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

                                  FORM  10-K
                                        
   X    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
  ---   EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1998.

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

                       Commission File Number:  0-26858
                                        
                             BLUE WAVE SYSTEMS INC.
            (Exact name of registrant as specified in its charter)
                                        
             DELAWARE                                      41-1425902
    (State or other jurisdiction of                    (I. R. S. Employer
    incorporation or organization)                   Identification Number)

    2410 LUNA ROAD, CARROLLTON, TX                            75006
(Address of principal executive offices)                   (Zip code)

      Registrant's telephone number, including area code: (972) 277-4600

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                        
                                                Name of each exchange
          Title of each class                    on which registered
          -------------------                   ---------------------
                 None                                    None

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                                        
                         COMMON STOCK, $0.01 PAR VALUE
                               (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 the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on September
23, 1998 as reported on the Nasdaq National Market, was approximately
$31,320,000.

As of September 23, 1998, Registrant had outstanding 13,014,038 shares of Common
Stock.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
                                        
    Portions of the Proxy Statement for Registrant's 1998 Annual Meeting of
     Stockholders, which will be filed on or before October 28, 1998, are
                    incorporated by reference in Part III.
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                                    PART I

                                        
ITEM 1.  BUSINESS


GENERAL

  Blue Wave Systems Inc. (the "Company or "Blue Wave Systems") designs, develops
and markets programmable digital signal processing ("DSP") computing sub-systems
that are used in a variety of real-time image and signal processing applications
including communications, medical imaging, radar, and sonar.  The Company's
products are typically sold to original equipment manufacturers ("OEMs"),
research organizations, and military contractors who integrate the Company's
products into special purpose computing platforms.   The Company was formed in
April 1998 upon the combination of Mizar, Inc. ("Mizar") and Loughborough Sound
Images Ltd. ("LSI"), a company based in the United Kingdom.

COMBINATION OF MIZAR AND LSI, AND THE FORMATION OF BLUE WAVE SYSTEMS INC.

  Blue Wave Systems was formed as a result of the combination between Mizar and
LSI that occurred in April 1998.  The combination was completed via a share
exchange whereby Mizar issued 7,876,964 common shares in exchange for all of the
outstanding capital stock of LSI.  As of September 23, 1998, the Company had
13,014,038 common shares outstanding.  Contemporaneous with completion of the
combination, Mizar, Inc. amended its articles of incorporation and changed its
name to Blue Wave Systems Inc.  The Company's common stock now trades under the
symbol BWSI.  Mizar's former trading symbol was MIZR.

  The combination was accounted for as a pooling of interests and all historical
financial information has been retroactively restated to reflect the
combination.  The Company's fiscal year end remains June, however, the
consolidation of LSI's results during fiscal 1997 (and prior) reflect LSI's
September fiscal year end.  Therefore, the reported results for fiscal 1997 (and
prior) reflect a June year end for Mizar and a September year end for LSI.

DIGITAL SIGNAL PROCESSING

  Digital signal processing involves the mathematical manipulation and analysis
of digitized image, sound, and other naturally occurring analog wave forms.
Examples of input devices which collect and digitize these analog wave forms
include video cameras, radar arrays, digital x-ray cameras, sonar arrays, and a
variety of telecommunications devices. As compared to general computing, the
mathematical algorithms used to manipulate digitized images, audio, and speech
use multiplication and addition functions more intensively. DSP microprocessors
perform these functions in one clock cycle at millions of instructions per
second, whereas non-DSP microprocessors may require several clock cycles to
accomplish the same operation. Generally, the mathematical algorithms are
applied in order to modify or improve a signal or image, or to identify and sort
signals or images that contain defined attributes. When embedded, DSP is a
scalable enabling technology applicable to a diverse range of existing and
emerging real-time image and signal processing applications that have
particularly demanding processing requirements. The market for high performance
DSP-based sub-systems and components has traditionally experienced rapid
technological change which requires high levels of expenditures for research and
development. The Company continues to introduce DSP-based products in order to
retain its competitive position and will be required to continually enhance its
existing products and successfully develop new products.

DSP SUB-SYSTEM MARKETS AND APPLICATIONS

  DSP sub-systems are utilized in a diverse range of existing and emerging
applications.

  Communications.  According to a published industry study, communications
electronic equipment constitutes the largest market for DSPs.  The largest
communications markets for DSPs are wireless communications, modems, voice/tone
activated response and recording systems, and copper bandwidth-enhancement
devices.  The rapid 

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proliferation of communications throughout the world has created demand for
electronic and computing devices that are capable of efficiently processing high
transmission volume. The unique computing capabilities of DSPs make it
particularly suited for the digital processing inherent in many forms of
communications.

  Military and Aerospace Electronics.  The military and aerospace ("mil/aero")
industry has employed multiprocessor DSPs in many electronics applications.
Although United States mil/aero spending as a whole is decreasing, the Company
believes that spending for many technological improvements and enhancements has
not been reduced.  Federal acquisition reform has also led to expanded market
opportunities for commercial-off-the-shelf ("COTS") products such as those
provided by Blue Wave Systems.  Many defense applications place a premium on
reduced size and weight for a given amount of computing power, particularly if
the system is to be airborne, onboard a ship, or in a battlefield vehicle.
Therefore, mil/aero applications often require maximum processing power within
specific weight and size constraints.

  Medical Imaging.  DSP's are used in a variety of sophisticated imaging
applications that are capable of relatively non-invasive procedures.  In these
applications the computer enables a physician or operator to "see" what is not
typically observable or record information so that additional analysis can be
performed.  Examples of these applications include computed tomography (CT),
magnetic resonance imaging (MRI), x-ray, and ultrasound.

  Test and Measurement.  DSP technology is also used for applications such as
vibration analysis, geophysical surveys, high-speed industrial sorting and
various types of process control systems.

  Machine Vision.  The machine vision industry has historically used many types
of enabling technologies including programmable DSPs.  Unlike the defense
industry, space and weight constraints and operation in harsh environments are
not as important in machine vision applications as is cost effectiveness.
Machine vision systems typically include one or more video cameras and a real-
time computer system which makes decisions and takes actions without human
intervention.
 
STRATEGY

  Blue Wave Systems' strategy is to use its depth of knowledge in DSP design to
be the leading world-wide supplier of DSP computing sub-systems to the real-time
signal and image processing industry.  Key elements of the Company's strategy
include the following:

  Provide General Purpose Enabling DSP Technology.  The Company has designed its
DSP products for a broad range of commercial and mil/aero applications.  Because
the Company's products are programmable, they are intended to interface with a
wide variety of other components or application software supplied by OEMs.  The
Company has focused its product line on those applications where high
performance, product quality, and reliability are the customer's most important
product considerations.  The Company's programmable, general purpose products
permit customers to decrease the time required to develop their products, with
the benefit of reduced risk and time to market.

  Telecommunications Industry.  There has been a well-documented proliferation
of various types of wireless and wireline communication devices including
cellular telephones, high-density modems, and voice/tone response systems which
use DSPs.  Many of the Company's latest generation of products are designed to
address the demands of specific application areas such as call recording and
screening, transcoding, and voice over IP.  A specific example is the
SoftBand(TM) Software Radio which has been targeted at the wireless base station
marketplace.  The Company's strategy to address vertical markets such as
telecommunications includes incorporating relatively unique value-added design
and software features that optimize performance for a specific application type.

  Ruggedization Design Capability.  The military and aerospace marketplace
requires that many system components be able to operate in non-benign
environmental conditions.  For example, many surveillance, radar and targeting
applications are used in places where temperature extremes, atmospheric
pressure, and vibration can not be controlled as contrasted to an office
environment.  In order for the Company's DSP sub-systems to operate in these

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environments many design aspects must be considered including circuit routing,
component choice and placement, and thermal modeling.  Blue Wave System's
products are available in several ruggedized build options which address a broad
variety of environmental conditions.  These ruggedized options are also
applicable to non-defense applications such as telecommunications where products
may be deployed in harsh environments.

  Global Support.  The Company's primary customer base is large companies that
have operations throughout the world.  The Company believes that it has the
ability to provide global life cycle support for its customers. For example, a
customer may have an application software development group in France which
requires intensive local assistance during early portions of the customer's
product development cycle. As that product is deployed the Company is capable of
providing logistics to supply the DSP sub-system to production facilities
throughout the world.

DSP PRODUCTS
 
  The Company's product line spans a wide variety of processor families,
computer bus architectures, and customization and scalability options.

