EXHIBIT 13

1998 ANNUAL REPORT TO SHAREHOLDERS

THE COMPANY

Vaughn Communications, Inc., through its VAUGHN COMMUNICATIONS DIVISION, is a
multimedia business services provider providing high volume video tape
duplication and digital media (compact disc and magnetic floppy disk)
replication for the corporate, educational, and institutional user. The
Communications Division has video tape duplication facilities in Minneapolis,
Milwaukee, Phoenix, Tampa, Portland, Atlanta, Dallas, Houston, Raleigh, Chicago,
Denver and Seattle, and its facility in Fremont, California provides digital
media replication services. Sales offices are located in St. Louis, New York
City, Irvine, Orlando, Knoxville, Baltimore and Ft. Lauderdale.

In addition to its multimedia services, the Company receives sixteen percent of
its total revenue from the VAUGHN PRODUCTS DIVISION which manufactures and sells
gift products and collectibles to retailers in growing niche markets.

FINANCIAL SUMMARY

%
F'98 F'97 Change
------- ---------- ---------

Revenue. . . . . . . . . $74,488,000 $68,798,000 8%
Pretax Income. . . . . . 3,338,000 3,475,000 (4)%
Net Income . . . . . . . 1,938,000 2,015,000 (4)%
--------- --------- ----
--------- --------- ----
Net Income per common
share . . . . . . . . . $.48 $.51 (6)%
---- ---- ---
---- ---- ---

LETTER TO SHAREHOLDERS

TO OUR SHAREHOLDERS

Last year's challenge was to exploit new technological opportunities and
still deliver excellent financial results. Here is how we did:

- Communication Division's sales increased 13% in fiscal 1998, from
$55,000,000 to $62,300,000.

- Acquisition of CD replication facility and customer base capable of
producing over $20 million annually.

- Improved gross margins from 32.9% to 33.5% in the Communications
Division.

- Pretax income increased 15% in the Communications Division excluding
results of the CD acquisition.

Consolidated net sales, including acquisitions, increased 8% in fiscal
1998. The increase was attributable to a 13% increase in the Communications
Division, but was offset by an 11% decrease in sales from the Products
Division. The Products Division manufactures and sells gift products
throughout the United States. A change in senior management at midyear and
continued difficulties in consolidating our operations in Seattle all
contributed to the disappointing results. We are investigating options to
ensure that we get an adequate return out of the resources allocated to this
division.

The Company continues to focus its investment efforts on the Communications
Division. We are transforming this division into a national multimedia business
services company providing media duplication (videotape, compact disc, floppy
disk, etc.) and related services throughout our 21 locations in the United
States. The market for software duplication (CD and floppy) is growing rapidly
(15-25%+) as more businesses convert to using interactive laptops and more
computers penetrate the home market. During fiscal 1998 we continued to seek
out strategic acquisitions. On July 31, 1997, Certified Media Corporation, a
compact disc replicator located in Fremont, California was acquired. On
February 1, 1998, Copywise, Inc., a software duplicator and assembly company,
also located in Fremont, was acquired. We have combined the operations of these
two companies and expect ongoing consolidated savings in overheads. We are now
rolling out the product and service offerings of these combined companies to our
existing national video sales force who are currently calling on 6,500 active
business customers. We believe that we are well positioned for strong sales
growth and market penetration.

A new initiative for us this year is to focus more resources on our direct
mail video business opportunity. Fiscal 1998 yielded impressive revenue in this
area. We expect to see significant revenue growth as we place more emphasis on
this area. This past year we opened a Direct Mail Media office and selected a
dedicated staff of product manager, sales, and customer service to focus on this
business. Businesses spend from $20-$40 billion annually on direct mail and
this business is growing at 15% a year). Due to newer technologies in desktop
editing, lower videotape material costs, improved manufacturing economics and a
cooperative postal climate, video direct mail is now comparably affordable with
print direct mail. We intend to be a major provider to this fast-growing
marketplace.

In conclusion, we look forward to an exciting new year. We have five areas
in which we expect to grow. First, we plan to roll out our new CD and software
replication services to our existing 6,500 active video customers. Second, we
plan to significantly increase the sales of our related business services such
as graphic design, video compression, digital translation, and fulfillment to
both our video and software customer base. Third, we plan to continue to seek
acquisitions as the video market consolidates its suppliers and as the software
market continues to expand rapidly in the business sector. Fourth, we plan to
add market share by expanding into new geographic areas with sales offices and
by adding software replication equipment to some of our existing video
facilities where overheads are already paid for. Fifth, and finally, we plan to
be a major provider of video direct mail services to the direct mail industry.

As a final note, I would like to talk about our most important asset. I am
proud of the hard work of our employee-owners. Their continued commitment to
helping the Company achieve its objectives has been a key factor in our

historical success. As we look to the future, I am confident that we will reach
our goals because of the dedication of our employees.

/s/ E. D. Willette
- -------------------------------------
E. D. Willette
Chairman and Chief Executive Officer

/s/ Donald J. Drapeau
- -------------------------------------
Donald J. Drapeau
President and Chief Operating Officer

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Vaughn Communications, Inc.'s consolidated financial statements represent
the combined results of the Company's magnetic and optical media replication
business (Communications Division), which represents 84% of the Company's sales,
and the gift products business (Products Division). Management's Discussion is
presented in three parts: Consolidated, Communications Division and Products
Division.

COMPARISON OF FISCAL 1998 AND 1997 OPERATING RESULTS

CONSOLIDATED:

The Company's net sales, including net sales provided by acquired business
from the date of acquisition, increased 8% in fiscal 1998 to approximately
$74,488,000. The increase was attributable to a 13% increase in net sales from
the Communications Division which offset an 11% decrease in net sales from the
Products Division. Gross margins increased slightly in fiscal 1998, from 31.5%
to 31.9%. Selling, general and administrative expenses were approximately
$19,093,000, a 12% increase over the previous year, and represent 25.6% of net
sales, compared to 24.7% the previous year. Net interest expense increased
slightly from approximately $1,237,000 in fiscal 1997 to $1,295,000 in fiscal
1998. Pretax income in fiscal 1998 was approximately $3,338,000, a 4% decrease
from the prior year. The decrease was due to a $532,000 decrease in pretax
income from the Products Division (pretax income of $161,000 in fiscal 1997
compared to a pretax loss of $371,000 in fiscal 1998). This decrease was
partially offset by a 12% increase in pretax income from the Communications
Division. The Company's effective tax rate remained at approximately 42%.
Consolidated net income declined 4%, from approximately $2,015,000 in fiscal
1997 to approximately $1,938,000 in fiscal 1998.

LIQUIDITY AND CAPITAL RESOURCES

Cash provided by operations and financing provided by banks and third
parties continue to be the Company's primary sources of funds to finance
operating needs and capital expenditures. In fiscal 1998, cash flow from
operations was $4,668,000, a 17% increase over the previous year. This cash, in
addition to borrowings from third parties, was used to fund capital expenditures
of $4,891,000 and to partially fund the $4,611,000 invested in the acquisitions
of Certified Media and Dub South. In addition to the above mentioned sources of
cash, the Company also issued common stock valued at $1,200,000 to fund the
acquisition of Certified Media.

