the general construction contract. All
Contractors shall be parties to or bound by collective bargaining agreement
with a labor organization affiliated with the Building and Trades
Department of the AFL-CIO. All change orders shall be approved in writing
by both the Tenant and Landlord.

3. Any work not outlined in Paragraph 1 above or in Exhibit C-5 (including but
not limited to furniture systems, telephone systems and other tenant
equipment or non-standard items) shall be considered the Tenant's
responsibility and Tenant shall, at its sole cost and expense, furnish and
install such improvements (referred to as the "Tenant's Work"). Tenant
shall adopt a schedule of construction for the Tenant's Work in conformance
with the schedule of Landlord's contractors and shall conduct its work in
such a manner as to maintain harmonious labor relations and as not to
interfere unreasonably with or delay the progress of the Landlord's Work.
Landlord shall give access and entry to the Premises to Tenant and its
contractors and subcontractors to enable the Tenant to perform and install
the Tenant's Work. All Tenant's Work shall (a) be performed in a first-
class, workmanlike manner, (b) not affect the structural integrity of the
Building, and (c) be performed and installed in accordance with all
applicable laws, rules, regulations and other requirements of all
governmental authorities having jurisdiction. All contractors,
subcontractors and laborers performing Tenant's work shall (a) be
acceptable to and approved by Landlord, (b) be subject to the
administrative supervision of Landlord's constructions manager, and (c) be
employed by Tenant so as to insure as far as may be possible the progress
of the Tenant's Work without interruption on account of strikes, work
stoppage or similar causes of delay. Without limiting the previous
sentence, all construction contractors performing Tenant's Work and the
respective subcontractors to each and every such construction contractor
(a) shall be parties to or bound by a collective bargaining agreement with
a labor organization affiliated with the Building and Construction Trades
Department of the AFL-CIO, and (b) shall employ only members of such labor
organizations licensed to perform work within their respective
jurisdiction. Tenant agrees to indemnify, defend and hold harmless Landlord
from and against any liability (including personal injury liability), claim
or suit arising out of or relating to any injury, damage, cost or loss
sustained by persons or property as a result of any defect or negligence in
design, materials, installation or workmanship of the Tenant's Work. In the
event any mechanics or other lien is filed against the Premises by any
contractor or subcontractor performing or installing the Tenant's Work,
Tenant shall immediately cause the removal of such lien by either paying
the full amount claimed by the lien claimant or entering into an indemnity
agreement with a title company approved by Landlord and posting a bond in
the amount of at least 150% of the amount claimed by the lien claimant. Any
such bonding arrangement and indemnity agreement shall be subject to the
prior written approval of Landlord.

4. All improvements associated with Landlord's Work shall become and remain
the property of Landlord as an when they are installed or incorporated into
the Premises, and Tenant shall have no claim under any circumstances to any
such improvements or for the value thereof.

10
<PAGE>

5. The Landlord will not permit the Tenant to create another "internal"
stairwell unless Tenant explicitly agrees in advance to restore such area
to its original condition.

6. Trammel Crow Company shall act as the construction manager and shall
receive compensation equal to five percent (5%) of the actual cost of all
tenant improvement work. The construction manager shall competitively bid
all tenant improvement work to at least 3 general contractors.
<PAGE>

EXHIBIT C-5

This exhibit shall be replaced by a final construction drawing mutually
acceptable to both Tenant and Landlord.

<PAGE>
EXHIBIT 10.11

LEASE AGREEMENT

THIS LEASE AGREEMENT, made and entered into by and between Riggs Bank N.A. as
trustee of the Multi-Employer Property Trust, hereinafter referred to as
"Landlord", and Applied Voice Technology Inc., a Washington Corporation,
hereinafter referred to as "Tenant";

WITNESSETH

1. PREMISES AND TERM.

A. In consideration of the obligation of Tenant to pay rent as herein
provided, and in consideration of the other terms, provisions and covenants
hereof, Landlord hereby demises and leases to Tenant, and Tenant hereby
takes and leases from Landlord those certain Premises as outlined in red on
Exhibit "A" attached hereto (hereinafter referred to as the "Premises") and
incorporated herein by reference, together with all rights, privileges,
easements, appurtenances, and amenities belonging to or in any way
appertaining to the Premises and together with the buildings and other
improvements situated or to be situated upon land described in Exhibit "B"
attached hereto.

B. TO HAVE AND TO HOLD the same for a term commencing on the "Commencement
Date", as hereinafter defined, and ending thereafter as specified in the
Basic Lease Information, attached hereto, (the "Lease Term"), provided,
however, that, in the event the "Commencement Date" is a date other than
the first day of a calendar month, said term shall extend for said number
of months in addition to the remainder of the calendar month following the
"Commencement Date".

C. The "Commencement Date" shall be the Scheduled Term Commencement Date
shown in the Basic Lease Information, attached hereto and incorporated
herein by reference, or the date upon which the Premises shall have been
substantially completed in accordance with the plans and specifications
described in Exhibit "C" attached hereto and incorporated herein by
reference, whichever is LATER UNLESS SUCH DELAY IS CAUSED BY A "TENANT
DELAY" AS DEFINED IN ADDENDUM TO PARAGRAPH 1C). If the Premises shall not
have been substantially completed as aforesaid by the Scheduled Term
Commencement Date, Tenant's obligations to pay Rent and its other
obligations for payment under this Lease shall commence on the date the
Premises are substantially completed as aforesaid, and Landlord shall not
be liable to Tenant for any loss or damage resulting from such delay.
Landlord shall notify Tenant in writing as soon as Landlord deems the
Premises to be substantially completed and ready for occupancy. In the
event that the Premises have not in fact been substantially completed as
aforesaid, Tenant shall notify Landlord of its objections. Landlord shall
have a reasonable time after delivery of such notice in which to take such
corrective action as may be necessary, and shall notify Tenant in writing
as soon as it deems such corrective action has been completed so that the
Premises are substantially completed and ready for occupancy. EXCEPT FOR
PUNCH LIST ITEMS IDENTIFIED BY TENANT, WHICH SHALL BE PROMPTLY COMPLETELY
OR REPAIRED BY LANDLORD, the taking of possession by Tenant shall be deemed
conclusively to establish that the Premises have been substantially
completed in accordance with the plans and specifications and that the
Premises are in good and satisfactory condition, as of when possession was
taken. Tenant acknowledges that no representations as to the repair of the
Premises have been made by Landlord, unless such are expressly set forth in
this Lease. After the Commencement Date, Tenant shall, upon demand, execute
and deliver to Landlord a letter of acceptance of delivery of the Premises,
specifying the Commencement Date and the rent commencement date, in
recordable form. In the event of any dispute as to the substantial
completion of work performed or required to be performed by Landlord, the
certificate of Landlord's architect or general contractor shall be
conclusive. (SEE ADDENDUM TO PARAGRAPH 1C.)

2. BASE RENT AND SECURITY DEPOSIT.

A. Tenant agrees to pay to Landlord Base Rent for the Premises, in advance,
without demand, deduction or set off, for the entire Lease Term hereof at
the rate specified in the Basic Lease Information, payable in monthly
installments. One such monthly installment shall be due and payable on or
before the first day of each calendar month BEGINNING WITH the Commencement
Date recited above during the Lease Term, except that the rental payment
for any fractional calendar month at the commencement or end of the Lease
period shall be prorated on the basis of a 30-day month.