  Processor Families.  Certain of Blue Wave Systems' products utilize a variety
of DSP and RISC (Reduced Instruction Set Computing) microprocessors available
from the leading suppliers in the industry including Texas Instruments ("TI"),
Analog Devices, Lucent and Motorola. These suppliers offer varying types of
microprocessors that are differentiated based on feature sets, interoperability,
performance and cost. The majority of the Company's product shipments
incorporate DSP's from TI and Analog Devices.

  Texas Instruments. According to published industry studies, TI is the largest
provider of DSP microprocessors.  Blue Wave Systems products utilize TI's C6x,
C4x, C3x, and C8x.   The C6x, and C4x families include a range of processors 
that are targeted for applications such as wireless or wireline communications,
or dense multiprocessor radar systems. The Company believes that it was first to
market with a subsystem based on TI's new C6x family. Additionally, the Company
believes that the C6x family will achieve widespread acceptance and be 
"designed-in" to a number of new applications. As a result, the Company's
product line now includes approximately 14 products based on TI's C6x family.
There are a number of existing applications that continue to utilize other
processors, such as the C4x, in existing systems.

  Analog Devices.  Also achieving widespread industry acceptance in the
Company's served market is the SHARC DSP device from Analog Devices.  The
Company's SHARC-based products utilize the 21060 and 21062 devices and are
appropriate for many types of applications including radar, sonar, and test and
measurement.  The SHARC device is typically utilized in high-performance, multi-
processor systems.

  Motorola. The Power PC RISC processor has been in numerous signal processing
applications in the defense and commercial markets for several years.  This has
resulted in a large body of third party support for the processor family
including real-time operating systems, standard algorithms, debuggers, compilers
and other development tools.  While the Power PC has been primarily used in
single board computer-type applications within the VMEbus environment, the
execution speed of the chip, which is now in excess of 300 MHz, has reached the
point where its floating point capability is such that it can service certain
types of signal processing applications.  The Company is currently developing
its first ruggedized Quad Processor-PowerPC Conduction Cooled Board for use in
high performance aircraft avionics applications.

  Computer Bus Architectures.  All of the Company's products are considered
"open architecture" compliant as it relates to computer bus structures.
Industry standard setting organizations, such as the IEEE (The Institute of
Electrical and Electronics Engineers, Inc.), garner consensus for a particular
type of computing architecture and then publish compatibility design
specifications that can be used by suppliers, such as Blue Wave Systems.  This
ensures that system designers can incorporate computing modules from a variety
of potential suppliers in order achieve a desired performance/cost metric.  Each
bus contains differing performance specifications which enable system designers
to choose the appropriate bus structure for their system.

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  VME (Versa Module Eurocard).  The VME bus is typically used in the most
demanding real-time systems.  It is also used extensively in ruggedized systems.
Examples include radar, sonar, and signal intelligence.

  CPCI (Compact PCI).  This bus is relatively new as compared to the VME bus and
is generally viewed as a lower cost alternative to the VME bus.  The Company
believes that many new communications and test and measurement applications have
chosen the CPCI bus for their next generation systems.

  PCI (Peripheral Component Interconnect).  This architecture is used in the
more cost sensitive and relatively less complex systems.  It is the computer bus
that is used in many of today's personal computers.

  Scalability and Customization Options.  Many of the Company's products are
scalable as it relates to the number of DSP's, memory modules, I/O
(input/output) devices, and level of ruggedization.  The Company believes that
the scalability and compatibility of its products is key to its strategy of
enabling its customers to speed their product to market.  For example, the
customer's application software development can begin early by using a first
generation off-the-shelf design from the Company.  As the customer refines its
system design for mass deployment it may be desirable to change the DSP sub-
system.  This can vary from relatively minor changes to memory modules or more
ambitious changes designed to significantly reduce system costs or significantly
improve system throughput.  These adaptations occur often and enable the
Company's customers to achieve a desired performance/cost metric and feature
set, as well as recoup their initial application software development
investment.

  The prices for the Company's DSP sub-systems can range from approximately
$2,000 for a single DSP PCI board to well over $20,000 for dense multi-processor
designs.

NON-DSP PRODUCTS

  The Company continues to sell its prior generation of non-DSP computing sub-
systems, primarily to existing commercial customers who have previously designed
these products into their equipment which they continue to market for industrial
automation applications.  The Company does not actively market these products
and is not currently designing any new non-DSP products.  Sales of these
products declined to approximately $3,064,000 in 1998 as compared to
approximately $5,355,000 in 1996.  This downward trend is expected to continue.

SALES AND MARKETING

  The Company uses its own direct sales force and, to a lesser extent,
independent manufacturer's representatives and distributors to market its
products. The Company's customers frequently require that a product be tailored
to their particular requirements. The Company believes that it is advantageous
to have its own employees interacting directly with customers on a world-wide
basis in order to fully understand their requirements. Blue Wave Systems' sales
personnel generally have engineering or technical backgrounds which the Company
believes enhances their ability to create relationships with their customer
counterparts, who are typically design and systems engineers. The Company
maintains its Corporate and North American headquarters in a suburb of Dallas,
Texas, USA, and a European headquarters in Loughborough, Leicestershire,
England. Regional sales and support offices are located in Paris, France;
Munich, Germany; as well as the East and West Coasts of the USA.

CUSTOMERS

  The Company's customer base consists primarily of OEMs, defense contractors
and research organizations  which incorporate the Company's products as a part
of their systems.  Typically, these customers initially purchase a small volume
of products for development testing and comparison to competitive products.  If
upon completion of testing the customer elects to incorporate the Company's
product into its design, it frequently purchases the Company's standard or
customized products in higher volumes.  Many global companies are users of the

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Company's DSP subsystems including:

        Agfa Technical Imaging Systems          AT & T
        The Boeing Company                      British Telecommunications plc
        Ericsson                                GDE Systems Inc.
        GE Medical Systems                      IBM
        Lockheed Martin Corporation             Lucent Technologies Incorporated
        Nokia                                   Northrop Grumman Corporation
        Panasonic                               Raytheon Company
        Schlumberger Ltd.                       Siemens AG
 
  During the three years in the period ended June 30, 1998, the Company had two
customers that comprised at least 10% of its annual revenue in a given year.
Raytheon Company represented approximately 13% of the Company's revenues in
fiscal 1998.  As governed under the terms of a distribution and manufacturing
agreement, Spectrum Signal Processing Inc. represented approximately 14% of the
Company's revenues in fiscal 1997.  During 1996, no customer individually
accounted for more than 10% of revenues.

BACKLOG

  The Company's backlog includes bookings based upon the receipt of a written
purchase order.  It generally does not include options in contracts for
additional quantities not covered by a current purchase order.  The Company's
backlog at June 30, 1998, was $11,298,000 as compared to $10,984,000 as of the
end of fiscal 1997.  The Company cautions readers who may utilize published
bookings and backlog information as tools to forecast the Company's revenue
during a given timeframe since certain purchase orders may be subject to
cancellation and/or delivery schedule revision.

PRODUCT DEVELOPMENT

  Blue Wave Systems has made a significant investment in its engineering group.
The Company's current internal design strengths exist in areas such as DSP
computing, high speed digital circuit design, architecture for multiprocessor
computing, application software development tools, harsh environment
architectures, drivers, and customization of designs.

  Currently, the most significant investments have been targeted at two vertical
markets, telecommunications and defense.  In February 1997, Mizar announced the
formation of its Telecommunications Products Group.  The Telecommunications
Products Group was responsible for migrating the Company's extensive experience
and expertise in designing and building real-time signal processing products to
the commercial telecommunications markets.  LSI also had formed a
telecommunications design and marketing team.  These teams have now merged and
are working on a number of programs to support the Company's growth strategy.
Examples include the SoftBand software radio which is a computing platform that
the Company believes will enable wireless system designers to greatly reduce
overall life cycle costs, and CTI (computer telephony integration) products for
voice/tone response and recording systems.  These teams have been formed from
professionals with expertise in telecommunication system architectures, radio
technology, telecommunication application software, and algorithms.

  Historically, the vast majority of Mizar's DSP-based product sales were to
defense contractors.  LSI has also derived significant revenues from this
market.  The combined Company's design teams are involved in several projects
for both rugged and benign defense applications, including signal intelligence.
Typically, these are more complex designs which dictate a longer elapsed time
from project initiation to product shipment.

  The remainder of the Company's investment in new product development is for
general purpose DSP sub-systems suitable for a variety of applications.