Based on past performance and current expectations, the Company believes
that working capital levels, coupled with its ability to borrow additional funds
under its $17,000,000 credit facility with a bank (of which approximately
$1,640,000 is available at January 31, 1998), are adequate to meet the operating
requirements of the Company for the next twelve months. The Company continues
to explore strategic acquisitions, and depending on the size and terms of the
potential transaction, additional financing may be required. Expenditures for
new equipment are expected to be approximately $6,000,000 in fiscal 1999 and
will be funded by leasing arrangements with third parties and cash from
operations. As part of the Company's strategic planning process, it continues
to explore alternative funding proposals.

CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS

This annual report and other written reports and oral statements made from
time to time by the Company may contain so-called "forward-looking statements,"
all of which are subject to risks and uncertainties. One can identify these
forward-looking statements by their use of words such as "expects," plans,"
"will," "estimates," and other words of similar meaning. One can also identify
them by the fact that they do not relate strictly to historical or current
facts. These statements are likely to address the Company's growth strategy,
financial results, or acquisition strategies. One must carefully consider any
such statement and should understand that many factors could cause actual
results to differ from the Company's forward-looking statements. These factors
include inaccurate

assumptions and a broad variety of other risks and uncertainties, including some
that are known and some that are not. No forward-looking statement can be
guaranteed and actual results may vary materially.

YEAR 2000 COMPLIANCE

Computer programs which were written using two digits (rather than four) to
define the applicable year may recognize a date using "00" as the year 1900
rather than the year 2000, a result commonly referred to as the "Year 2000"
problem. This could result in a system failure, or miscalculation.

In 1997 Vaughn initiated a program to evaluate whether internally developed
and purchased computer programs may experience operational problems when the
year 2000 is reached. The scope of this effort included internal computer
systems and supplier capabilities. The Company is completing this review to
determine whether its computer programs are Year 2000 compliant, as well as
determining what remedial action is required, and the costs associated with
required modification or replacements. A significant amount of information has
been collected and analyzed, however, the process will not be completed until
calendar year 1998. The Company plans to complete all remediation efforts for
its systems prior to the year 2000. Based on its evaluation to date, management
believes that, while the Company will incur internal and possibly external costs
to address the Year 2000 problem, such costs will not have a material impact on
the operations, cash flows, or financial condition of Vaughn Communications,
Inc.

COMMUNICATIONS DIVISION:

The Communications Division is a national multimedia business services
company providing videotape duplication and digital media (compact disc and
magnetic floppy disk) replication and related services throughout the United
States. Its strategy is to grow through internally generated growth and through
strategic acquisitions. The Company continued to implement this strategy in
fiscal 1998 with two strategic acquisitions. In order to better meet the
current and long-term needs of its business customers, the Company entered the
digital media replication business with the acquisition, on July 31, 1997, of
Certified Media Corporation, a compact disc ("CD") replicator located in
Fremont, California. The noncontingent purchase price of $5,500,000 included
$2,800,000 of cash, 171,210 shares of the Company's common stock valued at
$1,200,000 and a $1,500,000 note to the sellers. The purchase price may be
increased an additional $2,000,000 based upon Certified Media attaining certain
financial objectives. The Company believes it is well positioned for strong
sales growth and market penetration in this business as it intends to capitalize
on its existing sales force to sell this new product offering. Also on July 31,
1997, the Company acquired certain of the assets of Dub South, a videotape
duplicator located in Atlanta, Georgia. The operations of Dub South were merged
into the Company's pre-existing facility in Atlanta. The noncontingent purchase
price of $750,000 included approximately $311,000 of cash and the assumption of
$439,000 of liabilities. The purchase price may be increased by an additional
$1,200,000 depending on the financial performance of Dub South. Both
acquisitions have been accounted for as purchases and their operating results
are included in the Company's results for the period subsequent to their
acquisition date.

The Communications Division's net sales increased 13% in fiscal 1998, from
approximately $55,000,000 in fiscal 1997 to approximately $62,300,000. The net
sales generated due to the acquisition of Certified Media and a 3% increase in
the sales from pre-existing facilities contributed to the sales growth. The
Company believes that although the growth of videotape duplicators has slowed,
there continues to be opportunities for growth in this market and there are
significant growth opportunities in the CD replication market, although there
can be no assurances that such growth will be experienced by the Company.

The gross profit margins increased from 32.9% in fiscal 1997 to 33.5% in
fiscal 1998. The improvement was the result of cost control measures instituted
at the beginning of the year and continued leveraging of fixed expenses. The
Company expects to be able to maintain its profit margins by continuing to
improve efficiencies, the continued leveraging of fixed costs with increased
volume, and continuing to utilize low cost providers of raw materials.

Selling, general and administrative expenses in fiscal 1998 were up 16.7%
over fiscal 1997 and represented 26% of net sales in fiscal 1998 compared to
25.2% in fiscal 1997. The increase in selling, general and

administrative expenses reflects additional expenses associated with the
acquisitions previously discussed, including goodwill amortization and
noncompete payments.

Net interest increased to approximately $999,000 in fiscal 1998, an
increase of approximately $104,000 from the previous year. The increase was due
to interest associated with additional acquisition debt.

Pretax income for the Communications Division was $3,709,000, a 12%
increase over the previous year. Excluding the results of the acquisition of
Certified Media, pretax income increased by 15% in fiscal 1998. Certified
Media's operating profit after adding back amortization expense and interest on
the acquisition debt was approximately $260,000.

The Company invested approximately $4,432,000 on equipment and facilities
to expand its production capacity. This investment included approximately
$2,400,000 spent to expand the CD replication capacity. The investment in
capital equipment was funded by long-term financing and internally generated
funds.

PRODUCTS DIVISION:

The Products Division, which manufactures and sells gift products
throughout the United States, struggled during fiscal year 1998. A decrease in
sales from the prior year, a change in senior management at mid-year, and
continuing difficulties in consolidating its operations in Seattle all
contributed to the disappointing results. The Company is investigating options
which will ensure that the resources allocated to the Products Division will
generate an adequate return on its investment.

Net sales of approximately $12,196,000 were an 11% decrease from the prior
year. The decrease in sales also resulted in a decrease in the leveraging of
fixed costs, resulting in a reduction in gross margins from 26% in fiscal 1997
to 23% in fiscal 1998. Although selling, general and administrative expenses
decreased from approximately $3,273,000 in fiscal 1997 to approximately
$3,035,000, it was not enough to offset the decrease in net sales and gross
margins, and pretax income declined from $161,000 in fiscal 1997 to a pretax
loss of $371,000 in fiscal 1998.