1
<PAGE>

3. USE/HAZARDOUS SUBSTANCES.

A. USE. The Premises shall be used only for the purpose of general office,
receiving, storing, shipping, assembly, light manufacturing, and selling
(other than retail) products, materials and merchandise made and/or
distributed by Tenant and for such other lawful purposes as may be
incidental thereto. Outside storage, including without limitation, trucks
and other vehicles, is prohibited without Landlord's prior written consent.
Tenant shall at its own cost and expense obtain any and all licenses and
permits necessary for its use of the Premises. Subject to the provisions of
this Lease dealing with Access Laws, Tenant shall comply with all
governmental laws, ordinances and regulations applicable to the use of the
Premises, and shall promptly comply with all governmental orders and
directives including but not limited to those regarding the correction,
prevention and abatement of nuisances in or upon, or connected with, the
Premises, all at Tenant's sole expense. Tenant shall not permit any
objectionable or unpleasant odors, smoke, dust, gas, noise or vibrations to
emanate from the Premises, nor take any other action which would constitute
a nuisance or would disturb or endanger any other tenants of the building
in which the Premises are situated or unreasonably interfere with their use
of their respective Premises. In addition to any other remedies Landlord
may have for a breach by Tenant of the terms of this Section 3, Landlord
shall have the right to have Tenant evicted from the Premises. Without
Landlord's prior written consent, Tenant shall not receive, store or
otherwise handle any product, material or merchandise which is explosive or
highly inflammable. Tenant will not permit the Premises to be used for any
purpose or in any manner (including without limitation any method or
storage) which would render the insurance thereon void or the insurance
risk more hazardous or cause the State Board of Insurance or other
insurance authority to disallow any sprinkler credits. In the event
Tenant's use of Premises shall result in an increase in insurance premiums,
Tenant shall be solely responsible for said increase.

B. HAZARDOUS SUBSTANCES. (1) Tenant agrees that neither Tenant nor its
employees, agents, licensees or invitees will store, place, generate,
manufacture, refine, handle, or locate on, in or around the Premises any
Hazardous Substances, excepting for the storage, handling and use of
Hazardous Substances of types and in quantities as are reasonably necessary
for the operation of Tenant's business as described in the paragraph of
this Lease setting forth permitted uses; provided that (a) the storage,
handling and use of such permitted Hazardous Substances must at all times
conform to all Governmental Requirements and to all applicable fire, safety
and insurance requirements, (b) the types and quantities of permitted
Hazardous Substances which are stored in the Premises must be reasonable
and appropriate to the nature and size of the Tenant's operation in the
Premises and reasonable and appropriate for first-class industrial office
parks located in the I-405 Corridor market area, (c) no fluid Hazardous
Substances shall be stored in above-ground tanks or drums in the Leased
Premises or in sealed containers larger than (1) gallon, and (d) no
Hazardous Substance shall be spilled or disposed of on, in or around the
Premises or the building of which the Premises is a part (the "Building")
or any area adjacent thereto; provided further that, in no event will
Tenant be permitted to store, handle or use on, in or around the Premises
any Hazardous Substance which will increase the rate of fire or extended
coverage insurance on the Premises or the Building, unless (i) such
Hazardous Substance and the expected rate increase have been specifically
disclosed in writing to Landlord, (ii) Tenant has agreed in writing to pay
any rate increase related to each such Hazardous Substance and (iii)
Landlord has approved in writing each such Hazardous Substances, which
approval shall be subject to Landlord's sole and absolute discretion.
Tenant shall indemnify, defend and hold harmless the Landlord from and
against any and all loss, liability, damage, expense, cost, claim or injury
arising out of any breach of any provision of this paragraph, including,
but not limited to, attorneys' fees, laboratory testing fees, personal
injury claims, clean-up costs, and environmental consultants' fees. Tenant
agrees that Landlord may be irreparably harmed by Tenant's breach of this
paragraph and that a specific performance action may be appropriately
brought by Landlord; provided that, Landlord's election to bring or not
bring any such specific performance action shall in no way limit, waive,
impair or hinder Landlord's other remedies against Tenant.

(2). The term "Governmental Requirements" means any and all statutes,
ordinances, codes, laws, rules, regulations and directives of the United
States, the state in which the Leased Premises is located, any political
subdivision of that state or any board, agency or authority associated with
any such governmental entity, including, but not limited to, the
regulations of the fire department having jurisdiction over the Leased
Premises, excepting only the Americans with Disabilities Act of 1990 as now
or hereafter amended. The term "Hazardous Substance(s)" means asbestos
petroleum or petroleum based chemicals or substances, urea formaldehyde or
any chemical, material, element, compound, solution, mixture, substance or
other matter of any kind whatsoever which is now or hereafter defined,
classified, listed, designated or regulated as hazardous, toxic or
radioactive by any federal, state, or local governmental entity or agency.

4. TAXES AND OTHER CHARGES.

A. Tenant agrees to pay its proportionate share of any and all real and
personal property taxes, regular and special assessments, license fees,
public service impact fees and other charges of any kind and nature
whatsoever, payable by Landlord as a result of any public or quasi-public
authority, or owner's association levy, assessment or imposition against,
or arising out of Landlord's ownership of or interest in, the real estate
described in Exhibit "B" attached hereto, together with the building and
the grounds, parking areas, driveways, roads, and alleys around the
building in which the Premises are located, or any part thereof
(hereinafter collectively referred to as the "Charges"). During each month
of the Lease Term, Tenant shall make a monthly escrow deposit with Landlord
(the "Escrow Payment") equal to 1/12 of its proportionate share of the
Charges which will be due and payable for that particular calendar year.
Any lump sum public service impact fees paid by Landlord shall be amortized
over ten (10) years at interest not to exceed twelve percent (12%) per
annum, and equal installments of such fee, together with interest accrued
thereon, shall be payable monthly as a portion of the Charges. Tenant
authorizes Landlord to use the funds

2
<PAGE>

deposited by Tenant with Landlord under this Paragraph 4 to pay the
Charges. Each Escrow Payment shall be due and payable, as additional rent
at the same time and in the same manner as the payment of monthly rental as
provided herein. The amount of the Initial Monthly Escrow Payment will be
specified in the Basic Lease Information. The initial Escrow Payment is
based upon Tenant's proportionate share of the estimated Charges for the
year in question and the monthly Escrow Payment is subject to increase or
decrease as determined by the Landlord to reflect an accurate escrow of
Tenant's estimated proportionate share of the Charges. The Escrow Payment
account of Tenant shall be reconciled annually, AND TENANT SHALL RECEIVE A
WRITTEN STATEMENT SETTING FORTH THE ACTUAL CHARGES FOR THE PRIOR YEAR AND
TENANT'S ACTUAL PRO RATA SHARE OF SUCH CHARGES AS COMPARED TO TENANT'S
ESCROW PAYMENTS FOR THE PRIOR YEAR. If the Tenant's total Escrow Payments
are less than Tenant's actual pro rata share of the Charges, Tenant shall
pay to Landlord upon demand the difference; if the Tenant's total Escrow
Payments are more than Tenant's actual pro rata share of the Charges,
Landlord shall retain such excess and credit it to Tenant's Escrow Payment
account for the successive year's Charges. Tenant's proportionate share of
the Charges shall be computed by multiplying the Charges by a fraction, the
numerator of which shall be the number of gross leasable square feet of
floor space in the Premises and the denominator of which shall be the total
applicable gross leasable square footage; or such other equitable
apportionment as may be adopted. (SEE ADDITIONAL PARAGRAPH 37)

B. If Tenant should fail to pay any Escrow Payments required to be paid by
Tenant hereunder, in addition to any other remedies provided herein,
Landlord may, if it so elects, pay such Escrow Payments or taxes,
assessments, license fees and other Charges. Any sums so paid by Landlord
shall be deemed to be so much additional rental owing by Tenant to Landlord
and due and payable upon demand as additional rental plus interest at the
rate of eighteen percent (18%) per annum from the date of payment by
Landlord until repaid by Tenant.

C. (1) If at any time during the Lease Term, the present method of
taxation shall be changed so that in lieu of the whole or any part of
any taxes, assessments, fees or charges levied, assessed or imposed on
real estate and the improvements thereon, there shall be levied,
assessed or imposed on Landlord a capital levy or other tax directly
on the rents received therefrom and/or a franchise tax, assessment,
levy or charge measured by or based, in whole or in part, upon such
rents or the present or any future building or buildings, then all
such taxes, assessments, fees or charges, or the part thereof so
measured or based, shall be deemed to be included within the term
"Charges" for the purposes hereof.