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  Blue Wave Systems incurred approximately $7,151,000, $6,959,000, and
$5,466,000 in fiscal years 1998, 1997 and 1996, respectively, for product
development and engineering expenses, exclusive of amounts categorized as
discontinued operations.

MANUFACTURING AND QUALITY CONTROL

  The quality and reliability of its products are fundamental to the Company's
strategy.  LSI's quality control systems were awarded ISO9001 certification.  In
addition, the software development processes utilized in the United Kingdom have
achieved certification under the internationally recognized Tick-IT standard.

  The Company relies exclusively upon subcontractors to assemble its products.
The Company believes that this enhances its flexibility in product development,
as it is not required to invest in specialized capital equipment that may have
limited use, but instead can choose subcontractors based upon their capabilities
for particular manufacturing tasks.  The existence of these outsourcing
relationships allows the Company to absorb varying production levels without
incurring the costs normally attendant to such fluctuations.  The Company has
relationships with several contract manufacturers but has no long-term contracts
with any of them.  The Company believes there are a number of contract
manufacturers equipped to meet its needs although there is no assurance of this
in the future.  Blue Wave Systems' internal manufacturing operations consist
primarily of test engineering, material purchasing, incoming inspection, and
acceptance testing.  The Company's subcontractors perform quality control at
their facilities.  Blue Wave Systems undertakes subsequent additional quality
control procedures.

  All of the Company's products incorporate electronic components available from
a limited number of sources and in certain instances from a single source.  The
Company believes that electronic component availability is sufficient to meet
the demand for its products.

COMPETITION

  The industries and markets in which the Company operates are highly
competitive, and the Company believes that competition is likely to intensify.
Many of the Company's competitors have substantially greater financial
resources, larger research, development and sales staffs as well as greater name
recognition than the Company.  The Company has direct competitors which use DSP
technology similar to that of the Company.  The Company also has competitors
offering technologies other than programmable DSPs for signal/image processing
applications.  These technologies include application-specific integrated
circuits ("ASICs"), fixed program DSPs and programmable non-DSP processors.
Often, the Company competes with the in-house design department of its
customers.  However, the Company believes that its customers increasingly rely
on outside suppliers for computing sub-systems such as those designed and
marketed by the Company.

  New or improved products can be expected from competitors in the future.
Market participants must compete on many fronts, including development time;
engineering expertise; product quality, performance and reliability; price; name
recognition; financial stability; customer support; and access to distribution
channels.

INTELLECTUAL PROPERTY

  The Company believes that due to the rapid pace of innovation within its
industry, factors such as product quality, performance and reliability are more
important in establishing and maintaining customer relationships than are the
various protections afforded by patents.  The Company determined that trademark
protection for the SoftBandTM software radio was desirable, however, the
majority of its products are referred to by their part numbers rather than by
their specific names.

  In January 1997, the Company (LSI) entered into a distribution and
manufacturing agreement with Spectrum Signal Processing, whereby Spectrum was
appointed a distributor (non-exclusive from May 1, 1997) of certain of the
Company's (LSI) products in North America.  In addition, Spectrum was granted
non-exclusive rights to manufacture certain of the Company's (LSI's) older DSP
products in such territory for a period ending December 31, 2003.  In return,
Spectrum pays the Company at a rate based upon the selling price of the
product(s) 

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manufactured under this agreement. The Company retains ownership of its
intellectual property rights associated with the products covered by the
agreement.

EMPLOYEES

  As of June 30, 1998, the Company employed 171 full-time employees, including
49 in product development; 65 in sales, sales support and marketing; 34 in
operations; and 23 in finance, IT, and administration. The Company's continued
success will depend in large measure on its ability to attract and retain highly
skilled employees. None of the Company's employees is represented by a labor
union.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.

  Certain matters discussed in this Form 10-K, other printed material and in
oral presentations are forward-looking statements that involve risks and
uncertainties.  The following risk factors could affect the Company's actual
results and cause actual results to differ materially from those projected in
forward-looking statements.  The following risk factors should not be construed
as exhaustive and the Company disclaims any obligation subsequently to revise
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.

  Technological Change.  The market for high performance computer sub-systems
and components has traditionally experienced short product life cycles and rapid
technological change, requiring high levels of expenditures for research and
development.  The Company continues to introduce DSP-based products in order to
retain its competitive position and will be required to continually enhance its
existing products and successfully develop new products.  In the event the
Company does not continue to incorporate new advances in DSP technology into its
products, the Company's business will be adversely affected.  To the extent that
technologies, other than those offered by the Company, prove to be superior for
the high performance applications required by the Company's customers, the
Company's business would be significantly impaired.

  Quarterly Fluctuations.  The Company's quarterly financial results may vary
significantly depending upon factors such as the timing of significant orders
and the timing and success of new product introductions by the Company and its
competitors.  In the most recent fiscal years, the Company's business has been
increasingly dominated by longer and larger customer contracts.  Therefore, the
procurement or loss of a single contract, or the change in delivery schedules
thereunder, can significantly affect quarterly and annual financial results.
Factors such as quarterly variations in financial results could cause the market
price of the Company's common stock to fluctuate substantially.

  Dependence upon Suppliers and Subcontractors.  All of the Company's products
incorporate electronic components available from a limited number of sources
and, in certain instances, from a single source.  In the event of shortages of
any of the single source components, the Company would be severely impacted.
The vendors of these single source components include Texas Instruments, Analog
Devices, Cypress Semiconductor, Linear Technology, Matsushita, Motorola,
Philips, Quality Semiconductor, Quick Logic, Advanced Interconnection
Technology, and Xilinx. In addition, the Company has no internal manufacturing
capability. In the event that one or more of the several qualified
subcontractors currently used by the Company should cease operations or become
unable or unwilling to handle the Company's requirements, the Company's
relations with its customer may be adversely affected. In many cases, the
Company's contracts with its key customers contain remedial and penalty clauses
that could be triggered as a result of non-performance by one of the Company's
suppliers or subcontractors.

  Integration of Mizar's and LSI's Operations.  The Company may not be able to
successfully continue to integrate the operations, facilities and management of
Mizar and LSI.  Such integration could also have an adverse effect upon the
Company's respective relationships with customers, suppliers, and key employees.
The diversion of management time towards such integration may also adversely
affect customer support of existing products and the development of new
products.

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  Defense Industry Customer Concentration.  The Company's largest single
concentration of customers is prime contractors in the United States Military
and Aerospace Industry.  The United States federal government has reduced
overall defense spending and, in certain cases, delayed or deferred funding for
defense applications which in turn has, in certain occasions, adversely affected
the Company's revenues.  The Company believes, however, that reduced defense
spending has increased the demand for efficiency and for upgraded electronics in
new and existing defense electronics systems.  There can be no assurance that
continued defense cutbacks would not adversely affect the Company's customers
and its business. Additionally, there has been extensive consolidation of
companies in the defense industry, and further consolidation is possible in the
future.  There can be no assurance that such consolidation will not adversely
affect the Company.  The combination between Mizar and LSI lessened this
customer concentration for the Company.

  Dependence on Key Personnel.  The Company is highly dependent on their key
sales and technical personnel. There is a well-published acute market shortage
of skilled technical personnel that are critical to the Company's success.  The
Company's future success will depend on its ability to attract and retain highly
qualified personnel, which are in high demand in the job marketplace.  There can
be no assurance that the Company will be successful in hiring or retaining
qualified personnel.  The loss of key personnel, or inability to hire and retain
qualified personnel, could have an adverse effect on the Company's business,
financial condition and results of operations.  The Company does not have key-
person life insurance on any of its personnel other than its CEO, Simon Yates.

  Competition.  The Company participates in a highly competitive industry, which
is subject to rapid and innovative technological change.  There can be no
assurance that future technological changes or the development of new or
competitive products by others will not render the Company's current or planned
products less competitive or obsolete.  Additionally, many of the companies with
which the Company competes have significantly greater financial, and other
resources, than the Company.

  Historical and Anticipated Future Operating Losses.  Recently, the Company has
incurred significant operating losses, including approximately $1,084,000,
$311,000, and $9,770,000 (including a non-recurring provision of $8,426,000 for
merger and realignment expenses) in the second, third and fourth quarters of
fiscal 1998, respectively.  The recent losses are due primarily to a decrease in
the Company's revenues and, to a lesser extent, increased spending for product
and market development.  The decline in revenues is attributable to the risks
identified in "Risk Factors", specifically "Technological Change", "Quarterly
Fluctuations", "Dependence upon Suppliers and Subcontractors", and "Defense
Industry Concentration." Many of the Company's potential customers, including
those involved in the telecommunications and defense industries, are evaluating
new DSP microprocessor technology for their next generation products, which
appear to have dramatic performance enhancements as compared to current, widely
available DSP microprocessors. Since many customers are in an evaluation stage,
and availability of certain new DSP microprocessors is quite limited, the
Company's ability to generate significant revenues from new DSP products is
currently limited. Therefore, the Company anticipates that it will incur an
operating loss in the first quarter of fiscal 1999.

