<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                              --------------------

                                   FORM 10 - K
              Annual Report pursuant to Section 13 or 15 (d) of the
                         Securities Exchange Act of 1934

                      For the Year Ended December 31, 1998

                         Commission File Number 0-11630
                              ---------------------

                          INTELECT COMMUNICATIONS, INC.
             (Exact Name of Registrant as Specified in Its Charter)

                   DELAWARE                                   76-0471342
       (State or Other Jurisdiction of                     (I.R.S. Employer
        Incorporation or Organization)                   Identification No.)

   1100 EXECUTIVE DRIVE, RICHARDSON, TEXAS                      75081
   (Address of Principal Executive Offices)                   (Zip Code)

                                  972-367-2100
              (Registrant's Telephone Number, Including Area Code)

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

           Securities Registered Pursuant to Section 12 (b) of the Act
                                      NONE

           Securities Registered Pursuant to Section 12 (g) of the Act
                     COMMON STOCK PAR VALUE $0.01 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 preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

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 [ ]

The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $36,193,000 as of March 29, 1999 (based upon the
average of the highest bid and lowest asked prices on such date as reported on
the Nasdaq National Market).

There were 36,157,949 shares of Common Stock outstanding as of March 29, 1999.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's definitive Proxy Statement to be filed pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
(December 31, 1998) are incorporated by reference in items 10, 11, 12 and 13 of
PART III hereof.



<PAGE>   2
                                     PART I

ITEM 1 - BUSINESS

FORWARD LOOKING STATEMENT

         This Form 10-K contains certain forward looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E
of the Securities Exchange Act of 1934, as amended. The forward looking
statements involve risks and uncertainties that could cause actual results to
differ materially from those expressed in, or implied by, the forward looking
statements. Factors that might cause such a difference include, but are not
limited to, those relating to: general economic conditions in the markets in
which the Company operates, success in the development and market acceptance of
new and existing products (particularly SONETLYNX, FIBRETRAX, LANscape, and
CS4); dependence on suppliers, third party manufacturers and channels of
distribution; customer and product concentration; fluctuations in customer
demand; maintaining access to external sources of capital; ability to execute
management's margin improvement and cost control plans; overall management of
the Company's expansion; and other risk factors detailed from time to time in
the Company's filings with the Securities and Exchange Commission.

THE COMPANY

         Intelect Communications, Inc. (the "Company") was incorporated in
Delaware on May 23, 1995. The Company's predecessor, Intelect Communications
Systems Limited ("Intelect (Bermuda)") was incorporated under the laws of
Bermuda in April 1980 and operated under the name Coastal International, Ltd.
until September 1985 and as Challenger International Ltd. until December 1995.
On December 4, 1997, the shareholders of Intelect (Bermuda) approved a merger
proposal, the principal effect of which was to change the domicile of Intelect
(Bermuda) so that it became a publicly traded United States-domiciled, Delaware
corporation. The effect of the merger was that the shareholders of Intelect
(Bermuda) became shareholders of the Company with the Company becoming the
publicly traded company. In addition, the Company became the holding company for
Intelect (Bermuda) and replaced Intelect (Bermuda) as the holding company for
its subsidiaries. The merger was effected on December 4, 1997.

OVERVIEW

         The Company is engaged in the business of designing, developing,
manufacturing, marketing and selling products and services for managing digital
signals and converging voice, data and video networks. The Company's current
operations were established through a series of mergers in 1995 and 1996, at
which time four communications product platforms were defined to respond to the
increasing demands of speed and complexity in communications.

         The Company is strategically focusing its product lines and services to
take advantage of the convergence of telecommunications (telecom) and data
communications (datacom). This convergence is being driven by the explosive
growth of Internet applications such as E-commerce, which is accelerating the
expansion of network capacities. These industry trends create requirements for
today's network integrators and directors to manage multiple applications, at
multiple locations, within bandwidth resources and while balancing the need for
network reliability. The Company's product lines are designed to meet these
evolving markets, applications and requirements.

         The Company's objective is to develop and bring to market a new
generation of intelligent, flexible, and scalable communications products
designed to combine current voice, data and video networks (for example,
telephones, computers, surveillance) into a single communications network, which
would also upgrade communications into the latest generation of high-speed
technologies, while using a single network management system.


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<PAGE>   3


PRODUCTS, TECHNOLOGIES AND SERVICES

Multi-service Access Platform (MAP)

         Marketed initially and currently under the names SONETLYNX and
FIBRETRAX, the Company believes the MAP is a revolutionary networking
infrastructure product for public and private networks to cost-effectively
create voice, data and/or video networks of virtually any size and application.
It is defined as a platform because, from its basic architecture, it can be
configured into many separate products for a variety of functions and
applications. Through the use of different protocol cards, the MAP can
simultaneously combine multiple communication transmissions such as video and
graphics communications, data files, voice and any IP-based service over a
single network. The products are compatible with Synchronous Optical Network
(SONET) and Synchronous Digital Hierarchy (SDH) standards in order to provide
fail-safe networks. The SONETLYNX and FIBRETRAX, in addition to providing
add-drop multiplexing, provide the functions of traditional networking equipment
such as bridges, channel banks, routers and video matrix switches, thus offering
significant savings in cost and time for the user when OC-1 or OC-3 bandwidth is
required. The MAP expands into markets horizontally by increasing the types of
protocols (applications) it can transport, and vertically by increasing its
capacity (transmission speed). Currently, the MAP can transport voice, Fast
Ethernet (10/100baseT), JPEG video and low speed data protocols such as RS-232
and RS-422 at speeds up to the OC-3/STM-1 rate (155 Mbps). Product advancements
scheduled during 1999 include adding the protocol cards for ISDN, digital modem
pool and Frame Relay as well as increasing the MAP's transmission speed to the
OC-12/STM-3 rate (622 Mbps). Video and high speed data modules are planned with
higher port density. Network management systems are under development in the
Windows NT version. The cost effectiveness and competition advantage of the MAP
are expected to increase with the addition of each major protocol and increase
in transmission speed.

Engineering Services

         DNA Enterprises, the Company's engineering services operation, provides
advanced product and system design and development services for a variety of
clients in the communications industry. The Company believes DNA Enterprises is
a leading contract and outsource development resource for the communications
industry. DNA provides expertise in digital signal processing (DSP), switching
and transport systems, computer telephony integration (CTI), embedded systems,
data communications, intelligent networks, video processing, and wireless
communications technologies.

Digital Signal Processing

         The DSP Design Center is a Center of Excellence within DNA Enterprises
that provides state-of-the-art digital signal processing technology to systems
developers around the world to afford them leading-edge solutions, faster
time-to-market, and reduced technical risk for their product development
programs. The DSP Design Center has developed a product line consisting of
standard designs for high performance circuit boards, and offers custom designed
hardware, application support software, real-time operating systems, and
consulting services to product manufacturers and application developers in the
multimedia, image processing, communications, and remote sensing systems arenas.
The bulk of the Design Center's activities center around the Texas Instruments
("TI") line of Digital Signal Processors, with emphasis on TI's high performance
C5x and C8x devices and a particular focus on the new TI C6000 processor line.

Visual Communications

         The LANscape product is designed to provide full motion, collaborative
video communications in a single cost effective solution for desktop PCs to
large room systems. The product has the capability to conduct up to a three-way
conference call without a costly multiconferencing unit (MCU), transmit video
broadcasts using IP multicast, and use its integrated software to switch between
two incoming video sources. Each 




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<PAGE>   4

incoming video is contained in an individual window which the user can control
as to size and volume. In addition to video conferencing, LANscape features
video record and playback controls for applications such as education/training
and recorded event distribution. LANscape support of IP multicast allows for
transmission of live or pre-recorded video from one to many.

CS4 Intelligent Services Platform

         The Company believes the CS4 represents a revolutionary new class of
product. It is an integrated enhanced network server. Its array of integrated
capabilities transcends traditional product categories to introduce a flexible
system that can host a wide range of intelligent services in a variety of
network configurations. The design of the CS4 positions it to impact the
proliferation and profitability of intelligent services in the network, as well
as to improve the cost paradigm now in place for service nodes, intelligent
peripherals, enhanced service platforms, and programmable switches. Key
technological innovations reflected in the CS4 include highly distributed
processing power to the port level, scalable port capacity that extends up to
64k ports, an advanced call processing structure, a powerful service creation
facility, and an architecture that readily supports integration into low speed,
high speed, and broadband networks, all designed for a fault-tolerant, NEBS
compliant structure.

MARKETS AND CUSTOMERS

Multi-service Access Platform

         Primary markets for SONETLYNX and FIBRETRAX are purpose-built networks
such as advanced highway control systems and pipeline communication and control
systems. Target markets include corporate/enterprise networks, utilities,
airports, transportation entities, security services, prisons, health services,
academia, and local and state government, as well as public and private bypass
networks. The Company expects additional products being developed and planned
for the MAP platform to enable increased penetration in public and private
network access markets. The Company markets its SONETLYNX and FIBRETRAX network
products primarily through 25 distributors, system integrators and value added
resellers (51% of SONETLYNX and FIBRETRAX revenue in 1998). Sales are also made
by a direct sales force and through representatives. During 1997, the Company's
largest distributor, reselling to customers in the Republic of Korea, was
responsible for 85% of SONETLYNX sales. In 1998, no customer or distributor
accounted for more than 10% of consolidated sales. SONETLYNX is targeted for
markets and applications where multiple protocol communication mandates the
capacity and reliability of fiber, further strengthened by redundancy of
critical components and architecture.

Engineering Services

         The Company's engineering services are employed by clients that span
the spectrum from start-up ventures seeking to launch new products to large
multi-national corporations looking to access key know-how for extending current
product lines or introducing new products/services. The products the Company
develops range from compact circuit boards to multi-board systems that address
the consumer, commercial, industrial, and defense market sectors. The Company
markets its services directly to prospects worldwide. Principal customers for
the Company's services include board manufacturers, telecommunications equipment
vendors, semiconductor suppliers, and communications service providers.

Digital Signal Processing

         The products developed by the DSP Design Center are marketed both
directly by the Company and through sales channel partners to customers in North
America, Europe, and Asia. Customers for these products have a common need for
high-performance DSP capabilities for integration into their products, which
include commercial telecommunications systems, industrial control products,
video processing and image enhancement systems, and military communication
systems.



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<PAGE>   5

Visual Communication Products

         The Company generally markets its visual communication products
directly and through distributors and value added resellers. Primary markets for
its video communication products are businesses and educational and government
institutions. These markets include corporate networks, financial trading
networks, Internet deployment over digital subscriber lines and other high
capacity services, Educational/Distance learning networks, medical networks and
government networks.

CS4 Intelligent Services Platform

         The CS4 is scheduled to commence initial field trials in early second
quarter 1999. The Company currently intends to commercialize the CS4 through a
separate business unit that provides leading-edge solutions for high-value
intelligent voice services in wireline, wireless, and internet-related markets
and is seeking to arrange third party participation in the continuing
development and initial marketing of the CS4.

         The CS4 was developed to meet the requirements of high growth segments
in the telecommunications equipment and services market in both circuit-switched
and packet-switched networks. International and domestic target markets include
Competitive Local Exchange Carriers, Competitive Access Providers, PCS and
Cellular Service Providers, Inter-exchange Carriers, Internet Service Providers,
and emerging network infrastructures.

COMPETITION

         The market for the Company's products and services is intensely
competitive and rapidly changing. The Company competes, or may in the future
compete, directly or indirectly for customers in the following categories of
products and companies: (i) network transmission product manufacturers such as
Lucent Technologies Corp., Northern Telecom, Ltd., and Reltec; (ii) video
conferencing H.320/323-based product manufacturers such as VTEL Corp and
PictureTel Corp.; (iii) Enhanced Services Platform and Intelligent
Peripheral/Service Node providers such as Lucent Technologies, Ericsson, Nortel,
Comverse Technology, Intervoice, and Centigram Communications Corporation.

         In recent months, large telecom equipment companies including Lucent,
Northern Telcom, Alcatel and Siemens have announced acquisitions of datacom
companies. At the same time, a large datacom company, Cisco, has announced plans
for equipment to carry voice, data and video traffic using Internet technology.
These activities constitute the so-called "convergence" of voice and data
switching technologies. Large customers for switching equipment, including AT&T
and MCI WorldCom have announced their intentions to support this convergence.
The Company believes these actions ratify its product design strategies,
especially the development of the MAP and CS4. On the other hand, the recent
actions by large companies also represent an environment of increasing direct
competition for customers of the newly convergent technologies.

         The Company believes that the principal competitive factors affecting
the markets for its products and services include effectiveness, scope of
product offerings, technical features, ease of use, reliability, customer
service and support, distribution channels and price. Most competitors are
better capitalized and have greater resources than the Company and, accordingly,
may have a competitive advantage in product development and selling.

MANUFACTURING

         The basis of the Company's manufacturing strategy is to identify and
use the appropriate technology to obtain the most favorable combination of
quality and end product cost. The Company's manufactured products consist
largely of assembled printed circuit boards and chassis. These are sold either
as assembled 



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<PAGE>   6

systems (such as SONETLYNX or FIBRETRAX) or as a stand-alone product (such as
LANscape). As the Company's product lines expand and mature, the Company expects
to increase manufacturing capacity by means that could include adding employees,
expanding current facilities, leasing or purchasing additional facilities or
equipment, and expanding and adding outsourcing relationships. See ITEM 2 -
Properties.

         Raw materials are primarily electronic components available from
multiple sources. Certain sole source components are not generally considered a
vulnerability because they are reliably supplied by large companies. The Company
sources a fiber optic interface card, for the OC-3 product, from a third party
which is the sole source for the component. The Company also buys a video codec
card, used in SONETLYNX video applications from a sole source. Delays in
delivery of either component would restrict the Company's ability to increase
sales. In the event either vendor fails to meet commitments, the Company intends
to rely on its in-house manufacturing capabilities. However, the conversion to
in-house backup supply would not be without some interruption and may increase
cost. The Company has an ongoing program to reduce its exposure to limited
source components where possible.

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

         The Company believes it has a substantial base of intellectual
property, in the form of software and hardware, some of which is embodied in its
products and applied in its ongoing development programs. The Company believes
that factors such as technological and creative skills of its personnel, new
product developments, frequent product enhancements, name recognition, and
reliable product manufacturing are essential to establishing and maintaining a
technology leadership position.

         The Company relies on a combination of patent, copyright, trademark and
trade secret laws, and confidentiality procedures to protect its proprietary
rights. The Company currently has three United States patents relating to video
transmission and audio conferencing technology and has fifteen currently pending
patents relating to DSP, electronic design, internet, operating systems, voice
switching, video distribution and communications. "SONETLYNX(R)," "INTELECT(R),"
"VUBRIDGE(R)," "S4(R)," and "Special Services Switching System(R)" are
registered trademarks of the Company. "FIBRETRAX(TM)" and "PANORAMA(TM)" are
trademarks of the Company. The Company has received notice that its use of the
name LANSCAPE infringes a similar mark. The Company believes it is not
infringing. A third party has advised the Company of a cancellation proceeding
at the Patent and Trademark Office which, if successful, would nullify the
notice party's claim of first use. It is not possible to determine the outcome
of the cancellation proceeding. Under any possible outcome, the Company is
likely to be in a position of negotiating an agreement with another party for
the shared use of the LANSCAPE name. According to federal and state law, the
Company's trademark protection will continue for as long as the Company
continues to use its trademarks in connection with the products and services of
the Company. The Company seeks to protect its software, documentation and other
written materials under trade secret and copyright laws, which afford only
limited protection.

          In connection with the acquisition of DNA Enterprises and Intelect
Visual Communications and transactions with certain individuals, licenses were
acquired to support the development of SONETLYNX, video conferencing and DSP
products. The Company also incorporates third-party licenses into its products.

         The Company owns the rights to the following internet domain names:
intelectcom.com, intelectinc.com, videoconferencing.com, and dnaent.com.

         Litigation may be necessary to enforce the Company's patents and other
intellectual property rights, to protect the Company's trade secrets, to
determine the validity of and scope of the proprietary rights of others, or to
defend against claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of resources and could have a material
adverse effect on the Company's business, financial condition or results of
operations.



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<PAGE>   7

          In common with many companies in the telecommunications industry, the
Company has received notices that it may be infringing on certain intellectual
property rights of others. These claims have been defended with advice of
counsel and certain defenses are ongoing. In connection with such claims or
actions asserted against the Company, the Company may seek to obtain a license
under a third party's intellectual property rights, if necessary. There can be
no assurance, however, that a license will be available under reasonable terms
or at all. In addition, the Company could decide to litigate such claims, which
could be expensive and time consuming and which could have materially adverse
effects on the Company's business, financial condition or results of operations.

EMPLOYEES

         The Company had 307 full-time employees at December 31, 1998, of which
148 were engaged in engineering and development, 64 were engaged in sales,
marketing, and customer support, 72 were engaged in manufacturing operations,
and 23 were engaged in administration and finance. None of the Company's
employees is represented by a labor union. The Company has experienced no
material work stoppages and believes its relations with its employees to be
good. At December 31, 1997, the Company had 365 full-time employees.

GOVERNMENT REGULATION

         The telecommunications industry, including many of the Company's
customers, is subject to regulation from federal and state agencies, including
the Federal Communications Commission ("FCC") and various state public utility
and service commissions. Similar regulatory structures exist in most countries
outside the United States. While such regulation does not affect the Company
directly, the effects of such regulations on the Company's customers may, in
turn, adversely impact the Company's business and results of operations. For
example, FCC regulatory policies, affecting the availability of services and
other terms on which telecommunications service providers ("Telcos") conduct
their business, may impede the Company's penetration of certain markets. Current
FCC regulations restrict Telcos' ability to charge their customers based on
access cost to local subscribers and may affect the timing of Telcos' investment
in the Company's technology. These FCC regulations and policies are under
continuous review by the federal government and the courts and are subject to
change. Although many FCC restrictions on providing services in previously
restricted markets have been eliminated or modified, the failure to change, or a
substantial delay in changing, the existing restrictions on Telcos may
materially adversely affect their demand for products based upon the Company's
technology.

         The Telecommunications Act of 1996 removed certain restrictions
relating to the Regional Bell Operating Companies. The Company believes that
this has created and will continue to create increased competition in the
markets served by the Company's products.

         In addition, the Company's business and operating results may also be
adversely affected by the imposition of certain tariffs, duties and other import
restrictions on components that the Company obtains from non-domestic suppliers
or by the imposition of export restrictions on products that the Company sells
internationally. The governments of many other countries actively promote and
create competition in the telecommunications industry. Changes in current or
future laws or regulations, in the United States or elsewhere, could materially
and adversely affect the Company's business and results of operations.

ITEM 2 - PROPERTIES

         All of the Company's facilities are leased. The facilities are in
Richardson, Texas, New York, New York, and London, England. The Company's
principal operations are serviced from four leased facilities in Richardson,
Texas, (comprising 103,000 square feet) and one in New York (comprising 20,000
square feet). These facilities include manufacturing, engineering, sales,
marketing, and administrative offices. All of the 




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Company's manufacturing operations are located in a 28,000 square foot
Richardson, Texas facility. The Company moved its headquarters from Hamilton,
Bermuda to Richardson, Texas in March 1997. In March 1998, the Company closed
its offices in New York and London. The Company believes these facilities, which
total 124,000 square feet, are adequate for its present needs.

ITEM 3 - LEGAL PROCEEDINGS

         The Company is involved in various legal proceedings and claims arising
in the ordinary course of business.

         On October 28, 1998, in the 192nd Judicial District Court for Dallas
County, Texas, Richard Dzanski filed suit against Intelect Network Technologies
Company, a wholly owned subsidiary of the Company, and Intelect Systems Corp.,
the predecessor of the Company. In the suit, the plaintiff has claimed a breach
of an Irrevocable Option Agreement and that he has not received payments he
claims are due to him in the amount of at least $386,000. The defendants deny
liability to the plaintiff and intend to vigorously defend the case. The parties
are in discovery and it is too early to determine if the outcome of this case
will have a material impact on the Company.

         Intelect (Bermuda) is contingently liable for certain potential
liabilities related to its discontinued operations. Specifically, under a stock
purchase agreement dated October 3, 1995 ("1995 Agreement"), Intelect (Bermuda)
agreed to indemnify Savage Sports Corporation, the purchaser of Savage Arms,
Inc. (a manufacturer of fire arms), for certain product liability, environmental
clean-up costs and other contractual liabilities, including certain asserted
successor liability claims. One of the liabilities assumed involves a firearms
product liability lawsuit filed by Jack Taylor individually and as father of
Kevin Taylor in Alaska Superior Court (the "Taylor litigation"). Intelect
(Bermuda) is informed that a defendant in the Taylor litigation, Western Auto
Supply Co., settled the lawsuit for $5 million and, in turn, has asserted a
third-party claim against Savage Arms, Inc. for indemnification in the amount of
the settlement plus attorneys' fees and related costs. Savage Arms has asserted
defenses to the claims and Intelect (Bermuda) believes additional defenses may
be available. Based on the information available to date, it is impossible to
predict the outcome of this litigation or to assess the probability of any
verdict.

         Intelect (Bermuda) also has been notified that Savage Sports
Corporation seeks indemnification under the 1995 Agreement in connection with
certain other product liability claims. Most notably, Intelect (Bermuda) has
undertaken the defense of a lawsuit filed against Savage Arms, Inc. by Emhart
Industries, Inc. ("Emhart") in the United States District Court for the District
of Massachusetts (the "Emhart litigation"). In the lawsuit, Emhart requests
indemnification from Savage Arms, Inc. under an agreement Emhart allegedly
executed in 1981 with Savage Industries, Inc., claiming that Savage Arms, Inc.
is a successor to Savage Industries, Inc. To date, Emhart has claimed
indemnification of approximately $2.2 million for five lawsuits it has defended
or settled and also seeks a declaratory judgment that it is entitled to
indemnification for losses and expenses related to firearms product liability
actions which may be filed against Emhart in the future. Intelect (Bermuda)
intends to assert additional defenses. The parties are in discovery and Intelect
(Bermuda) cannot at this time predict the outcome of the litigation.

         In the event the Taylor litigation and/or Emhart litigation were to be
resolved adversely to Intelect (Bermuda), there would be a material adverse
effect on the Company's financial condition and results of operations. See Note
20 to the Consolidated Financial Statements.

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

         None




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<PAGE>   9

                                     PART II

ITEM 5 - MARKETS FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The common stock of the Company is traded in the over-the-counter
market and is listed on the Nasdaq Stock Market under the symbol "ICOM." The
high and low bid prices for the Company's common stock for each full quarter of
the last two fiscal years, as reported on Nasdaq, are as follows:

<TABLE>
<CAPTION>
                                                                                      High               Low
                                                                                      ----               ---
<S>                                                                                <C>               <C>  
         1st  quarter 1997 - period ended March 31, 1997                             5.125             1.875
         2nd quarter 1997 - period ended June 30, 1997                               4.625             1.375
         3rd quarter 1997 - period ended September 30, 1997                         11.500             4.250
         4th quarter 1997 - period ended December 31, 1997                          11.313             3.188

         1st  quarter 1998 - period ended March 31, 1998                             7.625             4.438
         2nd quarter 1998 - period ended June 30, 1998                               7.250             5.432
         3rd quarter 1998 - period ended September 30, 1998                          5.625             1.656
         4th quarter 1998 - period ended December 31, 1998                           3.563             1.438
</TABLE>

         The Company believes that as of March 29, 1999, its outstanding shares
of common stock were held by approximately 20,500 owners of record.

         The closing bid price of the common stock on the Nasdaq National Market
on March 29, 1999, was $1.00.