COMPARISON OF FISCAL 1997 AND 1996 OPERATING RESULTS

The Company's strategy is to increase revenue and profitability through
growth in existing channels, through acquisitions, and through improvement in
efficiencies. In fiscal 1997 the Company was partially successful in
implementing this strategy. The Company merged with Satastar Corporate
Services, Inc., a videotape duplicator located in Chicago, expanded the Seattle
operation from a sales office to a full service duplication facility, and
completed the integration of Indian Arts and Crafts, Inc. (acquired January 31,
1996) into the Products Division by consolidating the Division's operations in
Seattle. In spite of these accomplishments, the financial results for fiscal
1997 did not meet the Company's expectations. Lower than expected sales,
coupled with increased costs associated with expanding the business, resulted in
a decrease in net income from the previous year. In response to these results,
the Company implemented cost containment measures during the year and expects
these measures to have a positive impact on next year's results.

The Company's net sales increased from $59,569,000 in fiscal 1996 to
$68,798,000 in fiscal 1997, a 15% increase, while gross margins remained at
32%. Selling, general and administrative expenses for fiscal 1997 were up 21%
over the previous year and represented 25% of net sales, up one percentage
point from last year. Operating profit decreased 7% from last year to
approximately $4,712,000. Interest expense was down slightly from the
previous year. The Company's effective tax rate in fiscal 1997 was 42%. Net
income decreased 10% from $2,247,000 in fiscal 1996 to $2,015,000 in fiscal
1997.

The net contribution each division made to these results is discussed
below.

COMMUNICATIONS DIVISION:

On June 28, 1996, the Company acquired Satastar Corporate Services, Inc. by
issuing 165,357 shares of common stock in exchange for all the outstanding
capital stock of Satastar. The business combination has been

accounted for as a pooling of interest, and, accordingly, the financial
statements and analysis include the combined results of operations from the date
Satastar commenced operations.

The Communications Division's sales of $55,040,000 in fiscal 1997 were a 5%
increase from the previous year's sales of $52,365,000. The slowdown in sales
growth in fiscal 1997 is attributed in part to a decrease in sales to the
Company's largest customers. While the Company added more new customers in
fiscal 1997 than in fiscal 1996, it was unable to offset the reduced sales to
its largest accounts. The Company believes that by refocusing its sales
efforts, the growth in sales will continue. There can be no assurance, however,
that such growth will be at or near historical levels, particularly since the
growth of the videotape duplication market may not be as great as historical
levels.

The gross profit margin increased slightly to 32.9% in fiscal 1997 from
32.7% in fiscal 1996. Although the selling price of videotape duplication
continues to decline, the Company expects to maintain its profit margins by
improving efficiencies, leveraging fixed costs with increased volume, and
continuing to utilize low cost providers of raw materials.

Selling, general and administrative expenses in fiscal 1997 increased 12%
from $12,384,000 in fiscal 1996 to $13,872,000 in fiscal 1997, and represented
25% of net sales in fiscal 1997 compared to 24% of net sales in fiscal 1996.
The increase in selling, general and administrative expenses can be attributed
in part to additional costs associated with the acquisition of Satastar, and
expenses incurred during the consolidation of the Company's existing facility in
Chicago with the facility used by Satastar.

Net interest expense decreased 14% in fiscal 1997 due to lower levels of
borrowing.

Pre-tax profit for the Communications Division was $3,314,000, a 11%
decrease from the previous year's pre-tax profit of $3,707,000. The decrease
was attributable primarily to the higher levels of operating expenses.

The Company spent approximately $2,750,000 on equipment and facilities to
expand its production capacity. The investment was funded by long-term
financing and internally generated funds. The Communications Division expects
to spend approximately $1,400,000 for equipment in fiscal 1998.

PRODUCTS DIVISION:

The Products Division's sales of $13,758,000 in fiscal 1997 were up 91%
from the previous year. The increase was due entirely to the acquisition of
Indian Arts and Crafts, Inc. on January 31, 1996. The sales from the newly
acquired product line offset a slight decrease in sales of the pre-existing
product line.

The fiscal 1997 gross profit margin of 26% remained approximately the same
as the previous year. A slight decrease in raw material costs was offset by
higher labor costs. The higher labor costs were associated with operating two
facilities prior to consolidating operations in Seattle in September, 1996. The
company expects that the combined operations will result in improved
efficiencies next year.

Operating expenses for fiscal 1997 increased 85% to $3,270,000 due to the
acquisition of Indian Arts and Crafts, Inc. As a percentage of sales, operating
expenses decreased from 24.5% in fiscal 1996 to 23.8% in fiscal 1997.

Interest expense increased from $75,000 in fiscal 1996 to $195,000 in
fiscal 1997 due primarily to higher debt associated with the acquisition.

Pre-tax income increased 100% in fiscal 1997, from $80,000 to $161,000.

SELECTED FINANCIAL DATA FROM CONTINUING OPERATIONS (IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)

Year Ended January 31
1998 1997 1996 1995 1994
------ ------- ------ ------- ------

STATEMENT OF OPERATIONS DATA:
Net sales. . . . . . . . . . . . $ 74,488 $ 68,798 $ 59,569 $ 45,471 $ 35,014
Cost of goods sold . . . . . . . 50,762 47,111 40,518 30,920 23,802
--------- -------- -------- -------- --------
Gross profit . . . . . . . . . . 23,726 21,687 19,051 14,551 11,212
Operating expenses . . . . . . . 19,092 16,975 13,973 10,821 8,914
--------- -------- -------- -------- --------
Operating income . . . . . . . . 4,634 4,712 5,078 3,730 2,298
Interest expense . . . . . . . . (1,411) (1,295) (1,357) (710) (573)
Other income (expense) . . . . . 115 58 66 (67) 24
--------- -------- -------- -------- --------
Income from continuing operations
before income taxes. . . . . 3,338 3,475 3,787 2,953 1,749
Income taxes . . . . . . . . . . 1,400 1,460 1,540 1060 667
--------- -------- -------- -------- --------
Income from continuing operations 1,938 2,015 2,247 1,893 1,082
Income from
discontinued operations. . . - - - 493 74
--------- -------- -------- -------- --------
Net income . . . . . . . . . . . $ 1,938 $ 2,015 $ 2,247 $ 2,386 $ 1,156
--------- -------- -------- -------- --------
--------- -------- -------- -------- --------

Net income per common share:
Continuing operations. . . . $ .49 $ .55 $ .69 $ .64 $ .39
Discontinued operations . . . . - - - .17 .03
--------- -------- -------- -------- --------
. . . . . . . . . . . . . . . . $ .49 $ .55 $ .69 $ .81 $ .42
--------- -------- -------- -------- --------
--------- -------- -------- -------- --------

Net income per common share -
assuming dilution:
Continuing operations. . . . $ .48 $ .51 $ .61 $ .55 $ .32
Discontinued operations. . . - - - .14 .02
--------- -------- -------- -------- --------
. . . . . . . . . . . . . . . . $ .48 $ .51 $ .61 $ .69 $ .34
--------- -------- -------- -------- --------
--------- -------- -------- -------- --------