  Year 2000 compliance.  Currently, there is a significant uncertainty in the
software industry and among software users regarding the impact of the year 2000
on installed software.  Software database modifications, and/or implementation
modifications, will be required to enable such software to distinguish between
21st and 20th century dates. The Company has implemented a plan ("Y2K Plan") to
attempt to assess and mitigate the potential impact of the Year 2000 problem
throughout the Company. The Company uses third-party system software which will
need to be modified or replaced in order to address Year 2000 compliance.
Although the Company believes that its Y2K Plan will adequately address the
potential impact caused by the Year 2000 problem, there can be no assurance that
the Company's Y2K Plan will be sufficiently comprehensive or that it will be
completed on a timely basis. In addition, there can be no assurance that the
systems of other companies on which the Company's systems rely will be Y2K
compliant, or that a failure to convert by a supplier or customer, or a
conversion that is incompatible with the Company's systems, would not have a
material adverse affect on the Company. If a key supplier of the Company fails
to be Y2K compliant, the Company could suffer a material loss of business or
incur significant additional expenses. The Company has developed the framework
for contingency
                                       9
<PAGE>
 
plans in the event it or third parties are unable to complete system
modifications to address the Year 2000 issue. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations Year 2000
Initiatives".

ITEM 2.  PROPERTIES

  The Company's general corporate offices and North American headquarters are
located in Carrollton, Texas (a suburb of Dallas) where it leases approximately
21,000 square feet at an annual rate of approximately $87,000.  This lease
expires in 1999 and contains a 5 year renewal option.  In North America, the
Company also leases offices for regional sales operations on the West Coast, in
the Northeast, and mid-Atlantic regions of the USA.  The Company's European
headquarters are located in Loughborough, Leicestershire, England.  This 44,000
square foot facility is leased at an annual rate of approximately $860,000.

ITEM 3.  LEGAL PROCEEDINGS

  None.


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

  None.

                                       10
<PAGE>
 
                                    PART II
                                        

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS

  The Company's common stock trades on the Nasdaq National Market tier of The
Nasdaq Stock Market/sm/ under the symbol BWSI.  Prior to the combination and
name change in April 1998, it traded under the symbol MIZR.  The following table
lists the high and low price for each quarter.

          FISCAL YEAR 1998                High         Low
          ----------------                ----         ---
     First quarter                        7 1/8        3 3/8
     Second quarter                       6 3/4        5 3/4
     Third quarter                        6            4 1/8
     Fourth quarter                       5 3/4        3 19/64
 
          FISCAL YEAR 1997
          ----------------
     First quarter                        7            3 3/4
     Second quarter                       5 7/8        4
     Third quarter                        5 1/8        3 3/4
     Fourth quarter                       3 7/8        2 3/4

  As of September 23, 1998, the approximate number of beneficial stockholders
was 1,000.  Prior to the share exchange, there was no active market with respect
to the capital stock of LSI.

  The Company has not declared or paid any dividends on its common stock, and
does not anticipate paying any dividends in the foreseeable future.

  In May 1997, the Company announced a plan to repurchase up to $1,000,000 worth
of its common stock outstanding.  In August 1997, the Company announced a
$1,000,000 expansion to its repurchase plan.  Through September 1997, 281,900
shares had been repurchased for a total of $1,081,000.  The repurchase program
was cancelled in December 1997.

  In conjunction with combination between Mizar and LSI, the Company redeemed
all of the mandatorily redeemable preference shares of LSI that were owned by
Boston Holdings, Ltd.  The aggregate amount of the redemption was
(Pounds)5,971,394 (including accrued dividends) (or approximately $10,023,000).
Also, contemporaneous with the combination, Boston Holdings, Ltd. exercised for
(Pounds)3,318,975 (or approximately $5,571,000), a warrant for common shares of
LSI which, upon the share exchange, were converted into 1,903,522 common shares
of Blue Wave Systems Inc.

                                       11
<PAGE>
 
ITEM 6.  SELECTED FINANCIAL DATA (FISCAL YEARS 1994-1997 HAVE BEEN RESTATED TO
GIVE EFFECT TO THE COMBINATION)
<TABLE>
<CAPTION>
 
                                                                                    YEAR ENDED JUNE 30,
                                                                                    -------------------
                                                            1998(1)        1997(1)        1996(1)        1995            1994
                                                        -------------  -------------  -------------  -------------  ---------------
                                                                         (in thousands, except per share amounts)
<S>                                                     <C>            <C>            <C>            <C>            <C>
STATEMENTS OF OPERATIONS DATA:
Net sales                                                   $ 32,679        $34,388        $35,194        $32,043          $24,177
Cost of sales                                                 15,395         15,599         16,070         14,302           10,303
                                                            --------        -------        -------        -------          -------
Gross margin                                                  17,284         18,789         19,124         17,741           13,874
                                                            --------        -------        -------        -------          -------
 
Operating expenses:
      Product development & engineering                        7,151          6,959          5,466          5,735            3,846
      Sales and marketing                                      7,905          6,315          5,591          5,092            3,994
      General and administrative                               3,938          5,309          2,952          2,353            2,910
      Merger and realignment costs                             8,426             --             --             --               --
      Loss on assets held for sale                                --             --             --            204               --
                                                            --------        -------        -------        -------          -------
               Total operating expenses                       27,420         18,583         14,009         13,384           10,750
                                                            --------        -------        -------        -------          -------
Operating income (loss)                                      (10,136)           206          5,115          4,357            3,124
Interest and other (expense)                                     586            483            140            209             (287)
                                                            --------        -------        -------        -------          -------
Income (loss) from continuing operations
      before provision for income taxes                       (9,550)           689          5,255          4,566            2,837
Provision for income taxes                                       255            397            291            899              546
                                                            --------        -------        -------        -------          -------
Income (loss) from continuing operations                      (9,805)           292          4,964          3,667            2,291
Loss from discontinued operations                               (137)        (1,248)        (1,341)        (1,179)            (378)
                                                            --------        -------        -------        -------          -------
Net income (loss)                                             (9,942)          (956)         3,623          2,488            1,913
                                                            --------        -------        -------        -------          -------
Preference share dividends, accretion and
      amortization of issuance costs of  
      preference shares                                       (1,512)          (874)            --             --               --
                                                            --------        -------        -------        -------          -------
Net income (loss) applicable to common stock                $(11,454)       $(1,830)       $ 3,623        $ 2,488          $ 1,913
                                                            ========        =======        =======        =======          =======
 
Basic net income (loss) per share:
      Continuing operations                                 $  (0.89)       $ (0.05)       $  0.48        $  0.40          $  0.26
      Discontinued operations                                  (0.01)         (0.12)         (0.13)         (0.13)           (0.04)
                                                            --------        -------        -------        -------          -------
                                                            $  (0.90)       $ (0.17)       $  0.35        $  0.27          $  0.22
                                                            ========        =======        =======        =======          =======
Diluted net income (loss) per share:
      Continuing operations                                 $  (0.89)       $ (0.05)       $  0.41        $  0.33          $  0.23
      Discontinued operations                                  (0.01)         (0.12)         (0.11)         (0.11)           (0.04)
                                                            --------        -------        -------        -------          -------
                                                            $  (0.90)       $ (0.17)       $  0.30        $  0.22          $  0.19
                                                            ========        =======        =======        =======          =======
 
Weighted average shares outstanding:
      Basic                                                   12,684         10,594         10,457          9,118            8,750
                                                            ========        =======        =======        =======          =======
      Diluted                                                 12,684         10,594         12,218         11,204           10,140
                                                            ========        =======        =======        =======          =======
<CAPTION>  
                                                                                         JUNE 30,
                                                                                         --------
                                                            1998           1997           1996           1995            1994
                                                        -------------  -------------  -------------  -------------  ---------------
                                                                                      (IN THOUSANDS)
<S>                                                     <C>            <C>            <C>            <C>            <C>
BALANCE SHEET DATA:
Cash, cash equivalents and restricted cash                  $  1,895        $ 3,216        $ 1,745        $ 4,015          $ 1,575
Marketable securities                                          3,062          8,598         10,286             76               76
Working capital                                                6,401         18,389         14,550          4,650            2,884
Total assets                                                  20,544         31,555         27,993         19,560           14,481
Total debt and capital leases                                  3,137          1,094          3,934          5,758            4,237
Stockholders' equity                                           9,438         13,376         17,607          6,224            4,074
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) The accompanying restated consolidated statements of operations,
    stockholders' equity and cash flows combine Blue Wave's historical
    statements of operations, stockholders' equity and cash flows for each of
    the two years in the period ended June 30, 1997, with the corresponding Sub
    historical statements of operations, stockholders' equity and cash flows for
    each of the two years in the period ended September 30, 1997 (as combined,
    the "fiscal years 1997 and 1996"). The restated consolidated statements of
    stockholders' equity for each of the two years in the period ended June 30,
    1997 reflect the exchange of each Sub common share for 94.632 shares of Blue
    Wave common stock (see Note 2).