DIVIDEND POLICY

         No cash dividends were paid by the Company during 1996, 1997 or 1998.
The Company does not currently plan to pay any dividends on common stock in the
foreseeable future. The Company is restricted by its agreements with lenders and
the holders of certain of its preferred stock from any payment of dividends on
common stock and from the payment of dividends on preferred stock except
dividends payable with common stock. These restrictions remain in effect for so
long as any balance remains payable on the debt or such preferred stock remains
outstanding. See Note 14 to the Consolidated Financial Statements.

RECENT SALES OF UNREGISTERED SECURITIES

         Effective as of January 1, 1999, the Company issued 144,681 shares of
common stock in lieu of a $212,000 cash dividend on its Series A Preferred Stock
for the quarter ended December 31, 1998.

         On November 23, 1998 and December 4, 1998, in a transaction exempt from
registration under Section 4(2) of the Securities Act, the Company issued
300,000 shares each in connection with the exercise of warrants to purchase
common stock at a price of $2.00 per share.




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<PAGE>   10

ITEM 6 - SELECTED FINANCIAL DATA

         The following tables set forth certain historical consolidated
financial data for the Company.

<TABLE>
<CAPTION>
                                                                                                Two
                                                                                               months
                                                                                               ended
                                                                                              December           Years ended
                                                           Years ended December 31,              31,             October 31,
                                                   --------------------------------------    ----------    ------------------------
                                                      1998          1997          1996          1995          1995          1994
                                                   ----------    ----------    ----------    ----------    ----------    ----------
                                                                          ($ Thousands Except Per Share Data)
<S>                                                <C>           <C>           <C>           <C>           <C>           <C> 
STATEMENT OF OPERATIONS:
Net revenues                                       $   19,341        37,777         9,352           734         2,030            --
                                                   ==========    ==========    ==========    ==========    ==========    ==========
Operating loss                                     $  (38,787)      (17,642)      (33,638)       (2,943)       (4,652)         (558)
                                                   ==========    ==========    ==========    ==========    ==========    ========== 
Loss from continuing operations                    $  (42,735)      (19,743)      (42,983)       (2,776)       (5,194)         (538)
Income from discontinued
   operations                                              --            --            --            --         3,546         3,410
Income (loss) on disposal of
   discontinued operations                               (403)         (498)          (56)         (236)       13,824            --
Income (loss) before                               ----------    ----------    ----------    ----------    ----------    ----------
   extraordinary item                              $  (43,138)      (20,241)      (43,039)       (3,012)       12,176         2,872
Income (loss) allocable to common                  ==========    ==========    ==========    ==========    ==========    ==========
   stockholders                                    $  (46,105)      (20,798)      (43,039)       (3,012)       12,811         2,872
                                                   ==========    ==========    ==========    ==========    ==========    ==========

Basic and diluted income (loss) per share:
Continuing operations                              $    (1.76)        (0.99)        (3.32)        (0.24)        (0.47)        (0.05)
                                                   ==========    ==========    ==========    ==========    ==========    ==========
Discontinued operations                            $     (.02)        (0.02)        (0.01)        (0.02)         1.57          0.34
                                                   ==========    ==========    ==========    ==========    ==========    ==========
Extraordinary item                                         --            --            --            --          0.06            --
                                                   ==========    ==========    ==========    ==========    ==========    ==========
Net Income (loss) for period                       $    (1.78)        (1.01)        (3.33)        (0.26)         1.16          0.29
                                                   ==========    ==========    ==========    ==========    ==========    ==========
Weighted average shares (thousands)                    25,939        20,558        12,943        11,385        11,024         9,942
</TABLE>


<TABLE>
<CAPTION>
                                                   ------------------------------------   ----------   -----------------------
                                                                                           December 
                                                                December 31,                  31,           October 31,
                                                   ------------------------------------   ----------   -----------------------
                                                      1998         1997         1996         1995         1995         1994
                                                   ----------   ----------   ----------   ----------   ----------   ----------
<S>                                                <C>          <C>          <C>          <C>          <C>          <C> 
BALANCE SHEET:
ASSETS:
Current assets                                     $   16,413       25,552       11,594       19,957       24,587        2,599
Excess of cost over assets of
   companies acquired                                   4,787       13,249       14,573        8,685        9,349           --
Other long-term assets                                 10,882       10,430        9,269        2,597        1,786           --
                                                   ----------   ----------   ----------   ----------   ----------   ----------
Total assets                                       $   32,082       49,231       35,436       31,239       35,772       12,172
                                                   ==========   ==========   ==========   ==========   ==========   ==========

LIABILITIES & SHAREHOLDERS' EQUITY:
Current liabilities including current
    maturities of long-term debt                   $    9,852       22,939        9,810        5,331        7,091          269
Long-term liabilities                                  14,698          143       17,895          368          365           --
Shareholders' equity                                    7,532       26,149        7,731       25,540       28,266       11,903
                                                   ----------   ----------   ----------   ----------   ----------   ----------
                                                   $   32,082       49,231       35,436       31,239       35,722       12,172
                                                   ==========   ==========   ==========   ==========   ==========   ==========
</TABLE>




                                       10
<PAGE>   11

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

OVERVIEW

         Results of operations consist of:

         o        the fiber optic multiplexer and special services switch
                  businesses of Intelect Network Technologies Company ("INT")
                  from its April 24, 1995 acquisition,

         o        the engineering services business of DNA Enterprises, Inc.
                  ("DNA") from its February 13, 1996 acquisition,

         o        the digital signal processor products business of DNA since
                  product introductions in 1997 and 1998,

         o        the visual communication system business of Intelect Visual
                  Communications Corp. ("IVC") from its March 29, 1996
                  acquisition, and

         o        the information security business of Intelect Europe Limited
                  ("IEL") from its August 31, 1995 acquisition until its
                  liquidation in January 1997.

         The following table shows the revenue and gross profits for the
Company's products:

<TABLE>
<CAPTION>
                                         Years ended December 31,
                                     --------------------------------
                                       1998        1997        1996
                                     --------    --------    --------
                                              ($ Thousands)
<S>                                  <C>           <C>          <C>  
          Revenue:
          Fiber optic multiplexer       6,410      26,250         430
          Engineering services          8,147       8,632       4,332
          Digital signal processor      2,690         277          81
          Visual communication          1,448         636         172
          Switching and other             646       1,982       4,337
                                     --------    --------    --------
                                     $ 19,341      37,777       9,352
                                     --------    --------    --------
          Gross profit (loss):
          Fiber optic multiplexer      (1,903)     12,035        (625)
          Engineering services          2,002       2,375       1,270
          Digital signal processor      1,390         (88)       (306)
          Visual communication            497          41        (826)
          Switching and other          (1,078)       (112)     (2,134)
                                     --------    --------    --------
                                     $    908      14,251      (2,621)
                                     --------    --------    --------
</TABLE>

REVENUES

         Revenues in 1998 decreased 49% from 1997 after having increased 304%
over 1996. The revenue increase in 1997 was due to increased sales to Korean
customers, which represented 59% of that year's total revenues. The decline in
1998 revenues was due to the decline in sales to the Korean market reflecting
the financial condition of the Asian region. This decline was partially offset
by a 20%, or $785,000 increase in non-Korean sales.

         The Company is not basing future revenue expectations on recovery in
Asia. Prospects for continued growth in non-Asian markets are supported by new
orders in the United States for approximately $10,000,000 of fiber optic
multiplexer product received early in 1999.

                                       11
<PAGE>   12

         Engineering service revenues in 1998 approximated the level of 1997
when the revenues increased 99% over 1996. Growth of the services business was
constrained by the concentration of resources on DSP product development in the
DNA DSP Design Center.

         DSP products, primarily those based on the Texas Instruments C6000
components, increased 871% to $2,690,000 in 1998. The year included the launch
of development tools for the Texas Instruments components and end products with
powerful computing and signal processing capabilities.

         Visual communication product revenues in 1998 increased 127% over 1997
due to the first full year of availability of a redesigned product.

         Switching and other revenues consist primarily of the voice and data
switching products used in air traffic control applications, which have declined
in strategic significance to the Company, and certain information security
products phased out in 1996.

GROSS PROFIT (LOSS)

         Gross profit decreased to $908,000 in 1998 from $14,251,000 in 1997. A
($2,621,000) gross loss was experienced in 1996. Changes in both years were
primarily the result of the revenue levels of the fiber optic multiplexer
products. The gross profit in 1998 includes the effect of a $900,000 reserve for
obsolescence attributable to the air traffic control products line ("switching"
products above).

         The high level of fiber optic multiplexer products shipments in 1997
supported an economic production rate in manufacturing operations, a rate which
was not sustained in 1998. The negative gross profit on fiber optic multiplexer
products in 1998 included $1,820,000 of under absorbed overhead. At the
production levels of 1997, underabsorbed overhead for the SONETLYNX/FIBRETRAX
product was $613,000, all attributable to the first half year when production
volume had not yet increased.

         Engineering services gross profit maintained a similar percentage of
sales in 1998 and 1997 (25% and 27% respectively). The increase in 1997 over
1996 was primarily the result of a near doubling of revenue.

         DSP products contributed positive gross profit for the first time in
1998 as revenues grew to a level which allowed for a characteristic margin.

         The LANscape video products contributed gross profit improvements in
both 1998 and 1997 in line with increases in volume.




                                       12
<PAGE>   13
ENGINEERING & DEVELOPMENT (E&D) EXPENSES

         E&D expense decreased to $10,217,000 in 1998 from $11,899,000 in 1997.
The 1997 level was an increase from $8,719,000 in 1996. In all three years,
certain amounts of software development costs were capitalized. Including those
amounts, the total E&D expenditures were $12,117,000, $13,216,000 and
$10,114,000, respectively, in the years 1998, 1997 and 1996. Total E&D
expenditures by product line were distributed as follows:

<TABLE>
<CAPTION>
                                             Years ended December 31,
                                           ----------------------------
                                             1998      1997      1996
                                           -------   -------   -------
                                                  ($ Thousands)
<S>                                        <C>         <C>       <C>  
          Fiber optic multiplexer          $ 5,149     6,400     2,857
          CS4 enhanced services platform     4,798     3,816     5,565
          Visual communication               1,168     1,443       954
          Digital signal processing            988       488        --
          Switching and other                   14     1,069       738
                                           -------   -------   -------
                                           $12,117    13,216    10,114
                                           -------   -------   -------
</TABLE>

         Despite lower sales in 1998, the Company maintained engineering and
development expenditures in order to advance, enhance and complete strategic
products such as MAP, CS4, DSPs and LANscape. These expenditures are expected to
result in new product contributions in 1999 which are intended to address new
markets and maintain the Company's technological leadership.

         The fiber optic multiplexer product line was most significantly
expanded by the introduction of the international standard version, SDH
(Synchronous Digital Hierarchy). Branded FIBRETRAX, the SDH version serves the
approximately 70% of global markets for fiber optic transmission outside North
America. SONETLYNX and FIBRETRAX were enhanced by the addition of interfaces
for:

         o        Multi-point voice

         o        Ethernet

         o        Communication among multiple rings, including different speeds
                  
         o        T1/E1 backup for seven other interfaces

         o        Module level protection for T1/E1 and Ethernet

         o        DS3 transport.

         Network management systems were enhanced to support larger networks and
to support mixed modes as well as SONET-only mode. Also the Telenium management
system was offered to meet the demands of the public network environment.
Progress, which did not result in product releases, included:

         o        Fast (100BaseT) Ethernet

         o        Byte synchronous E1

         o        Increased video switching speed and quality

         o        Management system TL-1 and SNMP interfaces

         o        An access product strategy

         o        A new architecture for lower cost and reduced time to market
                  by allowing integration of third party products.

         Progress in the CS4 development program continued with the design and
development of the commercial version of the system. This included the design of
second generation hardware to provide significantly more processing capacity for
handling greater traffic loads and to afford greater flexibility for




                                       13
<PAGE>   14

product migration and manufacturing efficiency. In addition, the software
architecture was refined to provide higher system performance and to address
early stage requirements for product commercialization.

         Systems were configured for CS4 subsystem testing, systems integration,
load testing and performance analysis. A beta site customer was identified and a
system was readied for commencement of field testing early in the second quarter
of 1999. Planning for supporting the customer's applications and installation of
the beta system at the customer's site was completed.

         Videoconferencing products were developed in Windows NT version.
Progress was made on development of PCI compliant hardware. A Gateway to H.320
conferencing systems was introduced. Enhancements were made to minimize the
installation task.

         Digital signal processing product developments built the foundation for
the first year of significant revenues in 1998. Including work funded by a
customer, these developments included:

         o        A development platform for the C6000 circuits of Texas
                  Instruments, the EVM module

         o        A proprietary operating system for C6000 developers

         o        VME board-level products under a private label arrangement.

SELLING AND ADMINISTRATIVE EXPENSES

         Selling and administrative expenses of $17,724,000 includes $1,148,000
of warranty expense, primarily the extra costs of start up and first year
operations of two major installations of the SONETLYNX product in Korea and on
the Alyeska pipeline. Selling expense declined 11% from the prior year,
excluding unusual warranty costs. Administrative expense of $6,547,000 in 1998
was 12% below the prior year level. Expenses in 1998 included sales development
activities which resulted in the approximately $10,000,000 of orders received
for SONETLYNX products early in 1999. General corporate expenses contributed
$800,000 of the decrease from 1997 when extra costs were incurred to remove the
corporate headquarters from Bermuda. The Company estimates that the usual level
of warranty expenses would have been approximately $200,000 but for special
startup difficulties caused by distance, cultural differences and unusual
technical characteristics.

         Selling and administrative expenses increased 28% to $18,671,000 in
1997 compared to 1996. Selling expense increased to $11,213,000 from $6,412,000,
primarily due to higher revenues for SONETLYNX products and to market
development activities for SONETLYNX and LANscape products. Administrative
expense of $7,458,000 in 1997 was 9% below the prior year, partly due to the
removal of corporate headquarters from Bermuda during 1997.

ASSET WRITE DOWNS

         In accordance with the evolving focus of the Company's primary
technologies, products and markets and forward growth plans, and in accordance
with the Company's accounting policies, including reviews of realizability of
its long-term assets, including goodwill, the Company wrote off the September
30, 1998 balance of $6,888,000 of goodwill from the acquisition in 1995 of
Intelect Inc., which at that time was primarily engaged in the supply of
communications systems for air traffic control and air defense installations,
and is presently operating as Intelect Network Technologies, emphasizing the
SONETLYNX and FIBRETRAX product lines. Goodwill amortization charges in the
amount of $149,000 per quarter also will be eliminated following the writeoff of
goodwill. The writeoff decision was determined by the recent loss of three major
identified business opportunities, the absence of significant identified future
opportunities and business combinations which strengthened competitors, all
leading the Company to reassess the outlook for the air traffic control business
segment. The Company concluded that the outlook for future business would not
support a forecast of revenue and contribution margin adequate to liquidate
inventories and support amortization of the goodwill asset.



                                       14
<PAGE>   15

         Accounts and notes receivable from the Company's Korean distributor,
and relating to the sales of the Company's products in Korea, totaled $4,696,000
at the end of September 1998, compared to $9,879,000 at December 31, 1997, from
which $6,731,000 was collected and to which $1,730,000 of shipments were added
during 1998. The Company was advised, at a meeting in October, of the
distributor's illiquidity and inability to maintain any certain schedule of
payments of receivables. Accordingly, the Company determined that it would be
prudent and timely to write off or reserve substantially all the distributor's
receivables adjusted for a collection of $1,000,000 received in February 1999.
In connection with this collection, and contingent on certain future payments,
the Company agreed not to pursue any further collections of the receivable.

         In connection with the acquisition of IVC, certain assets and licenses,
which constituted the design of a videoconferencing product, were purchased from
a major computer company. The design proved to be flawed and market introduction
was delayed approximately nine months. In 1996, the Company deemed the
recoverability of IVC goodwill to be significantly impaired by the delay in
introduction of the product to a rapidly changing market and accordingly reduced
the carrying value of IVC goodwill by $4,175,000 (its remaining unamortized net
book value at the time) and wrote off $51,000 of fixed assets deemed of no
value. The Company's assessment of the future prospects for the information
security products business in the United Kingdom led to a complete shut down of
those operations in Chesterfield, England at the end of 1996. In January 1997,
liquidation proceedings began. The Company was an unsecured creditor of IEL and
wrote off all net assets related to those operations in England in the amount of
$1,807,000.

INTEREST EXPENSE

         Interest expense, primarily non-cash financing charges, of $4,385,000,
$2,863,000 and $9,911,000 in the years ended December 31, 1998, 1997 and 1996
consists of:

<TABLE>
<CAPTION>
                                                Years ended December 31,
                                         ------------------------------------
                                            1998         1997         1996
                                         ----------   ----------   ----------
                                                     ($ Thousands)
<S>                                      <C>          <C>          <C>
          Interest on debt instruments   $    1,109          930          704
          Non-cash financing costs            3,242        1,721        7,534
          Other costs of financing               28          199        1,571
          Other interest                          6           13          102
                                         ----------   ----------   ----------
                                         $    4,385        2,863        9,911
                                         ----------   ----------   ----------
</TABLE>

         Interest on debt instruments in 1998 was primarily attributable to
amounts borrowed from St. James Capital Corp., SJMB, L.P., and the Coastal
Trust. In 1997, the interest was attributable to St. James Capital Corp. and
Coastal Trust borrowing and to two series of convertible debentures. In 1996,
the interest was attributable to three series of convertible debentures.

         Non-cash financing costs in 1998 and 1997 were the result of warrants
to purchase common stock issued in connection with various financings. The
reported expense amount is the value of the warrants determined by using the
Black-Scholes pricing model. In 1996, in addition to $2,942,000 of warrant
values, $4,592,000 of reportable expense was attributable to a beneficial
conversion feature of the convertible debentures.

         Other costs of financing consist primarily of legal and placement fees.




                                       15
<PAGE>   16

INCOME (LOSS) FROM DISPOSAL OF DISCONTINUED OPERATIONS

         Losses in 1998, 1997 and 1996 represent legal expenses in connection
with the indemnity agreement with Savage Sports Corporation. See ITEM 3, Legal
Proceedings.

YEAR 2000 COMPLIANCE

         The Company has conducted a review of its computer systems and products
to identify those that could be affected by the "Year 2000 Problem," the result
of computer programs using two digits rather than four to define the year
portion of dates. The Company has determined that none of its significant
systems or products fail to distinguish the year 2000 from the year 1900. The
review continues, in an ongoing process, to examine the risk, if any, to the
Company, of vendor or customer exposure to the Year 2000 Problem. To date, no
exposure has been discovered which would have a material adverse effect on the
Company. Certain purchased software, resold or used in company products, has
been certified by the vendors to be compliant. The financial impact of Year 2000
compliance has not been and is not anticipated to be material to the Company's
financial position or results of operations in any given year.

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

LIQUIDITY AND CAPITAL RESOURCES

         Year to year cash balances were lower by $1,103,000 at December 31,
1998. During the year, cash expended in operations ($22,929,000) and in
investing activities ($4,144,000) was funded by the reduction of cash balances
and by securing new financing of $25,970,000 (net of $14,831,000 of debt
repayments).

OPERATING ACTIVITIES

         Net cash applied in operations primarily reflects the $43,138,000 net
loss offset by $8,170,000 of non-cash charges, non-cash asset write downs of
$10,628,000, and the $3,948,000 net increase in working capital. The net cash
requirement for operations is the combined effect of a reduced gross profit
contribution compared to 1997 and a continuation of expenditures related to the
Company's technology and product development programs and marketing, selling and
distribution activities. The lower level of gross profit reflects mainly the
abrupt discontinuance of sales in Korea and the lead times to develop sales in
other markets and to launch new products into markets, distribution and sales.

         o        Accounts receivable were a source of funding due to $4,597,000
                  collections from customers in excess of new shipments and
                  billings.

         o        Inventory increased $565,000 due to restocking, longer term
                  purchase commitments, and production for orders received near
                  the end of the year.

         o        Accounts payable were reduced $3,276,000 due to payments of
                  obligations similarly related to prior year operating levels.

         o        The non-cash charges were primarily $4,357,000 of depreciation
                  and amortization of intangible assets and $3,242,000 of
                  amortization of deferred financing costs.

         o        Asset write downs reflect the decision to write off goodwill
                  related to the air traffic control communication equipment
                  business and the recognition that the Company's Korean
                  distributor became illiquid and unable to pay accounts
                  receivable.

INVESTING ACTIVITIES

         Investments during 1998 were primarily $2,035,000 of fixed asset
additions and $1,898,000 of capitalized SONETLYNX and LANscape product
enhancements and advancements. The fixed asset additions were 




                                       16
<PAGE>   17

concentrated in computers, software, and test equipment to support engineering
activities, and manufacturing equipment for new products.

FINANCING ACTIVITIES

         Cash uses were financed by the following transactions during 1998:

         o        $10,000,000 from the sale of Series C Preferred Stock in
                  February

         o        $3,000,000 borrowed in February

         o        A deferred payment arrangement converting $2,100,000
                  originally due in February to monthly payments through
                  December 1998, of which $440,000 remains owed and unpaid at
                  year end

         o        $7,000,000 borrowed in April

         o        $5,000,000 from the sale of Series D Preferred Stock in May

         o        $5,000,000 from the sale of Series D Preferred Stock in June

         o        $5,000,000 borrowed in September through November

         o        $750,000 borrowed in November

         o        $1,200,000 from the exercise of common stock warrants in
                  December

         o        $1,000,000 from the sale of common stock in December

         Proceeds from these financings were used to retire maturing obligations
of $13,410,000 and for additional working capital.

SUBSEQUENT FINANCING ACTIVITIES

         In January 1999, the Company sold $1,800,000 of common stock in a
private placement.

         On January 13, 1999, the Coastal Trust extended the maturity of the
Receivables Loan previously maturing on August 31, 1999, to February 12, 2000.

         On January 13, 1999, the Company elected to extend to February 12, 2000
the maturity of the convertible promissory notes of the Credit Facility.

         On March 2, 1999, the Company entered into a Security Purchase
Agreement with a group of private investors. The Agreement provides for the sale
of up to $9,600,000 of Series E preferred stock contingent on certain
conditions. On March 5, 1999, the Company sold $3,000,000 of the Series E
preferred stock in an Initial Closing. An additional $3,000,000 will become
available to the Company in a Mandatory Closing contingent primarily on a
registration statement becoming effective to cover resale of common stock
issuable upon conversion of the preferred and the satisfaction of certain other
conditions.

OUTLOOK

         During the last three years, the Company has continued various programs
and activities to design, develop, bring to market and establish distribution
and sales for four product lines targeting multiple markets internationally. For
the network access market, the SONETLYNX product line was introduced in 1996.
The line was expanded in 1998 by the addition of the FIBRETRAX (SDH)
international version. The Company has developed the CS4 Intelligent Services
Platform for beta testing and commercial availability in 1999. The DSP Design
Center in the Company's engineering services group continues to develop products
using advanced DSP circuits and design skills applicable to a variety of
companies in the networking and telecommunications industry. For video
communication, the Company has developed LANscape, a standards-based video
system offering full-motion collaborative communications for desktop and room
applications. These four product lines 




                                       17
<PAGE>   18

are each expected to have significant potential revenue and profit opportunities
for the Company and have been the focus of considerable development and
marketing expense during the last three years. The product lines and their
applications are more fully described in the ITEM I above. The Company has
incurred operating losses in 1998, 1997, and 1996 of $46,105,000, $20,798,000
and $43,039,000. Negative cash flows from operations in the same periods were,
respectively, $22,929,000, $24,852,000 and $23,050,000. The cash flows were
funded by proceeds from borrowings under credit facilities and sales of
preferred stock and common stock in 1998 and 1997 and by proceeds from issuance
of convertible debentures in 1996. The Company expects operating losses and
negative operating cash flow to continue at least through mid-year 1999. It is
uncertain when, if ever, the Company will report operating income or positive
cash flow from operations.