Weighted average common
shares outstanding . . . . . . . 3,918 3,640 3,244 2,963 2,749
Dilutive options . . . . . . . . 102 284 434 455 600
--------- -------- -------- -------- --------
. . . . . . . . . . . . . . . . 4,020 3,924 3,678 3,418 3,349
--------- -------- -------- -------- --------
--------- -------- -------- -------- --------

January 31
1998 1997 1996 1995 1994
------ ------- ------ ------ ------
BALANCE SHEET DATA:

Working capital. . . . . . . . . $ 9,093 $ 9,268 $ 7,559 $ 4,186 $ 2,420
Total assets . . . . . . . . . . 44,312 34,751 32,816 22,186 19,573
Long-term obligations
(excluding current portion) . 9,075 5,603 7,778 3,626 4,024
Total liabilities. . . . . . . . 23,993 17,903 19,298 13,681 13,646
Total stockholders' equity . . . 20,319 16,848 13,518 8,505 5,927

Consolidated Balance Sheets

JANUARY 31
1998 1997
--------------------------

ASSETS
Current assets:
Trade receivables, less allowance of $1,126,000 and $650,000,
respectively $13,822,621 $10,685,149
Other receivables 195,372 179,369
Inventories 8,887,898 9,256,455
Deferred income taxes 285,070 115,070
Prepaid expenses and other current assets 748,177 668,061
Income taxes receivable 72,668 664,042
---------------------------
Total current assets 24,011,806 21,568,146

Property, plant and equipment:
Land 48,424 48,424
Buildings and leasehold improvements 3,350,257 2,866,038
Machinery and equipment 27,786,725 22,039,414
---------------------------
31,185,406 24,953,876
Less accumulated depreciation (19,899,664) (16,237,440)
---------------------------
11,285,742 8,716,436
Intangible assets, net of accumulated amortization
of $1,102,000 and $620,000, respectively 8,331,705 3,549,917
Long-term receivable 476,905 705,781
Other 205,466 210,943
---------------------------
$44,311,624 $34,751,223
---------------------------
---------------------------

JANUARY 31
1998 1997
---------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable to banks under credit facilities $ 5,760,436 $ 4,781,312
Accounts payable 3,216,356 2,982,508
Salaries, wages and payroll taxes 818,300 696,894
Other 1,255,415 1,009,306
Current portion of long-term debt and capital
lease obligations 3,867,986 2,830,033
---------------------------
Total current liabilities 14,918,493 12,300,053

Long-term debt, net of current portion 6,517,724 4,563,880
Capital lease obligations, net of current portion 2,502,540 963,533
Deferred income taxes 54,326 75,326

SHAREHOLDERS' EQUITY
Common Stock, par value $.10 per share:
Authorized shares--20,000,000
Issued and outstanding shares--4,088,582 and
3,726,513, respectively 408,858 372,652
Additional paid-in capital 9,074,004 7,578,406
Retained earnings 10,835,679 8,897,373
---------------------------
Total shareholders' equity 20,318,541 16,848,431
---------------------------
$44,311,624 $34,751,223
---------------------------
---------------------------

SEE ACCOMPANYING NOTES.

CONSOLIDATED STATEMENTS OF INCOME

YEAR ENDED JANUARY 31
1998 1997 1996
---------------------------------------

Net sales $74,487,763 $ 68,797,983 $ 59,568,901
Cost of goods sold 50,761,624 47,111,338 40,518,292
---------------------------------------
Gross profit 23,726,139 21,686,645 19,050,609

Selling, general and administrative
expenses 19,092,543 16,974,225 13,973,199
---------------------------------------
Income from operations 4,633,596 4,712,420 5,077,410

Other income (expense):
Interest income 115,194 57,615 36,384
Interest expense (1,410,484) (1,294,539) (1,356,958)
Other - - 30,000
---------------------------------------
Income before income taxes 3,338,306 3,475,496 3,786,836
Income taxes 1,400,000 1,460,000 1,539,660
---------------------------------------
Net income $ 1,938,306 $ 2,015,496 $ 2,247,176
---------------------------------------
---------------------------------------

Net income per share:
Basic $.49 $.55 $.69
Diluted .48 .51 .61

SEE ACCOMPANYING NOTES.

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

COMMON STOCK ADDITIONAL
-------------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
---------------------------------------------------------------------------------

Balance at January 31, 1995 2,997,658 $299,766 $3,570,984 $ 4,634,701 $ 8,505,451
Common Stock issued in
connection with business
acquisition 325,138 32,514 2,387,486 - 2,420,000
Stock options exercised 148,965 14,897 175,041 - 189,938
Common Stock received as partial
consideration of stock options
exercised (8,935) (894) (62,520) - (63,414)
Tax benefit on stock options
exercised - - 218,374 - 218,374
Net income - - - 2,247,176 2,247,176
---------------------------------------------------------------------------------
Balance at January 31, 1996 3,462,826 346,283 6,289,365 6,881,877 13,517,525
Stock options exercised 275,278 27,528 529,307 - 556,835
Common Stock received as partial
consideration of stock options
exercised (11,591) (1,159) (149,524) - (150,683)
Tax benefit on stock options
exercised - - 909,258 - 909,258
Net income - - - 2,015,496 2,015,496
---------------------------------------------------------------------------------
Balance at January 31, 1997 3,726,513 372,652 7,578,406 8,897,373 16,848,431
Common Stock issued in
connection with business
acquisition 171,210 17,120 1,182,880 - 1,200,000
Stock options exercised 202,183 20,218 211,296 - 231,514
Common Stock received as partial
consideration of stock options
exercised (11,324) (1,132) (83,592) - (84,724)
Tax benefit on stock options
exercised - - 185,014 - 185,014
Net income - - - 1,938,306 1,938,306
---------------------------------------------------------------------------------
Balance at January 31, 1998 4,088,582 $408,858 $9,074,004 $10,835,679 $ 20,318,541
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------

SEE ACCOMPANYING NOTES.