(2) Tenant may, alone or along with other tenants of the building
containing the Premises, at its sole cost and expense, in its or their
own name(s) dispute and contest any Charges by appropriate proceedings
diligently conducted in good faith, but only after Tenant and all
other tenants, if any, joining with Tenant in such contest have
deposited with Landlord the amount so contested and unpaid or their
proportionate shares thereof as the case may be, which shall be held
by Landlord without obligation for interest until the termination of
the proceedings, at which time the amount(s) deposited shall be
applied by Landlord toward the payment of the items held valid (plus
any court costs, interest, penalties and other liabilities associated
with the proceeding(s)), and Tenant's share of any excess shall be
returned to Tenant. Tenant further agrees to pay to Landlord upon
demand Tenant's share (as among all Tenants who participated in the
contest) of all court costs, interest, penalties and other liabilities
relating to such proceedings. Tenant hereby indemnifies and agrees to
hold harmless the Landlord from and against any cost, damage or
expense (including attorney's fees) in connection with any such
proceedings.

(3) Any payment to be made pursuant to this Paragraph 4 with respect
to the calendar year in which this Lease commences or terminates shall
bear the same ratio to the payment which would be required to be made
for the full calendar year as that part of such calendar year covered
by the Lease Term bears to a full calendar year.

D. Tenant shall be liable for all taxes levied against personal property
and trade fixtures placed by Tenant in the Premises AND Tenant shall pay to
Landlord upon demand that part of such taxes for which Tenant is primarily
liable hereunder.

5. TENANT'S MAINTENANCE.

A. Tenant shall at its own cost and expense keep and maintain all parts of
the Premises (except those for which Landlord is expressly responsible
under the terms of this Lease) in good condition, promptly making all
necessary repairs and replacements, including but not limited to, windows,
glass (EXCEPT IF REPAIRS TO WINDOWS OR GLASS IS REQUIRED BECAUSE OF
LANDLORD'S FAILURE TO MAINTAIN BUILDING AS SET FORTH IN PARAGRAPH 6 OF THE
LEASE) and plate glass, doors, any special office entry, interior walls and
finish work, floor and floor covering, heating and air-conditioning
systems, truck doors, plumbing work and fixtures, termite and pest
extermination, regular removal of trash and debris, keeping the whole of
the Premises in a clean and sanitary condition. Tenant shall not be
obligated to repair any damage caused by fire, tornado, or other casualty
covered by the insurance to be maintained by Landlord pursuant to
subparagraph 13(A) below, except that Tenant shall be obligated to repair
all wind damage to glass except with respect to tornado or hurricane
damage.

B. Tenant shall not damage any demising wall or disturb the integrity and
support provided by any demising wall and shall, at its sole cost and
expenses, promptly repair any damage or injury to any demising wall caused
by Tenant or

3
<PAGE>

its employees, agents, licensees or invitees.

C. Tenant and its employees, customers and licensees shall have the right
to use the parking areas, if any, as may be designated by Landlord in
writing, subject to such reasonable rules and regulations as Landlord may
from time to time prescribe and subject to rights of ingress and egress of
other tenants. Landlord shall not be responsible for enforcing Tenant's
parking rights against any third parties, HOWEVER, TENANT MAY CONTACT
LANDLORD IF A PROBLEM DEVELOPS, AND LANDLORD AGREES TO USE COMMERCIALLY
REASONABLE EFFORTS TO ASSIST TENANT. If Tenant or any other particular
tenant of the building can be clearly identified as being responsible for
obstructions or stoppage of a common sanitary sewage line, then Tenant, if
Tenant is responsible, or such other responsible Tenant, shall pay the
entire cost thereof, upon demand, as additional rent. (SEE ADDENDUM TO
PARAGRAPH 5C)

D. Tenant shall, at its own cost and expense, enter into a regularly
scheduled preventive maintenance/service contract with a maintenance
contractor for servicing all heating and air-conditioning systems and
equipment within the Premises. (SEE ADDENDUM TO PARAGRAPH 5D)

6. LANDLORD'S REPAIRS. Landlord shall MAINTAIN THE EXTERIOR WALLS, FOUNDATION
AND ROOF IN GOOD CONDITION AND REPAIR, and the cost thereof shall be shared
as provided in Paragraph 7. TENANT SHALL USE COMMERCIALLY REASONABLE
EFFORTS TO NOTIFY THE LANDLORD IF TENANT BELIEVES A REPAIR IS REQUIRED.
Tenant shall repair and pay for any damage to such items to be maintained
by Landlord caused by any act, omission or negligence of Tenant, or
Tenant's employees, agents, licensees or invitees, or caused by Tenant's
default hereunder. The term "walls" as used herein shall not include
windows, glass or plate glass, doors, special store fronts or office
entries. Tenant shall immediately give Landlord written notice of defect or
need for repairs, after which Landlord shall have a reasonable opportunity
and time to repair same or cure such defect. Landlord's liability with
respect to any defects, repairs or maintenance for which Landlord is
responsible under any of the provisions of this Lease shall be limited to
the cost of such repairs or maintenance or the curing of such defect.

7. MONTHLY COMMON-AREA MAINTENANCE CHARGE. Tenant agrees to pay as an
additional charge each month its proportionate share of the cost of
operation and maintenance of the Common Area which shall be defined from
time to time by Landlord. Common Area costs which may be incurred by
Landlord, at its discretion, shall include, but not be limited to costs
incurred for lighting, water, sewage, trash removal, exterior painting,
exterior window cleaning, accounting, policing, sweeping, services
negotiation, customary COMMERCIALLY REASONABLE property management fee not
to exceed 5% of rentals, sewer lines, plumbing, DOCK BUMPERS, DOCK BOARDS,
DOWNSPOUTS, GUTTERS, paving, landscape maintenance, plant material
replacement and other like charges, and for administration of the items set
forth in this paragraph. Landlord shall maintain the Common Areas in
reasonably good condition and repair. The proportionate share to be paid by
Tenant of the cost of operation and maintenance of the Common Area shall be
computed on the ratio that the gross leasable square feet of the Premises
bears to the total applicable gross leasable square footage or such other
equitable apportionment as may be adopted by Landlord. Tenant shall make
monthly or other periodic payments based upon the estimated annual cost of
operation and maintenance of the Common Area, payable in advance but
subject to adjustment after the end of the year on the basis of the actual
cost for such year. Any such periodic charges shall be due and payable upon
delivery of notice thereof. The initial Common-Area Maintenance Charges,
subject to adjustment as provided herein, shall be due and payable, as
additional rent, at the same time and in the same manner as the time and
manner of the payment of monthly rental as provided herein. The amount of
the initial monthly Common-Area Maintenance Charge shall be as specified in
the Basic Lease Information. (SEE ADDENDUM TO PARAGRAPH 7 AND ADDITIONAL
PARAGRAPH 37)

8. ALTERATIONS.

A. Tenant shall not make any alterations, additions or improvements to the
Premises (including but not limited to roof and wall penetrations) without
the prior written consent of Landlord WHICH CONSENT SHALL NOT BE
UNREASONABLY WITHHELD. Tenant may, without the consent of Landlord, but at
its own cost and expense and in a good workmanlike manner erect such
shelves, bins, machinery and trade fixtures as it may deem advisable,
without altering the basic character of the building or improvements and
without overloading or damaging such building or improvements, and in each
case complying with all applicable governmental laws, ordinances,
regulations and other requirements. All alterations, additions,
improvements and partitions erected by Tenant shall be and remain the
property of Tenant during the Term of this Lease and Tenant shall, unless
Landlord otherwise elects as hereinafter provided, to remove all
alterations, additions, improvements and partitions erected by Tenant and
restore the Premises to their original condition by the date of termination
of this Lease or upon earlier vacating of the Premises. All shelves, bins,
machinery and trade fixtures installed by Tenant may be removed by Tenant
prior to the termination of this Lease if Tenant so elects, and shall be
removed by the date of termination of this Lease or upon earlier vacating
of the Premises if required by Landlord; upon any such removal Tenant shall
restore the Premises to their original condition. All such removals and
restoration shall be accomplished in good workmanlike manner so as not to
damage the primary structure or structural qualities of the buildings and
other improvements situated on the Premises. (SEE ADDENDUM TO PARAGRAPH
8A).