                                       12
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

  Net Sales.  Net sales decreased from $35,194,000 in fiscal 1996, to
$34,388,000 in fiscal 1997, to $32,679,000 in fiscal 1998.  Sales of LSI's
products were $21,142,000 (or 60% of consolidated revenues), $22,881,000 (67%),
and $20,568,000 (63%) during each of fiscal 1996, 1997, and 1998, respectively.
LSI's traditional customer base is heavily weighted toward commercial OEM's.
Product development and life cycles for commercial OEM's are typically short as
compared to mil/aero programs.  Commercial OEM's and defense contractors are now
developing products that utilize next generation DSP's from suppliers such as TI
(C6000 family) and Analog Devices which, in turn, creates tremendous
opportunities for the Company in a number of emerging application areas such as
wireless communications and internet telephony.  However, many of these
opportunities are at the expense of existing technologies that are available in
plentiful supply.  This technology transition has had a significant impact on
the Company's operations during fiscal 1998 and ultimately contributed to the
decline in revenues during fiscal 1998 and is expected to continue to impact
revenues during the first half of the Company's fiscal 1999.  When TI introduced
their C4x family of DSP's in 1992 LSI experienced a revenue trend similar to
that experienced in 1998, followed by a significant increase in revenues when
the C4x family was in plentiful supply.  The majority of Mizar's DSP-based
revenues were to prime contractors to the federal government and were used in
defense, aviation and intelligence applications.  The Company believes that the
trend of the federal government to emphasize the purchase of commercial-off-the-
shelf (COTS) products versus proprietary designs dedicated to a specific
application will continue to have a positive impact in the future.  Major
program selling in this industry inherently raises the risk of revenue
fluctuations such as that experienced in fiscal 1997 when Mizar's DSP-based
revenues declined from $8,697,000 in fiscal 1996 to $7,701,000 in fiscal 1997,
then increased 17% to $9,047,000 in fiscal 1998.  The decline in Mizar's DSP
revenues in 1997 occurred despite bookings associated with DSP-based products
increasing from $8,288,000 in fiscal 1996 to $11,367,000 in fiscal 1997.  In
1996 and throughout 1998, the Company has experienced a significant increase in
bookings for "ruggedized" DSP-based products.  The time lag between order
booking and revenue recognition associated with ruggedized products can be much
longer due to design adaptation, component ordering and manufacturing lead-
times.  Although short-term variability is increased, the Company views this as
a very positive long-term trend since more programs are progressing to a
production stage versus a prototype or testing phase.  Revenues from the
Company's non-DSP products have declined steadily from 1996 ($5,355,000) to 1998
($3,064,000).  This non-strategic product line is expected to decline further in
fiscal 1999. The Company believes that as a result of the merger its dependence
on a particular industry group, geographic area, or technology will be reduced.

  Gross Margin.  Gross margin as a percentage of revenues was 54.3% in fiscal
1996, 54.6% in fiscal 1997, and 52.9% in fiscal 1998.  The decline in gross
margin percentage in 1998 is attributable to the Company's fixed manufacturing
expenses being spread over declining shipments, and inventory provisions related
to product scrap and obsolescence.  Much of the provision for product
obsolescence is related to the technology transition discussed above that has
impacted current revenues.  The Company's gross margin percentage has varied
each year, and each quarter, in both a positive and negative fashion due to
factors mentioned above, and changes in customer and specific product mix.  Such
variations will continue to impact gross margin percentages in future reporting
periods.
 
  Product Development and Engineering.  Engineering expenses increased from
$5,466,000 in fiscal 1996, to $6,959,000 in fiscal 1997, and to $7,151,000 in
fiscal 1998.  These expenses expressed as a percentage of revenues were 15.5%,
20.2%, and 21.9% in fiscal 1996, 1997 and 1998, respectively.  The Company has
steadily increased its investment in new product development throughout these
periods, especially in emerging application areas, and expanding the
capabilities of its products to function in non-benign environments such as
extended shock, vibration, humidity or temperature ranges.  The Company's
telecommunications product development efforts now comprise almost one-half of
the Company's new product development efforts.  The Company believes this will
greatly expand its available served market during 1999 and beyond.

  Sales and Marketing.  Sales and marketing expenses increased from $5,591,000
in fiscal 1996, to $6,315,000 in fiscal 1997, to $7,905,000 in fiscal 1998.
These expenses expressed as a percentage of revenues were 15.9%, 18.3%, and
24.2% in fiscal 1996, 1997 and 1998, respectively.  These increases are due to
the Company expanding 

                                       13
<PAGE>
 
its geographic coverage (Germany and the USA) and marketing expenditures to
support the Company's telecommunications strategy. Sales and marketing expenses
are expected to remain relatively flat during fiscal 1999.

  General and Administrative. General and administrative expenses were
$2,952,000 in fiscal 1996, $5,309,000 in fiscal 1997, and $3,938,000 in fiscal
1998. These expenses expressed as a percentage of revenues were 8.4%, 15.4%, and
12.1% in fiscal 1996, 1997 and 1998, respectively. The increase in fiscal 1997
was, in part, due to a number of non-recurring expenses including settlement
expenses aggregating $677,000 associated with a dispute with LSI's former German
distributor; and the recognition of $340,000 expense associated with the
employment agreement of David Irwin, former President and CEO of Mizar, who
resigned in June 1997, and executive search fees for his successor. Other
increases include facility expansion expenses in Europe, and increased expenses
associated with IT. General and administrative expenses are expected to decline
during fiscal 1998 as a result of merger related synergies.

  Merger and Realignment Expenses. The Company incurred significant costs and
expenses to consummate the complex, cross-border transaction with LSI. Also, in
conjunction with the merger, the Company realigned its business operations in
order to better meet the needs of its customers, capitalize on the synergy
between Blue Wave and LSI and to strategically focus the Company on the growing
telecommunications market. The Company recorded an $8,426,000 nonrecurring
charge for merger and strategic realignment related costs and expenses. In broad
terms this provision includes all professional and statutory fees relating to
the combination, a non-cash charge related to LSI stock options, and the cost
necessary to execute the plan to streamline operations and reduce the Company's
cost base from that of two independent companies. Approximately $4,100,000 of
the total charge has or will result in a cash outlay and approximately
$4,300,000 of the charge was non-cash. Professional and statutory fees included
legal, accounting, investment banking, and printing fees for both companies as
well as statutory fees for a transaction based tax in the UK, and SEC expenses
in the US totalling approximately $2,500,000. Other cash outlays include travel,
costs associated with the name change, and employment severance aggregated
approximately $1,600,000. Of the total provision that will result in cash
outlay, approximately $2,700,000 was paid in fiscal 1998 and it is estimated
that an additional $1,400,000 will be paid in fiscal 1999.

  The $4.3 million non-cash portion provides for the vesting of stock options at
LSI as well as duplicate and excess facilities and assets that occurred as a
result of merging the two companies. The amount associated with the stock option
provision was approximately $2,700,000 and relates to the establishment of a
vesting date for LSI options as a result of the combination. Although reflected
as a charge against income this provision had no net impact on shareholders'
equity since it also increased paid-in-capital. See Note 2 to the Consolidated
Financial Statements.

  Interest Income.  Interest income increased from $491,000 in fiscal 1996, to
$611,000 in fiscal 1997, and declined to $506,000 in fiscal 1998.  Interest
income increased in 1997, primarily as a result of investing the proceeds of the
Company's initial public offering for a full year in fiscal 1997 versus a
portion of the year in fiscal 1996.  In 1998, interest income declined due to
lower amounts of cash to invest attributable to the merger.  Interest income
will decline significantly in 1999 due to cash used to redeem the LSI preference
shares (net of the warrant exercise), and to pay transaction and realignment
costs associated with the merger.