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEAR ENDED JANUARY 31
1998 1997 1996
-----------------------------------------

OPERATING ACTIVITIES
Net income $ 1,938,306 $ 2,015,496 $ 2,247,176
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization 481,922 277,642 190,767
Depreciation 3,696,103 3,195,898 2,877,538
Deferred income taxes (191,000) 48,121 168,639
Changes in operating assets and liabilities:
Receivables (3,121,225) (564,055) (541,104)
Inventories 500,496 (1,478,188) 80,364
Income taxes 776,388 193,295 353,128
Prepaid expenses and other current assets (14,284) 74,047 (81,485)
Accounts payable 233,848 45,151 (1,072,440)
Salaries, wages and payroll taxes 121,406 113,498 (118,013)
Other liabilities 246,109 81,100 (127,381)
-----------------------------------------
Net cash provided by operating activities 4,668,069 4,002,005 3,977,189

INVESTING ACTIVITIES

Purchases of businesses, less cash acquired (3,186,009) - (4,355,010)
Additions to property, plant and equipment (4,452,983) (3,069,391) (2,627,110)
Long-term receivables 228,876 (14,223) 158,908
Net carrying amount of property disposals 6,131 1,444 5,938
Other (1,929) 255,347 18,992
-----------------------------------------
Net cash used in investing activities (7,405,914) (2,826,823) (6,798,282)

FINANCING ACTIVITIES
Increase in long-term debt 2,800,000 400,000 5,740,922
Proceeds from sale of Common Stock under option plans 146,790 406,152 126,524
Payments of long-term debt and capital lease obligations (3,286,791) (3,404,244) (3,181,486)
(Payments) borrowings under revolving credit facility 979,124 766,907 (1,058,792)
Lease financing of equipment 2,098,722 656,003 1,188,697
-----------------------------------------
Net cash provided by (used in) financing activities 2,737,845 (1,175,182) 2,815,865
-----------------------------------------

Decrease in cash and cash equivalents - - (5,228)
Cash and cash equivalents at beginning of year - - 5,228
-----------------------------------------
Cash and cash equivalents at end of year $ - $ - $ -
-----------------------------------------
-----------------------------------------
Supplemental schedule of non-cash investing and
financing activities:
Capital leases of equipment $ 437,974 $ 93,112 $ 163,488

SEE ACCOMPANYING NOTES.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

BUSINESS ACTIVITY

Vaughn Communications, Inc. is one of the largest providers in the United States
of high volume videotape duplication and compact disc replication services to
corporations, publishers and educational companies located in the United States.
The Company operates videotape duplication centers throughout the country in
areas selected because of their proximity to large corporate bases. In addition
to video services, the Company has generated approximately 16%, 20% and 12% of
its net sales for the years ended January 31, 1998, 1997 and 1996, respectively,
from the manufacture and sale of gift products to retailers in niche markets.
Additional information on the Company's operations by segment is included in
Note 9 to the consolidated financial statements.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and of
its majority-owned subsidiaries after elimination of all significant
intercompany accounts and transactions.

INVENTORIES

Inventories are valued at the lower of average cost (first-in, first-out method)
or market.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated on the basis of cost. Assets are
depreciated using the straight-line and declining balance methods over their
estimated useful lives which are as follows:

Buildings 40 years
Equipment 3 - 5 years
Leasehold improvements 5 - 10 years

The carrying value of property, plant and equipment is assessed annually and/or
when factors indicating an impairment are present.

INTANGIBLE ASSETS

The intangible assets include the excess of purchase price over the fair value
of net assets of businesses acquired and are being amortized over periods of 10
to 40 years using the straight-line method. The carrying value of intangible
assets is assessed annually and/or when factors indicating impairment are
present.

INCOME TAXES

The Company accounts for income taxes utilizing the liability method. Deferred
taxes are recorded to reflect the tax consequences of differences between tax
and financial reporting basis of assets and liabilities.

NET INCOME PER SHARE

In fiscal 1998, the Company adopted Statement of Financial Accounting Standard
No. 128 (SFAS 128), "Earnings Per Share." SFAS 128 requires the disclosure of
basic and diluted earnings per share (EPS). Basic EPS is calculated using income
available to common shareholders divided by the weighted average of common
shares outstanding during the year. Diluted EPS is similar to basic EPS except
that the weighted average of common shares outstanding

is increased to include the number of additional shares that would have been
outstanding if the dilutive potential common shares, such as options, had been
issued. All prior year earnings per share have been restated in accordance with
the provisions of SFAS 128. (See Note 11).

STATEMENT OF CASH FLOWS

For purposes of the statements of cash flows, the Company considers all highly
liquid investments with a maturity of three months or less when purchased to be
cash equivalents.

STOCK-BASED COMPENSATION

The Company follows Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, (APB 25) and related interpretations in accounting
for its employee stock options. Under APB 25, when the exercise price of
employee stock options equals the market price of the underlying stock on the
date of the grant, no compensation expense is recognized.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

2. INVENTORIES

The components of inventories were as follows at January 31:

1998 1997
-------------------------

Raw material $1,723,940 $2,190,327
Finished goods 7,163,958 7,066,128
-------------------------
$8,887,898 $9,256,455
-------------------------
-------------------------

3. NOTES PAYABLE TO BANKS

In August 1997, the Company amended its $17,000,000 credit facility with a bank
to provide acquisition funding in the amount of $2,800,000 used in the
acquisition of Certified Media Corporation (see Note 10). In addition to the
$2,800,000 of acquisition term loan, the facility provides funding for prior
acquisitions, equipment purchases, and a revolving credit facility to be used to
finance working capital. The interest rate on the term debt and the revolving
debt is at the prime rate (8.5% at January 31, 1998). Advances under the credit
facility are limited to the lesser of $17,000,000 less the sum of the
outstanding principal amounts on any term notes payable to the bank, or the
collateral value of receivables and inventory. Interest on the credit facility
is payable monthly. All the Company's assets except real estate and fixtures
have been pledged to secure this indebtedness. This facility expires on May 31,
1998.

Pursuant to the loan agreement, the Company is required, among other things, to
maintain minimum levels of net worth, net income, debt service coverage and
ratio of debt to net worth. The Company is required to receive approval from the
bank prior to incurring or assuming any indebtedness not in the ordinary course
of business, paying any dividends or redeeming its capital stock, entering into
any transactions of merger, consolidation or liquidation, or making loans or
investments in another business.

4. LONG-TERM DEBT

Long-term debt consists of the following at January 31:

1998 1997
--------------------------

Term note payable to bank under credit facility in
20 quarterly installments of $140,000, secured
by all the Company's assets except real estate
and fixtures thereon. Interest is payable
monthly at the bank's prime rate (8.5% at
January 31, 1998). $2,520,000 $ -

Term note payable to bank under credit facility in
20 quarterly installments of $250,000, secured
by all the Company's assets except real estate
and fixtures thereon. Interest is payable
monthly at the bank's prime rate (8.5% at
January 31, 1998).
2,250,000 3,250,000

Note payable to Certified Media Corporation
payable in five annual installments of $300,000
plus accrued interest commencing July 31, 1998.
Interest is at the prime rate (8.5% on January
31, 1998). Secured by certain assets.
1,500,000 -

First mortgage loan on land and building secured
by properties having a net book value of
$620,000 at January 31, 1998.
1,315,342 1,366,545

Note payable to former shareholders of Certified
Media Corporation, payable in three annual
installments of $133,333 plus accrued interest
commencing July 31, 1998. Interest is at the
prime rate (8.5% on January 31, 1998).
400,000 -

Term note payable to bank in 36 monthly
installments of $23,611, secured by all the
Company's assets except real estate and fixtures
thereon. Interest is payable at
the bank's prime rate (8.5% on January 31, 70,833 330,555
1998).