B. Notwithstanding anything to the contrary contained herein, Landlord
agrees that the Tenant shall not be responsible for, and Landlord shall
hold Tenant harmless against, any costs of cleanup or removal arising from
or associated with

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any hazardous material existing in, on or throughout the Premises, as of
the date Tenant occupies the Premises pursuant to the terms of this Lease.

9. SIGNS. Tenant shall not install signs upon the Premises without Landlord's
prior written approval, and any such signage shall be subject to EXHIBIT G
ATTACHED HERETO, any applicable governmental laws, ordinances, regulations
and other requirements. Tenant shall remove all such signs by the
termination of this Lease. Such installations and removals shall be made in
such a manner as to avoid injury or defacement of the building and other
improvements, and Tenant shall repair any injury or defacement, including
without limitation discoloration caused by such installation and/or
removal.

10. INSPECTION.

A. EXCEPT IN THE EVENT OF AN EMERGENCY, Landlord and Landlord's agents and
representatives shall have the right to enter and inspect the Premises at
any reasonable time WITH REASONABLE NOTICE during business hours, for the
purpose of ascertaining the condition of the Premises or in order to make
such repairs as may be required or permitted to be made by Landlord under
the terms of this Lease. During the period that is six (6) months prior to
the end of the Term hereof, Landlord and Landlord's agents and
representatives shall have the right to enter the Premises at any
reasonable time WITH REASONABLE NOTICE during business hours for the
purpose of showing the Premises (AND LANDLORD WILL MAKE REASONABLE EFFORTS
TO IDENTIFY THE PROSPECT TO TENANT IN ADVANCE) and shall have the right to
erect on the Premises a suitable sign indicating the Premises are
available.

B. Tenant shall give written notice to Landlord at least thirty (30) days
prior to vacating the Premises and shall arrange to meet with Landlord for
a joint inspection of the Premises prior to vacating. In the event of
Tenant's failure to give such notice or arrange such joint inspections,
Landlord's inspection at or after Tenant's vacating the Premises shall be
conclusively deemed correct for the purposes of determining Tenant's
responsibility for repairs and restoration. It shall be the responsibility
of Tenant, prior to vacating the Premises, to clean and repair the Premises
and restore them to the condition in which they were in upon delivery of
the Premises to Tenant at the Commencement Date, reasonable wear and tear
excepted. Cleaning, repair and restoration shall include, but not be
limited to, removal of all trash, cleaning OF WALLS and PATCHING OF HOLES
OR DAMAGED WALL AREAS AND TOUCH-UP repainting of walls where necessary,
VACUUMING AND SPOT cleaning of carpet and flooring, replacement of ALL NON-
FUNCTIONING light bulbs and tubes, cleaning and wiping down of all
fixtures, maintenance and repair of all heating and air-conditioning
systems, and all similar work, which shall be done at the latest practical
date prior to vacation of the Premises.

11. UTILITIES. Landlord agrees to provide at its cost water, electricity and
gas service connections into the Premises; but Tenant shall pay for all
water, gas, heat, light, power, telephone, sewer, sprinkler charges and
other utilities and services used on or from the Premises, together with
any taxes, penalties, surcharges or the like pertaining thereto and any
maintenance charges for utilities and shall furnish all electric light
bulbs and tubes. If any such services are not separately metered to Tenant,
Tenant shall pay a reasonable proportion as determined by Landlord of all
charges jointly metered with other premises. Landlord shall in no event be
liable for any interruption or failure of utility services on the Premises
UNLESS SUCH INTERRUPTION OR FAILURE IS A RESULT OF THE GROSS NEGLIGENCE OF
LANDLORD, ITS AGENTS, CONTRACTORS OR EMPLOYEES. IN THE EVENT OF ANY
INTERRUPTION OR FAILURE OF UTILITIES AFFECTING THE PREMISES OR BUILDING,
LANDLORD AGREES TO USE GOOD FAITH EFFORTS TO ASSIST IN THE RESTORATION OF
SUCH UTILITIES.

12. ASSIGNMENT AND SUBLETTING.

A. Tenant shall not have the right, voluntarily or involuntarily, to
assign, convey, transfer, mortgage or sublet the whole or any part of the
Premises under this Lease without the prior written consent of Landlord
WHICH CONSENT SHALL NOT BE UNREASONABLY WITHHELD. In the event Tenant
applies to Landlord for consent to assign, convey, transfer or sublet the
Premises, Landlord may condition such consent upon the right to receive
one-half of the profit, if any, which Tenant may realize on account of such
assignment, conveyance, transfer or sublease of the Premises. For purposes
of this paragraph, "profit" shall mean any sum which the assignee,
sublessee or transferee is required to pay, or which is credited to Tenant
as rent in excess of the rents required to be paid by Tenant to Landlord
under this Lease. IN THE EVENT TENANT MAKES A WRITTEN REQUEST TO SUBLEASE
MORE THAN FORTY-NINE PERCENT (49%) OF THE PREMISES, Landlord also reserves
the right to recapture the Premises or applicable portion thereof in lieu
of giving its consent by notice given to Tenant within Twenty (20) days
after receipt of Tenant's written request for assignment or subletting.
Such recapture shall terminate this Lease as to the applicable space
effective on the prospective date of assignment or subletting, which shall
be the last day of a calendar month and not earlier than sixty (60) days
after receipt of Tenant's request hereunder. In the event that Landlord
shall not elect to recapture and shall thereafter give its consent, in
addition to any fees paid to outside parties assisting Tenant in subletting
or assignment, Tenant shall REIMBURSE Landlord FOR THE Landlord's ACTUAL
AND REASONABLE COSTS RELATED TO processing costs incurred in connection
with such consent (SEE ADDENDUM TO PARAGRAPH 12A)

B. Notwithstanding any permitted assignment or subletting, Tenant shall at
all times remain directly, primarily and fully responsible and liable for
the payment of the rent herein specified and for compliance with all of its
other obligations under the terms, provisions and covenants of this Lease.
Upon the occurrence of an "event of default" as hereinafter defined, if the
Premises or any part thereof are then assigned or sublet, Landlord, in
addition to any other remedies herein provided, or provided by law, may at
its option collect directly from such assignee or subtentant all rents
becoming due to Tenant under such assignment, transfer or sublease and
apply such rent against any sums due to Landlord from Tenant hereunder, and
no such collection shall be construed to constitute a novation or a release
of

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<PAGE>

Tenant from the further performance of Tenant's obligations hereunder.

13. INSURANCE, FIRE AND CASUALTY DAMAGE.

A. Landlord agrees to maintain insurance covering the building of which the
Premises are a part in an amount not less then ONE HUNDRED percent (100%)
(or such greater percentage as may be necessary to comply with the
provisions of any co-insurance clauses of the policy) of the "replacement
cost" thereof as such term is defined in the Replacement Cost Endorsement
to be attached thereto, insuring against the perils of Fire, Lightning,
FLOOD, EARTHQUAKE, Extended Coverage, Vandalism and Malicious Mischief,
extended by Special Extended Coverage Endorsement to insure against all
other Risks of Direct Physical Loss, such coverages and endorsements to be
as defined, provided and limited in the standard bureau forms prescribed by
the insurance regulatory authority for the State in which the Premises are
situated for use by insurance companies admitted in such state for the
writing of such insurance on risks located within such state. Subject to
the provisions of subparagraph 13, C, D, E below, such insurance shall be
for the sole benefit of Landlord and under its sole control. In the event
the insurance policy shall contain a deductible, Tenant shall be liable for
and pay ITS PROPORTIONATE SHARE, WHICH SHALL IN NO EVENT EXCEED $10,000.00,
OF any deductible withheld from insurance proceeds or payable under the
terms of the insurance policy in the event of a claim or insured loss
thereunder.