         Redeploying and refocusing resources and new activities to replace
Korean with non-Korean business are still in process of producing results to
recover sales levels and gross profit contribution.

         In response to lower levels of sales and production, the Company has
contained or reduced costs and expenses in engineering, selected product
development, and sales areas (net of non-recurring expenses recognized primarily
in connection with Korean business). Marketing and selling expenditures were
maintained on the SONETLYNX product line in connection with new distribution
relationships and the related quantity and quality of promising prospects. To
better align costs with near-term prospects, expenses related to video product
sales were reduced by closing offices in New York, California, and England.
Development costs of SONETLYNX and FIBRETRAX products were reduced as certain
schedules neared completion and lower cost outsourcing became feasible in some
areas. Expense reductions have not been sufficient to fully compensate for the
reduced gross margin contribution on lower sales volumes. Accordingly, lower
production volumes and ongoing costs and expenses have impeded progress toward
profitability and cash equilibrium.

         The Company's initiative to arrange third party (partner)
participation(s) in CS4 development, funding and/or marketing led to increases
in spending from the recognition that potential interest is enhanced by the
accelerated commercialization of marketable product applications. The increased
spending of 1998 is being curtailed to a level supporting beta testing.

         The Company is obligated to repay the Inventory Loan in two remaining
payments of $250,000 each plus accumulated interest on April 1 and May 1, 1999.
Obligations to two former shareholders of DNA, in the aggregate amount of
approximately $500,000, remain unpaid. The Company is in discussion with the
note holders and expects to reach agreement on a payment schedule for the
balance of the notes. The Credit Facility and Receivables Loan become due on
February 12, 2000. The Company intends to refinance those debts at the maturity
date, but no assurance can be given that a refinancing can be arranged.

         The Company may be obligated to redeem all of the outstanding shares of
Series D and Series E Convertible Preferred Stock in the event of a Triggering
Event, which can occur if the Company is unable to make effective the
registration statement covering the resale of the shares issuable upon
conversion of such shares effective by May 19, 1999 for the Series D and July 7,
1999 for the Series E. The Company currently does not have the cash resources
available to effect such a required redemption, or pay the penalties required in
the event of such a redemption.

CONCLUSION

         Considering the available financial resources, current business
prospects, the outlook for cash available from customer collections, the outlook
for cash to be used in operations and investing, and actions to control
spending, the Company believes it has or can obtain the financial resources to
meet its business requirements for the balance of the current year. There can be
no assurance, however, that the assumptions and projections underlying or
supporting this outlook will be realized. If cash needs exceed available
resources, there also can be no assurance that additional capital will be
available through public or private equity or debt financings. The




                                       18
<PAGE>   19

financial statements have been prepared assuming the Company will continue as a
going concern and do not include any adjustments that might result from the
unfavorable outcome of such an uncertainty.

CONTINGENT LIABILITIES

         As discussed in "ITEM 3 - Legal Proceedings" in the Company's Annual
Report on Form 10-K, the Company is exposed to certain contingent liabilities
which, if resolved adversely to the Company, would adversely affect its
liquidity, its results of operations, and/or its financial position.


ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The Company is exposed to market risk with regard to financial
instruments because two loans from The Coastal Trust bear interest based on the
prime rate.

         At December 31, 1998, a hypothetical 100 basis point increase in
interest rates would result in a reduction of approximately $57,000 in annual
pre-tax earnings. The estimated reduction is based upon the increased interest
expense of the Company's variable rate debt and assumes no change in the volume
or composition of debt at December 31, 1998.




                                       19
<PAGE>   20

ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



<TABLE>
<S>                                                                    <C>
Reports of Independent Accountants...........................          21
Consolidated Balance Sheets..................................          24
Consolidated Statements of Operations........................          26
Consolidated Statements of Stockholders' Equity..............          27
Consolidated Statements of Cash Flows........................          30
Notes to Consolidated Financial Statements...................          32
</TABLE>


                                       20
<PAGE>   21

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


Board of Directors and Stockholders
Intelect Communications, Inc.


We have audited the accompanying consolidated balance sheet of Intelect
Communications, Inc., and subsidiaries as of December 31, 1998, and the related
consolidated statements of operations, stockholder's equity, and cash flows for
the year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Intelect
Communications, Inc. and subsidiaries as of December 31, 1998, and the
consolidated results of their operations and their consolidated cash flows for
the year then ended in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has experienced continuing operating losses
and negative cash flows. Its continued existence is dependent upon the
successful development of its products and obtaining adequate capital, neither
of which is assured. These matters raise substantial doubt about its ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.


/s/ Grant Thornton LLP

Dallas, Texas
March 31, 1999




                                       21
<PAGE>   22

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To:      The Board of Directors and Shareholders of
         Intelect Communications, Inc.


         We have audited the accompanying consolidated balance sheet of Intelect
Communications, Inc. (a Delaware corporation) as of December 31, 1997, and the
related statements of operations, stockholders' equity and cash flows for the
year ended December 31, 1997. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.

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

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Intelect
Communications, Inc. as of December 31, 1997, and the results of their
operations and their cash flows for the year ended December 31, 1997, in
conformity with generally accepted accounting principles.


/s/ Arthur Andersen LLP

Dallas, Texas
March 27, 1998



                                       22
<PAGE>   23



                          INDEPENDENT AUDITORS' REPORT


To the Board of Directors and Shareholders of
Intelect Communications Systems Limited

We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows of Intelect Communications Systems Limited
and its subsidiaries for the year ended December 31, 1996. In connection with
our audit of the consolidated financial statements, we have also audited the
financial statement schedule for the year ended December 31, 1996. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audit.

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

In our opinion, the consolidated statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Intelect
Communications Systems Limited and its subsidiaries for the year ended December
31, 1996, in conformity with United States generally accepted accounting
principles. Also in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements, taken as
a whole, presents fairly, in all material respects, the information set forth
therein.

The accompanying consolidated financial statements and financial statement
schedule have been prepared assuming that the Company will continue as a going
concern. As discussed in Note 1 to the consolidated financial statements, the
Company has suffered recurring losses from continuing operations and is
dependent upon the successful development and commercialization of its products
and its ability to secure adequate sources of capital until the Company is
operating profitably. These matters raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans with regard to these
matters are also described in Note 1. The consolidated financial statements and
financial statement schedule do not include any adjustments that might result
from the outcome of this uncertainty.


/s/ KPMG Peat Marwick

Chartered Accountants
Hamilton, Bermuda
April 9, 1997 ....





                                       23
<PAGE>   24

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                           Consolidated Balance Sheets
                           December 31, 1998 and 1997
                    (Thousands of dollars, except share data)

<TABLE>
<CAPTION>
                                                      1998         1997
                                                   ----------   ----------
<S>                                                <C>          <C>   
                     Assets
Current assets:
   Cash and cash equivalents                       $      991        2,094
   Investments                                            681          942
   Accounts receivable net of allowances of $870
       and $542 in 1998 and 1997                        7,232       15,569
   Inventories                                          6,854        6,289
   Prepaid expenses                                       655          658
                                                   ----------   ----------
         Total current assets                          16,413       25,552

Property and equipment, net                             6,386        6,041
Goodwill, net                                           4,787       13,249
Software development costs, net                         3,134        2,229
Other intangible assets, net                              916        1,168
Other assets                                              446          992
                                                   ----------   ----------
                                                   $   32,082       49,231
                                                   ----------   ----------
</TABLE>


                                                                     (continued)



                                       24
<PAGE>   25

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                     Consolidated Balance Sheets (continued)
                           December 31, 1998 and 1997
                    (Thousands of dollars, except share data)

<TABLE>
<CAPTION>
                                                                                   1998            1997
                                                                               ------------    ------------
<S>                                                                            <C>             <C> 
                         Liabilities and Stockholders' Equity
Current liabilities:
   Notes payable, net of unamortized discount of $578 in 1997                         1,173           9,132
   Current maturities of long-term debt                                                 440           2,527
   Accounts payable                                                                   4,293           7,569
   Accrued liabilities                                                                3,375           3,173
   Net liabilities of discontinued operations                                           400             400
   Deferred income taxes                                                                 45              49
   Current installments of obligations under capital leases                             126              89
                                                                               ------------    ------------
                           Total current liabilities                                  9,852          22,939

Long-term debt, net of unamortized discount of $388                                  14,612              --
Long-term obligations under capital leases, net of current installments                  42              55
Deferred income taxes                                                                    44              88
                                                                               ------------    ------------
                                                                                     24,550          23,082
                                                                               ------------    ------------
Commitments and contingencies

Stockholders' equity:
   $2.0145, 10% cumulative convertible preferred stock, series A, $.01
       par value (aggregate involuntary liquidation preference $20,145,000) 
       Authorized 10,000,000 shares; 4,219,409 shares issued and
       outstanding                                                                       42              42
   $4.375, 10% cumulative convertible preferred stock, series B, $.01
       par value (aggregate involuntary liquidation preference $4,000,000) 
       Authorized 914,286 shares; none and 914,286 shares issued
       and outstanding in 1998 and 1997, respectively                                    --               9
   Series C convertible preferred stock, $.01 par value (aggregate
       involuntary liquidation preference $10,000,000).  Authorized
       12,500 shares; 1,843 issued and outstanding in 1998                                1              --
   Series D convertible preferred stock, $.01 par value (aggregate
       involuntary liquidation preference $10,000,000).  Authorized
       10,000 shares; 8,250 issued and outstanding in 1998                                1              --
   Common stock, $.01 par value.  Authorized 50,000,000 shares;
       32,333,085 and 23,954,978 shares issued in 1998 and 1997,
       respectively                                                                     323             240
   Additional paid-in capital                                                       104,451          75,940
   Accumulated other comprehensive income                                                --               2
   Accumulated deficit                                                              (96,189)        (50,084)
                                                                               ------------    ------------
                                                                                      8,629          26,149
   Less 191,435 shares of common stock in treasury                                   (1,097)             --
                                                                               ------------    ------------
                           Total stockholders' equity                                 7,532          26,149
                                                                               ============    ============
                                                                               $     32,082          49,231
                                                                               ============    ============
</TABLE>



See accompanying notes to consolidated financial statements.



                                       25
<PAGE>   26

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                  Years ended December 31, 1998, 1997 and 1996
                      Consolidated Statements of Operations
                    (Thousands of dollars, except share data)

<TABLE>
<CAPTION>
                                                          Years ended December 31,
                                               --------------------------------------------
                                                   1998            1997            1996
                                               ------------    ------------    ------------
<S>                                            <C>             <C>             <C>  
Net revenue                                    $     19,341          37,777           9,352
Cost of revenue                                      18,433          23,526          11,973
                                               ------------    ------------    ------------
             Gross profit (loss)                        908          14,251          (2,621)
                                               ------------    ------------    ------------

Expenses:
   Engineering and development                       10,218          11,899           8,719
   Selling and administrative                        17,724          18,671          14,601
   Amortization of goodwill                           1,125           1,323           1,664
   Asset writedowns                                  10,628              --           6,033
                                               ------------    ------------    ------------
                                                     39,695          31,893          31,017
                                               ------------    ------------    ------------
             Operating loss                         (38,787)        (17,642)        (33,638)
                                               ------------    ------------    ------------

Other income (expense):
   Interest expense                                  (4,385)         (2,863)         (9,911)
   Interest income and other                            483             636             653
                                               ------------    ------------    ------------
                                                     (3,902)         (2,227)         (9,258)
                                               ------------    ------------    ------------
             Loss from continuing operations
                before income taxes                 (42,689)        (19,869)        (42,896)

Income tax expense (benefit)                             46            (126)             87
                                               ------------    ------------    ------------
             Loss from continuing operations        (42,735)        (19,743)        (42,983)

Loss on disposal of discontinued
   operations, net of tax                              (403)           (498)            (56)
                                               ------------    ------------    ------------
        Net loss                                    (43,138)        (20,241)   $    (43,039)

Dividends on preferred stock                         (2,967)           (557)             --
                                               ------------    ------------    ------------

Loss allocable to common stockholders          $    (46,105)        (20,798)        (43,039)
                                               ============    ============    ============

Basic and diluted loss per share:
   Continuing operations                       $      (1.76)          (0.99)          (3.32)
   Discontinued operations                            (0.02)          (0.02)          (0.01)
     Net loss per share                        $      (1.78)          (1.01)          (3.33)
                                               ============    ============    ============

Weighted average number of common
shares outstanding (thousands)                       25,939          20,558          12,943
                                               ============    ============    ============
</TABLE>

See accompanying notes to consolidated financial statements.





                                       26
<PAGE>   27

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                 Consolidated Statements of Stockholders' Equity
                  Years ended December 31, 1998, 1997 and 1996
                    (Thousands of dollars, except share data)


<TABLE>
<CAPTION>
                                           Preferred Stock
                                     -----------------------------                                           Accumulated   Total
                                        Series A       Series B        Common Stock    Additional               Other      Stock-
                                     --------------  -------------  ------------------  Paid-in    Retained Comprehensive  holders'
                                     Shares   Par    Shares   Par     Shares     Par    Capital    Earnings    Income      Equity
                                     ------  ------  ------  -----  ----------  ------ ---------- ---------- ----------   --------
<S>                                  <C>     <C>     <C>     <C>    <C>         <C>     <C>       <C>        <C>         <C>   
Balances at December 31, 1995        $   --      --      --     --  11,385,117     114    11,673      13,753       --      25,540
   Comprehensive Income:
     Net loss                                                                                        (43,039)      --     (43,039)
     Change in unrealized gain
       on marketable securities                                                                                    18          18
                                                                                                                          -------
         Total                                                                                                            (43,021)
   Conversion of debentures              --      --      --     --   1,837,205      18    10,069          --       --      10,087
   Acquisition of IVC                    --      --      --     --     545,420       5     2,747          --       --       2,752
   Exercise of employee stock
     options                             --      --      --     --     530,000       5     1,012          --       --       1,017
   Exercise of warrants from
     acquisition of Savage
     Corporation                         --      --      --     --     360,000       4     1,076          --       --       1,080
   Settlement of subordinated
     debt and contingent
     purchase consideration of
     INT                                 --      --      --     --     169,986       2       848          --       --         850
   Purchase of other assets              --      --      --     --     100,000       1       374          --       --         375
   Employee compensation -
     IVC                                 --      --      --     --     100,000       1       499          --       --         500
   Allocation of proceeds to
     beneficial conversion features
     of convertible debentures           --      --      --     --          --      --     4,947          --       --       4,947
   Detachable warrants issued
     with convertible debentures         --      --      --     --          --      --     3,117          --       --       3,117
   Stock option compensation             --      --      --     --          --      --       487          --       --         487
                                     ------  ------  ------  -----  ----------  ------  --------  ----------   ------    --------

Balances at December 31, 1996        $   --      --      --     --  15,027,728     150    36,849     (29,286)      18       7,731
                                     ======  ======  ======  =====  ==========  ======  ========  ==========   ======    ========
</TABLE>



See accompanying notes to consolidated financial statements 


                                                                     (continued)


                                       27
<PAGE>   28


                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                 Consolidated Statements of Stockholders' Equity
                  Years ended December 31, 1998, 1997 and 1996
                    (Thousands of dollars, except share data)

<TABLE>
<CAPTION>
                                     Preferred Stock
                               -----------------------------                                                 Accumulated     Total
                                     Series A        Series B         Common Stock     Additional               Other       Stock-
                               -----------------  ---------------  ------------------   Paid-in   Retained  Comprehensive   holders'
                                  Shares     Par   Shares    Par     Shares       Par    Capital  Earnings      Income       Equity
                               -----------  ----  --------  -----  -----------  ------  --------  --------  -------------   --------
<S>                            <C>          <C>   <C>       <C>    <C>          <C>     <C>       <C>      <C>              <C>   
Balances at 
   December 31, 1996           $        --    --        --     --   15,027,728     150    36,849   (29,286)         18        7,731
Comprehensive Income
   Net loss                                                                                        (20,241)                 (20,241)
   Change in unrealized
     gain on marketable
     securities                                                                                                    (16)         (16)
                                                                                                                            -------
       Total                                                                                                                (20,257)
Private placements
   Preferred, Series A           2,482,005    25        --     --           --      --     4,886        --          --        4,911
   Preferred, Series B                  --    --   914,286      9           --             3,868        --          --        3,877
   Common                               --    --        --     --      696,400       7     3,323        --          --        3,330
Conversion of debentures                --    --        --     --    5,376,864      54    14,796        --          --       14,850
Conversion of notes 
   payable                       2,482,006    25        --     --           --      --     4,975        --          --        5,000
Conversion of preferred 
  stock                           (780,583)   (8)       --     --      780,583       8        --        --          --           --
Detachable warrants issued              --
   with notes                           --    --        --     --           --      --     1,661        --          --        1,661
Warrants issued for services            --    --        --     --           --      --       250        --          --          250
Exercise of warrants                    --    --        --     --      930,000       9     1,881        --          --        1,890
Exercise of employee stock
   options                              --    --        --     --      561,666       6     1,569        --                    1,575
Stock option compensation               --    --        --     --           --      --       354        --          --          354
Settlement of royalty 
   agreement                            --    --        --     --      542,182       6       841        --          --          847
Interest expense paid 
   with stock:
   Preferred, Series A              35,981    --        --     --           --      --        72        --          --           72
   Common                               --    --        --     --       11,407      --        58        --          --           58
Preferred dividends paid 
   with stock                           --    --        --     --       28,148      --       296      (296)         --           --
Preferred dividends accrued
   Series A                             --    --        --     --           --      --       215      (215)         --           --
   Series B                             --    --        --     --           --      --        15       (15)
Amortization of beneficial 
conversion features of 
preferred stock, Series B               --    --        --     --           --      --        31       (31)         --           --
                               -----------  ----  --------  -----  -----------  ------  --------  --------      ------     -------

Balances at 
   December 31, 1997           $ 4,219,409    42   914,286      9   23,954,978     240    75,940   (50,084)          2      26,149
                               ===========  ====  ========  =====  ===========  ======  ========  ========      ======     =======
</TABLE>



See accompanying notes to consolidated financial statements

                                                                     (continued)




                                       28
<PAGE>   29

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                 Consolidated Statements of Stockholders' Equity
                  Years ended December 31, 1998, 1997 and 1996
                    (Thousands of dollars, except share data)

<TABLE>
<CAPTION>
                                                                                                                                
                                                               Preferred Stock                                                  
                                  ------------------------------------------------------------------------                      
                                      Series A            Series B           Series C         Series D          Common Stock    
                                  -----------------  ------------------   ----------------  ---------------  ------------------ 
                                    Shares     Par     Shares      Par    Shares     Par    Shares     Par     Shares     Par   
                                  ----------  -----  ----------   -----   -------   ------  -------   -----  ----------  ------ 
<S>                               <C>         <C>    <C>          <C>     <C>       <C>     <C>       <C>    <C>         <C>    
Balances at December 31, 1997     $4,219,409     42     914,286       9        --       --       --      --  23,954,978     240 
Comprehensive income:
   Net loss                               --     --          --      --        --       --       --      --          --      -- 
   Change in unrealized gain on
     Marketable securities                --     --          --      --        --       --       --      --          --      -- 
                                                                                                                                
               Total                      --     --          --      --        --       --       --      --          --      -- 
Private placements:
   Series C Preferred                     --     --          --      --    10,000       --       --      --          --      -- 
   Series D Preferred                     --     --          --      --        --       --   10,000      --          --      -- 
   Common                                 --     --          --      --        --       --       --      --   1,000,000      10 
Conversion of notes payable               --     --          --      --        --       --       --      --      10,600      -- 
Conversion of preferred stock             --     --    (914,286)     (9)   (8,157)      --   (1,750)     --   5,997,819      60 
Warrants issued with notes                --     --          --      --        --       --       --      --          --      -- 
Warrants issued for services              --     --          --      --        --       --       --      --          --      -- 
Exercise of warrants                      --     --          --      --        --       --       --      --     600,000       6 
Exercise of employee stock
   options                                --     --          --      --        --       --       --      --     226,458       2 
Settlement of dispute                     --     --          --      --        --       --       --      --      18,000      -- 
Stock option compensation                 --     --          --      --        --       --       --      --          --      -- 
Preferred dividends paid
   with stock                             --     --          --      --        --       --       --      --     333,795       3 
Preferred dividends accrued               --     --          --      --        --       --       --      --          --      -- 
Beneficial conversion features
   of preferred stock issued              --     --          --      --        --       --       --      --          --      -- 
Issue and subsequent acquisition
   of common stock                        --     --          --      --        --       --       --      --     191,435       2 
                                  ----------  -----  ----------   -----   -------   ------  -------   -----  ----------  ------ 

Balances at December 31, 1998     $4,219,409     42          --      --     1,843       --    8,250      --  32,333,085     323 
                                  ==========  =====  ==========   =====   =======   ======  =======   =====  ==========  ====== 

<CAPTION>
                                                          Accumu-
                                                          lated                     
                                     Addi-                other                         Total
                                    tional                compre-   Treasury Stock      Stock-
                                    Paid-in    Retained   hensive  ------------------   holders
                                    Capital    Earnings   Income    Shares     Cost     Equity
                                   --------   ----------  ------   ---------  -------  --------
<S>                                <C>        <C>          <C>     <C>        <C>      <C>
Balances at December 31, 1997        75,940      (50,084)      2          --       --    26,149
Comprehensive income:
   Net loss                              --      (43,138)     --          --       --   (43,138)
   Change in unrealized gain on
     Marketable securities               --           --      (2)         --       --        (2)
                                                                                       --------
               Total                     --           --      --          --       --   (43,140)
Private placements:
   Series C Preferred                 9,117           --      --          --       --     9,117
   Series D Preferred                 9,444           --      --          --       --     9,444
   Common                               990           --      --          --       --     1,000
Conversion of notes payable              21           --      --          --       --        21
Conversion of preferred stock           (51)          --      --          --       --        --
Warrants issued with notes            2,980           --      --          --       --     2,980
Warrants issued for services            155           --      --          --       --       155
Exercise of warrants                  1,194           --      --          --       --     1,200
Exercise of employee stock
   options                              396           --      --          --       --       398
Settlement of dispute                   101           --      --          --       --       101
Stock option compensation               105           --      --          --       --       105
Preferred dividends paid
   with stock                         1,306       (1,309)     --          --       --        --
Preferred dividends accrued           1,040       (1,040)     --          --       --        --
Beneficial conversion features
   of preferred stock issued            618         (618)     --          --       --        --
Issue and subsequent acquisition
   of common stock                    1,097           --      --     191,435   (1,097)        2
                                   --------   ----------   -----   ---------  -------  --------

Balances at December 31, 1998       104,453      (96,189)     --     191,435   (1,097)    7,532
                                   ========   ==========   =====   =========  =======  ========
</TABLE>

See accompanying notes to consolidated financial statements




                                       29
<PAGE>   30

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                      Consolidated Statements of Cash Flows
                  Years ended December 31, 1998, 1997 and 1996
                             (Thousands of dollars)

<TABLE>
<CAPTION>
                                                                    Years ended December 31,
                                                              ----------------------------------
                                                                1998         1997         1996
                                                              --------     --------     --------
<S>                                                           <C>          <C>          <C>     
Cash flows from operating activities:
   Net loss                                                   $(43,138)     (20,241)     (43,039)
   Adjustments to reconcile net loss to
     net cash used in operating activities:
        Depreciation and amortization                            4,357        3,412        3,581
        Amortization of loan discount                            3,242        1,920        9,105
        Asset writedowns                                        10,628           --        6,033
        Loss on disposal of discontinued
           operations                                              403          498           56
        Stock option compensation                                  100          354          487
        Noncash operating expenses (income)                       (217)         191          500
        Other                                                      285         (143)          43
        Change in operating assets and liabilities, net of
          effects of acquired companies:
             Accounts receivable                                 4,597      (13,242)        (898)
             Inventories                                          (565)      (3,311)        (350)
             Other assets                                          599         (165)         (95)
             Accounts payable and accrued liabilities           (3,220)       5,875        1,603
             Net liabilities of discontinued operations             --           --          (76)
                                                              --------     --------     --------
               Net cash used in operating activities           (22,929)     (24,852)     (23,050)
                                                              --------     --------     --------

Cash flows from investing activities:
   Payments for disposal of discontinued operations               (403)        (498)         (56)
   Purchase of other intangible assets                             (69)         (94)      (1,075)
   Capital expenditures                                         (2,035)      (2,993)      (3,660)
   Purchase of marketable securities                                --         (103)        (836)
   Purchase of other assets                                         --         (338)        (110)
   Software development costs                                   (1,898)      (1,317)      (1,395)
   Proceeds from sale of fixed assets                               --           --          200
   Proceeds from sale of marketable securities                     261           --           --
   Payment for acquisition of DNA, net of cash
        acquired                                                    --                    (3,009)
   Loan to IVC, prior to acquisition                                --           --         (700)
   Payment for acquisition of IVC, net of cash
        acquired                                                    --           --         (668)
                                                              --------     --------     --------
               Net cash used in investing activities            (4,144)      (5,343)     (11,309)
                                                              --------     --------     --------
</TABLE>

See accompanying notes to consolidated financial statements


                                                                     (Continued)



                                       30
<PAGE>   31

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES
                Consolidated Statements of Cash Flows (continued)
                  Years ended December 31, 1998, 1997 and 1996
                             (Thousands of dollars)

<TABLE>
<CAPTION>
                                                               Years ended December 31,
                                                         ----------------------------------
                                                           1998         1997         1996
                                                         --------     --------     --------
<S>                                                      <C>          <C>          <C> 
Cash flows from financing activities:
   Proceeds from issuance of convertible
      Debentures                                         $     --           --       25,000
   Proceeds from issuance of notes payable                 19,657       14,910           --
   Debt issuance costs                                       (155)        (255)      (1,623)
   Principal payments on notes payable                    (12,557)        (200)        (880)
   Principal payments under capital lease obligations         (25)         (76)        (311)
   Principal payments on long-term debt                    (2,274)      (2,473)        (100)
   Proceeds from issuance of preferred shares              18,815        8,789           --
   Proceeds from issuance of common shares                  1,000        3,266           --
   Proceeds from exercise of common stock warrants          1,200        1,890        1,080
   Proceeds from exercise of employee stock options           309        1,575        1,017
                                                         --------     --------     --------
               Net cash provided by financing
                      activities                           25,970       27,426       24,183
                                                         --------     --------     --------

Net (decrease) in cash and cash
   equivalents                                             (1,103)      (2,769)     (10,176)
Cash and cash equivalents, beginning of year                2,094        4,863       15,039
                                                         ========     ========     ========
Cash and cash equivalents, end of year                   $    991        2,094        4,863
                                                         ========     ========     ========
</TABLE>


See accompanying notes to consolidated financial statements.