Term note payable to bank in 36 monthly
installments of $11,111, secured by all the
Company's assets except real estate and fixtures
thereon. Interest is payable at
the bank's prime rate (8.5% on January 31, 1998). 222,222 344,444

Notes payable to Indian Arts and Crafts, Inc.
Interest on both notes is payable annually on
the anniversary date at 8.5%. Notes are secured
by assets having a net book value of $2,019,000
at January 31, 1998.

Note I is payable in annual installments of
$83,333 plus accrued interest. 166,667 166,667
Note II is payable in annual installments of
$107,143 plus accrued interest. 642,857 642,857

4. LONG-TERM DEBT (CONTINUED) 1998 1997
--------------------------

Note payable to Cranberry Novelty Manufacturing
Inc. payable in 10 annual installments of
$17,500. Interest is payable annually at the
prime rate (8. 5% at January 31, 1998). $ 87,500 $ 105,000

Note payable to Advanced Audio/Video Productions,
Inc., payable in 3 annual installments of
$33,333 plus accrued interest at the prime rate
(8. 5% on January 31, 1998). Secured by certain 33,333 66,667
assets.

Note payable, paid in full in fiscal 1998 - 91,125
--------------------------
9,208,754 6,363,860
Current portion (2,691,030) (1,799,980)
--------------------------
$ 6,517,724 $4,563,880
--------------------------
--------------------------

In January 1997, the Company renewed its mortgage for three years at an interest
rate of 7.625%. It is payable in monthly installments of $12,802 including
interest with the balance payable in full on January 1, 2000. The agreement
grants the Company a three year renewal option at the then prevailing three year
commercial mortgage lending rate. The mortgage may be prepaid in whole at any
time subject to a prepayment premium. The interest rate is subject to a 4%
increase in certain events of default.

Required annual principal payments on long-term debt are as follows for years
ending January 31: 1999--$2,691,030; 2000--$3,460,462; 2001--$1,367,976;
2002--$984,644; 2003--$704,642.

Interest paid approximated interest expense for 1996, 1997 and 1998.

5. LEASES

The Company leases various types of equipment under long-term lease agreements
classified as capital leases. Property, plant and equipment includes the
following leased property:

JANUARY 31
1998 1997
--------------------------

Equipment $ 6,430,000 $ 4,392,000
Less accumulated amortization (2,336,000) (2,224,000)
--------------------------
$ 4,094,000 $ 2,168,000
--------------------------
--------------------------

Amortization of leased assets is included in depreciation.

The Company leases certain facilities, equipment and autos under noncancelable
operating lease agreements with initial lease terms in excess of one year. Rent
expense from these operating leases was $2,552,017, $1,724,000 and $1,069,000 in
1998, 1997 and 1996, respectively.

Future minimum payments under capital leases and noncancelable operating leases
with initial terms of one year or more consisted of the following at January 31,
1998:

5. LEASES (CONTINUED)

CAPITAL OPERATING
LEASES LEASES
-------------------------

Year ending January 31:
1999 $ 1,354,636 $2,627,334
2000 1,123,073 2,070,516
2001 813,351 1,451,300
2002 733,040 710,675
2003 426,408 131,421
-------------------------
Total minimum lease payments 4,450,508 $6,991,246
Amount representing interest (771,012) ------------
------------ ------------
Present value of net minimum lease payments 3,679,496
Current portion (1,176,956)
------------
Long-term capital lease obligations $ 2,502,540
------------
------------

6. STOCK OPTIONS

Under the terms of the Company's stock option plans, 132,452 shares of Common
Stock were reserved at January 31, 1998 for issuance or grant to officers,
directors and employees at prices ranging from 85% to 110% of fair market value
at the date of grant. The options granted are determined by the Compensation
Committee. Options granted are usually exercisable at any time after grant,
except for those granted under the Company-wide stock option plan, which vest
over a four-year period. The options generally expire after five years.

A summary of outstanding options and shares reserved under the plans is as
follows:

WEIGHTED
SHARES AVERAGE
RESERVED OPTIONS EXERCISE PRICE
FOR GRANT OUTSTANDING PER SHARE
-----------------------------------------

Balance January 31, 1995 173,609 758,222 $1.96
Shares reserved 300,000 - -
Options exercised - (148,869) 1.28
Options granted (137,206) 137,206 6.54
Options terminated/expired 1,494 (1,494) 3.82
--------------------------
Balance January 31, 1996 337,897 745,065 2.88
Options exercised - (275,278) 2.02
Options granted (114,670) 114,670 10.74
Options terminated/expired 26,137 (26,137) 9.79
--------------------------
Balance January 31, 1997 249,364 558,320 4.73
Options exercised - (202,183) .89
Options granted (128,564) 128,564 6.19
Options terminated/expired 11,652 (11,652) 6.32
--------------------------
Balance January 31, 1998 132,452 473,049 $6.61
--------------------------
--------------------------

6. STOCK OPTIONS (CONTINUED)

As permitted by Statement of Financial Accounting Standard No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation," the Company has elected to follow
Accounting Principles Board Opinion 25, "Accounting for Stock Issued to
Employees," to measure compensation cost for employee stock options. Under APB
25, if the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.

Pro forma information regarding net income and net income per share is required
by SFAS 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions for years
ended January 31, 1996, 1997 and 1998: risk-free interest rates ranging from
5.26% to 7.5%; dividend yield of 0%; volatility factor of the expected market
price of the Company's common stock of .60; and a weighted average expected life
of the option of 5 years. The weighted average fair value of options granted
during the years ended January 31, 1998, 1977 and 1966 was $3.87, $6.51, and
$3.96 per share, respectively.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restriction and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable measure of
the fair value of its employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized over the options vesting period. The Company's pro forma
information follows:

YEAR ENDED JANUARY 31
1998 1997 1996
-------------------------------------

Pro forma net income $1,702,000 $1,851,000 $2,091,000
Pro forma net income per share:
Basic $.43 $.51 $.64
Diluted $.43 $.48 $.57

The above pro forma effects on net income and net income per share are not
likely to be representative of the effects of reported net income for future
years because options vest over several years and additional awards generally
are made each year.

The following table summarizes information about the stock options outstanding
at January 31, 1998:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------------------------------------------------------- -----------------------

$ 2.0000 - 3.1250 50,242 2.09 $ 2.9843 50,242 $ 2.9843
3.5000 - 5.1000 53,158 4.63 4.2070 33,358 3.6769
5.2500 - 5.8438 78,939 5.04 5.6207 47,912 5.6405
6.0000 - 6.2500 31,500 5.42 6.0794 12,150 6.2058
6.5000 - 6.5000 56,500 5.23 6.5000 47,500 6.5000
6.8750 - 6.8750 93,707 3.73 6.8750 42,904 6.8750
6.8758 - 9.2500 59,333 3.48 8.6370 32,575 8.1857
9.5000 - 9.5000 350 3.79 9.5000 350 9.5000
11.0500 - 11.0500 25,000 8.38 11.0500 6,250 11.0500
13.0000 - 13.0000 24,320 5.35 13.0000 6,320 13.0000
------------------------------------- -----------------------
$2.0000 - $13.0000 473,049 4.46 $ 6.6134 279,561 $ 5.8776

At January 31, 1997, the Company had 404,921 options exercisable at a weighted
average exercise price of $3.32.