B. Tenant agrees to pay its proportionate share of Landlord's cost of
carrying fire, LIGHTNING, FLOOD, EARTHQUAKE, VANDALISM AND MALICIOUS
MISCHIEF and extended coverage insurance ("Insurance") on the building.
During each month of the term of this Lease, Tenant shall make a monthly
escrow deposit with Landlord equal to one-twelfth of its proportionate
share of the Insurance on the buildings and grounds which will be due and
payable for that particular year. Tenant authorizes Landlord to use the
funds deposited by him with Landlord under this paragraph to pay the cost
of such Insurance. Each Insurance Escrow Payment shall be due and payable,
as additional rent, at the same time and manner of the payment of the
monthly rental as provided herein. The initial share of the estimated
Insurance for the year in question, and the monthly Insurance Escrow
Payment is subject to increase or decrease as determined by Landlord to
reflect an accurate monthly escrow of Tenant's estimated proportionate
share of this Insurance. The Insurance Escrow Payment account of Tenant
shall be reconciled annually. If the Tenant's total Insurance Escrow
Payments are less than Tenant's actual pro rata share of the Insurance,
Tenant shall pay to Landlord upon demand the difference; if the total
Insurance Escrow Payments of Tenant are more than Tenant's actual pro rata
share of the Insurance, Landlord shall promptly refund the balance of such
excess to Tenant after first crediting the excess to the next monthly
payment by Tenant for its proportionate share of Taxes and Insurance.
Tenant's cost of insurance shall be computed by multiplying the cost of
Insurance by a fraction, the numerator of which shall be the number of
gross leasable square feet of floor space in the Premises and the
denominator of which shall be the total applicable gross leasable square
footage. The amount of the initial monthly Insurance Escrow Payment will be
as specified in the Basic Lease Information. (SEE ADDITIONAL PARAGRAPH 37)

C. If the building, in which the Premises are a part, should be damaged or
destroyed by fire, tornado or other casualty, Tenant shall give immediate
written notice thereof to Landlord.

D. If the building, of which the Premises are a part, should be totally
destroyed by fire, tornado or other casualty, or if it should be so damaged
thereby that rebuilding or repairs cannot in Landlord's estimation be
completed within two hundred (200) days after the date upon which Landlord
is notified by Tenant of such damage, this Lease shall terminate and the
rent shall be abated during the unexpired portion of this Lease, effective
upon the date of the occurrence of such damage. Landlord shall give notice
to Tenant in writing of its determination to terminate this Lease within
SEVENTY-FIVE (75) days following the date of the occurrence of such damage.
NOTWITHSTANDING ANYTHING IN THIS LEASE TO THE CONTRARY, IF THE BUILDING OF
WHICH THE PREMISES ARE A PART SHOULD BE TOTALLY DESTROYED DURING THE LAST
TWELVE (12) MONTHS OF THE THEN CURRENT LEASE TERM, EITHER PARTY MAY
TERMINATE THE LEASE BY WRITTEN NOTICE TO THE OTHER WITHIN FIFTEEN (15) DAYS
OF THE OCCURRENCE OF THE DAMAGE.

E. If the building, of which the Premises are a part, should be damaged by
any peril covered by the Insurance to be provided by Landlord under
subparagraph 13(A) above, but only to such extent that rebuilding or
repairs can in Landlord's estimation be completed within two hundred (200)
days after the date upon which Landlord is notified by Tenant of such
damage, this Lease shall not terminate, and Landlord shall at its sole cost
and expense thereupon proceed with reasonable diligence to rebuild and
repair such building to substantially the condition in which it existed
prior to such damage, except that Landlord shall not be required to
rebuild, repair or replace any part of the partition, fixtures, additions
and other improvements which may have been placed in, or about the Premises
by Tenant. If the Premises are untenantable in whole or in part following
such damage, the rent payable hereunder during the period in which they are
untenantable shall be reduced to such extent as may be fair and reasonable
under all of the circumstances AS MUTUALLY DETERMINED BY LANDLORD AND
TENANT. In the event that Landlord shall fail to complete such repairs and
rebuilding within two hundred (200) days after the date upon which Landlord
is notified by Tenant of such damage, Tenant may at its option terminate
this Lease by delivering written notice of termination as Tenant's
exclusive remedy, whereupon all rights and obligations hereunder shall
cease and terminate.

F. Notwithstanding anything herein to the contrary, in the event the holder
of any indebtedness secured by a mortgage or deed of trust covering the
Premises requires that the Insurance proceeds be applied to such
indebtedness, then Landlord shall have the right to terminate this Lease by
delivering written notice of termination to Tenant within fifteen (15) days
after such requirement is made by any such holder, whereupon all rights and
obligations hereunder shall cease and terminate.

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G. Each of Landlord and Tenant hereby releases the other from any loss or
damage to property caused by fire or any other perils insured through or
under them by way of subrogation or otherwise for any loss or damage to
property caused by fire or any other perils insured in policies of
Insurance covering such property, even if such loss or damage shall have
been caused by the fault or negligence of the other party, or anyone for
whom such party may be responsible; provided, however, that this release
shall be applicable and in force and effect only with respect to loss or
damage occurring during such times as the releasor's policies shall contain
a clause or endorsement to the effect that any such release shall not
adversely affect or impair said policies or prejudice the right of the
releasor to recover thereunder and then only to the extent of the Insurance
proceeds payable under such policies. Each of the Landlord and Tenant
agrees that it will request its Insurance carriers to include in its
policies such a clause or endorsement. If extra cost shall be charged
therefor, each party shall advise the other thereof and of the amount of
the extra cost, and the other party, at its election, may pay the same, but
shall not be obligated to do so.

14. LIABILITY. Landlord shall not be liable to Tenant or Tenant's employees,
agents, servants, guests, invitees or visitors, for any injury to person or
damage to property on or about the Premises, resulting from and/or caused
in part or whole by the negligence or misconduct of Tenant, its employees,
agents, servants, guests, invitees or visitors, entering upon the Premises,
or caused by the building and improvements located on the Premises becoming
out of repair, or caused by leakage of gas, oil, water or steam or by
electricity emanating from the Premises, or due to any cause whatsoever,
and Tenant hereby covenants and agrees that it will at all times indemnify
and hold safe and harmless the property, the Landlord (including without
limitation the trustee and beneficiaries if Landlord is a trust),
Landlord's employees, agents, servants, guests, invitees and visitors from
any loss, liability, claims, suits, costs, expenses, including without
limitation attorney's fees and damages, both real and alleged, arising out
of any such damage or injury; except injury to persons or damage to
property TO THE EXTENT CAUSED BY the negligence of Landlord or the failure
of Landlord to repair OR MAINTAIN any part of the Premises which Landlord
is obligated to repair and maintain hereunder within a reasonable time
after the receipt of written notice from Tenant of needed repairs. Tenant's
obligation to indemnify Landlord under this Paragraph 14 includes an
obligation to indemnify for losses resulting from death or injury to
Tenant's employees, and Tenant accordingly hereby waives any and all
immunities it now has or hereafter may have under any Industrial Insurance
Act, or other worker's compensation, disability benefit or other similar
act which would otherwise be applicable in the case of such a claim. Tenant
shall procure and maintain throughout the term of this Lease a policy or
policies of PUBLIC LIABILITY Insurance, at its sole cost and expense,
insuring both Landlord and Tenant against all claims, demands or actions
arising out of or in connection with: (i) the Premises; (ii) the condition
of the Premises; (iii) Tenant's operations in and maintenance and use of
the Premises; and (iv) Tenant's liability assumed under this Lease, the
limits of such policy or policies to be in the amount of not less than
$1,000,000 per occurrence in respect of injury to persons (including death)
and in respect of property damage or destruction, including loss of use
thereof. All such policies shall be procured by Tenant from responsible
Insurance companies REASONABLY satisfactory to Landlord. CERTIFICATES OF
INSURANCE together with receipt evidencing payment of premiums therefor,
shall be delivered to Landlord prior to the Commencement Date of this
Lease. Not less than fifteen (15) days prior to the expiration date of any
such policies, RENEWAL CERTIFICATES (bearing notations evidencing the
payment of renewal premiums) shall be delivered to Landlord. Such
CERTIFICATES shall further provide that not less than thirty (30) days
written notice shall be given to Landlord before such policy may be
canceled or changed to reduce insurance provided thereby.