                                       31
<PAGE>   32

                 INTELECT COMMUNICATIONS, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements


(1)    Description of Business

       Intelect Communications, Inc. (the "Company") was incorporated in
       Delaware on May 23, 1995, and is the successor company of a
       reorganization, effective December 4, 1997, whereby the Company became a
       U. S. domiciled public company. The previous public company, Intelect
       Communications Systems Limited ("Intelect (Bermuda)"), a Bermuda company,
       became a subsidiary of Intelect Communications, Inc. Intelect (Bermuda)
       had operated under the name of Coastal International, Ltd. until
       September 1985 and as Challenger International, Ltd. until December 1995.
       The Company operates in one industry segment and is an international
       communications technology and products company that designs, develops,
       manufactures, markets, and sells products and services for the
       integration of voice, data, and video networks. The Company's products
       include a multi-service access platform for fiber optic networks, digital
       signal processing system components, video communications equipment, and
       telecommunications system design and development services.

       Former subsidiaries of the Company were engaged in information security
       product sales and services (from 1995 to 1997), in the manufacture and
       marketing of sporting arms (from 1989 to 1995), and in various energy
       related activities (from 1981 to 1988). These subsidiaries were sold or
       liquidated before December 31, 1997.

       The Company has incurred significant operating losses and negative cash
       flows from operations in 1998, 1997 and 1996. The cash flows were funded
       by proceeds from borrowings under credit facilities and sales of
       preferred stock and common stock in 1998 and 1997 and by proceeds from
       issuance of convertible debentures in 1996. The Company expects operating
       losses and negative operating cash flow to continue at least through
       mid-year 1999. It is uncertain when, if ever, the Company will report
       operating income or positive cash flow from operations.

       Considering the available financial resources, current business
       prospects, the outlook for cash available from customer collections, the
       outlook for cash to be used in operations and investing, and actions to
       control spending, the Company believes it has or can obtain the financial
       resources to meet its business requirements for the balance of the
       current year. There can be no assurance, however, that the assumptions
       and projections underlying or supporting this outlook will be realized.
       If cash needs exceed available resources, there also can be no assurance
       that additional capital will be available through public or private
       equity or debt financings. The financial statements have been prepared
       assuming the Company will continue as a going concern and do not include
       any adjustments that might result from the unfavorable outcome of such an
       uncertainty.

(2)    Significant Accounting Policies and Practices

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

                                       32
<PAGE>   33

       (a)    Principles of Consolidation

              The consolidated financial statements include the financial
              statements of the Company and its subsidiaries, all of which are
              wholly owned, since their dates of acquisition. All significant
              intercompany balances and transactions have been eliminated in
              consolidation.

       (b)    Fair Value of Financial Instruments

              Statement of Financial Accounting Standards No. 107, "Disclosures
              about Fair Value of Financial Instruments," requires disclosure of
              the fair value of certain financial instruments for which it is
              practicable to estimate fair value. For purposes of the disclosure
              requirements, the fair value of a financial instrument is the
              amount at which the instrument could be exchanged in a current
              transaction between willing parties, other than in a forced sale
              or liquidation. The carrying values of cash, accounts receivable,
              marketable securities, notes payable and accounts payable are
              reasonable estimates of their fair value due to the short-term
              maturity of underlying financial instruments. It was not practical
              to estimate the fair value of the Company's long-term debt because
              quoted market prices do not exist and comparable securities were
              not available.

       (c)    Revenue and Expense Recognition

              Revenue from product sales is recognized upon shipment of
              products. Reserves for estimated sales returns and allowances are
              recorded in the same accounting period as the related revenues.

              Revenue from engineering services is recognized as the services 
              are provided to the customers.

              Contracts that are expected to be completed within one year are
              generally considered short-term contracts and revenue is
              recognized upon shipment to the customer. Revenue on longer-term
              contracts is generally recognized using the
              percentage-of-completion method. Under the
              percentage-of-completion method, revenue recognition is measured
              by the proportion of the contract costs incurred to date to
              estimated total costs for each contract. Contract costs include
              all direct material and labor costs and those indirect costs
              related to contract performance, such as indirect labor, supplies,
              tools and repair costs. General, administrative and engineering
              and development costs are charged to expense as incurred. Changes
              in estimated profit on contracts are recognized in the period in
              which the revisions are determined. Provisions for estimated
              losses on uncompleted contracts are charged to earnings in the
              period in which such losses first become apparent.

       (d)    Inventories

              Inventories consist of raw materials, work in progress and
              finished goods, and are stated at the lower of cost (determined on
              a first-in, first-out basis) or market.

       (e)    Property and Equipment

              Property and equipment are stated at cost. Equipment under capital
              leases is stated at the present value of minimum lease payments.

                                       33
<PAGE>   34

              Depreciation on equipment is calculated on the straight-line
              method over the estimated useful lives of the assets. Equipment
              held under capital leases and leasehold improvements are amortized
              on a straight-line basis over the shorter of the lease term or
              estimated useful life of the assets and included in depreciation
              expense. The estimated useful lives are as follows:

<TABLE>
<CAPTION>
                                                                                      Years
                                                                                      -----
<S>                                                                                   <C> 
                   Machinery and equipment                                            5 to 7
                   Computer equipment and software                                    3 to 5
                   Furniture and fixtures                                             5 to 7
                   Motor vehicles                                                       3
</TABLE>

       (f)    Deferred Financing Costs

              Deferred financing costs in connection with the issuance of debt
              are amortized to interest expense using the effective interest
              method over the term of the related debt instrument (note 8). A
              portion of the proceeds from the issuance of convertible debt
              securities with beneficial conversion features and/or detachable
              stock purchase warrants is recognized as additional paid-in
              capital and as a discount to its related debt instrument and
              amortized to interest expense ratably from the date of issuance to
              the date the related debt first becomes convertible. Other costs
              in connection with the issuance of the same securities are also
              deferred and amortized in the same manner.

       (g)    Engineering and Development and Software Development Costs

              Engineering and development costs are expensed as incurred.
              Capitalization of software development costs commences upon the
              establishment of technological feasibility and ceases when the
              product is generally available for sale. Both the establishment of
              technological feasibility and the ongoing assessment of
              recoverability of capitalized development costs involve judgments
              by management with respect to certain external factors, including,
              but not limited to, anticipated future revenues, estimated
              economic life and possible developments in software and hardware
              technologies. In 1996, the Company determined that technological
              feasibility and future revenue potential had been established for
              the SONETLYNX product line. In 1997, the Company's LANscape
              product line achieved technological feasibility and future revenue
              potential was established. During the years ended December 31,
              1998, 1997 and 1996, the Company capitalized $1,987,735,
              $1,317,000 and $1,395,000 of software development costs and
              charged operations for $1,083,424, $477,000 and $6,000 of
              amortization, respectively. Amortization prior to 1998 is based on
              estimated product revenues over the next five years or straight
              line, whichever is greater. After 1997, amortization is based on
              the greater of product revenues or two years.

              During the first three quarters of 1996, the Company capitalized
              software development costs associated with the development of the
              CS4 programmable switch, having established technological
              feasibility early in 1996. In December 1996, a reassessment of the
              product definition rendered invalid the establishment of
              technological feasibility because feasibility had not been
              attained for all the inter-related modules of the product.
              Accordingly, all costs that had been capitalized in previous
              quarters, totaling $2,442,000, were charged to engineering and
              development expense in the fourth quarter of 1996.

              During the year ended December 31, 1996, the Company advanced
              $396,000 to a software developer in connection with the
              development of certain software and related technology. Such
              amounts were charged to 1996 engineering and development expense.



                                       34
<PAGE>   35

       (h)    Earnings (Loss) Per Common Share

              In February 1997, the Financial Accounting Standards Board issued
              Statement of Financial Accounting Standards (SFAS) No. 128,
              "Earnings per Share." SFAS 128 established standards for computing
              and presenting earnings per share (EPS) and is effective for
              financial statements issued for periods ending after December 15,
              1997. This statement requires presentation of basic and dilutive
              EPS. Basic EPS excludes the effect of common stock equivalents
              while diluted EPS gives effect to all dilutive potential common
              shares outstanding during the period.

       (i)    Foreign Currency Translation

              The Company's United Kingdom subsidiaries, Intelect Europe Limited
              ("IEL") and Intelect Network Systems Limited ("INSL"), used the
              local currency as the functional currency and translated net
              assets at the exchange rates in effect on the balance sheet dates,
              while income and expense accounts were translated at average
              rates. Foreign transaction exchange gains and losses were
              recognized as income or expense. Foreign currency translation
              adjustments and transaction amounts were not significant.

       (j)    Income Taxes

              The Company accounts for income taxes under the liability method
              as required by Statement of Financial Accounting Standards No.
              109, "Accounting for Income Taxes." Under this method, deferred
              tax assets and liabilities are determined based on differences
              between the financial reporting and income tax bases of assets and
              liabilities and are measured using the enacted tax rates and laws
              expected to apply to taxable income in the years in which those
              temporary differences are expected to be recovered or settled. The
              effect on deferred tax assets and liabilities of a change in tax
              rates is recognized in income in the period that includes the
              enactment date.

       (k)    Cash and Cash Equivalents

              For purposes of the consolidated statements of cash flows, cash
              and cash equivalents include cash held in banks and time deposits
              having maturities within three months of the date of purchase by
              the Company.

       (l)    Goodwill

              Goodwill, which represents the excess of purchase price over fair
              value of net assets acquired, is amortized on a straight-line
              basis over 10 to 15 years. Accumulated amortization at December
              31, 1998 and 1997 was $4,076,000 and $2,951,000, respectively.

              The Company assesses the recoverability of goodwill by determining
              whether the amortization of the goodwill balance over its
              remaining life can be recovered through undiscounted future
              operating cash flows of the acquired operation. The amount of the
              goodwill impairment, if any, is measured based on projected
              discounted future operating cash flows using a discount rate
              reflecting the Company's average cost of funds. The assessment of
              the recoverability of goodwill will be impacted if estimated
              future operating cash flows are not achieved.



                                       35
<PAGE>   36

              During the year ended December 31, 1998, the Company charged
              $6,888,000 to operations for the writedown of goodwill in
              connection with the 1995 acquisition of Intelect Network
              Technology Company (INT) (See note 6(a)). The goodwill was
              considered impaired due to the loss of three significant bids for
              air traffic control (ATC) projects, the absence of any significant
              future prospects for the ATC products of INT, and the industry
              trend toward consolidation, all combining to diminish the outlook
              for the ATC business.

              During the year ended December 31, 1996, the Company charged
              $4,175,000 to operations for the writedown of goodwill in
              connection with the 1996 acquisition of Intelect Visual
              Communications Corp. (see note 6(d)). The goodwill was considered
              impaired due to design flaws in the products acquired, which
              required design changes and enhancements and delayed market
              introduction. In addition, due to the liquidation of IEL, as
              described in note 6(b), goodwill of $740,000 associated with the
              1995 acquisition of IEL was charged to 1996 operations.

              The aforementioned writedowns were measured in accordance with the
              policy described above. At December 31, 1998, the Company believes
              that no significant impairment of the remaining goodwill has
              occurred and that no reduction of the estimated useful lives is
              warranted.

       (m)    Other Intangible Assets

              Other intangible assets consist of a software license from a
              vendor (1996 only) and purchased product technology (note 7).
              Product technology assets are being amortized by the straight-line
              method over periods ranging from three to five years.

       (n)    Stock Option Plan

              The Company accounts for its stock option plan in accordance with
              the provisions of Accounting Principles Board ("APB") Opinion No.
              25, Accounting for Stock Issued to Employees, and related
              interpretations. As such, compensation expense is recorded on the
              date of grant only if the current market price of the underlying
              stock exceeded the exercise price. On January 1, 1996, the Company
              adopted SFAS No. 123, Accounting for Stock-Based Compensation,
              which permits pro forma net income and pro forma earnings per
              share disclosures for employee stock option grants made in 1995
              and future years as if the fair-value-based method defined in SFAS
              No. 123 had been applied.

       (o)    Warranty Reserve

              The Company accrues a reserve for warranty expense based on
              estimated future costs of startup and first year operations at
              customer sites.

       (p)    Reclassification

              Certain prior period balances have been reclassified to conform to
              the current year presentation.




                                       36
<PAGE>   37

(3)    Investments

       Equity securities are considered available-for-sale and are stated at
       fair value. Unrealized holding gains and losses, net of the related tax
       effect, on available-for-sale securities are excluded from earnings and
       are reported as a separate component of shareholders' equity until
       realized. Realized gains and losses from the sale of such securities are
       determined on a specific identification basis. Holdings of equity
       securities were sold in 1998. Certificates of deposit are
       interest-bearing and are pledged in the course of contractual performance
       and for the purpose of obtaining operating leases. A summary of such
       securities follows:

<TABLE>
<CAPTION>
                                                                      December 31,
                                  -------------------------------------------------------------------------------------
                                                    1998                                       1997
                                  -----------------------------------------  ------------------------------------------
                                                   Gross                                       Gross
                                                 unrealized                                  unrealized
                                                  holding         Fair                        holding         Fair
                                     Cost          gains          value          Cost          gains          value
                                  ------------  -------------  ------------  -------------  -------------  ------------
<S>                               <C>           <C>            <C>           <C>            <C>            <C>
        Equity securities         $          -              -             -             52              2            54
        Certificates
          of deposit                       681              -           681            888              -           888
                                  ------------  -------------  ------------  -------------  -------------  ------------
                Total             $        681              -           681            940              2           942
                                  ============  =============  ============  =============  =============  ============
</TABLE>

(4)    Inventories

       The components of inventories are as follows:

<TABLE>
<CAPTION>
                                           December 31,
                                   -----------------------------
                                       1998             1997
                                   ------------     ------------
<S>                                <C>              <C>  
Raw materials                      $      5,038            5,209
Work in progress                            888              630
Finished goods                            3,472            2,050
                                   ------------     ------------
                                          9,398            7,889
Less allowance for obsolescence          (2,544)          (1,600)
                                   ------------     ------------
                     Total         $      6,854            6,289
                                   ============     ============
</TABLE>

(5)    Property and Equipment

       Property and equipment are summarized as follows:

<TABLE>
<CAPTION>
                                                         December 31,
                                                 -----------------------------
                                                     1998             1997
                                                 ------------     ------------
<S>                                              <C>                     <C>  
Machinery and equipment                          $      6,826            3,883
Computer equipment and software                         2,386            3,026
Furniture and fixtures                                    763            1,138
Leasehold improvement                                     343              223
                                                 ------------     ------------
                                                       10,318            8,270
Less:
    Accumulated depreciation and amortization          (3,932)          (2,229)
                                                 ------------     ------------
                 Total                           $      6,386            6,041
                                                 ============     ============
</TABLE>



                                       37
<PAGE>   38

(6)    Acquisitions

       During 1995, the Company purchased Intelect Network Technologies Company
       ("INT") and Intelect Europe Limited ("IEL"). During 1996, the Company
       purchased DNA Enterprises, Inc. ("DNA") and Intelect Visual
       Communications Corp. ("IVC"). A summary of these acquisitions is as
       follows:

       (a)    Intelect Network Technologies Company

              On January 13, 1995, the Company acquired 16% of the capital stock
              of INT (formerly known as Intelect, Inc.) for $400,000. On March
              31, 1995, the Company entered into an agreement to purchase the
              remaining 84% of the capital stock of INT (the "Option
              Agreement"). Under the terms of the Option Agreement, the Purchase
              Price was payable as follows:

              (i)    $2,500,000 payable in debentures (the "Debentures") of INT
                     plus the amount by which certain of INT's debts to two
                     major customers (the "Debts") were settled for less than
                     $6,000,000. The Debts were settled by the Company for
                     $5,180,000 and, accordingly, the face value of the
                     Debentures was increased to $3,320,000 ($2,500,000 plus
                     $6,000,000 minus $5,180,000). The face value of the
                     Debentures was reduced by the amount that defined net
                     assets at the acquisition date (April 24, 1995) was less
                     than $1,268,000. The amount of this reduction was
                     $3,013,000 and, accordingly, the face value of the
                     Debentures at December 31, 1995 was $307,000.

              (ii)   $4,000,000 in "Contingent Purchase Consideration"
                     calculated on the future profitability of INT over the four
                     year period from January 1, 1995. The additional payments
                     were payable in cash or common stock, at the Company's
                     option.

              The first step of the acquisition of INT involved the purchase of
              a minority interest (16%) for cash. The Company's equity in the
              earnings of INT prior to acquisition of the remaining 84%, the
              second step, amounted to a loss of $280,000 and equity in the
              extraordinary gain arising from the restructuring of certain notes
              payable of $646,000, which were stated separately in the 1995
              Consolidated Statements of Operations.

              On October 7, 1996, the Company reached an agreement with the
              holders of the Debentures (the "Vendors"), under which the Vendors
              exchanged their remaining rights to the Debentures and Contingent
              Purchase Consideration in exchange for 169,986 shares of common
              stock. The transaction increased Goodwill by $660,000.

       (b)    Intelect Europe Limited

              On August 31, 1995, the Company acquired 100% of the capital stock
              of IEL for $391,000 in cash and up to 300,000 of the Company's
              common shares in additional payments based on the future
              profitability of IEL over the five year period beginning August
              31, 1995.

              In December 1996, management made the decision to close the
              operations of IEL, which was subsequently placed in voluntary
              liquidation. The liquidation represented a disposal of a part of a
              line of business. Asset impairments were recorded and estimated
              liabilities to be incurred as a result of the liquidation were
              accrued, resulting in a charge to expense of $1,807,000 in 1996,
              including a writedown of $740,000 of unamortized goodwill.



                                       38
<PAGE>   39

       (c)    DNA Enterprises, Inc.

              On February 13, 1996, the Company acquired 100% of the capital
              stock of DNA for $8,000,000, plus costs, payable as follows:

              (i)    $3,000,000 cash at closing.

              (ii)   $1,000,000 cash on the first anniversary of closing.

              (iii)  $400,000 cash on the second anniversary of closing.

              (iv)   Warrants to purchase 300,000 common shares at $5.00 per
                     share on the first anniversary of closing.

              (v)    Warrants to purchase 300,000 common shares at $7.00 per
                     share on the second anniversary of closing.

              The Company agreed to redeem the $5.00 warrants at prices of
              $5.00, $5.50 and $6.00 per warrant share on the first, second, and
              third anniversaries of closing, respectively, and redeem the $7.00
              warrants at prices of $5.50 and $6.00 per warrant share on the
              second and third anniversaries of closing, respectively, in each
              such case at the option of the warrant holders. The warrants were
              classified similar to redeemable preferred stock and included in
              long-term debt at their highest redemption price, totaling
              $3,600,000 at December 31, 1996 (note 9).

              The Company is renegotiating terms of payment of its redemption
              obligations (notes 9 and 23). On the first and second
              anniversaries, the warrant holders elected to redeem all 300,000
              common share warrants available on each date.

       (d)    Intelect Visual Communications Corporation

              On March 29, 1996, the Company acquired 100% of the capital stock
              of IVC (formerly known as Mosaic Information Technologies, Inc.)
              for 479,370 common shares valued at $5.00 per share. The Company
              also paid $695,000 cash, and issued 66,050 common shares, valued
              at $5.375 per share, as payment of certain other acquisition
              costs. The total cost of the acquisition, including working
              capital advances prior to acquisition, was $4,747,000. An
              additional 50,000 common shares, valued at $5.00 per share, were
              issued to each of two selling shareholders pursuant to employment
              agreements, and charged to compensation expense.

       All acquisitions have been accounted for by the purchase method of
       accounting and, accordingly, the purchase prices have been allocated to
       the assets acquired and the liabilities assumed based on the estimated
       fair values at the dates of acquisition. The excess of purchase price
       over the estimated fair values of the net assets acquired has been
       recorded as goodwill, which is being amortized over 10 years for DNA. As
       discussed in note 2, all goodwill in connection with the acquisition of
       INT was written off in 1998, and in connection with the acquisitions of
       IVC and IEL was written off in 1996.