7. INCOME TAXES

The provision for federal and state income tax expense from continuing
operations was as follows:

YEAR ENDED JANUARY 31
1998 1997 1996
-------------------------------------

Current:
Federal $1,349,000 $1,185,300 $1,142,300
State 242,000 226,600 228,660
-------------------------------------
1,591,000 1,411,900 1,370,960
Deferred:
Federal (162,000) 40,900 143,400
State (29,000) 7,200 25,300
-------------------------------------
-------------------------------------
$1,400,000 $1,460,000 $1,539,660
-------------------------------------
-------------------------------------

The components of the deferred tax assets and liabilities were as follows at
January 31:

1998 1997
------------------------

Current deferred taxes:
Inventory reserves $ 580,000 $ 390,800
Bad debt expense 451,000 248,000
Additional tax cost of inventory 160,000 143,000
Rental equipment depreciation (906,000) (667,000)
Other - 300
------------------------
285,000 115,100
Non-current deferred taxes:
Depreciation (69,000) (82,000)
Other 15,000 6,700
------------------------
(54,000) (75,300)
------------------------
Net deferred tax assets $ 231,000 $ 39,800
------------------------
------------------------

The difference between total income tax expense and the amount computed by
applying the statutory federal income tax rate to income before income taxes was
as follows:

YEAR ENDED JANUARY 31
1998 1997 1996
--------------------------------------------

Income taxes at statutory rate of 34% $1,135,000 $1,219,000 $1,274,300
State income taxes, net of federal tax benefit 160,000 158,000 166,960
Intangible amortization 77,000 77,000 64,600
Other 28,000 6,000 33,800
--------------------------------------------
$1,400,000 $1,460,000 $1,539,660
--------------------------------------------
--------------------------------------------

The Company paid income taxes of $1,459,000, $1,327,000 and $938,000 in 1998,
1997 and 1996, respectively.

8. RELATED PARTY TRANSACTION

Pursuant to a Stock Put Redemption Agreement between the Company and its Chief
Executive Officer ("CEO") as amended June 24, 1992, the Company has agreed to
redeem shares of Common Stock having a value of up to $1,500,000 from the CEO's
estate, following his death or, unless the Board determines that such redemption
is not in the best interest of the Company, from the CEO upon any entity
acquiring beneficial ownership of in excess of 20% of the Company without Board
approval. The put options to require or request redemption by the Company can be
exercised any time up to one year after the date of the event giving rise to the
option. The per share redemption price, in the event of death, will be the
greater of the fair market value or book value of the Common Stock. The per
share redemption price in event of change in control will be the greater of fair
market value, the highest price paid

by the new controlling shareholder, or a multiple of ten times net pretax income
per share. Any redemption from the CEO's estate will be paid out of the proceeds
of $1,500,000 of term life insurance which the Company carries on the CEO's
life.

9. INDUSTRY SEGMENTS

The Company operates within two industry segments. Vaughn Communications
Division is engaged in video tape duplication and digital media replication. The
Vaughn Products Division is engaged in the manufacture and/or sale of souvenirs,
gifts, leather products and soft goods.

YEAR ENDED JANUARY 31
1998 1997 1996
-------------------------------------

Net sales from continuing operations:
Communications Division $62,291,279 $55,040,394 $52,365,437
Products Division 12,196,484 13,757,589 7,203,464
--------------------------------------
Total net sales $74,487,763 $68,797,983 $59,568,901
--------------------------------------
--------------------------------------

Income from operations:
Communications Division $ 4,816,141 $ 4,345,161 $ 4,905,638
Products Division (182,545) 367,259 171,772
--------------------------------------
Total income from operations 4,633,596 4,712,420 5,077,410

Interest expense, net of interest income (1,295,290) (1,236,924) (1,320,574)
Other income - - 30,000
--------------------------------------
Income before income taxes $ 3,338,306 $ 3,475,496 $ 3,786,836
--------------------------------------
--------------------------------------
Depreciation and amortization:
Communications Division $ 3,860,588 $ 3,257,280 $ 2,994,128
Products Division 317,437 216,260 74,177
--------------------------------------
Total $ 4,178,025 $ 3,473,540 $ 3,068,305
--------------------------------------
--------------------------------------

Capital expenditures:
Communications Division $ 4,632,292 $ 2,752,630 $ 2,740,709
Products Division 258,665 409,873 50,489
--------------------------------------
Total $ 4,890,957 $ 3,162,503 $ 2,791,198
--------------------------------------
--------------------------------------

JANUARY 31
1998 1997 1996
-------------------------------------

Identifiable assets:
Communications Division $37,803,951 $27,321,777 $26,376,905
Products Division 6,507,673 7,429,446 6,438,913
--------------------------------------
Total assets $44,311,624 $34,751,223 $32,815,818
--------------------------------------
--------------------------------------

10. ACQUISITIONS

In July 1997, the Company acquired certain assets and assumed certain
liabilities of Certified Media Corporation ("CMC"), a compact disc replicator
located in Fremont, California. The initial purchase price was $5,500,000,
including $2,800,000 of cash, 171,210 shares of Vaughn Communications, Inc.
common stock valued at $1,200,000, and long-term debt to the sellers of
$1,500,000. The purchase price may be increased to a maximum of $7,500,000
depending upon CMC's attainment of specific financial objectives through January
31, 1999. Goodwill recorded in this transaction is being amortized over 15 years
using the straight-line method.

In July 1997, the Company also acquired certain assets of Dub South, a videotape
duplicator located in Atlanta, Georgia. The noncontingent purchase price
included $311,000 of cash and the assumption of approximately $439,000 of
liabilities. The purchase price may be increased by an additional $1,200,000,
depending on the profit performance for the next five years. There was no
goodwill recorded on this transaction.

10. ACQUISITIONS (CONTINUED)

Both acquisitions have been accounted for by the purchase method of accounting,
and the consolidated financial statements for the year ended January 31, 1998,
reflect the purchase of the businesses, and include any results from operations
subsequent to the closing dates of the respective transactions.

Satastar Corporate Services, Inc. ("Satastar," dba PVS Corporate Services), a
videotape duplicator located in Chicago, Illinois, was merged with the Company
in June 1996 by the issuance of 165,357 shares of common stock in exchange for
all of the outstanding capital stock of Satastar Corporate Services, Inc. The
business combination has been accounted for as a pooling of interests, and
accordingly, the consolidated financial statements of the Company include the
combined results of operations of the Company and Satastar for all years
presented.