  Interest Expense.  Interest expense decreased from $419,000 in fiscal 1996, to
$205,000 in fiscal 1997, to $109,000 in fiscal 1998.  The decrease in interest
expense is due to debt reductions made possible by utilizing the
(Pounds)5,500,000 proceeds from the issuance of the LSI preference shares in
April 1997.  Interest expense will increase in fiscal 1999 as the Company
continues to utilize bank credit facilities.

  Provision for Income Taxes. Provision for income taxes was $291,000, $397,000,
and $255,000 in fiscal 1996, 1997 and 1998, respectively. In 1998, the Company
incurred a substantial book loss but relatively small tax loss because a
substantial portion of the merger and realignment expenses are not deductible
for tax purposes.  The 1998 provision relates to state tax due in the US and tax
due in the UK.  The Company recorded a valuation allowance on 

                                       14
<PAGE>
 
100% of the tax losses in 1998 due to the recent unfavorable operating results.
As a result of the significant net losses incurred in previous years, the
Company has accumulated a net operating loss ("NOL") carryforward, a portion of
which was used to reduce the Company's US federal income tax liability in fiscal
years 1992 through 1997. Pursuant to Section 382 of the Internal Revenue Code, a
change in ownership of the Company greater than 50%, as defined, within a three-
year period occurred twice, once due to the Company's IPO in 1995 and once due
to the merger with LSI in 1998. The Company's US annual utilization limitation
related to its NOL carryforward is now approximately $1,400,000.

  The Company believes it is more likely than not that it will realize the net
deferred tax asset of $511,000 recorded in the balance sheet as of June 30, 1998
and accordingly no valuation allowance has been provided on this portion of the
asset.  This conclusion is based on (1) changes in operations that have recently
occurred, including the acquisition of LSI, which management believes will
expand its product capabilities and customer base, (2) cost reduction or
synergies to be gained from the combination of Mizar and LSI, (3) the
realignment of the Company including its strategy to expand its markets in the
telecommunications industry, (4) the introduction of systems based upon the C6x
technology, (5) limitation of the net operating loss carryforwards, as described
above, related to the LSI merger, and (6) projections of sufficient taxable US
income to fully realize the net recognized deferred tax asset by the end of
calendar year 2000. Management continually evaluates the realizability of the
net deferred tax assets and the need for a valuation allowance on such assets.

  Discontinued Operations.  The Company provided $1,341,000, $1,248,000 and
$137,000 during fiscal 1996, 1997 and 1998, respectively, related to the
discontinuance of a videoconferencing product line being developed at LSI.

LIQUIDITY AND CAPITAL RESOURCES

  The Company's cash flow provided by (used in) operations was $2,848,000,
($262,000), and ($2,655,000) in fiscal 1996, 1997 and 1998, respectively.  Net
working capital was $14,550,000, $18,389,000, and $6,400,000 as of the end of
fiscal 1996, 1997, and 1998, respectively.  The increase in working capital in
1997 is the result of proceeds received from the placement of LSI's preference
shares with a financial institution.  Merger related transactions had a
significant negative impact upon the Company's working capital and cash flow
from operations during 1998 as did the Company's operating loss.  The 
redemption of the preference shares, net of a warrant exercise consumed
approximately $4,500,000 in cash in 1998. Merger and realignment related
expenses consumed an additional $2,700,000 of cash during 1998 and is also a
large portion of the cash consumed by operations in 1998. The merger and
realignment provision also included a $1,400,000 non-cash provision for
inventory and duplicate and excess facilities and assets. These non-cash
provisions further reduced reported working capital by $1,270,000. Approximately
$1,200,000 was spent in 1998 for capital additions and $280,000 was consumed for
debt service. Additionally, a common stock repurchase program at Mizar consumed
$509,000 and $572,000 of cash during fiscal 1997 and 1998, respectively. This
program was cancelled in December 1997. Common stock was repurchased by LSI for
approximately $2,270,000 during fiscal 1997 pursuant to the preference share
subscription agreement with Boston Holdings, Ltd.

  The Company's investment in capital equipment was $881,000, $1,842,000, and
$1,233,000 in fiscal 1996, 1997, and 1998, respectively.  Capital equipment
generally consists of production test equipment, design engineering tools, and
computers for general use.  In 1997, significant investments in design, software
and IT were made.  Additionally, the Company expanded its North American and
European office facilities in order to accommodate a larger workforce.

  The Company currently utilizes a bank facility to support its operation in
Europe and as of September 23, 1998, has approximately $2,900,000 outstanding
under the facility as compared to (Pounds)1,379,000 ($2,302,000) at June 30,
1998.  The facility is collateralized by the assets of the Company's European
operation, bears interest at the bank's base rate plus 1.75%, and is due on
demand.

  In connection with the establishment of an employee stock ownership plan
("ESOP"), the Company has guaranteed the debt of the ESOP. The guarantee
required the Company to place cash in escrow in an amount equal to the debt.
Such cash has been reflected as restricted cash in the accompanying consolidated
financial statements.

                                       15
<PAGE>
 
  Management believes that through its cash resources and currently available
debt facility it will have adequate resources to fund the Company's 1999
operating plan.  In order to increase its available working capital the Company
does plan to augment its currently available debt facility.  The Company will,
from time to time, evaluate potential strategic transaction opportunities
including acquisitions and joint ventures.  In order to fund such a transaction
the Company may find it necessary to seek additional working capital via a
borrowing transaction or consider raising additional funds through an equity
offering.

YEAR 2000 INITIATIVES

  The Company has implemented a plan ("Y2K Plan") to attempt to assess and
mitigate the potential impact of the Year 2000 problem throughout the Company.
This problem can arise when time-sensitive embedded software utilizes a two
digit year date field, sorting years beginning in 2000 ("00") before the year
1999 ("99").  Improper sorting can result in data corruption and processing
errors.  This problem can be present in licensed software, software developed
for internal use, software developed for customer use, and technology equipment.
Additionally, Year 2000 problems resident with key business partners to the
Company must also be identified and addressed.

  The Company has completed a detailed assessment of its internal systems and
will have to replace portions of software used internally so that its computer
systems will function properly with respect to dates beginning in 2000, and
thereafter.  Year 2000 compliance questionnaires are being sent to key suppliers
and a monitoring process has been established to ensure the suppliers respond
and comply with the requirements.  Key customers will be questioned about their
Year 2000 plans to ensure that our products remain compatible with the
customer's requirements.  Compliance testing of all areas covered by the
Company's Y2K Plan are scheduled for completion by, and any required corrective
action plans are scheduled to be established by, December 31, 1998. Any required
corrective actions are scheduled for completion by June 1, 1999, and will be
tested to insure they are Year 2000 compliant.  The total Year 2000 project cost
is not expected to be material in relation to the Company's financial position
or results of operations.

  Although the Company believes that its Y2K Plan will adequately address the
potential impact caused by the Year 2000 problem, there can be no assurance that
the Company's Y2K Plan will be sufficiently comprehensive or that it will be
completed on a timely basis.  In addition, there can be no assurance that the
systems of other companies on which the Company's systems rely will be Y2K
compliant, or that a failure to convert by a supplier or customer, or a
conversion that is incompatible with the Company's systems, would not have a
material adverse affect on the Company.  If a key supplier of the Company fails
to be Y2K compliant, the Company could suffer a material loss of business or
incur significant additional expenses.  The Company has developed the framework
for contingency plans in the event it or third parties are unable to complete
system modifications to address the Year 2000 issue.

STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED

  The Financial Accounting Standards Board has issued SFAS No. 130, "Reporting
Comprehensive Income" (SFAS No. 130).  SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements.  Comprehensive income is defined as the
total of net income and all other non-owner changes in equity.  The adoption of
SFAS No. 130 is required for fiscal years beginning after December 15, 1997.
The Company currently has two types of non-owner changes in equity, excluding
net income, including foreign currency translation gains and losses and
unrealized gains and losses on investments.

  The Financial Accounting Standards Board has issued SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information" (SFAS No. 131).  This
pronouncement changes requirements under which public businesses must report
segment information.  The objective of the pronouncement is to provide
information about a company's different types of business activities and
different economic environments.  SFAS No. 131 requires companies to select and
report segments based on their internal reporting system.  The adoption of SFAS
No. 131 is required for fiscal years beginning after December 15, 1997.  The
Company is evaluating what impact SFAS No. 131 will have on the Company's
disclosures.