                                       39
<PAGE>   40


       The estimated fair values of assets acquired and liabilities assumed on
       the respective transaction dates are summarized as follows:

<TABLE>
<CAPTION>
                                   DNA        IVC          INT         IEL
                                 -------     -------     -------     -------
<S>                              <C>         <C>         <C>         <C>
Cash                             $     3          27          40          --
Accounts receivable                  621          19         454         388
Inventory                             --         245       2,683         278
Property and equipment               502          81         700         492
Goodwill                           7,280       4,514       8,260         812
Accounts payable and accruals       (166)       (123)     (4,721)     (1,293)
Deferred taxes                      (228)         --          --          --
Debt                                  --         (16)     (6,530)       (286)
                                 -------     -------     -------     -------
                                 $ 8,012       4,747         886         391
                                 -------     -------     -------     -------
</TABLE>

       Purchase prices include legal and other costs associated with the
       acquisitions.

       Operating results of the acquisitions are included in the Company's
       consolidated results of operations from the effective dates of the
       acquisitions. The following unaudited pro-forma summary presents the
       consolidated results of operations as if the acquisitions of DNA and IVC
       had occurred at January 1, 1996 after giving effect to certain
       adjustments, including amortization of goodwill, additional interest
       expense on the acquisition debt and related income tax effects. These
       pro-forma results have been prepared for comparative purposes only and do
       not purport to be indicative of what would have occurred had the
       acquisitions been made as of those dates or of results which may occur in
       the future:

<TABLE>
<CAPTION>
                                  Year ended
                               December 31, 1996
                               -----------------
<S>                                <C>     
Net revenues                       $ 10,320
                                   ========
Loss from continuing operations    $(43,251)
                                   ========
Net loss per common share          $  (3.34)
                                   ========
</TABLE>

(7)    Other Intangible Assets

       Other intangible assets are summarized as follows:

<TABLE>
<CAPTION>
                                                     December 31,
                                            -----------------------------
                                                1998             1997
                                            ------------     ------------
<S>                                         <C>              <C> 
Investment in technology associated with
    SONETLYNX products (note 14)            $      1,407            1,407
Other intellectual property                          230              159
                                            ------------     ------------
                                                   1,637            1,566
Less accumulated amortization                       (721)            (398)
                                            ------------     ------------
                                            $        916            1,168
                                            ============     ============
</TABLE>



                                       40
<PAGE>   41


(8)    Notes Payable

       In August 1997, the Company executed an amended and restated loan
       agreement with The Coastal Corporation Second Pension Trust (the "Coastal
       Trust") providing for borrowing, on a revolving credit basis, of up to
       $5,000,000 and $3,000,000 was advanced in 1997. The balance was paid in
       connection with the revision to the Credit Facility (note 9) in May 1998.
       The balance due at December 31, 1997 was $2,598,000.

       The note payable with a carrying value of $5,824,000 at December 31,
       1997 was refinanced by the Credit Facility described in note 9.

       In November 1998, the Company executed with the Coastal Trust a credit
       agreement for $750,000 secured primarily by inventory (the "Inventory
       Loan").

       Notes payable at December 31, 1998, are as follows:

<TABLE>
<S>                                                                                      <C>
           Inventory Loan with the Coastal Trust, due in $250,000 amounts each
              of March 1, April 1 and May 1, 1999, including interest at the
              rate of 3.5% over prime (10.5% at December 31, 1998) secured by
              inventory and a second lien on all outstanding shares of the
              Company's wholly owned U.S. subsidiaries
                                                                                         $          750

           Unsecured demand promissory notes, bearing interest at 3% over prime (10% at
              December 31, 1998), payable to a group of individuals, including $233,000
              to directors and $90,000 to employees of the Company, convertible at any
              time by the holders into common stock at a price of $2.00 per share
              (balance
              December 31, 1997, $710,000)                                                          423
                                                                                         --------------
                                                                Total                    $        1,173
                                                                                         --------------
</TABLE>

(9)    Long-term Debt

       In February 1998, the Company executed a revolving credit agreement with
       a private lender (the "Credit Facility") under which $3,000,000 was
       borrowed and warrants to purchase 450,000 shares of common stock were
       issued. The agreement was revised in April 1998, refinancing the existing
       borrowing of $3,000,000 and adding $7,000,000 to the Facility in exchange
       for warrants to purchase 1,050,000 shares of common stock. In February
       1999, the due date was extended to March 12, 2000, in exchange for an
       additional 535,000 warrant shares. The balance due at December 31, 1997
       on a refinanced facility with affiliates of the private lender, was
       $5,824,000.

       In September 1998, the Company executed with the Coastal Trust a
       revolving credit agreement for up to $5,000,000 secured primarily by
       accounts receivable (the "Receivables Loan").



                                       41
<PAGE>   42

       Components of long-term debt are as follows:

<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                   -------------------------------
                                                                                       1998              1997
                                                                                   --------------  ---------------
<S>                                                                                <C>             <C>
           Credit Facility with a private lender, due February 12, 2000,
               Including interest at the fixed rate of 7%, secured by all
               Outstanding shares of the Company's wholly owned U.S.
               Subsidiaries (less unamortized discount of $388,000)                $      9,612               --

           Receivables Loan with the Coastal Trust, due February 12, 2000,
               including interest at the rate of 3.5% over prime (10.5% at
               December 31, 1998) secured by accounts receivable and a second
               lien on all outstanding shares
               of the Company's wholly owned U.S. subsidiaries                            5,000               --

           Repurchase agreements for common stock warrants held by former
               shareholders of DNA, payable in two installments: (1) $1,500,000
               in February 1997, renegotiated and paid in monthly installments
               of $200,000, including interest at 6%, through December 1997, and
               (2) $2,100,000 in February 1998, renegotiated and paid in monthly
               installments of $150,000 including interest at 14.38% through
               December 1998. Balance at December 31, 1998 represents the
               balance due on three unpaid installments with interest, penalty
               and fees (note 6(c))                                                         440            2,100

           Partial purchase price of DNA, payable in two installments -
               $1,000,000 in February 1997 and $400,000 in February 1998,
               renegotiated into notes payable in monthly installments of
               $100,000, including interest of 6% through December 1997, and 8%
               after February 1998, through May 1998 (note 6(c))                             --              427
                                                                                   ------------      -----------
                                                                                         15,052            2,527
           Less current installments                                                       (440)          (2,527)
                                                                                   ------------      -----------
           Long-term, due in 2000                                                  $     14,612               --
                                                                                   ============      ===========
</TABLE>

       The Credit Facility prohibits additional debt, payment of dividends
       except on preferred stock, and encumbering any assets of the operating
       subsidiaries. The Credit Facility requires no payment of principal or
       interest until maturity. The outstanding balance is convertible into
       common stock at $9.082 per share, subject to anti-dilution adjustment, at
       the election of the lender. Financing costs in connection with the
       issuance of the Credit Facility were $3,053,000, including $2,980,000 in
       fair value of warrants to purchase 1,500,000 shares of common stock,
       valued using the Black-Scholes model, and $73,000 in cash. In 1998,
       amortization of financing costs, using the effective interest method over
       the loan period, was $2,665,000.



                                       42
<PAGE>   43

       The Receivables Loan and the Inventory Loan prohibit additional debt,
       liens on property, dividends or distributions on capital stock (except
       dividends on preferred stock payable in common stock). Advances under the
       Receivables Loan are limited to 80% of "eligible accounts" as defined.

(10)   Convertible Debentures

       During the year ended December 31, 1996, the Company issued three series
       of convertible debentures: "June Debentures" in the aggregate principal
       amount of $5,000,000 bearing interest at 7.5%, "August Debentures" in the
       aggregate principal amount of $10,000,000 bearing interest at 7.5%, and
       "October Debentures" in the aggregate principal amount of $10,000,000
       bearing interest at 7%.

       At December 31, 1996, the June Debentures were fully converted into
       773,514 shares of common stock, the August Debentures were partially
       converted into 883,691 shares of common stock, and the October Debentures
       were partially converted into 180,000 shares of common stock.

       At December 31,1997, the August Debentures were fully converted into
       2,582,106 shares of common stock and the October debentures were fully
       converted into 3,868,449 shares of common stock.

       Financing costs incurred in 1996 in connection with the issuance of
       debentures were $9,687,000, including $4,947,000 allocated to beneficial
       conversion features, $3,117,000 in the fair value of warrants to purchase
       420,063 shares of common stock (note 14), valued using the Black-Scholes
       model, and $1,623,000 in cash. Interest expense included $582,000 and
       $9,105,000 in 1997 and 1996, respectively.

  (11)   Lease Commitments

       The Company is obligated under various capital equipment leases that
       expire during the next two years. The gross amounts of equipment and
       vehicles and related accumulated amortization recorded under capital
       leases were as follows:

<TABLE>
<CAPTION>
                                                                          December 31,
                                                                ----------------------------------
                                                                    1998                  1997
                                                                ------------           -----------
<S>                                                             <C>                    <C>
          Equipment                                             $        257                   257
          Less accumulated amortization                                 (118)                  (69)
                                                                ------------           -----------
                                                                $        139                   188
                                                                ============           ===========
</TABLE>

       The Company leases office space and certain equipment under leases
       expiring at various dates through 2004. Rental expense under operating
       leases was approximately$1,607,000, $1,528,000 and $1,032,000 for the
       years ended December 31, 1998, 1997 and 1996, respectively.



                                       43
<PAGE>   44

       Future minimum commitments as of December 31, 1998 under capital and
       operating leases are as follows:

<TABLE>
<CAPTION>
                                                                   Capital               Operating
           Years ending December 31,                               Leases                 Leases
                                                                ------------           -----------
<S>                                                             <C>                    <C>  
           1999                                                 $         42                 1,494
           2000                                                           17                   772
           2001                                                           --                   693
           2002                                                           --                   538
           2003                                                           --                   434
           2004 and thereafter                                            --                5  135
                                                                ------------           -----------
               Total minimum lease payments                     $         59               5,4,066
                                                                ============           ===========
</TABLE>


       Imputed interest included in future minimum commitments on capital leases
       is not material.

(12)   Employee Benefit Plans

       The Company sponsors defined contribution 401(k) plans for substantially
       all employees. Pursuant to the plans, employees may request the Company
       to deduct and contribute amounts from their salary on a pre-tax basis.
       Employee contributions are subject to certain limitations and the Company
       may make matching contributions, at its discretion. The Company may also
       make discretionary contributions in addition to matching contributions.
       Company contributions vest ratably over periods of four to five years,
       beginning in the second or first year of employment, respectively.
       Company contributions to the plans were $460,000, $345,000 and $459,000
       for the years ended December 31, 1998, 1997 and 1996, respectively.

 (13)  Income Taxes

       Total income tax expense was allocated as follows:

<TABLE>
<CAPTION>
                                                                      Years ended December 31,
                                                           -----------------------------------------------
                                                               1998             1997             1996
                                                           -------------    -------------    -------------
<S>                                                        <C>              <C>               <C>
         Loss from continuing operations                   $          46             (126)             87
         Goodwill, for initial recognition
            of acquired tax liabilities                               --               --             228
                                                           -------------    -------------    -------------
                                                           $          46             (126)            315
                                                           =============    =============    =============
</TABLE>




                                       44
<PAGE>   45

       Significant components of the provision for income taxes attributable to
       continuing operations for the years ended December 31, 1998, 1997 and
       1996 are as follows:

<TABLE>
<CAPTION>
                                          1998           1997           1996
                                       ----------     ----------     ----------
<S>                                    <C>            <C>            <C> 
         Current
            Federal                    $       --             --             --
            State                              94             51             --
                                       ----------     ----------     ----------
                   Total current               94             51             --
                                       ----------     ----------     ----------
         Deferred:
            Federal                           (48)          (171)            84
            State                              --             (6)             3
                                       ----------     ----------     ----------
                   Total deferred             (48)          (177)            87
                                       ----------     ----------     ----------
         Total current and deferred    $       46           (126)            87
                                       ==========     ==========     ==========
</TABLE>

       The difference between the actual income tax benefit and the benefit
       computed by applying the statutory corporate income tax rate of 34% to
       pretax losses from continuing operations is attributable to the
       following:

<TABLE>
<CAPTION>
Years ended December 31,
                                              ----------------------------------------------
                                                   1998             1997             1996
                                              ------------     ------------     ------------
<S>                                           <C>              <C>              <C> 
         Computed expected tax benefit        $    (14,667)          (6,755)         (14,585)
            Increase in net operating loss
            carryforwards not providing
            current benefit                         11,349            5,394            7,530
         Permanent items                               315              407            1,776
         Writeoff of goodwill                        2,494               --               --
         Tax effect of loss not subject to
            U.S. taxation                               --              856            4,517
         Other                                         555              (28)             849
                                              ------------     ------------     ------------
                    Tax expense (benefit)     $         46             (126)              87
                                              ============     ============     ============
</TABLE>

       The tax effects of temporary differences that give rise to significant
       portions of the deferred tax assets and deferred tax liabilities at
       December 31, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>
                                                                  December 31,
                                                          -----------------------------
                                                              1998             1997
                                                          ------------     ------------
<S>                                                       <C>                     <C>  
Deferred tax assets:
    Preacquisition net operating loss carryforwards       $      4,831            4,831
    Postacquisition net operating loss carryforwards            25,505           14,156
    Inventories - due to reserves and additional costs
      capitalized for tax                                          866              544
    Accrued contract completion costs                               34               34
    Goodwill                                                        --               71
    License fees and intellectual property                          11               11
    Other expenses                                                 887              836
    Alternative minimum tax and other credit
      Carryforwards                                                298              298
                                                          ------------     ------------
                                                                32,432           20,781
Gross deferred tax assets
    Less valuation allowance                                   (32,432)         (20,781)
                                                          ------------     ------------

Deferred tax assets                                                 --               --
                                                          ============     ============
Deferred tax liabilities:                                 $         89              137
                                                          ============     ============
</TABLE>

                                       45
<PAGE>   46

       At December 31, 1998, the Company had federal net operating loss
       carryforwards of approximately $89,225,000 and tax credit carryforwards
       of $298,000. The future utilization of $14,210,000 of the preacquisition
       net operating losses and the credit carryforwards related to the
       acquisition of INT and IVC will be limited under Internal Revenue Code
       Sections 382 and 383. The tax benefits from the utilization of the
       preacquisition operating loss carryforwards and the tax credits will be
       credited to goodwill when realized.

       Following is a summary of the carryforwards and the expiration dates as
       of December 31, 1998:

<TABLE>
<CAPTION>
                                                                                                   Expiration
                                                                                Amounts               Dates
                                                                            ----------------    ----------------
<S>                                                                             <C>                 <C>  
         Postacquisition net operating loss carryforwards                       $75,015             2012-2018
         Preacquisition net operating loss carryforwards                         14,210             2008-2009
         Alternative minimum tax credit                                              38                 -
         General business credit                                                    260             1999-2000
</TABLE>

       In 1996, Intelect (Bermuda) was not subject to income tax in Bermuda and
       did not consider itself to be engaged in trade or business in the U.S. As
       such, Intelect (Bermuda) does not expect to be subject to direct United
       States taxation.

 (14)  Stockholders' Equity

       Authorized share capital of $0.01 par value was as follows:

<TABLE>
<CAPTION>
                                                                              December 31,
                                                                 ---------------------------------------
                                                                       1998                  1997
                                                                 -----------------     -----------------
<S>                                                                   <C>                   <C>       
          Preferred Stock                                             50,000,000            50,000,000
          Common Stock                                                50,000,000            50,000,000
</TABLE>

       Share transactions during the year ended December 31, 1998, were as
       follows:

       a.     Authorized 12,500 and sold 10,000 shares of Series C convertible
              preferred stock for $10,000,000 in a private placement, resulting
              in net proceeds of $9,117,000 after issuance costs of $883,000. A
              premium accrues at 4% annually and is payable upon conversion in
              cash or common stock at the option of the Company. Shares may be
              redeemed at $1,100 per share plus 110% of accrued dividends. The
              preferred stock, plus accrued premium, may be converted after May
              10, 1998 to common stock at a price which is the lower of $9.082
              or 97% of the average of the three lowest closing bid prices for
              the ten trading days preceding a notice of conversion. Effective
              March 5, 1999, the variable conversion price is 83.5% of the
              average of the two lowest closing bid prices for the 40 trading
              days prior to the date of conversion.

       b.     Authorized and sold an aggregate of 10,000 shares of Series D
              convertible preferred stock for $10,000,000 in two separate
              private placements, resulting in net proceeds of $9,444,000 after
              issuance costs of $556,000. A premium accrues at 4% annually and
              is payable in cash or common stock at the option of the Company.
              Shares may be redeemed at $1,100 per share plus 110% of accrued
              premium. The preferred stock, plus accrued premium, may be
              converted to common stock at a price which is the lower of $2.998
              or 97% of the average of the three lowest closing bid prices for
              the ten trading days preceding a notice of conversion. The
              conversion right was available June 8, 1998 for the first
              placement of 5,000 shares and September 24, 1998 for the second
              5,000 shares. Effective March 5, 1999, the variable




                                       46
<PAGE>   47

              conversion price is 83.5% of the average of the two lowest closing
              bid prices for the 40 trading days prior to the date of
              conversion.

       c.     Sold 1,000,000 shares of common stock in private placements at
              $1.00 per share, to accredited investors.

       d.     Issued 1,325,339 shares of common stock upon conversion of Series
              B preferred stock. Issued 4,006,532 shares of common stock upon
              conversion of Series C convertible preferred stock. Issued 784,184
              shares of common stock upon conversion of Series D convertible
              preferred stock.

       e.     Issued 600,000 shares of common stock upon exercise of warrants at
              $2.00 per share by an assignee of St. James Capital Corp., LP.

       f.     Issued 226,458 shares of common stock upon exercise of employee
              stock options.

       g.     Issued 333,795 shares of common stock in payment for $1,309,000 of
              dividends on preferred stock.

       h.     Issued 18,000 shares of common stock in partial settlement of an
              employment dispute with a seller of Mosaic Information
              Technologies.

       i.     Issued 10,600 shares of common stock upon the partial conversion
              of a promissory note held by a former employee.

       j.     Issued warrants exercisable for common stock as follows:

<TABLE>
<CAPTION>
                                                 Warrant        Exercise
                    Grant Date                   Shares           Price                   Exercise Period
        ------------------------------------  --------------   ------------   ----------------------------------------
<S>                                            <C>              <C>           <C>             
        February 12, 1998*                           450,000       7.50       February 1998 - February 2001
        (*)Replaced with warrant for 300,000 shares on April 2, 1998 

        April 2, 1998**                              300,000       7.50       April 1998 - February 2001

        April 2, 1998**                            1,200,000       7.50       April 1998 - February 2001 
        (**) Repriced to $2.998 by its terms on November 10, 1998. Pursuant to anti-dilution provisions in the warrant,
        holders have the right to acquire an aggregate of 3,753,000 shares. Holders of such warrants have claimed they 
        may be entitled to additional antidilution protection due to sales of common stock below the warrant
        exercise price.
 
        May 20, 1998                                  33,036     10.292       May 1998 - May 2003                        
                                                                                                                                
        June 20, 1998***                              30,000       5.00       June 1998 - April 2005                     
        (***) Replaced on September 1, 1998                                                                                     
        September 1, 1998                             30,000       2.00       September 1998 - April 2005                
                                                                                                                                
        September 1, 1998****                        200,000       2.00       September 1998 - December 2002             
        (****) Replacing warrants issued May 1, 1997, 100,000 at $5.00 and 100,000 at $7.00

        December 2, 1998                             300,000       1.50       February 1999 - March 2002
        December 2, 1998                             300,000       1.50       February 1999 - March 2002
        December 22, 1998                            150,000       2.998      February 1999 - December 2003
        December 22, 1998                            150,000       2.998      February 1999 - December 2003
</TABLE>




                                       47
<PAGE>   48

       The fair value of warrants issued was determined using the Black-Scholes
       option pricing model with the following assumptions:

<TABLE>
<CAPTION>
                                   Stock Price    Exercise     Term (years)                  Interest
                 Issue                              Price                     Volatility       Rate         Fair Value
       --------------------------  ------------  ------------  -------------  ------------  ------------  ---------------
<S>                                <C>               <C>           <C>            <C>          <C>        <C>         
       Credit facility with private lender:
       February 12, 1998           7.0125            7.50          1.00           75%          5.6%       $    909,172
       April 2, 1998               6.9375            7.50          1.00           75%          5.6%          2,071,195
                                                                                                          ------------
                                                                                            Total         $  2,980,367
                                                                                                          ------------

       Advisory services agreement:
       September 1, 1998           2.2188            2.00          1.00           75%          5.6%            155,408

       Equity placement services:
       May 20, 1998                Not valued because services were for placement of equity.
       June 20, 1998               Not valued because services were for placement of equity.
       December 2, 1998            Not valued because services were for placement of equity.
       December 22, 1998           Not valued because services were for placement of equity.
</TABLE>

       At December 31, 1998, outstanding warrants were as follows:

<TABLE>
<CAPTION>
                                               Warrant         Exercise
                     Grant Date                 Shares           Price              Exercise Period
                     ----------                -------           -----              ---------------
<S>                                            <C>               <C>            <C>          
              June 7, 1996                     125,000           13.1875        June 1996 - June 2001
              August 8, 1996                    70,063            8.56375       August 1996 - August 2001
              September 9, 1996                125,000            9.5625        September 1996 - September 2001
              October 5, 1996                  225,000            7.50          October 1996 - October 2001
              May 1, 1997                      100,000            3.00          January 1998 - December 2002
              May 8, 1997                       50,000            2.00          May 1997 - May 2002
              June 19, 1997                      6,750*`          3.6313        June 1997 - June 2001
              July 25, 1997                      6,750*           3.6313        July 1997 - June 2001
              August 15, 1997                    6,750*           3.6313        August 1997 - June 2001
              August 27, 1997                  450,000            6.00          August 1997 - August 2002
              August 29, 1997                    6,750*           3.6313        August 1997 - June 2001
              September 17, 1997                13,500*           3.6313        September 1997 - June 2001
              April 2, 1998                    300,000**          2.998         April 1998 - February 2001
              April 2, 1998                  1,200,000**          2.998         April 1998 - February 2001
              May 20, 1008                      33,036           10.292         May 1998 - May 2002
              September 1, 1998                 30,000            2.00          September 1998 - April 2005
              September 1, 1998                200,000            2.00          September 1998 - December 2002
              December 2, 1998                 300,000            1.50          February 1999 - March 2002
              December 2, 1998                 300,000            2.50          February 1999 - March 2002
              December 22, 1998                150,000            2.998         February 1999 - December 2003
              December 22, 1998                150,000            2.998         February 1999 - December 2003
                         Total               3,848,599
</TABLE>

       *Surrendered February 19, 1999 in connection with payment of receivables.