Included in results of operations for the year ended January 31, 1997 are the
following results of the previously separate companies for the period of
February 1, 1996 to June 28, 1996:

YEAR ENDED JANUARY 31, 1997
COMPANY SATASTAR COMBINED
----------------------------------------

Net sales $67,436,266 $1,361,717 $68,797,983
Net income (loss) 2,099,227 (83,731) 2,015,496

The following is a reconciliation of revenue and earnings previously reported by
the Company for the year ended January 31, 1996 with the combined amounts
currently presented in the financial statement for the period.

YEAR ENDED JANUARY 31, 1996
COMPANY SATASTAR COMBINED
----------------------------------------

Net sales $55,513,000 $4,056,000 $59,569,000
Net income 2,145,000 102,000 2,247,000

In April 1995, the Company completed the acquisition of all the capital stock of
Centercom, Inc. and Centercom South, Inc. (collectively "Centercom"), a
videotape duplicator with facilities in Milwaukee, Wisconsin; Chicago, Illinois;
and Tampa, Florida. The acquisition was accounted for by the purchase method of
accounting and, accordingly, results from operations have been included in
the consolidated financial statements from the date of the acquisition.

The purchase price was $6,420,000 including $5,250,000 of cash and 180,000
shares of Vaughn Communications, Inc. common stock valued at $1,170,000. In
addition, the selling shareholders of Centercom collectively receive $200,000 a
year for seven years under non-compete and consulting agreements. Goodwill
recorded in this transaction is being amortized over 15 years using the
straight-line method.

In January 1996, the Company completed the acquisition of substantially all of
the assets of Advanced Audio/Video Productions, Inc., a video tape duplicator
located in Denver, Colorado. The acquisition has been accounted for by the
purchase method of accounting, and the consolidated statement of income for the
year ended January 31, 1996 includes the results of Advanced Audio/Video for the
month of January 1996.

The purchase price was approximately $282,000 including a cash payment by the
Company of approximately $182,000 and long-term debt to the seller of $100,000.
(See Note 4 for description of long-term debt.) Goodwill recorded in this
transaction is being amortized over 15 years using the straight-line method.

On January 31, 1996, the Company acquired the assets and assumed certain
liabilities of Indian Arts and Crafts, Inc., a gift products business located in
Seattle, Washington. The acquisition has been accounted for by the purchase
method of accounting, and the consolidated financial statements for the year
ended January 31, 1996 reflect the purchase of the business, but do not include
any results from operations since the transaction was completed on the last day
of the fiscal year.

10. ACQUISITIONS (CONTINUED)

The purchase price was approximately $2,332,000 including approximately $82,000
of cash, 145,138 shares of Vaughn Communications, Inc. common stock valued at
$1,250,000, and long-term debt to the seller of $1,000,000. (See Note 4 for
description of long-term debt.) Goodwill recorded in this transaction is being
amortized over 10 years using the straight-line method.

The following unaudited pro forma information presents the consolidated results
of operations of the Company as if the acquisitions had been completed at the
beginning of the year in which the acquisition occurred and the immediately
preceding year. In the opinion of the Company's management, all adjustments
necessary to present fairly such pro forma summary have been made based on the
terms and structure of the transactions.

YEAR ENDED JANUARY 31
1998 1997 1996
---------------------------------------

Net sales $78,266,000 $75,175,000 $70,126,000
Net income 1,731,000 704,000 2,526,000
Net income per share:
Basic $.43 $.18 $.74
Diluted .42 .17 .66

11. EARNINGS PER SHARE

YEAR ENDED JANUARY 31
1998 1997 1996
--------------------------------------

Basic net income per share:
Net income $1,938,306 $2,015,496 $2,247,176
Weighted average shares outstanding 3,918,263 3,640,304 3,243,905

Net income per share $.49 $.55 $.69

Diluted net income per share:
Net income $1,938,306 $2,015,496 $2,247,176

Shares used in calculation:
Weighted average shares outstanding 3,918,263 3,640,304 3,243,905
Dilutive shares issuable in
connection with stock plans 101,719 284,129 433,648
--------------------------------------
4,019,982 3,924,433 3,677,553
--------------------------------------
--------------------------------------

Net income per share $.48 $.51 $.61

Options to purchase 204,648 shares of common stock were not included in the
computation of diluted net income per share for fiscal 1998 because the options'
exercise price was greater than the average market price of the common shares.

12. FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of the Company's financial instruments as of January 31,
1998 and 1997 approximated their fair value.

13. SUBSEQUENT EVENT

In February 1998, the Company completed the acquisition of the assets of
Copywise, Inc. ("Copywise"), a floppy disk replicator located in Fremont,
California. The acquisition will be accounted for by the purchase method of
accounting. Goodwill associated with the purchase will be amortized over 15
years. The noncontingent purchase was approximately $1,670,000 of cash and the
assumption of approximately $667,000 of liabilities. The purchase price may be
increased by an additional $1,560,000 depending upon the attainment of certain
financial objectives by the acquired business through January 31, 2000.

Copywise net sales and income before income taxes (unaudited) for the years
ended December 31 were as follows:

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

Net sales $7,531,000 $10,028,000
Income before income taxes 1,159,000 1,753,000

COMMON STOCK INFORMATION

The Company's Common Stock is traded over-the-counter and has been included in
the National Association of Securities Dealers, Inc. Automated Quotations System
("NASDAQ") National Market System since March 26, 1994, under the symbol VGHN.
The information presented is the quarterly high and low closing sales prices as
reported in the NASDAQ's National Market System. All prices are without retail
markups, markdowns or commissions.

CALENDAR PERIOD SALE PRICE
- --------------------------------------------- --------------------------
HIGH LOW

1996: First Quarter. . . . . . . . . . . $ 9.375 $ 8.375
Second Quarter . . . . . . . . . . 19.00 9.00
Third Quarter. . . . . . . . . . . 15.00 9.50
Fourth Quarter . . . . . . . . . . 10.50 7.00

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1997: First Quarter. . . . . . . . . . . $ 8.00 $ 6.00
Second Quarter . . . . . . . . . . 7.50 5.25
Third Quarter. . . . . . . . . . . 8.563 6.75
Fourth Quarter . . . . . . . . . . 8.00 5.4375

1998: First Quarter. . . . . . . . . . . $ 8.125 $ 5.50

As of January 31, 1998, the Company had 310 shareholders of record.

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REPORT OF INDEPENDENT AUDITORS

The Shareholders and Board of Directors
Vaughn Communications, Inc.

We have audited the accompanying consolidated balance sheets of Vaughn
Communications, Inc. and subsidiaries as of January 31, 1998 and 1997, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended January 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Vaughn
Communications, Inc. and subsidiaries at January 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended January 31, 1998, in conformity with generally
accepted accounting principles.

Minneapolis, Minnesota
March 27, 1998

/s/ Ernst & Young, LLP