15. CONDEMNATION.

A. If the whole or any substantial part of the Premises should be taken for
any public or quasi-public use under governmental law, ordinance or
regulation, or by right of eminent domain, or by CONVEYANCE in lieu thereof
and the taking would prevent or, INSURANCE THE REASONABLE JUDGEMENT OF
TENANT AND LANDLORD, materially interfere with the use of the Premises for
the purpose for which they are being used, this Lease shall terminate and
the rent shall be abated during the unexpired portion of this Lease,
effective when the physical taking of said Premises shall occur.

B. If part of the Premises shall be taken for any public or quasi-public
use under any governmental law, ordinance or regulation, or by right of
eminent domain, or by CONVEYANCE in lieu thereof, and this Lease is not
terminated as provided in the subparagraph above, this Lease shall not
terminate but the rent payable hereunder during the unexpired portion of
this Lease shall be reduced to such extent as may be fair and reasonable
under all of the circumstances.

C. In the event of any such taking or CONVEYANCE in lieu thereof, Landlord
shall be entitled to receive the entire award. Tenant shall be entitled to
make a claim in any condemnation proceedings which does not reduce the
amount of Landlord's award, for the value of any furniture, furnishings and
fixtures installed by and at the sole expense of Tenant.

16. HOLDING OVER. Tenant will, at the termination of this Lease by lapse of
time or otherwise, yield up immediate possession to Landlord. If Landlord
agrees in writing that Tenant may hold over after the expiration or
termination of this Lease, unless the parties hereto otherwise agree in
writing on the terms of such holding over, the hold over tenancy shall be
subject to termination by Landlord at any time upon not less THIRTY (30)
days advance written notice, or by Tenant at any time upon not less than
thirty (30) days advance written notice, and all of the other terms and
provisions of this Lease shall be applicable during that period, except
that Tenant shall pay Landlord from time to time upon demand, as rental for
the period of any hold over, an amount equal to ONE HUNDRED TWENTY PERCENT
(120%) OF the Base Rent in effect on the termination date, plus all
additional rental as defined

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<PAGE>

herein, computed on a daily basis for each day of the hold over period. No
holding over by Tenant, whether with or without consent of Landlord, shall
operate to extend this Lease except as otherwise expressly provided. The
preceding provisions of this paragraph 16 shall not be construed as
Landlord's consent for Tenant to hold over.

17. QUIET ENJOYMENT. Landlord covenants that it now has, or will acquire before
Tenant takes possession of the Premises, good fee or leasehold title to the
Premises, free and clear of all liens and encumbrances, excepting only the
lien for current taxes not yet due, such mortgage or mortgages as are
permitted by the terms of this Lease, zoning ordinances and other building
and fire ordinances and governmental regulations relating to the use of
such property, and easements, restrictions and other conditions of record.
In the event this Lease is a sublease, then Tenant agrees to take the
Premises subject to the provisions of the prior leases. Landlord represents
and warrants that it has full right and authority to enter into this Lease
and that Tenant, upon paying the rental herein set forth and performing its
other covenants and agreements herein set forth, shall peaceably and
quietly have, hold and enjoy the Premises for the term hereof without
hindrance or molestation from Landlord, subject to the terms and provisions
of this Lease.

18. EVENTS OF DEFAULT. The following events shall be deemed to be events of
default by Tenant under this Lease:

A. Tenant shall fail to pay any installment of the rent herein reserved
when due, or any payment with respect to taxes hereunder when due, or any
other payment or reimbursement to Landlord required herein when due, and
such failure shall continue for a period of TEN (10) days from the date
such payment was due.

B. Tenant shall become insolvent, or shall make a transfer in fraud of
creditors, or shall make an assignment for the benefit of creditors.

C. Tenant shall file a petition under any section or chapter of the
National Bankruptcy Act, as amended, or under any similar law or statute of
the United States or an State thereof; or Tenant shall be adjudged bankrupt
or insolvent in proceedings filed against Tenant thereunder.

D. A receiver or trustee shall be appointed for all or substantially all of
the assets of Tenant.

E. Tenant shall desert or vacate any substantial portion of the Premises
UNLESS TENANT HAS RECONFIRMED IN WRITING ITS OBLIGATIONS UNDER THE LEASE
AND IS CURRENT WITH RESPECT TO THE PAYMENT OF ALL MONTHLY BASE RENT AND
ADDITIONAL RENT, AND IS OTHERWISE NOT INSURANCE DEFAULT OF THE LEASE.

F. Tenant shall fail to comply with any term, provision or covenant of this
Lease (other than the foregoing in this Paragraph 18), and shall not cure
such failure within twenty (20) days after written notice thereof to Tenant
(OR SUCH LONGER PERIOD AS MAY BE REASONABLY NECESSARY UNDER THE
CIRCUMSTANCES PROVIDED TENANT HAS COMMENCED TO CURE WITHIN SUCH TWENTY (20)
DAYS AND THEREAFTER DILIGENTLY AND IN GOOD FAITH PURSUE SUCH CURE.)
NOTWITHSTANDING THE PRECEEDING SENTENCE, IN THE EVENT THAT LANDLORD
REASONABLY DETERMINES THAT COMPLETION OF THE CURE BECOMES IMPOSSIBLE, OR
CANNOT BE COMPLETED PROIR TO THE LEASE EXPIRATION DATE, LANDLORD MAY CALL
AN EVENT OF DEFAULT.

19. REMEDIES. Upon the occurrence of any such events of default described in
Paragraph 18 hereof, Landlord shall have the option to pursue any one or
more of the following remedies without any notice or demand whatsoever.

A. Landlord may accelerate all rent payments due hereunder FOR THE
REMAINDER OF THE LEASE TERM AND TENANT SHALL PAY THE PRESENT VALUE
(DISCOUNTED AT THE PRIME RATE AS PUBLISHED IN THE WALL STREET JOURNAL) OF
THE AGGREGATE OF SUCH AMOUNTS TO LANDLORD LESS A REASONABLE ESTIMATE AND
PROJECTION OF THE MONEYS TO BE REALIZED OVER THE REMAINDER OF THE LEASE
TERM FROM FUTURE LEASES OF THE PREMISES PROCURED THROUGH LANDLORD'S GOOD
FAITH EFFORTS TO MITIGATE DAMAGES REDUCED BY THE REASONABLY PROJECTED COSTS
(INCLUDING THE REASONABLE COST OF ATTORNEY'S FEES) OF OBTAINING SUCH MONEYS
AND ACCOMPLISHING SUCH MITIGATION.

B. Terminate this Lease, in which event Tenant shall immediately surrender
the Premises to Landlord, and if Tenant fails so to do, Landlord may,
without prejudice to any other remedy which it may have for possession or
arrearages in rent, enter upon and take possession of the Premises and
expel or remove Tenant and any other person who may be occupying such
Premises or any part thereof, by force if necessary, without being liable
for prosecution or any claim of damages therefor, and Tenant agrees to pay
to Landlord on demand the amount of all loss and damage which Landlord may
suffer by reason of such termination, whether through inability to relet
the Premises on satisfactory terms or otherwise.