       **See  comment above regarding antidilution effects.

Share transactions during the year ended December 31, 1997, were as follows:



                                       48
<PAGE>   49

       a.     Authorized 10,000,000 shares and sold 2,482,005 shares of $2.0145,
              10% Cumulative Convertible Preferred Stock, Series A, for
              $5,000,000, in conjunction with a loan agreement with the Coastal
              Trust, resulting in net proceeds of $4,911,000, after issuance
              costs of $89,000. Dividends are payable quarterly, in cash or
              common stock, at the Company's option. The Company elected to pay
              dividends payable at September 30 and December 31, 1997, in common
              stock. The series may be redeemed, at the Company's option, at
              110%, 105% and 100% of face value after June 1, 1999, 2000, and
              2001, respectively, and is convertible into shares of common stock
              on a share for share basis, subject to anti-dilution provisions.
              The holders have the right of first refusal to participate in
              certain private equity or debt offerings. The series ranks in pari
              passu with the Series B and Series C preferred stock.

       b.     Authorized and sold 914,286 shares of $4.375, 10% Cumulative
              Convertible Preferred Stock, Series B, for $4,000,000, in a
              private placement, resulting in net proceeds of $3,877,000, after
              issuance costs of $123,000. Dividends are payable quarterly, in
              cash or common stock, at the Company's option, beginning March 31,
              1998. The series may be redeemed, at the Company's option, at the
              greater of $5.25 per share or the average closing market bid price
              for the five consecutive trading days prior to the date of
              redemption. Beginning after May 31, 1998, 50% of the preferred
              stock is convertible into common stock and the remaining 50% is
              convertible into common stock on June 30, 1998. The number of
              common shares the holder is entitled to receive on conversion is
              the greater of (i) the number of shares of preferred stock
              multiplied by 1.10, or (ii) the number of shares of preferred
              stock multiplied by a number, the numerator of which is $4.375 and
              the denominator of which is 0.85 multiplied by the average daily
              closing market bid price for the common stock, as quoted on the
              Nasdaq National Market system, for the five trading days
              immediately preceding the date of the notice of election of
              conversion. The holders have the right of first refusal to
              participate in certain private equity or debt offerings. The
              series ranks in pari passu with the Series A and Series C
              preferred stock.

       c.     Sold 675,000 shares of common stock in private placements of
              60,000 shares at $5.00 per share and 615,000 shares at $5.25 per
              share, to accredited investors, resulting in net proceeds of
              $3,330,000, after issuance costs of $199,000. An additional 21,400
              shares were issued in payment for placement services related to
              the 615,000 shares.

       d.     Issued 780,583 shares of common stock upon the conversion of
              Series A preferred stock by the Coastal Trust.

       e.     Issued 930,000 shares of common stock upon the exercise of
              warrants. 750,000 common shares at $2.00 were issued to the
              Coastal Trust; 150,000 shares at $2.00 were issued to the Credit
              Facility private lender; and 30,000 shares at $4.50 were issued
              pursuant to a consulting agreement, resulting in net proceeds of
              $1,890,000 after issuance costs of $45,000.

       f.     Issued 542,182 shares of common stock at $1.5625, totaling
              $847,000, together with $60,000 cash in settlement of all future
              royalties under a technology purchase agreement. The royalty
              agreement had been initially executed in conjunction with certain
              technology purchased by the Company.

       g.     Issued 11,407 shares of common stock in payment for $58,000 of
              interest on Convertible Debentures, due June 30, 1997.

       h.     Issued 28,148 shares of common stock in payment for $296,000 of
              dividends on Series A preferred stock.



                                       49
<PAGE>   50

i. Issued warrants exercisable for common shares as follows:

<TABLE>
<CAPTION>
                                               Warrant         Exercise
                     Grant Date                 Shares           Price             Exercise Period
                     ----------                -------           -----             ---------------
<S>                                          <C>            <C>                <C>
              February 26, 1997(*)             300,000           $5.00          February 1997 - February 2002
              March 27, 1997(*)                300,000            3.25          March 1997 - March 2002
              April 24, 1997(*)                150,000            3.25          April 1997 - April 2002
              May 1, 1997                      100,000            3.00          January 1998 - December 2002
              May 1, 1997                      100,000            5.00          January 1998 - December 2002
              May 1, 1997                      100,000            7.00          January 1998 - December 2002
              May 8, 1997                      300,000            2.00          May 1997 - February 2002
              May 8, 1997                      300,000            2.00          May 1997 - March 2002
              May 8, 1997                      150,000            2.00          May 1997 - April 2002
              May 8, 1997                       50,000            2.00          May 1997 - May 2002
              May 8, 1997                      750,000            2.00          May 1997 - May 2002
              June 19, 1997                      6,750            3.6313        June 1997 - June 2004
              July 2,1997                       30,000            4.50          August 1997 - December 2001
              July 25, 1997                      6,750            3.6313        July 1997 - June 2004
              August 15, 1997                    6,750            3.6313        August 1997 - June 2004
              August 27, 1997                  450,000            6.00          August 1997 - August 2002
              August 29, 1997                    6,750            3.6313        August 1997 - June 2004
              September 17, 1997                13,500            3.6313        September 1997 - June 2004
                   (*)  Replaced on May 8, 1997.
</TABLE>

       The fair value of warrants issued was determined using the Black-Scholes
       option pricing model with the following assumptions:

<TABLE>
<CAPTION>
                                            Stock     Exercise    Term                    Interest        Fair
              Issue                         Price       Price     (Yrs)     Volatility       Rate        Value
              -----                         -----       -----     -----     ----------       ----       -------
<S>                                         <C>        <C>       <C>      <C>             <C>          <C>
              Credit Facility with private lender:
              February 26, 1997(*)          $ 4.675    $ 5.00     1.00      70.06%        6.19%        $ 381,000
              March 27, 1997(*)               2.325      3.25     1.00      74.07         6.67           139,000
              April 24, 1997(*)               1.619      3.25     1.00      74.36         6.77            26,000
                                                                                                       ---------
                                                                                          Total          546,000
                                                                                                       ---------
                   (*) Replaced on May 8, 1997.  The fair value of the replacement warrants was less than the 
                   unamortized value of the original warrants on date of replacement.

              May 8, 1997                     1.975      2.00     1.00      74.30         6.62           183,000
              May 8, 1997                     1.975      2.00     1.00      74.30         6.62           183,000
              May 8, 1997                     1.975      2.00     1.00      74.30         6.61            91,000
              May 8, 1997                     1.975      2.00     1.00      74.30         6.59            30,000

              Advisory Services Agreement:
              May 1, 1997                     1.55       3.00     1.67      74.71         6.60            33,000
              May 1, 1997                     1.55       5.00     1.67      74.71         6.60            16,000
              May 1, 1997                     1.55       7.00     1.67      74.71         6.60             9,000
                                                                                                       ---------
                                                                                          Total           58,000
                                                                                                       ---------
</TABLE>




                                       50
<PAGE>   51

              Loan Agreements with Coastal Trust:

<TABLE>
<S>               <C>                         <C>        <C>      <C>       <C>           <C>            <C>    
              May 8, 1997                     1.975      2.00     1.00      74.30         6.59           457,000
              August 27, 1997                 6.444      6.00     1.00      75.00         6.24           987,000

              Distributor Agreement:
              June 19, 1997                   3.581      3.6313   1.00      75.00         6.38             8,000
              July 25, 1997                   6.344      3.6313   1.00      75.00         6.11            22,000
              August 15, 1997                 6.475      3.6313   1.00      75.00         6.20            23,000
              August 29, 1997                 6.731      3.6313   1.00      75.00         6.24            25,000
              September 17, 1997              9.438      3.6313   1.00      75.00         6.24            84,000
                                                                                                        --------
                                                                                          Total          162,000
</TABLE>

              Equity Placement Services:
              July 2, 1997      Not valued because services were for placement
                                of equity.

       Share transactions during the year ended December 31, 1996, were as
       follows:

       a.     Issued 180,000 common shares at $2.50 per share and 180,000 common
              shares at $3.50 per share upon the exercise of warrants issued to
              the previous owners of Savage Corporation. The warrants had been
              issued in connection with the acquisition of Savage Corporation.

       b.     Issued 100,000 common shares at $3.75 per share in consideration
              for an investment of $375,000 in debentures with a CDN $500,000
              face value, previously issued by Lakefield Arms Limited. The
              unsecured debentures bear interest at 8% per annum, and mature
              August 4, 1999.

       c.     Issued warrants exercisable for common shares in conjunction with
              the issuance of convertible debentures, and in conjunction with
              the acquisition of DNA Enterprises, Inc., as follows:

<TABLE>
<CAPTION>
                                                  Warrant       Exercise
                       Grant Date                 Shares          Price            Exercise Period
                       ----------                 ------        --------           ---------------
<S>                                              <C>            <C>           <C>
                February 13, 1996                 300,000       $  5.00       February 1997 - February 1999
                February 13, 1996                 300,000          7.00       February 1998 - February 1999
                June 7, 1996                      125,000         13.1875     June 1996 - June 2001
                August 8, 1996                     70,063          8.56375    August 1996 - August 2001
                September 9, 1996                 125,000          9.5625     September 1996 - September 2001
                October 15, 1996                  225,000          7.50       October 1996 - October 2001
</TABLE>

         d.     The fair value of warrants issued in conjunction with the
                convertible debentures was determined using the Black-Scholes
                option pricing model with the following assumptions:

<TABLE>
<CAPTION>
                                             Stock       Exercise     Term                  Interest        Fair
                         Issue               Price        Price       (Yrs)   Volatility      Rate          Value
                         -----               -----        -----       -----   ----------      ----          -----
<S>                                         <C>         <C>             <C>      <C>          <C>         <C>        
                June 7, 1996                $13.1875    $ 13.1875       5.0      70.5%        7.05%       $ 1,058,000
                August 8, 1996                9.5625       8.56375      5.0      73.1         7.05            453,000
                September 9, 1996             7.50         9.5625       5.0      71.6         7.05            561,000
                October 15, 1996              7.50         7.50         5.0      68.3         6.00          1,045,000
                                                                                                          -----------
                                                                                            Total         $ 3,117,000
                                                                                                          ===========
</TABLE>

       There have been no dividends declared on common shares for any of the
       periods reported.




                                       51
<PAGE>   52

(15)   Employee Stock Option Plan

       In 1995, Intelect (Bermuda) adopted a stock option plan (the "Plan")
       pursuant to which the Company's Board of Directors may grant stock
       options to directors, officers and key employees. The Plan, adopted by
       the Company as part of the redomiciling process, authorizes grants of
       options to purchase up to 5,000,000 shares of authorized common stock.
       The exercise price for stock options granted may range from 25% to 110%
       of the fair market value of the shares on the date of grant. All stock
       options have 10-year terms and vest and become fully exercisable
       according to schedules determined by the Board of Directors, generally
       one-third on each of the first three anniversaries of the date of grant.
       At December 31, 1998, there were 560,840 shares available for grant under
       the Plan. The Plan replaced a predecessor plan which continues only to
       the extent that there are 140,000 unexercised options outstanding at
       December 31, 1998.

       The per share weighted-average fair value of stock options granted during
       1998, 1997 and 1996 was $1.91, $2.04 and $4.66, respectively, on the
       dates of grants. 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:


<TABLE>
<CAPTION>
                                                                Years ended December 31,
                                            ---------------------------------------------------------------
                                                  1998                   1997                   1996
                                            ------------------    -------------------    ------------------
<S>                                                <C>                    <C>                    <C>
           Expected dividend yield                 0%                     0%                     0%
           Stock price volatility                  100%                   75%                    68%
           Risk free interest rate                 4.6%                   5.7%                   6.1%
           Expected option term                    3 years                3 years                3 years
</TABLE>

       The Company applies APB Opinion No. 25 in accounting for its Plan and,
       accordingly, has recognized compensation expense with respect to certain
       options granted at exercise prices less than the stock's market value on
       the date of grant. During the years ended December 31, 1998, 1997 and
       1996, the Company recognized compensation expense of $101,000, $354,000
       and $487,000, respectively.

       Had the Company determined compensation cost based on the fair value on
       the grant date for its stock options under SFAS No. 123, the Company's
       net losses would have been increased to pro forma amounts as follows:

<TABLE>
<CAPTION>
                                                               Years ended December 31,
                                           ----------------------------------------------------------------
                                                  1998                   1997                   1996
                                            ------------------    -------------------    ------------------
<S>                                         <C>                   <C>                    <C>     
          Net loss allocable to common 
            shareholder:
              As reported                   $         (46,105)                (20,798)              (43,039)
              Pro forma                               (52,107)                (25,217)              (45,955)

          Loss per share:
              As reported                   $          (1.78)                  (1.01)                (3.33)
              Pro forma                                (2.01)                  (1.23)                (3.55)
</TABLE>

       Pro forma net losses reflect only options granted in 1998, 1997 and 1996.
       Therefore, the full impact of calculating compensation cost for stock
       options under SFAS No. 123 is not reflected in the pro forma net loss
       amounts presented above because compensation cost is reflected over the
       option's vesting period of three years and compensation cost for options
       granted prior to November 1, 1995 is not considered. Furthermore, the
       effects of applying SFAS No. 123 may not be representative of the effects
       on reported net income for future years.



                                       52
<PAGE>   53

       Stock option activity during the periods indicated was as follows:

<TABLE>
<CAPTION>
                                                           Years ended December 31,
                                              -------------------------------------------------------
                                                   1998                1997                1996
                                              ---------------     ---------------     ---------------
<S>                                           <C>                 <C>                 <C> 
Number of options:
             Outstanding, beginning of
               period                               3,271,000           2,526,500           1,917,800
             Granted                                3,488,000           2,208,500           1,260,000
             Exercised                               (226,450)           (561,666)           (530,000)
             Canceled                              (2,501,506)           (902,334)           (121,300)
                                              ---------------     ---------------     ---------------
             Outstanding, end of period             4,031,044           3,271,000           2,526,500

          Weighted average exercise price:
             Outstanding, beginning of
               period                         $          3.93                4.58                2.56
             Granted                                     2.98                3.87                6.85
             Exercised                                   1.76                3.03                1.93
             Canceled                                    5.54                6.32                7.77
             Outstanding, end of period       $          2.23                3.93                4.58
</TABLE>

       At December 31, 1998, 1997 and 1996, the number of options exercisable
       was 1,316,341, 1,056,659, and 734,332, respectively, and the
       weighted-average exercise price of those options was $2.49, $3.78, and
       $2.79 respectively.

       At December 31, 1998, the range of exercise prices and the
       weighted-average remaining contractual life of outstanding options, was
       $1.00 to $6.25 and 8.8 years, as shown in the following table:

<TABLE>
<CAPTION>
                                              Option
               Option shares                  shares                Exercise prices             Expiration
                outstanding                exercisable                 per share                   Dates
          -------------------------   -----------------------   ------------------------  ------------------------
          <S>                         <C>                       <C>                       <C>  
                 3,160,703                     686,009                   $2.000                   2007-8
                    40,000                      40,000                    2.375                    2004
                   100,000                     100,000                    2.660                    2003
                   672,000                     452,000                    3.000                   2005-7
                    10,000                       3,333                    4.250                    2007
                    25,000                      16,666                    4.375                    2006
                    15,000                      10,000                    5.375                    2006
                     8,333                       8,333                    6.250                    2007
</TABLE>

(16)   Income (Loss) Per Share

       Basic and diluted income (loss) per share is based on the weighted
       average number of common shares outstanding for the period. Potential
       common shares relating to the exercise of stock options and stock
       warrants, conversion of preferred stock or conversion of convertible debt
       have been excluded from the computation as the effects would have been
       anti-dilutive.

                                       53
<PAGE>   54

       Contingent shares, which were part of the INT and IVC acquisitions, have
       been excluded from the calculations because it was considered unlikely
       that the underlying performance criteria would be met.

(17)   Contingencies

       On October 28, 1998, in the 192nd Judicial District Court for Dallas
       County, Texas Richard Dzanski filed suit against Intelect Network
       Technologies Company, a wholly owned subsidiary of the Company, and
       Intelect Systems Corp., the predecessor of the Company. In the suit, the
       plaintiff has claimed a breach of an Irrevocable Option Agreement and
       that he has not received payments he claims are due to him in the amount
       of at least $386,000. The defendants deny liability to the plaintiff and
       intend to vigorously defend the case. The parties are in discovery and it
       is too early to determine if the outcome of this case will have a
       material impact on the Company.

       Intelect (Bermuda) is contingently liable for certain potential
       liabilities related to its discontinued operations. Specifically, under a
       stock purchase agreement dated October 3, 1995 ("1995 Agreement"),
       Intelect (Bermuda) agreed to indemnify Savage Sports Corporation, the
       purchaser of Savage Arms, Inc. (a manufacturer of firearms), for certain
       product liability, environmental clean-up costs and other contractual
       liabilities, including certain asserted successor liability claims. One
       of the liabilities assumed involves a firearms product liability lawsuit
       filed by Jack Taylor individually and as father of Kevin Taylor in Alaska
       Superior Court (the "Taylor litigation"). Intelect (Bermuda) is informed
       that a defendant in the Taylor litigation, Western Auto Supply Co.,
       settled the lawsuit for $5 million and, in turn, has asserted a
       third-party claim against Savage Arms, Inc. for indemnification in the
       amount of the settlement plus attorneys' fees and related costs. Savage
       Arms has asserted defenses to the claims and Intelect (Bermuda) believes
       additional defenses may be available. Based on the information available
       to date, it is impossible to predict the outcome of this litigation or to
       assess the probability of any verdict.

       Intelect (Bermuda) also has been notified that Savage Sports Corporation
       seeks indemnification under the 1995 Agreement in connection with certain
       other product liability claims. Most notably, Intelect (Bermuda) has
       undertaken the defense of a lawsuit filed against Savage Arms, Inc. by
       Emhart Industries, Inc. ("Emhart") in the United States District Court
       for the District of Massachusetts (the "Emhart litigation"). In the
       lawsuit, Emhart requests indemnification from Savage Arms, Inc. under an
       agreement Emhart allegedly executed in 1981 with Savage Industries, Inc.,
       claiming that Savage Arms, Inc. is a successor to Savage Industries, Inc.
       To date, Emhart has claimed indemnification of approximately $2.2 million
       for five lawsuits it has defended or settled and also seeks a declaratory
       judgment that it is entitled to indemnification for losses and expenses
       related to firearms product liability actions which may be filed against
       Emhart in the future. Intelect (Bermuda) intends to assert additional
       defenses. The parties are in discovery and Intelect (Bermuda) cannot at
       this time predict the outcome of the litigation.

       In the event the Taylor litigation and/or Emhart litigation were to be
       resolved adversely to Intelect (Bermuda), there would be a material
       adverse effect on the Company's financial condition and results of
       operations.




                                       54
<PAGE>   55

(18)   Segments of Business and Geographic Areas

       See Products, Technologies and Services in ITEM I for a description of
       the segments in which the Company does business.

       Sales to external customers:

<TABLE>
<CAPTION>
                                                                     Years ended December 31,             
                                                                  -----------------------------           
                                                                    1998       1997       1996            
                                                                  -------    -------    -------           
<S>                                                               <C>         <C>           <C>           
Fiber optic multiplexer                                           $ 6,410     26,250        430           
Engineering services                                                8,147      8,632      4,332           
Digital signal processor                                            2,690        277         81           
Visual communication                                                1,448        636        172           
Other - United States                                                 646      1,982      1,892           
Other - Europe                                                         --         --      2,445           
                                                                  -------    -------    -------           
Worldwide total                                                   $19,341     37,777      9,352           
                                                                  =======    =======    =======           
                                                                 
Included in the above were direct and indirect export sales of:

                                                                  $ 4,068     25,071      1,402
                                                                  =======    =======    =======
</TABLE>

       In 1997, 59% of sales were to Asia, substantially all to the Republic of
       Korea. See note 20 for a description of customer concentration.

       Segment-specific margins (Gross Profit less total engineering and
       development costs, including capitalized software, and asset write downs
       for the segment):

<TABLE>
<CAPTION>
                                     Years ended December 31,
                               ----------------------------------
                                 1998         1997         1996
                               --------     --------     --------
<S>                            <C>             <C>         <C>    
Fiber optic multiplexer        $(10,792)       5,635       (3,482)
Engineering services              2,002        2,375        1,270
Digital signal processor            402         (576)        (306)
Visual communication               (671)      (1,402)      (6,006)
Other                           (12,747)      (4,997)     (10,244)
                               --------     --------     --------
  Subtotal segment specific     (21,806)       1,035      (18,768)
Capitalized software              1,988        1,317        1,395
All other expenses              (18,969)     (19,994)     (16,265)
                               --------     --------     --------
   Operating loss               (38,787)     (17,642)     (33,638)
                               ========     ========     ========
</TABLE>



                                       55
<PAGE>   56

       Assets, capital expenditures and depreciation are identifiable only by
combined segments, as grouped below:

<TABLE>
<CAPTION>
ASSETS                                     At December 31,
                                   -----------------------------
                                     1998       1997       1996
                                   -------    -------    -------
<S>                                <C>         <C>        <C>   
Fiber optic multiplexer, visual
  communication and other -
  United States                    $20,906     35,554     12,547
Engineering services and DSP         8,200      8,840      6,607
Other - Europe                                               221
Not allocable to a segment           2,755      4,837     16,864
                                   -------    -------    -------
Worldwide total                    $32,082     49,231     36,018
                                   =======    =======    =======
</TABLE>

<TABLE>
<CAPTION>
CAPITAL EXPENDITURES                  Years ended December 31, 
                                   -----------------------------
                                     1998       1997       1996
                                   -------    -------    -------
<S>                                <C>         <C>        <C>   
Fiber optic multiplexer, visual
  communication and other          $ 1,662      2,539      2,265
Engineering services and DSP           354        454      1,047
Not allocable to a segment              19         --        348
                                   -------    -------    -------
Worldwide total                    $ 2,035      2,993      3,660
                                   =======    =======    =======

DEPRECIATION

Fiber optic multiplexer, visual
  communication and other          $ 1,161        836        725
Engineering services and DSP           396        354        195
Not allocable to a segment             145         --        541
                                   -------    -------    -------
Worldwide total                    $ 1,702      1,190      1,461
                                   =======    =======    =======

</TABLE>


(19)   Related Party Transactions

       During the year ended December 31, 1998, the following related party
       transactions were recorded:

       (a)    Renewed a loan to an officer in the amount of $171,000, including
              accrued interest and additional advances, which was outstanding at
              December 31, 1998. The 5% note is secured by a stock pledge
              agreement. 

       (b)    Repaid a loan of $200,000 from an officer, including interest of
              $4,000.

       During the year ended December 31, 1997, the following related party
       transactions were recorded:

       (a)    Borrowed $200,000 from a director in May and repaid the loan in
              September, including interest of $8,000.

       (b)    Renewed a loan to an officer in the amount of $95,000, including
              accrued interest, which was outstanding at December 31, 1997. The
              5% note is secured by a stock pledge agreement.

       (c)    Borrowed $643,000 from a group of individuals, including $233,000
              from directors, $200,000 from an officer and $210,000 from
              employees.

       During the year ended December 31, 1996, the following related party
       transactions were recorded:

       (a)    Purchased patents, intellectual property and related proprietary
              information from a company owned by an officer for $125,000 and
              entered into a royalty agreement with respect to products sold by
              the Company which are covered by the patents.

       (b)    Loaned an officer $135,000, of which $91,000, including accrued
              interest, remained outstanding at December 31, 1996. The 5% note
              is secured by a stock pledge agreement.

       (c)    Borrowed $500,000 from a company controlled by a director who was
              also the Company's president in July, and repaid the loan in
              September, including interest of $13,000.

       (d)    Paid $120,000 for management fees and rented facilities from a
              company controlled by a director who was also the Company's
              president.

       (e)    Amended employment agreements with the now former president and
              the present chairman which, generally upon termination, provide
              for continuation of salaries for three years following the current
              year of employment.

(20)   Significant Customers and Concentration of Credit Risk

       In 1998, no customer accounted for more than 10% of consolidated net
       revenues.

       In 1997, a distributor and one customer represented 59% and 11%,
       respectively, of consolidated net revenues. The distributor sold to at
       least five end users in the Republic of Korea.



                                       56
<PAGE>   57

       In 1996, one customer represented 25% of consolidated net revenue.

       The Company is subject to credit risk through trade receivables. At
       December 31, 1997, the distributor responsible for all revenue from Korea
       accounted for $9,879,000 (63%) of the accounts receivable. In October
       1998, the Company was advised of the illiquidity of the distributor and
       wrote off or reserved substantially all of the $4,696,000 receivables
       remaining unpaid at the end of September 1998, adjusted, effective in
       December 1998, for a payment of $1,000,000 in February 1999.