  The Financial Accounting Standards Board has issued SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirements Benefits" (SFAS No. 132).
This pronouncement revises employers' disclosures about pension and other
postretirement benefit plans.  It does not change the measurement or recognition
of those plans, however, it does require additional information on changes in
the benefit obligations and fair values of plan assets in order to facilitate
financial analysis.  The adoption of SFAS 

                                       16
<PAGE>
 
No. 132 is required for fiscal years beginning after December 15, 1997. The
Company currently does not have any pension or postretirement benefit plans.

  The Financial Accounting Standards Board has issued SFAS No. 133, "Accounting
for Derivative and Similar Financial Instruments For Hedging Activities" (SFAS
No. 133).  This pronouncement revises the accounting for derivative financial
instruments.  It requires entities to recognize all derivatives as either assets
or liabilities in the balance sheet and measure those instruments at fair value.
The adoption of this statement is required for fiscal years beginning after
December 15, 1997.  Historically, the Company has not invested in derivatives
nor hedged any significant risks with the use of derivative financial
instruments.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

  See Financial Statements beginning on page F-1.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
  None.

                                       17
<PAGE>
 
                                   Part III
                                        

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

  The directors and executive officers of the Company are as follows:

     NAME               AGE           Position
     ----               ---           --------
 Simon Yates             35  Chief Executive Officer and Director
 Rob N. Shaddock         40  Executive Vice President and Director
 Sam K. Smith            66  Chairman of the Board of Directors (1) (2)
 John L. Rynearson       51  Director (1) (2)
 John R. Forrest         54  Director (1) (2)
 Joseph E. Andrulis      34  Vice President Marketing
 Charles D. Brockenbush  38  Vice President Finance, and Chief Financial Officer
 M. Keith Burgess        36  Chief Technology Officer
 Julian S. Jenkins       33  President Europe
 Andy N. MacCaig         29  Vice President Operations
 Kevin Parslow           39  Vice President Worldwide Sales

 (1)  Member of the Compensation Committee.
 (2)  Member of the Audit Committee.
 
  Simon Yates became Chief Executive Officer and a director on the date of
combination, and prior to the combination, had served as Managing Director of
LSI since 1995. Mr. Yates joined LSI in 1984 and became a board member in 1988.
Mr. Yates was appointed LSI's Technical Director in 1990 and Director of PC
Products in 1992.

  Rob Shaddock joined LSI in October 1992 as Technical Director, when LSI
merged with Data Beta Ltd.  He served as Marketing Director of LSI from 1997
until the time of the combination.  In April 1998, he was named as Executive
Vice President and a director of Blue Wave Systems.

  Samuel K. Smith has been a director since 1994, and interim Chief Executive 
Officer of Mizar from June 1997 until April 1998. From 1984 until 1993, Mr.
Smith was a special partner of Sevin-Rosen Management Co., a venture capital
firm. In June 1997, Mr. Smith was named Chairman of the Board of Directors of
Mizar and continues to serve in that capacity for Blue Wave Systems. He serves
as a director of Hart Graphics, TD Technologies, and Silicon Biology, and
Journee Software Corporation.

  John L. Rynearson has been a director since 1982.  Mr. Rynearson co-founded 
Mizar in 1982 and held a variety of technical and managerial positions with
Mizar until 1991. He has served as the Technical Director of VITA (VME
International Trade Association) since 1993. From 1992 to 1993, he served as
President of Rystar, Inc., a VME training company. He is a director of Open
Systems Service Corporation, a subsidiary of VITA.

  John R. Forrest, a director of LSI since 1996, was elected as a director of
the Company on the date of the combination. He was a Professor of Electronic
Engineering from 1970 to 1984 at University College London, following which he
joined Marconi Defense Systems as Technical Director. Between 1986 and 1991, he
was Director of Engineering at the Independent Broadcasting Authority. In 1991,
he was appointed Chief Executive of National Transcommunications Limited ("NTL")
from which he resigned in 1994. Since leaving NTL, Mr. Forrest has been engaged
in the management of investments and continues to serve as director of several
entities based in the United Kingdom.

  Joseph E. Andrulis joined Mizar in May 1996 as Vice President-Strategic
Marketing. From December 1993 to May 1996, he held various positions at Pinpoint
Communications, Inc., the most recent of which was Director of 

                                       18
<PAGE>
 
Marketing. Mr. Andrulis was an Associate at McKinsey & Co. from September 1990
to December 1993. In April 1998, he was named Vice President Marketing for the
Company.

  Charles D. Brockenbush joined Mizar in January 1996 as Vice President-Finance
and Chief Financial Officer.  From February 1995 to January 1996, he served as
Vice-President and Chief Financial Officer of TeKnowlogy, Inc.  From 1988 to
1995, he served as Corporate Controller and Assistant Treasurer of Interphase
Corporation.  In April 1998, he was named Vice President Finance, and Chief
Financial Officer of the Company.

  M. Keith Burgess joined Mizar in September 1989 and has served in a variety of
engineering and technical marketing management positions.  He was named Vice
President-Advanced Technology of Mizar in January 1997, and in April 1998, was
named the Chief Technology Officer for the Company.

  Julian S. Jenkins joined LSI in September 1995 as Finance Director.  At the
time of the combination, he was appointed as President - Europe, with
responsibility for all European operations.  Prior to joining LSI, he was a
senior manager with Price Waterhouse in the UK, a leading international
accounting firm. In April 1998, he was named the President of the European
operations for the Company.

  Andy N. MacCaig joined LSI in March 1995 as the hardware manager for one of
the two engineering groups.  He had also previously served at LSI as Technical
Manager for the first products based on the TI C6x DSP.  Prior to his joining
LSI, he held a number of management positions with a leading supplier of
military radar products.  In April 1998, he was named the Vice President
Operations for the Company.

  Kevin Parslow joined LSI in October 1992 when LSI merged with Data Beta, where
he was Sales and Marketing Director.  In 1994, he was appointed as Sales
Director of LSI, and in April 1998, was named the Vice President of Worldwide
Sales for the Company.

  Each of the Company's directors holds office until the next annual meeting of
stockholders and until their respective successors shall have been elected and
qualified or until their earlier death, resignation or removal.  The Company's
officers are elected annually by, and serve at the discretion of, the Board of
Directors.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

  Under the securities laws of the United States, the Company's directors and
executive officers and persons who own more than 10% of the Company's common
stock are required to report their initial ownership of the Company's common
stock and any subsequent changes in that ownership to the Securities and
Exchange Commission.  Specific due dates have been established for these
reports, and the Company is required to disclose any failure to file by these
dates.  All of these filing requirements were satisfied during fiscal 1998.

ITEM 11. EXECUTIVE COMPENSATION

  The information required by this item is incorporated by reference to the
Company's Proxy Statement for the
Annual Meeting of Stockholders' which will be filed on or before October 28,
1998.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

  The information required by this item is incorporated by reference to the
Company's Proxy Statement for the
Annual Meeting of Stockholders' which will be filed on or before October 28,
1998.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

  The information required by this item is incorporated by reference to the
Company's Proxy Statement for the Annual Meeting of Stockholders' which will be
filed on or before October 28, 1998.

                                       19
<PAGE>
 
                                    PART IV


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

(a)  1. and 2.  Financial Statements and Financial Statement Schedules

         These documents are filed with this report and are listed in the Index
         to Financial Statements on page F-1.
 
     3.  Exhibits

         A list of exhibits required to be filed as a part of this 10-K is set
         forth in the Exhibit Index.
 
(b)  Reports on Form 8-K filed during the last quarter of 1998.
 
     The Company filed a report on Form 8-K dated May 12, 1998, related to the
combination with LSI.

                                       20
<PAGE>
 
                                  SIGNATURES
                                        
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                                       Blue Wave Systems Inc.
 

Dated: September 28, 1998              By: /s/    Simon Yates
       ------------------                  ------------------------------------
                                                  Simon Yates, President and
                                                  Chief Executive Officer
                                                  (Principal Executive Officer)

     Pursuant to the requirements of the Securities Exchange 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 dates indicated.