C. Enter upon and take possession of the Premises and expel or remove
Tenant and any other person who may be occupying such Premises or any part
thereof, by force if necessary, without being liable for prosecution or any
claim for damages therefor, and relet the Premises for such terms ending
before, on or after the expiration date of the Lease Term, at such rentals
and upon such other conditions (including concessions and prior occupancy
periods) as Landlord in its sole discretion may determine, and receive the
rent therefor; and Tenant agrees to pay to the Landlord on demand any
deficiency that may arise by reason of such reletting. Landlord shall USE
GOOD FAITH EFFORTS to relet the Premises or any part thereof BUT shall not
be liable for refusal or failure to relet. In the event of reletting, THE
LANDLORD SHALL NOT BE LIABLE for refusal or failure to collect any rent due
upon such reletting. In the event Landlord is successful in reletting the
Premises at a rental in excess of that agreed to be paid by Tenant pursuant
to the terms of this Lease, Landlord and Tenant each mutually agree that
Tenant shall not be entitled, under

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<PAGE>

any circumstances, to such excess rental, and Tenant does hereby
specifically waive any claim to such excess rental.

D. Enter upon the Premises, by force if necessary, without being liable for
prosecution or any claim for damages therefor, and do whatever Tenant is
obligated to do under the terms of this Lease; and Tenant agrees to
reimburse Landlord on demand for any expenses which Landlord may incur in
thus effecting compliance with Tenant's obligations under this lease, and
Tenant further agrees that Landlord shall not be liable for any damages
resulting to the Tenant from such action, UNLESS caused by the negligence
of Landlord.

E. Whether or not Landlord retakes possession or relets the Premises,
Landlord shall have the right to recover unpaid rent and all damages caused
by Tenant's default, including attorney's fees. Damage shall include,
without limitation, all rents lost, all legal expenses and other related
costs incurred by Landlord following Tenant's default, all costs incurred
by Landlord in restoring the Premises to good order and condition, or in
remodeling, renovating or otherwise preparing the Premises for reletting,
all costs (including without limitation any brokerage commissions and the
value of Landlord's time) incurred by Landlord, plus interest thereon from
the date of expenditure until fully repaid at the rate of eighteen percent
(18%) per annum.

F. In the event Tenant fails to pay any installment of rent, additional
rent or other charges hereunder as and when such installment is due, to
help defray the additional cost to Landlord for processing such late
payments Tenant shall pay to Landlord on demand a late charge in an amount
equal to five percent (5%) of such installment; and the failure to pay such
amount within ten (10) days after demand therefor shall be an event of
default hereunder. The provision for such late charge shall be in addition
to all of Landlord's other rights and remedies hereunder. The provision for
such late charge shall be in addition to all of Landlord's other rights and
remedies hereunder or at law and shall not be construed as liquidated
damages or as limiting Landlord's remedies in any manner.

G. Pursuit of any of the foregoing remedies shall not preclude pursuit of
any of the other remedies herein provided or any other remedies provided by
law, such remedies being cumulative and non-exclusive, nor shall pursuit of
any remedy herein provided constitute a forfeiture or waiver of any rent
due to Landlord hereunder or of any damages accruing to Landlord by reason
of the violation of any of the terms, provisions and covenants herein
contained. No act or thing done by the Landlord or its agents during the
Lease Term hereby granted shall be deemed a termination of this Lease or an
acceptance of the surrender of the Premises, and no agreement to terminate
this Lease or accept a surrender of said Premises shall be valid unless in
writing signed by Landlord. No waiver by Landlord of any violation or
breach of any of the terms, provisions and covenants herein contained shall
be deemed or construed to constitute a waiver of any other violation or
breach of any of the terms, provisions and covenants herein contained.
Landlord's acceptance of the payment of rental or other payments hereunder
after the occurrence of an event of default shall not be construed as a
waiver of such default, unless Landlord so notifies Tenant in writing.
Forbearance by Landlord to enforce one or more of the remedies herein
provided upon an event of default shall not be deemed or construed to
constitute a waiver of such default or of Landlord's right to enforce any
such remedies with respect to such default or any subsequent default. If,
on account of any breach or default by Tenant in Tenant's obligations under
the terms and conditions of this Lease, it shall become necessary or
appropriate for Landlord to ENGAGE THE SERVICES OF an attorney concerning
or to enforce or defend any of Landlord's rights or remedies hereunder,
Tenant agrees to pay any reasonable attorney's fees so incurred.

20. LANDLORD'S LIEN. LANDLORD SHALL HAVE ALL RIGHTS OF LANDLORDS LIEN IN
ACCORDANCE WITH THE STATE OF WASHINGTON STATUTES.

21. MORTGAGES. Tenant accepts this Lease subject and subordinate to any
mortgage(s) and/or deed(s) of trust now or at any time hereafter
constituting a lien or charge upon the Premises or the improvements
situated thereon, provided, however, that if the mortgagee, trustee, or
holder of any such mortgage or deed of trust elects to have Tenant's
interest in this Lease superior to any such instrument, then by notice to
Tenant from such mortgagee, trustee or holder, this Lease shall be deemed
superior to such lien, whether this lease was executed before or after said
mortgage or dead of trust. Tenant shall at any time hereafter on demand
execute any instruments, releases or other documents which may be
REASONABLY required by any mortgagee for the purpose of subjecting and
subordinating this Lease to the lien of any such mortgage. (SEE ADDENDUM TO
PARAGRAPH 21.)

22. LANDLORD'S DEFAULT. In the event Landlord should become in default in any
payment due on any such mortgage described in Paragraph 21 hereof or in the
payment of taxes or any other item which might become a lien upon the
Premises and which Tenant is not obligated to pay under the terms and
provisions of this Lease, Tenant is authorized and empowered after giving
Landlord five (5) days prior written notice of such default and Landlord's
failure to cure such default, to pay any such items for and on behalf of
Landlord, and the amount of any item so paid by Tenant for or on behalf of
Landlord, together with any interest or penalty required to be paid in
connection therewith, shall be payable on demand by Landlord to Tenant;
provided, however, that Tenant shall not be authorized and empowered

9
<PAGE>

to make any payment under the terms of this Paragraph 22 unless the item
shall be superior to Tenant's interest hereunder. In the event Tenant pays
any mortgage debt in full, in accordance with this paragraph, it shall, at
its election, be entitled to the mortgage security by assignment or
subrogation.

23. MECHANIC LIENS. Tenant shall have no authority, express or implied, to
create or place any lien or encumbrance of any kind or nature whatsoever
upon, or in any manner to bind, the interest of Landlord in the Premises or
to charge the rentals payable hereunder for any claim in favor of any
person dealing with the Tenant, including those who may furnish materials
or perform labor for any construction or repairs, and each such claim shall
affect and each such lien shall attach to, if at all, only the leasehold
interest granted to Tenant by this instrument. Tenant covenants and agrees
that it will pay or cause to be paid all sums legally due and payable by it
on account of any labor performed or materials furnished in connection with
any work performed BY TENANT OR ON TENANT'S BEHALF on the Premises on which
any lien is or can be validly and legally asserted against its leasehold
interest in the Premises or the improvements thereon and that it will save
and hold Landlord harmless from any and all loss, cost or expense based on
or arising out of asserted claims or liens against the leasehold estate or
against the right, title and interest of the Landlord in the Premises or
under the terms of this Lease.

24. NOTICES. Each provision of this instrument or of any applicable
governmental laws, ordinances, regulations and other requirements with
reference to the sending, mailing or delivery of any notice or the making
of any payment by Landlord to Tenant or with reference to the sending,
mailing or delivery of any notice or the making of any payment by Tenant to
Landlord shall be deemed to be complied with when and if the following
steps are taken:

A. All rent and other payments required to be made by Tenant to Landlord
hereunder shall be payable to Landlord at the address hereinbelow set forth
or at such other address as Landlord may specify from time to time by
written notice delivered in accordance herewith. Tenant's obligation to pay
rent and any other amounts have been actually received by Landlord.