(21)   Supplemental Disclosure of Cash Flow Information

<TABLE>
<CAPTION>
                                                               Years ended December 31,
                                                 -----------------------------------------------------
                                                       1998               1997               1996
                                                 ---------------    ---------------    ---------------
<S>                                              <C>                <C>                <C> 
Cash paid during the period for:
   Interest                                      $         1,126                704                509
</TABLE>

       Noncash Items

       During the year ended December 31, 1998, the Company recorded the
       following noncash transactions:

       (a)    Converted notes payable into common stock -$21,000.

       (b)    Converted 914,286 shares of Series B preferred stock and 8,157
              shares of Series C preferred stock and 1,750 shares of Series D
              preferred stock into 5,997,819 shares of common stock.

       (c)    Issued common stock in payment of preferred stock dividends -
              $1,309,000

       (d)    Issued common stock warrants in conjunction with notes payable
              -$2,980,000.

       (e)    Issued common stock warrants in conjunction with an advisory
              services agreement -$155,000.

       (f)    Allocation of retained earnings to beneficial conversion feature
              of preferred stock issued -$618,000.

       During the year ended December 31, 1997, the Company recorded the
       following noncash transactions:

       (a)    Converted convertible debentures into common stock - $14,913,000.

       (b)    Converted notes payable into preferred stock - $5,000,000.

       (c)    Converted preferred stock into common stock (par value only) -
              $8,000.

       (d)    Applied a note payable against a technology license asset upon
              settlement of a contractual dispute - $2,363,000.

       (e)    Issued common stock in conjunction with termination of a royalty
              agreement - $847,000.

       (f)    Issued common stock in payment of preferred stock dividends -
              $296,000.

       (g)    Issued preferred stock in payment of interest on notes payable -
              $72,000.

       (h)    Issued common stock in payment of interest on convertible
              debentures - $58,000.

       (i)    Issued common stock warrants in conjunction with notes payable -
              $1,661,000.

       (j)    Issued common stock warrants in conjunction with a distributor
              agreement - $162,000.

       (k)    Issued common stock warrants in conjunction with an advisory
              services agreement - $58,000.

       (l)    Issued common stock warrants upon termination of credit facility -
              $30,000.

       (m)    Allocation of retained earnings to beneficial conversion feature
              of preferred stock issued - $31,000.

       (n)    Acquired equipment under capital leases - $117,000.



                                       57
<PAGE>   58

       During the year ended December 31, 1996, the Company recorded the
       following noncash transactions:

       (a)    Converted convertible debentures into stock - $10,087,000.

       (b)    Allocation of proceeds from convertible debentures to beneficial
              conversion features - $4,947,000.

       (c)    Issued common stock warrants in conjunction with convertible
              debentures - $3,117,000.

       (d)    Obtained a technology license in exchange for a note - $3,267,000.

       (e)    Issued stock in final settlement of the Intelect, Inc. acquisition
              - $850,000.

       (f)    Issued stock as part of employment agreements - $500,000.

       (g)    Recognized compensation expense on stock options granted at less
              than market price - $487,000.

       (h)    Acquired a long term asset with stock - $375,000.

       (i)    Acquired equipment under capital leases - $111,000.


(22)     Valuation and Qualifying Accounts

<TABLE>
<CAPTION>
                                              Balance at        Additions          Additions
                                              beginning         charged to         charged to                              Balances
                                                 of             costs and            other                                  at end
                                               period            expenses           accounts          Deductions          of period
                                            ------------       ------------       ------------       ------------       ------------
<S>                                         <C>                <C>                <C>                <C>                <C>
For the year ended December 31, 1998:
     Allowances deducted from assets:
     Accounts and notes receivable          $        541              4,206                 --              3,877(a)             870
     Inventories                                   1,600              1,021                 --                 77(b)           2,544
                                            ------------       ------------       ------------       ------------       ------------
       Total allowances
         deducted from assets               $      2,141              5,227                 --              3,954              3,414
                                            ============       ============       ============       ============       ============

For the year ended December 31, 1997:

  Allowances deducted from assets:
     Accounts and notes receivable          $        542                632                 --                633(a)(c)          541
     Inventories                                   1,254                590                 --                244(b)(c)        1,600
                                            ------------       ------------       ------------       ------------       ------------
       Total allowances
         deducted from assets               $      1,796              1,222                 --                877              2,141
                                            ============       ============       ============       ============       ============

For the year ended December 31, 1996:
     Allowances deducted from assets:
     Accounts and notes receivable          $         25                521                 --                  4(a)             542
     Inventories                                     730              1,058                 --                534(b)           1,254
                                            ------------       ------------       ------------       ------------       ------------
       Total allowances
         deducted from assets               $        755              1,579                 --                538              1,796
                                            ============       ============       ============       ============       ============
</TABLE>


Notes:
       (a)    Accounts written off
       (b)    Scrapped, sold or other disposition 
       (c)    Includes liquidation of subsidiary.



                                       58
<PAGE>   59

(23)   Subsequent Events

       On March 5, 1999, the Company sold 3,000 shares of series E Convertible
       Preferred Stock, in the Initial Closing of a private placement, for
       $3,000,000. Premiums accumulate at the rate of 8% per year, are payable
       on conversion and may be paid in cash or common stock at the Company's
       option. The preferred stock will automatically convert into common stock
       on March 5, 2004 and may be converted prior to that date at the holder's
       option. The conversion price is the lesser of $1.80 per common share or
       83.5% of the average of the two lowest closing bid prices of the common
       stock for the forty consecutive trading days before the date of
       conversion. Purchasers of the preferred stock received warrants to
       purchase 300,000 of common stock at a price of 110% of the "Market Price"
       (as defined) on the date of the Initial Closing . Redemption of the
       preferred stock may be required by the holders upon the occurrence of
       Major Transactions, such as merger or sale of substantially all assets,
       or in case of Triggering Events, such as failure to register the resale
       of conversion shares by July 2, 1999 and certain other events which would
       impair the ability of preferred stockholders to resell conversion shares.
       The March 5 Initial Closing is the first of multiple closings subject to
       satisfaction of terms and conditions in a Securities Purchase Agreement
       all as more fully described in the Form 8-K of the Company filed March 2,
       1999.

       In connection with the Initial Closing of the Series E preferred stock,
       the Company agreed to allow holders to sell all of their remaining 1,843
       shares of Series C preferred stock and 1,144 shares of Series D preferred
       stock to new investors. In connection with the issuance of the Series E
       preferred stock, the holders of the Series C and Series D preferred stock
       have the right under the Certificates of Designations of such securities
       to use the variable conversion price of the Series E preferred stock.
       Thus, after the Initial Closing, when the holders of the Series C and
       Series D preferred stock submit a conversion notice, they will likely
       elect to use the variable conversion price of the Series E preferred
       stock instead of the variable conversion price of the Series C and D
       preferred stock (which is 97% of the average of the three lowest closing
       bid prices in the ten prior trading days). In addition, the Company has
       agreed that the new investors are not required to limit their conversions
       of the Series C and Series D preferred stock to 1,200,000 shares of
       Common Stock in any continuing thirty (30) day period. Original holders
       will continue to be subject to contractually agreed conversion
       restrictions.

       During January 1999, the Company sold in a private placement 1,800,000
       shares of common stock at a price of $1.00 per share and warrants to
       purchase 540,000 shares of common stock in connection with the private
       placement. The warrants have an exercise price of $2.998. The offering
       was made solely to accredited investors. The Company granted to the
       purchasers registration rights covering the resale of the common stock
       and the warrant shares.

       Effective January 13, 1999, the Coastal Trust agreed to extend the
       maturity date of the Receivables Loan which previously matured on August
       31, 1999, to February 12, 2000. In addition, the Coastal Trust agreed to
       extend the maturity date on the Inventory Loan to May 1, 1999, with
       payments of $250,000 plus accrued interest due on each of March 1, April
       2 and May 1, 1999.

       Effective January 13, 1999, as permitted under the terms of the Credit
       Facility dated as of February 12, 1998, the Company elected to extend the
       maturity date of the Convertible Promissory Notes issued pursuant to the
       Facility to February 12, 2000. In connection with the extension, the
       Company issued to the investor warrants to purchase an aggregate of
       535,000 shares of common stock of the Company. The exercise price of the
       warrants is $1.81. The warrants are subject to antidilution provisions
       which are triggered in the event that the Company issues or sells common
       stock or securities convertible or exercisable into common stock at a
       price less than the exercise




                                       59
<PAGE>   60

       price then in effect. Such provisions would enable the holder to obtain a
       reduction in the warrant exercise price as well as an increase in the
       applicable number of warrant shares.

       On February 12, 1999, the Company reached an agreement with its
       distributor in Korea to forbear from collection of remaining receivable
       balances due from the distributor in exchange for (1) immediate payment
       of $1,000,000, (2) delivery to the Company of a proprietary product
       design, (3) assumption by the distributor of warranty obligations to
       Korean customers, (4) surrender of exclusive distribution rights in Korea
       after 1999, and (5) surrender of warrants to purchase 40,500 shares of
       common stock. The forbearance is voidable if the distributor fails either
       to order an additional $1,000,000 of the Company's products before
       February 10, 2000 or to pay $250,000 by January 31, 2000.





                                       60
<PAGE>   61

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

         The Company's Board of Directors, in accordance with the recommendation
of its Audit Committee, which is composed of non-employees of the Company, has
requested Grant Thornton LLP ("Grant Thornton") to act as independent auditors
of the Company for the 1998 fiscal year, subject to shareholder approval, in
replacement of Arthur Andersen LLP ("Arthur Andersen").

         As disclosed in the Form 10-Q of the Company filed on November 16,
1998, the Company's previous independent auditors, Arthur Andersen, resigned on
November 13, 1998. The report by Arthur Andersen LLP for the year ended December
31, 1997 contained no adverse opinion or disclaimer of opinion, nor was it
qualified or modified as to audit scope or accounting principles. There have
been no disagreements by the Company with Arthur Andersen LLP on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope and procedure, which disagreement(s), if not resolved to the satisfaction
of Arthur Andersen LLP would have caused it to make reference to the subject
matter of the disagreement(s) in connection with its report. There are no
"reportable events" as set forth in Regulation S-K, Item 304(a)(1)(v)(A)-(D)
except as follows: (1) Arthur Andersen LLP informed the Company that it appears
likely its auditor's report for 1998 would have contained a qualification as to
the Company's ability to continue as a going concern, (2) Arthur Andersen
informed the Audit Committee Chairman, the Chairman of the Board and the Chief
Financial Officer that with respect to Capitalized Software Development Costs,
compliance with SFAS #86 had not been evaluated particularly as it relates to
current year additions and realizability of such asset and (3) Arthur Andersen
informed the Audit Committee Chairman, the Chairman of the Board and the Chief
Financial Officer that as a result of the revenue restatement for the quarter
ended June 30, 1998, they would have had to expand the scope of the 1998 audit
if they had not resigned. Arthur Andersen encouraged the Audit Committee
Chairman, the Chairman of the Board and the Chief Financial Officer to closely
monitor these matters. Substantive audit tests and further investigation into
these matters would have been a necessary part of Arthur Andersen's audit
procedures for the year-end December 31, 1998 financial statements had the
client/auditor relationship not terminated. Arthur Andersen has been authorized
by the Company to respond to any and all inquiries by the successor auditors,
without limitation. The Company has indicated that it will cooperate fully with
the new auditors to address these matters. Arthur Andersen has provided to the
Company a letter to the Securities and Exchange Commission stating that it has
reviewed the disclosure provided in this Form 10-Q and has no disagreement with
relevant portions of this disclosure, pursuant to the requirements of Item
304(a)(3) of Regulation S-K. A copy of such letter, dated November 16, 1998, is
filed as an exhibit to the Form 10-Q filed on November 16, 1998.

         As disclosed in the Form 8-K of the Company filed on August 18, 1997,
the term of the Company's previous independent auditors, KPMG, expired at the
Company's annual general meeting of its stockholders held August 13, 1997. The
KPMG report dated April 9, 1997 on the consolidated financial statements of the
Company for the year ended December 31, 1996, noted that the Company has
suffered recurring losses from continuing operations and is dependent upon the
successful development and commercialization of its products and its ability to
secure adequate sources of capital until the Company is operating profitably and
noted that these matters raise substantial doubt about the Company's ability to
continue as a going concern, and that management's plans with regard to these
matters were described in Note 1 to the consolidated financial statements.

         During the two years ended December 31, 1995 and December 31, 1996, and
the subsequent interim period through the date of the appointment of Arthur
Andersen as the Company's new outside auditors, there were no "disagreements"
between the Registrant and KPMG as described in Item 304(a)(1)(iv) of Regulation
S-K. The Registrant requested KPMG to furnish it with a letter addressed to the
SEC stating whether or not it agreed with the above statements. A copy of such
letter, dated August 14, 1997, was filed as an Exhibit to the Form 8-K of the
Company filed on August 18, 1997.

         Arthur Andersen LLP has consented to the Company's inclusion of Arthur 
Andersen's report on the company's financial statements for a certain prior 
period (1997). In connection with this consent, Arthur Andersen has asked the 
Company to indemnify and hold harmless Arthur Andersen LLP for any loss 
incurred as a result of the consent to the inclusion of Arthur Andersen's 
report, unless such loss results from Arthur Andersen's being adjudicated by a 
court, after appeal, to be liable as a result of consenting to the use of its 
report. The Company agreed to such request for an indemnification and hold 
harmless agreement.

         KPMG has consented to the Company's inclusion of KPMG's report on the
Company's financial statements for certain prior periods. In connection with the
consent, KPMG asked the Company to indemnify KPMG for any loss incurred as a
result of the consent to the inclusion of KPMG's report, unless such loss
results from KPMG's professional malpractice. The Company agreed to such request
for indemnification.



                                       61
<PAGE>   62

                                    PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The Company will file with the Securities and Exchange Commission a
definitive Proxy Statement no later than 120 days after the close of its fiscal
year ended December 31, 1998 (the "Proxy Statement"). The information required
by this Item is incorporated by reference from the Proxy Statement.

ITEM 11 - EXECUTIVE COMPENSATION

         The information required by this Item is incorporated by reference from
the Proxy Statement.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by this Item is incorporated by reference from
the Proxy Statement.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by this Item is incorporated by reference from
the Proxy Statement.


                                     PART IV

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

         A. The Financial Statements filed as part of this report are listed and
indexed on Page 20. Schedules other than those listed in the index have been
omitted because they are not applicable or the required information has been
included elsewhere in this report.

         B. Listed below are all Exhibits filed as part of this report. Certain
Exhibits are incorporated by reference to documents previously filed by the
Registrant with the Securities and Exchange Commission pursuant to Rule 12b-32
under the Securities Exchange Act of 1934, as amended. Exhibits which are
incorporated by reference are indicated by the information in the parenthetical
following such exhibit.

<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>        <C>
2.1        Plan and Agreement of Merger dated as of October 29, 1997 by and among      
           Intelect Communications Systems Limited ("Intelect (Bermuda)"), Intelect    
           Communications, Inc. (the "Company"), and Intelect Merger Co. (1)           
                                                                                       
3.1        Amended and Restated Certificate of Incorporation of the Company (1)        
                                                                                       
3.2        Certificate of Correction dated December 17, 1999 to Amended and            
           Restated Certificate of Incorporation (21)                                  
                                                                                       
3.3        Certificate of Amendment to Amended and Restated Certificate of             
           Incorporation (20)                                                          
                                                                                       
3.4        Amended and Restated By-Laws of the Company (1)                             
                                                                                       
4.1        Specimen Stock Certificate of the Company (2)                               
                                                                                       
4.2        Certificate of Designations of the Series A Preferred Stock dated           
           December 2, 1997(1)                                                         
                                                                                       
4.3        Certificate of Designations of the Series B Preferred Stock dated           
           December 17, 1997 (22)                                                      
                                                                                       
4.4        Certificate of Designations of the Series C Preferred Stock dated           
           February 6, 1998 (3)                                                        
                                                                                       
4.5        Certificate of Designations of the Series D Preferred Stock dated May 8,    
           1998 (16)                                                                   
                                                                                       
4.6        Certificate of Designations of the Series E Preferred Stock dated March     
           3, 1999 (19)                                                                
</TABLE>
           

                                       62
<PAGE>   63


<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>     <C>
10.1    Option Agreement dated March 31, 1995 by and among the Company, certain
        sellers and Intelect, Inc. (5)

10.2    Stock Purchase Agreement dated October 3, 1995 by and among Intelect
        (Bermuda), Savage Corporation and Savage Sports Corporation (5)

10.3    Management Agreement dated as of October 1, 1995 between the Company and
        Herman Frietsch*(6)

10.4    Amendment No. One dated January 1, 1996 to Management Agreement between
        the Company and Herman Frietsch referred to in Exhibit 10.4*(7)

10.5    Employment Agreement dated as of April 1, 1996 between the Company and
        Eugene Helms*(4)

10.6    Employment Agreement dated as of April 24, 1995 between the Company and
        Peter Ianace*(6)

10.7    Stock Purchase Agreement dated January 13, 1996 by and between Intelect
        (Bermuda), Intelect Systems Corp., Robert E. Nimon, Kim F. Nimon, Edgar
        L. Read, Gregory L. Mayhan and DNA Enterprises, Inc. (8)

10.8    Warrants dated February 13, 1996 issued to Edgar L. Read and Gregory L.
        Mayhan to be delivered one year after Closing (9)

10.9    Employment Agreement dated as of February 13, 1996 between Edgar L. Read
        and DNA Enterprises, Inc.*(8)

10.10   Employment Agreement dated as of February 13, 1996 between Gregory L.
        Mayhan and DNA Enterprises, Inc.*(8)

10.11   Agreement and Plan of Merger dated March 19, 1996 among the Company,
        Mid-Ocean, Inc. and Mosaic Information Technologies, Inc. (10)

10.12   Employment Agreement dated March 29, 1996 among Matthew Feldman, the
        Company and Mosaic Information Technologies, Inc.*(10)

10.13   Promissory Note dated as of February 26, 1997 to St. James Capital Corp.
        from the Company (7)

10.14   Pledge Agreement dated as of February 26, 1997 between the Company and
        St. James Capital Corp. (7)

10.15   Warrant to Purchase Common Stock of the Company Expiring February 26,
        2002 (7)

10.16   Registration Rights Agreement dated February 26, 1997 between the
        Company and St. James Capital Corp. (7)

10.17   Amended and Restated Promissory Note dated as of February 26, 1997 to
        St. James Capital Corp. from the Company (7)

10.18   First Amendment to Pledge Agreement dated as of March 27, 1997 between
        the Company and St. James Capital Corp. (7)

10.19   Warrant to Purchase Common Stock of the Company Expiring March 27, 2002
        (7)

10.20   Amendment No. 1 to Registration Rights Agreement dated as of March 27,
        1997 between the Company and St. James Capital Corp. (7)

10.21   Employee Stock Option Plan adopted April 24, 1986* (7) 10.22 Stock
        Incentive Plan adopted December 13, 1995* (7)

10.23   Lease Agreement between TCIT Dallas Industrial and Intelect Network
        Technologies, dated February 25, 1997 (11)

10.24   Lease Agreement between Campbell Place One Joint Venture and DNA
        Enterprises, dated February 1, 1997 (11)

10.25   Advisory Services Agreement with Renaissance Financial Securities
        Corporation dated July 8, 1997 (12)

10.26   Warrant issued to AJC, Inc. to Purchase Common Stock of the Company
        expiring on December 31, 2002 (12)

10.27   Loan Agreement dated as of May 8, 1997 between the Company and The
        Coastal Corporation Second Pension Trust (12)

10.28   Warrant issued to The Coastal Corporation Second Pension Trust to
        Purchase Common Stock of the Company expiring on May 7, 2002 (12)
</TABLE>



                                       63
<PAGE>   64

<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>     <C>
10.29   Registration Rights Agreement dated as of May 8, 1997 between the
        Company and The Coastal Corporation Second Pension Trust (12)

10.30   Subscription Agreement for Series A Cumulative Preferred Stock dated as
        of May 30, 1997 between the Company and The Coastal Corporation Second
        Pension Trust (12)

10.31   Registration Rights Agreement dated as of May 30, 1997 between the
        Company and The Coastal Corporation Second Pension Trust (12)

10.32   Agreement dated April 25, 1997 between the Company and the beneficiary
        of a royalty agreement (12)

10.33   Irrevocable Option Agreement dated October 1, 1995 between the Company
        and owners of certain intellectual property rights * (12)

10.34   Agreement dated July 7, 1997 among Robert E. Nimon, Kim F. Nimon, Nimon
        Consulting, Inc., Intelect Systems Corp. and the Company (12)

10.35   Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
        from the Company (12)

10.36   Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
        from the Company (12)

10.37   Amended and Restated Loan Agreement dated August 27, 1997 among the
        Company, Intelect Systems Corp., and The Coastal Corporation Second
        Pension Trust (13)

10.38   Warrant to purchase Company Common Stock expiring August 26, 2002 issued
        to The Coastal Corporation Second Pension Trust (13)

10.39   Amendments Nos. 2 and 3 to Registration Rights Agreements dated April 24
        and May 8, 1997 among the Company and St. James Capital Corp. (13)

10.40   Warrants to purchase Company Common Stock dated April 24 and May 8, 1997
        issued to St. James Capital Corp. (13)

10.41   Second Amended and Restated Floating Rate Promissory Noted dated
        effective February 26, 1997 to St. James Capital Corp. from the Company
        (13)

10.42   Second and Third Amendments to Borrower's Pledge Agreement dated April
        24 and May 8, 1997 among Intelect Systems Corp. and St. James Capital
        Corp. (13)

10.43   Warrant expiring December 31, 2001 issued to Lifeline Industries, Inc.
        (13)

10.44   Amended License Agreement among Digital Equipment Corporation and
        Intelect Visual Communications Corp., dated effective November 5, 1997
        (14)

10.45   Registration Rights Agreement among the Company and Citadel, dated
        February 6, 1998 relating to the Series C Preferred Stock (3)

10.46   Registration Rights Agreement dated February 12, 1998 between the
        Company and St. James Partners, L.P. (3)

10.47   Warrant to Purchase Common Stock of the Company dated February 12, 1998
        issued to St. James Partners, L.P. expiring on February 12, 2001 (3)

10.48   Securities Purchase Agreement among the Company and Citadel, dated
        February 6, 1998 (3)

10.49   Agreement for Purchase and Sale dated February 12, 1998 between the
        Company and St. James Partners, L.P. (3)

10.50   Convertible Promissory Note dated February 12, 1998 by the Company in
        favor of St. James Partners, L.P. (3)

10.51   Pledge Agreement dated February 12, 1998 between the Company and St.
        James Partners, L.P. (3)

10.52   Purchase Agreement among the Company and Navesink dated December 16,
        1997 (22)

10.53   Registration Rights Agreement among the Company and Navesink dated
        December 16, 1997 (22)

10.54   Sales Representative Agreement between Intelect Network Technologies
        Company and Amerix Electronics, Inc. dated January 12, 1998 (22)

10.55   Exchange Agreement between Intelect Network Technologies Company and
        Amerix Electronics dated February 20, 1998 (22)

10.56   Warrant issued to Amerix Electronics, Inc. to Purchase Common Stock of
        the Company expiring on June 19, 2001 (22)
</TABLE>



                                       64
<PAGE>   65



<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>     <C>
10.57   Letter Agreement dated February 9, 1999 among Tehan Oh, Opicom Co. Ltd.,
        Optronix Inc., Amerix Electronics, Inc., and Intelect Network
        Technologies Company

10.58   Company Stock Incentive Plan Amendment adopted December 4, 1997* (1)

10.59   Registration Rights Agreements between the Company and the Buyers, dated
        May 8, 1998 relating to the Series D Convertible Preferred Stock (16)

10.60   Securities Purchase Agreement among the Company and the Buyers, dated
        May 8, 1998 relating to the Series D Convertible Preferred Stock (16)

10.61   Assignment and Acceptance executed by St. James Partners and SJMB, L.P.
        ("SJMB") as to Agreement for Purchase and Sale dated February 12, 1998
        by the Company and St. James Capital Partners (23)

10.62   $2,000,000 Convertible Promissory Note issued to St. James Partners by
        the Company dated April 2, 1998 (23)

10.63   $13,000,000 Convertible Promissory Note issued to SJMB by the Company
        dated April 2, 1998 (23)

10.64   Warrant issued to St. James Partners by the Company dated April 2, 1998,
        exercisable as to 300,000 shares of Common Stock (23)

10.65   Warrant issued to SJMB by the Company dated April 2, 1998, exercisable
        as to 1,200,000 shares of Common Stock (23)

10.66   Amendment No. 1 to Registration Rights Agreement dated as of April 2,
        1998 between the Company and St. James Partners (23)

10.67   Registration Rights Agreement between the Company and the Buyers dated
        June 26, 1998 relating to the Series D Convertible Preferred Stock (17)

10.68   Registration Rights Agreement dated June 19, 1998 between the Company
        and Lifeline Industries, Inc. (21)

10.69   Securities Purchase Agreement dated June 26, 1998 between the Company
        and the Buyers relating to the Series D Convertible Preferred Stock (17)

10.70   Warrant issued to Lifeline Industries, Inc. dated June 29, 1998,
        exercisable as to 30,000 shares of Common Stock (21)

10.71   Warrant issued to Hambrecht & Quist LLC exercisable to purchase up to
        33,036 shares of Common Stock at an exercise price of $10.292 per share,
        expiring May 20, 2003 (23)

10.72   Letter Agreement dated July 15, 1998 between the Company and Navesink
        Equity Derivative Fund LDC (21)

10.73   Amended and Restated Warrant issued to AJC, Inc. exercisable to purchase
        up to 300,000 shares of Common Stock (24)

10.74   Amended and Restated Warrant issued to Lifeline Industries, Inc.
        exercisable to purchase up to 30,000 shares of Common Stock (24)

10.75   Form of Amended and Restated Promissory Notes held by various employees,
        directors, and related individuals of the Company with face values
        totaling $419,600, convertible into Common Stock of the Company at a
        rate of $2.00 per share (24)

10.76   Loan Agreement for Receivables Backed Borrowing dated as of September
        14, 1998 between the Company and Coastal (18)

10.77   Promissory Note dated September 14, 1998 issued by the Company to
        Coastal (18)

10.78   Security Agreement for Receivables Backed Borrowing dated September 14,
        1998 among the Company, Intelect Visual Communications Corp., Intelect
        Network Technologies Company, DNA Enterprises, Inc., and Coastal (18)

10.79   Borrower Pledge Agreement dated September 14, 1998 between the Company
        and Coastal (18)

10.80   Security Agreement dated September 14, 1998 between the Company and St.
        James (18)

10.81   Letter Agreement dated September 14, 1998 among the Company, St. James
        and Falcon Seaboard (18)

10.82   Registration Rights Agreement among the Company and the Buyers, dated
        February 24, 1999, relating to the Series E Convertible Preferred Stock
        and warrants (19)

10.83   Form of Registration Rights Agreement between the Company and the
        Buyers, dated as of December 22, 1998 (19)
</TABLE>


                                       65
<PAGE>   66

<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>     <C>
10.84   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc., relating to the Series E Preferred Stock (19)

10.85   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc. at an exercise price of $2.998 (19)

10.86   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc., issued as of December 2, 1998 (19)

10.87   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc. issued to St. James Capital Partners, L.P. and SJMB, L.P., issued
        January 13, 1999 (19)

10.88   Securities Purchase Agreement among the Company and the Buyers, dated
        February 24, 1999, relating to the Series E Convertible Preferred Stock
        and warrants (19)

10.89   Loan Agreement for Inventory Backed Borrowing dated November 24, 1998 by
        and between Intelect Communications, Inc. and The Coastal Corporation
        Second Pension Trust, as amended by the Addendum to Loan Agreement for
        Inventory Backed Borrowing dated December 31, 1998 (19)

10.90   Security Agreement for Inventory Backed Borrowing dated November 24,
        1998 by and among Intelect Network Technologies Company, DNA
        Enterprises, Inc., and Intelect Visual Communications Corp., Intelect
        Communications, Inc., and The Coastal Corporation Second Pension Trust
        (19)

10.91   Promissory Note Amended and Restated as of December 31, 1998 in the
        original principal amount of $750,000 issued to The Coastal Corporation
        Second Pension Trust (19)

10.92   Addendum to Loan Agreement for Receivables Backed Borrowing dated as of
        January 13, 1999 between The Coastal Corporation Second Pension Trust
        and Intelect Communications, Inc. (19)

10.93   Promissory Note Amended and Restated as of January 13, 1999 in the
        original principal amount of $5,000,000 issued to The Coastal
        Corporation Second Pension Trust (19)

10.94   Amended and Restated Stock Incentive Plan *(25)

16.1    Letter regarding change in certifying accountants (17)

16.2    Letter from Arthur Andersen, LLP regarding its concurrence with
        statements in Item 5 of Form 10Q filed November 16, 1998 (24)

16.3    Letter from KPMG Peat Marwick regarding its concurrence with statements
        in Form 8-K filed August 19, 1997 (15)

21.1    Subsidiaries of the Company

23.1    Consents of KPMG Peat Marwick

23.2    Consents of Arthur Andersen LLP

23.3    Consent of Grant Thornton LLP

27.1    Financial data schedule
</TABLE>

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

*Management contract or other compensatory plan or arrangement.

(1)     Incorporated herein by reference to the Company's Form S-4 filed October
        30, 1997

(2)     Incorporated herein by reference to the Company's Form 8-K filed
        December 5, 1997

(3)     Incorporated herein by reference to the Company's Form 8-K filed
        February 17, 1998

(4)     Incorporated herein by reference to the Company's Form 10-Q filed
        November 13, 1996

(5)     Incorporated herein by reference to the Company's Form 8-K dated
        November 10, 1995

(6)     Incorporated herein by reference to the Company's Form 8-K/A dated April
        12, 1996

(7)     Incorporated herein by reference to the Company's Form 10-K filed April
        15, 1997

(8)     Incorporated herein by reference to the Company's Form 8-K dated
        February 20, 1996

(9)     Incorporated herein by reference to the Company's Form 10-K for the year
        ending December 31, 1995

(10)    Incorporated herein by reference to the Company's Form 8-K dated April
        12, 1996

(11)    Incorporated herein by reference to the Company's Form 10-Q filed May
        15, 1997

(12)    Incorporated herein by reference to the Company's Form 10-Q filed August
        14, 1997


                                       66
<PAGE>   67

(13)    Incorporated herein by reference to the Company's Form S-3 filed
        September 17, 1997

(14)    Incorporated herein by reference to the Company's Form 10-Q filed
        November 13, 1997

(15)    Incorporated herein by reference to the Company's Form 8-K filed August
        19, 1997

(16)    Incorporated herein by reference to the Company's Form 8-K filed on May
        11, 1998

(17)    Incorporated herein by reference to the Company's Form 8-K filed on June
        29, 1998

(18)    Incorporated herein by reference to the Company's Form 8-K filed on
        September 16, 1998

(19)    Incorporated herein by reference to the Company's Form 8-K filed on
        March 2, 1999

(20)    Incorporated herein by reference to the Company's Form 8-K filed on
        March 8, 1999

(21)    Incorporated herein by reference to the Company's Form S-3 filed on
        August 10, 1998

(22)    Incorporated herein by reference to the Company's Form 10-K filed on
        March 31, 1998

(23)    Incorporated herein by reference to the Company's Form 10-Q filed on
        August 14, 1998

(24)    Incorporated herein by reference to the Company's Form 10-Q filed on
        November 16, 1998

(25)    Incorporated herein by reference to the Company's Definitive Proxy
        Statement filed on April 28, 1998.

         C. The Registrant has not filed any reports on Form 8-K during the last
quarter of the period covered by this Report, except as follows:

         None



                                       67
<PAGE>   68


                                   SIGNATURES

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


                                       INTELECT COMMUNICATIONS, INC.
                                               (Registrant)

Date: April 2, 1999                    By: /s/ Herman M. Frietsch
                                           ----------------------------------
                                           Herman M. Frietsch
                                           Chief Executive Officer



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



/s/ Herman M. Frietsch                        /s/ ANTON VON AND ZU LIECHTENSTEIN
------------------------------------------    ----------------------------------
Herman M. Frietsch                            Anton von and zu Liechtenstein, 
Chief Executive Officer and Director          Director
(Principal Executive Officer)




/s/ EDWIN J. DUCAYET, JR.                     /s/ PHILIP P. SUDAN, JR.
------------------------------------------    ----------------------------------
Edwin J. Ducayet, Jr.                         Philip P. Sudan, Jr., Director
Chief Financial Officer
(Principal Financial and 
Accounting Officer)


                                             /s/ ROBERT E. GARRISON, II
                                             ----------------------------------
                                             Robert E. Garrison, II, Director



                                       68



<PAGE>   69


                               INDEX TO EXHIBITS


<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>     <C>
2.1     Plan and Agreement of Merger dated as of October 29, 1997 by and among
        Intelect Communications Systems Limited ("Intelect (Bermuda)"), Intelect
        Communications, Inc. (the "Company"), and Intelect Merger Co. (1)
                                                                                       
3.1     Amended and Restated Certificate of Incorporation of the Company (1)
                                                                                       
3.2     Certificate of Correction dated December 17, 1999 to Amended and
        Restated Certificate of Incorporation (21)
                                                                                       
3.3     Certificate of Amendment to Amended and Restated Certificate of
        Incorporation (20)
                                                                                       
3.4     Amended and Restated By-Laws of the Company (1)
                                                                                       
4.1     Specimen Stock Certificate of the Company (2)
                                                                                       
4.2     Certificate of Designations of the Series A Preferred Stock dated
        December 2, 1997(1)
                                                                                       
4.3     Certificate of Designations of the Series B Preferred Stock dated
        December 17, 1997 (22)
                                                                                       
4.4     Certificate of Designations of the Series C Preferred Stock dated
        February 6, 1998 (3)
                                                                                       
4.5     Certificate of Designations of the Series D Preferred Stock dated May 8,
        1998 (16)
                                                                                       
4.6     Certificate of Designations of the Series E Preferred Stock dated March
        3, 1999 (19)

10.1    Option Agreement dated March 31, 1995 by and among the Company, certain
        sellers and Intelect, Inc. (5)

10.2    Stock Purchase Agreement dated October 3, 1995 by and among Intelect
        (Bermuda), Savage Corporation and Savage Sports Corporation (5)

10.3    Management Agreement dated as of October 1, 1995 between the Company and
        Herman Frietsch*(6)

10.4    Amendment No. One dated January 1, 1996 to Management Agreement between
        the Company and Herman Frietsch referred to in Exhibit 10.4*(7)

10.5    Employment Agreement dated as of April 1, 1996 between the Company and
        Eugene Helms*(4)

10.6    Employment Agreement dated as of April 24, 1995 between the Company and
        Peter Ianace*(6)

10.7    Stock Purchase Agreement dated January 13, 1996 by and between Intelect
        (Bermuda), Intelect Systems Corp., Robert E. Nimon, Kim F. Nimon, Edgar
        L. Read, Gregory L. Mayhan and DNA Enterprises, Inc. (8)

10.8    Warrants dated February 13, 1996 issued to Edgar L. Read and Gregory L.
        Mayhan to be delivered one year after Closing (9)

10.9    Employment Agreement dated as of February 13, 1996 between Edgar L. Read
        and DNA Enterprises, Inc.*(8)

10.10   Employment Agreement dated as of February 13, 1996 between Gregory L.
        Mayhan and DNA Enterprises, Inc.*(8)

10.11   Agreement and Plan of Merger dated March 19, 1996 among the Company,
        Mid-Ocean, Inc. and Mosaic Information Technologies, Inc. (10)

10.12   Employment Agreement dated March 29, 1996 among Matthew Feldman, the
        Company and Mosaic Information Technologies, Inc.*(10)

10.13   Promissory Note dated as of February 26, 1997 to St. James Capital Corp.
        from the Company (7)

10.14   Pledge Agreement dated as of February 26, 1997 between the Company and
        St. James Capital Corp. (7)

10.15   Warrant to Purchase Common Stock of the Company Expiring February 26,
        2002 (7)

10.16   Registration Rights Agreement dated February 26, 1997 between the
        Company and St. James Capital Corp. (7)

10.17   Amended and Restated Promissory Note dated as of February 26, 1997 to
        St. James Capital Corp. from the Company (7)

10.18   First Amendment to Pledge Agreement dated as of March 27, 1997 between
        the Company and St. James Capital Corp. (7)

10.19   Warrant to Purchase Common Stock of the Company Expiring March 27, 2002
        (7)

10.20   Amendment No. 1 to Registration Rights Agreement dated as of March 27,
        1997 between the Company and St. James Capital Corp. (7)

10.21   Employee Stock Option Plan adopted April 24, 1986* (7) 10.22 Stock
        Incentive Plan adopted December 13, 1995* (7)

10.23   Lease Agreement between TCIT Dallas Industrial and Intelect Network
        Technologies, dated February 25, 1997 (11)

10.24   Lease Agreement between Campbell Place One Joint Venture and DNA
        Enterprises, dated February 1, 1997 (11)

10.25   Advisory Services Agreement with Renaissance Financial Securities
        Corporation dated July 8, 1997 (12)

10.26   Warrant issued to AJC, Inc. to Purchase Common Stock of the Company
        expiring on December 31, 2002 (12)

10.27   Loan Agreement dated as of May 8, 1997 between the Company and The
        Coastal Corporation Second Pension Trust (12)

10.28   Warrant issued to The Coastal Corporation Second Pension Trust to
        Purchase Common Stock of the Company expiring on May 7, 2002 (12)
</TABLE>


<PAGE>   70

<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>     <C>
10.29   Registration Rights Agreement dated as of May 8, 1997 between the
        Company and The Coastal Corporation Second Pension Trust (12)

10.30   Subscription Agreement for Series A Cumulative Preferred Stock dated as
        of May 30, 1997 between the Company and The Coastal Corporation Second
        Pension Trust (12)

10.31   Registration Rights Agreement dated as of May 30, 1997 between the
        Company and The Coastal Corporation Second Pension Trust (12)

10.32   Agreement dated April 25, 1997 between the Company and the beneficiary
        of a royalty agreement (12)

10.33   Irrevocable Option Agreement dated October 1, 1995 between the Company
        and owners of certain intellectual property rights * (12)

10.34   Agreement dated July 7, 1997 among Robert E. Nimon, Kim F. Nimon, Nimon
        Consulting, Inc., Intelect Systems Corp. and the Company (12)

10.35   Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
        from the Company (12)

10.36   Promissory note dated July 7, 1997 to Robert E. Nimon and Kim F. Nimon
        from the Company (12)

10.37   Amended and Restated Loan Agreement dated August 27, 1997 among the
        Company, Intelect Systems Corp., and The Coastal Corporation Second
        Pension Trust (13)

10.38   Warrant to purchase Company Common Stock expiring August 26, 2002 issued
        to The Coastal Corporation Second Pension Trust (13)

10.39   Amendments Nos. 2 and 3 to Registration Rights Agreements dated April 24
        and May 8, 1997 among the Company and St. James Capital Corp. (13)

10.40   Warrants to purchase Company Common Stock dated April 24 and May 8, 1997
        issued to St. James Capital Corp. (13)

10.41   Second Amended and Restated Floating Rate Promissory Noted dated
        effective February 26, 1997 to St. James Capital Corp. from the Company
        (13)

10.42   Second and Third Amendments to Borrower's Pledge Agreement dated April
        24 and May 8, 1997 among Intelect Systems Corp. and St. James Capital
        Corp. (13)

10.43   Warrant expiring December 31, 2001 issued to Lifeline Industries, Inc.
        (13)

10.44   Amended License Agreement among Digital Equipment Corporation and
        Intelect Visual Communications Corp., dated effective November 5, 1997
        (14)

10.45   Registration Rights Agreement among the Company and Citadel, dated
        February 6, 1998 relating to the Series C Preferred Stock (3)

10.46   Registration Rights Agreement dated February 12, 1998 between the
        Company and St. James Partners, L.P. (3)

10.47   Warrant to Purchase Common Stock of the Company dated February 12, 1998
        issued to St. James Partners, L.P. expiring on February 12, 2001 (3)

10.48   Securities Purchase Agreement among the Company and Citadel, dated
        February 6, 1998 (3)

10.49   Agreement for Purchase and Sale dated February 12, 1998 between the
        Company and St. James Partners, L.P. (3)

10.50   Convertible Promissory Note dated February 12, 1998 by the Company in
        favor of St. James Partners, L.P. (3)

10.51   Pledge Agreement dated February 12, 1998 between the Company and St.
        James Partners, L.P. (3)

10.52   Purchase Agreement among the Company and Navesink dated December 16,
        1997 (22)

10.53   Registration Rights Agreement among the Company and Navesink dated
        December 16, 1997 (22)

10.54   Sales Representative Agreement between Intelect Network Technologies
        Company and Amerix Electronics, Inc. dated January 12, 1998 (22)

10.55   Exchange Agreement between Intelect Network Technologies Company and
        Amerix Electronics dated February 20, 1998 (22)

10.56   Warrant issued to Amerix Electronics, Inc. to Purchase Common Stock of
        the Company expiring on June 19, 2001 (22)

10.57   Letter Agreement dated February 9, 1999 among Tehan Oh, Opicom Co. Ltd.,
        Optronix Inc., Amerix Electronics, Inc., and Intelect Network
        Technologies Company

10.58   Company Stock Incentive Plan Amendment adopted December 4, 1997* (1)

10.59   Registration Rights Agreements between the Company and the Buyers, dated
        May 8, 1998 relating to the Series D Convertible Preferred Stock (16)

10.60   Securities Purchase Agreement among the Company and the Buyers, dated
        May 8, 1998 relating to the Series D Convertible Preferred Stock (16)

10.61   Assignment and Acceptance executed by St. James Partners and SJMB, L.P.
        ("SJMB") as to Agreement for Purchase and Sale dated February 12, 1998
        by the Company and St. James Capital Partners (23)

10.62   $2,000,000 Convertible Promissory Note issued to St. James Partners by
        the Company dated April 2, 1998 (23)

10.63   $13,000,000 Convertible Promissory Note issued to SJMB by the Company
        dated April 2, 1998 (23)

10.64   Warrant issued to St. James Partners by the Company dated April 2, 1998,
        exercisable as to 300,000 shares of Common Stock (23)

10.65   Warrant issued to SJMB by the Company dated April 2, 1998, exercisable
        as to 1,200,000 shares of Common Stock (23)

10.66   Amendment No. 1 to Registration Rights Agreement dated as of April 2,
        1998 between the Company and St. James Partners (23)

10.67   Registration Rights Agreement between the Company and the Buyers dated
        June 26, 1998 relating to the Series D Convertible Preferred Stock (17)

10.68   Registration Rights Agreement dated June 19, 1998 between the Company
        and Lifeline Industries, Inc. (21)

10.69   Securities Purchase Agreement dated June 26, 1998 between the Company
        and the Buyers relating to the Series D Convertible Preferred Stock (17)

10.70   Warrant issued to Lifeline Industries, Inc. dated June 29, 1998,
        exercisable as to 30,000 shares of Common Stock (21)

10.71   Warrant issued to Hambrecht & Quist LLC exercisable to purchase up to
        33,036 shares of Common Stock at an exercise price of $10.292 per share,
        expiring May 20, 2003 (23)

10.72   Letter Agreement dated July 15, 1998 between the Company and Navesink
        Equity Derivative Fund LDC (21)

10.73   Amended and Restated Warrant issued to AJC, Inc. exercisable to purchase
        up to 300,000 shares of Common Stock (24)

10.74   Amended and Restated Warrant issued to Lifeline Industries, Inc.
        exercisable to purchase up to 30,000 shares of Common Stock (24)

10.75   Form of Amended and Restated Promissory Notes held by various employees,
        directors, and related individuals of the Company with face values
        totaling $419,600, convertible into Common Stock of the Company at a
        rate of $2.00 per share (24)

10.76   Loan Agreement for Receivables Backed Borrowing dated as of September
        14, 1998 between the Company and Coastal (18)

10.77   Promissory Note dated September 14, 1998 issued by the Company to
        Coastal (18)

10.78   Security Agreement for Receivables Backed Borrowing dated September 14,
        1998 among the Company, Intelect Visual Communications Corp., Intelect
        Network Technologies Company, DNA Enterprises, Inc., and Coastal (18)

10.79   Borrower Pledge Agreement dated September 14, 1998 between the Company
        and Coastal (18)

10.80   Security Agreement dated September 14, 1998 between the Company and St.
        James (18)

10.81   Letter Agreement dated September 14, 1998 among the Company, St. James
        and Falcon Seaboard (18)

10.82   Registration Rights Agreement among the Company and the Buyers, dated
        February 24, 1999, relating to the Series E Convertible Preferred Stock
        and warrants (19)

10.83   Form of Registration Rights Agreement between the Company and the
        Buyers, dated as of December 22, 1998 (19)
</TABLE>


<PAGE>   71

<TABLE>
<CAPTION>
Exhibit    Description of Exhibit

<S>     <C>
10.84   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc., relating to the Series E Preferred Stock (19)

10.85   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc. at an exercise price of $2.998 (19)

10.86   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc., issued as of December 2, 1998 (19)

10.87   Form of Warrant to Purchase Common Stock of Intelect Communications,
        Inc. issued to St. James Capital Partners, L.P. and SJMB, L.P., issued
        January 13, 1999 (19)

10.88   Securities Purchase Agreement among the Company and the Buyers, dated
        February 24, 1999, relating to the Series E Convertible Preferred Stock
        and warrants (19)

10.89   Loan Agreement for Inventory Backed Borrowing dated November 24, 1998 by
        and between Intelect Communications, Inc. and The Coastal Corporation
        Second Pension Trust, as amended by the Addendum to Loan Agreement for
        Inventory Backed Borrowing dated December 31, 1998 (19)

10.90   Security Agreement for Inventory Backed Borrowing dated November 24,
        1998 by and among Intelect Network Technologies Company, DNA
        Enterprises, Inc., and Intelect Visual Communications Corp., Intelect
        Communications, Inc., and The Coastal Corporation Second Pension Trust
        (19)

10.91   Promissory Note Amended and Restated as of December 31, 1998 in the
        original principal amount of $750,000 issued to The Coastal Corporation
        Second Pension Trust (19)

10.92   Addendum to Loan Agreement for Receivables Backed Borrowing dated as of
        January 13, 1999 between The Coastal Corporation Second Pension Trust
        and Intelect Communications, Inc. (19)

10.93   Promissory Note Amended and Restated as of January 13, 1999 in the
        original principal amount of $5,000,000 issued to The Coastal
        Corporation Second Pension Trust (19)

10.94   Amended and Restated Stock Incentive Plan *(25)

16.1    Letter regarding change in certifying accountants (17)

16.2    Letter from Arthur Andersen, LLP regarding its concurrence with
        statements in Item 5 of Form 10Q filed November 16, 1998 (24)

16.3    Letter from KPMG Peat Marwick regarding its concurrence with statements
        in Form 8-K filed August 19, 1997 (15)

21.1    Subsidiaries of the Company

23.1    Consents of KPMG Peat Marwick

23.2    Consents of Arthur Andersen LLP

23.3    Consent of Grant Thornton LLP

27.1    Financial data schedule
</TABLE>