B. All payments required to be made by Landlord to Tenant hereunder shall
be payable to Tenant at the address hereinbelow set forth, or at such other
address within the continental United States as Tenant may specify from
time to time by written notice delivered in accordance herewith.

C. Any notice or document required or permitted to be delivered hereunder
shall be deemed to be delivered whether actually received or not when
deposited in the United States mail, postage prepaid, Certified or
Registered Mail, addressed to the parties hereto at the respective
addresses set out below, or at such address as they have theretofore
specified by written notice delivered in accordance herewith:

LANDLORD: TENANT:

Riggs Bank N.A. Applied Voice Technology, Inc.
as trustee of the Multi-Employer
Property Trust 11410 NE 122nd Way
c/o Trammell Crow Company Building A-1, Suite 110
1687 114th Avenue SE Kirkland, WA 98034
Suite 250 Attn: Chief Financial Officer
Bellevue, WA 98004

with a copy to:

Riggs Bank N.A./MEPT
808 17th Street N.W.
P.O. Box 96202
Washington D.C. 20090-6202
Attn: Leanne Tobias

Marc Winters
McNaul Ebel Nawrot Helgren & Vance
600 University Street, Suite 2700
Seattle, WA 98101-3143

If and when included within the term "Landlord", as used in this
instrument, there are more than one person, firm or corporation, all shall
jointly arrange among themselves for their joint execution of such a notice
specifying some individual at some specific address for the receipt of
notices and payments to landlord; if and when included within the term
"Tenant", as used in this instrument, there are more than one person, firm
or corporation, all shall jointly arrange among themselves for their joint
execution of such a notice specifying some individual at some specific
address within the continental United States for the receipt of notices and
payments to Tenant. All parties included within the terms "Landlord" and
"Tenant", respectively, shall be bound by notices given in accordance with
the provisions of this paragraph to the same effect as if each had received
such notice.

25. MISCELLANEOUS.

10
<PAGE>

A. Words of any gender used in this Lease shall be held and construed to
include any other gender, and words in the singular number shall be held to
include the plural, unless the context otherwise requires.

B. The terms, provisions and covenants and conditions contained in this
Lease shall apply to, inure to the benefit of, and be binding upon, the
parties hereto and upon their respective heirs, legal representatives,
successors and permitted assigns, except as otherwise herein expressly
provided. Landlord shall have the right to assign any of its rights and
obligations under this Lease. Each party agrees to furnish to the other,
promptly upon demand, a corporate resolution, proof of due authorization
by partners, or other appropriate documentation evidencing the due
authorization of such party to enter into this Lease.

C. The captions inserted in this Lease are for convenience only and in no
way define, limit or otherwise describe the scope or intent of this Lease,
or any provision hereof, or in any way affect the interpretation of this
Lease.

D. Tenant agrees from time to time within ten (10) days after request of
Landlord, to deliver to Landlord, or Landlord's designee, an estoppel
certificate stating that this Lease is in full force and effect, the date
to which rent has been paid, the unexpired term of this Lease and such
other matters pertaining to this Lease as may be requested by Landlord. It
is understood and agreed that Tenant's obligation to furnish such estoppel
certificates in a timely fashion is a material inducement for Landlord's
execution of this Lease.

E. This Lease may not be altered, changed or amended except by an
instrument in writing signed by both parties hereto.

F. All obligations of Tenant hereunder not fully performed as of the
expiration or earlier termination of the term of this Lease shall survive
the expiration or earlier termination of the Term hereof, including without
limitation of all payment obligations with respect to taxes and insurance
and all obligations concerning the condition of the Premises. Upon the
expiration or earlier termination of the Term hereof, and prior to Tenant
vacating the Premises. Tenant shall COMPLY WITH Paragraph 10(B) hereof.
Tenant shall also, prior to vacating the Premises, pay to Landlord the
amount, as estimated by Landlord, of Tenant's obligation hereunder for REAL
estate taxes and insurance premiums for the year PRORATED THROUGH THE
EXPIRATION DATE OR TERMINATION DATE OF THE LEASE. All such amounts shall be
used and held by Landlord for payment of such obligations of Tenant
hereunder, with Tenant being liable for any additional costs therefor upon
demand by Landlord, or with any excess to be returned to Tenant after all
such obligations have been determined and satisfied, as the case may be.
Any security deposit held by Landlord shall be credited against the amount
payable by Tenant under this Paragraph 25(F).

G. If any clause or provision of this Lease is illegal, invalid or
unenforceable under present or future laws effective during the Term of
this Lease, then and in that event, it is the intention of the parties
hereto that the remainder of this Lease shall not be affected thereby, and
it is also the intention of the parties to this Lease that in lieu of each
clause or provision of this Lease that is illegal, invalid or
unenforceable, there be added as part of this Lease contract a clause or
provision as similar in terms to such illegal, invalid or unenforceable
clause or provision as may be possible and be legal, valid and enforceable.

H. Because the Premises are on the open market and are presently being
shown, this Lease shall be treated as an offer with the Premises being
subject to prior lease and such offer subject to withdrawal or non-
acceptance by Landlord or to other use of the Premises without notice, and
this Lease shall not be valid or binding unless and until accepted by
Landlord in writing and a fully executed copy delivered to both parties
hereto.

I. All reference in this Lease to "the date hereof" or similar references
shall be deemed to refer to the last date, in point of time, on which all
parties hereto have executed this Lease.

J. During the term of this Lease and any subsequent option periods,
Landlord shall have the right to request and obtain Tenant's current
financial statements with reasonable advance notice. Tenant shall comply
with Landlord's request for financial statements in a reasonable time frame
not to exceed thirty (30) days from the date of request.

26. LIABILITY OF LANDLORD. Tenant agrees that no trustee, officer, employee,
agent or individual partner of Landlord, or its constituent entities, shall
be personally liable for any obligation of Landlord hereunder, and that
Tenant must look solely to the interests of Landlord, or its constituent
entities in the subject real estate, for the enforcement of any claims
against Landlord arising hereunder.

11
<PAGE>

27. ADDITIONAL PROVISIONS. The addendum and paragraph(s) attached hereto are
hereby incorporated and made a part of this lease. In the event of any
conflict between the terms of the Addendum and the terms of the printed
form portion of this Lease, the terms of the Addendum shall control.

LANDLORD: TENANT:

Riggs Bank N.A., as Trustee of Applied Voice Technology, Inc. a
The Multi-Employer Property Trust Washington Corporation

By: By: /s/ Richard J. LaPorte
----------------------------- -------------------------------
Leanne Tobias Richard J. LaPorte
Its: Vice President Its: President - CEO
-------------------------------
12

<PAGE>

EXHIBIT 21.1

EXHIBIT 21.1 - SUBSIDIARIES OF APPLIED VOICE TECHNOLOGY, INC.

JURISDICTION OF
SUBSIDIARY INCORPORATION
- ---------- ---------------
AVT International, Inc. ................... Washington
Applied Voice Technology of Canada, Inc. .. Canada
AVT Foreign Sales Corporation.............. Barbados
RightFAX, Inc. ............................ Washington
CommercePath, Inc. ........................ Oregon

<PAGE>

EXHIBIT 23.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K, into the Company's previously filed Form
S-8 registration statement.

/s/ Arthur Andersen LLP

Seattle, Washington,
March 23, 1998
<PAGE>

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K, into the Company's previously filed Form
S-8 Registration Statements, File Nos. 33-92438, 333-85452, 333-38557 and

333-42279.

Arthur Andersen

Seattle, Washington,
March 23, 1998

<PAGE>

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<PAGE>

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