By:/s/ Simon Yates              President and Chief        Dated: September 28, 
   -------------------------    Executive Officer                 1998          
       Simon Yates              and Director (Principal      
                                Executive Officer)           
                                                             
                                                             
By:/s/ Charles D. Brockenbush   Vice President, Finance    Dated: September 28,
   --------------------------   and Chief Financial               1998         
       Charles D. Brockenbush   Officer (Principal Financial 
                                and Accounting Officer)     
 

By:/s/ Sam K. Smith             Chairman of the            Dated: September 28,
   --------------------------   Board of Directors                1998         
       Sam K. Smith
 

By:/s/ John R. Forrest          Director                   Dated: September 28,
   --------------------------                                     1998         
       John R. Forrest


By:/s/ John L. Rynearson        Director                   Dated: September 28,
   --------------------------                                     1998         
       John L. Rynearson




<PAGE>
 
                            BLUE WAVE SYSTEMS INC.

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION> 
                                                                                                         PAGE
                                                                                                         ----
<S>                                                                                                      <C> 
Report of Independent Public Accountants                                                                 F-2 
Consolidated Balance Sheets as of June 30, 1998 and 1997                                                 F-3 
Consolidated Statements of Operations For the Years Ended June 30, 1998, 1997 and 1996                   F-4 
Consolidated Statements of Changes in Stockholders' Equity For the Years Ended June 30, 1998, 
  1997 and 1996                                                                                          F-5
Consolidated Statements of Cash Flows For the Years Ended June 30, 1998, 1997 and 1996                   F-6 
Notes to Consolidated Financial Statements                                                               F-7 
Schedule II - Valuation and Qualifying Accounts                                                          F-22 
</TABLE>

                                      F-1
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Blue Wave Systems Inc.:

We have audited the accompanying consolidated balance sheets of Blue Wave
Systems Inc. (formerly Mizar, Inc.) and subsidiaries (the "Company") at June 30,
1998 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the years in the three-year
period ended June 30, 1998.  The consolidated financial statements give
retroactive effect to the merger with Blue Wave Ltd. (formerly Loughborough
Sound Images Limited) on April 27, 1998, which has been accounted for as a
pooling of interests as described in Note 1.  These consolidated financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We did not audit the consolidated financial statements of Blue Wave Systems Ltd.
included in the restated consolidated financial statements of the Company for
fiscal years prior to fiscal year 1998, which statements reflect total assets
and revenues constituting 47% and 67%, respectively, in 1997 and 43% and 60%,
respectively, in 1996 of the related consolidated totals.  These statements were
audited by other auditors whose report thereon has been furnished to us, and our
opinion expressed herein, insofar as it relates to the amounts included for Blue
Wave Ltd., is based solely upon the report of the other auditors.

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

In our opinion, based upon our audit and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of June 30, 1998 and
1997, and the results of its operations and its cash flows for each of the years
in the three-year period ended June 30, 1998, after giving retroactive effect to
the merger with Blue Wave Ltd. as described in Note 1, all in conformity with
generally accepted accounting principles.

Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole.  Schedule II listed in the
index to consolidated financial statements is presented for the purpose of
complying with the Securities and Exchange Commission's rules and is not a part
of the basic consolidated financial statements.  This schedule has been
subjected to the auditing procedures applied in our audits of the basic
consolidated financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.



                                    ARTHUR ANDERSEN LLP



Dallas, Texas
August 11, 1998

                                      F-2
<PAGE>
 
                             BLUE WAVE SYSTEMS INC.

                           CONSOLIDATED BALANCE SHEETS
                          AS OF JUNE 30, 1998 AND 1997
                   (in thousands, except par value per share)


<TABLE>
<CAPTION>
                                                                                            As of June 30,
                                                                                          1998          1997
                                                                                       ----------    ----------
                                                                                                     (restated)
                                              ASSETS
<S>                                                                                    <C>           <C>       
Current assets:
    Cash and cash equivalents                                                          $    1,060    $    2,406
    Restricted cash                                                                           835           810
    Marketable securities, at fair value                                                    3,062         8,598
    Accounts receivable, net of allowances of $336 and $306, respectively                   4,975         7,842
    Inventories, net                                                                        4,156         4,602
    Prepaid expenses and other                                                                612         1,585
    Deferred tax asset                                                                      1,101         1,110
                                                                                       ----------    ----------
                         Total current assets                                              15,801        26,953
                                                                                       ----------    ----------

Plant and equipment:
    Machinery and equipment                                                                 7,320         5,998
    Furniture and fixtures                                                                  2,876         3,250
                                                                                       ----------    ----------
                                                                                           10,196         9,248
    Less accumulated depreciation                                                          (5,838)       (4,692)
                                                                                       ----------    ----------
                         Plant and equipment, net                                           4,358         4,556
                                                                                       ----------    ----------

Deferred tax asset-noncurrent                                                                 280          --
Other assets                                                                                  105            46
                                                                                       ----------    ----------
                         Total assets                                                  $   20,544    $   31,555
                                                                                       ==========    ==========

                               LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                                                   $    2,402    $    4,505
    Accrued compensation                                                                      706           421
    Other current liabilities                                                               3,991         3,354
    Line of credit                                                                          2,302          --
    Current maturities of debt and capital lease obligations                                 --             284
                                                                                       ----------    ----------
                         Total current liabilities                                          9,401         8,564
                                                                                       ----------    ----------

Deferred income taxes                                                                         870           632
Long-term debt, net of current maturities                                                     835           810
                                                                                       ----------    ----------
                         Total liabilities                                                 11,106        10,006
                                                                                       ----------    ----------

Commitments and Contingencies

Mandatorily redeemable preference shares                                                     --           8,173

Stockholders' equity:
    Preference stock, $.01 par value; 1,000 shares authorized; no shares
            issued and outstanding at June 30, 1998 and 1997, respectively                   --            --
    Common stock, $.01 par value; 50,000 shares authorized; 13,537 and 10,820
            shares issued; 12,791 and 10,852 shares outstanding at June 30, 1998 and
            1997, respectively                                                                135           108
    Additional paid-in capital                                                             22,973        14,758
    Net unrealized gain (loss) on marketable securities                                      --             (16)
    Retained earnings (deficit)                                                           (12,208)          235
    Cumulative translation adjustment                                                         (61)          201
                                                                                       ----------    ----------
                                                                                           10,839        15,286
                                                                                       ----------    ----------
    Less -- treasury stock, at cost                                                        (1,401)       (1,910)
                                                                                       ----------    ----------
                         Total stockholders' equity                                         9,438        13,376
                                                                                       ----------    ----------
                         Total liabilities and stockholders' equity                    $   20,544    $   31,555
                                                                                       ==========    ==========
</TABLE>


             The accompanying notes are an integral part of these
                       consolidated financial statements.


                                      F-3
<PAGE>
 
                             BLUE WAVE SYSTEMS INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS

            FOR THE FISCAL YEARS ENDED JUNE 30, 1998, 1997, AND 1996
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                                      For the Fiscal Years
                                                                                1998          1997          1996
                                                                             ----------    ----------    ----------
                                                                                           (restated)    (restated)
<S>                                                                          <C>           <C>           <C>       
Net sales                                                                    $   32,679    $   34,388    $   35,194
Cost of sales                                                                    15,395        15,599        16,070
                                                                             ----------    ----------    ----------

                    Gross margin                                                 17,284        18,789        19,124

Operating expenses:
     Product development and engineering                                          7,151         6,959         5,466
     Sales and marketing                                                          7,905         6,315         5,591
     General and administrative                                                   3,938         5,309         2,952
     Merger and realignment costs                                                 8,426          --            --
                                                                             ----------    ----------    ----------

                    Total operating expenses                                     27,420        18,583        14,009
                                                                             ----------    ----------    ----------

Operating income (loss)                                                         (10,136)          206         5,115
                                                                             ----------    ----------    ----------

Other income (expense):
     Interest expense                                                              (109)         (205)         (419)
     Interest income                                                                506           611           491
     Other, net                                                                     189            77            68
                                                                             ----------    ----------    ----------

                    Total other income                                              586           483           140
                                                                             ----------    ----------    ----------

Income (loss) from continuing operations before provision for income taxes       (9,550)          689         5,255
                                                                             ----------    ----------    ----------

Provision for income taxes                                                          255           397           291

Income (loss) from continuing operations                                         (9,805)          292         4,964

Loss from discontinued operations, net of tax benefit of $62, $560,
                    and $661, respectively                                         (137)       (1,248)       (1,341)
                                                                             ----------    ----------    ----------

Net income (loss)                                                                (9,942)         (956)        3,623

Preference share dividends, accretion and amortization of issuance cost
                    of preference shares                                         (1,512)         (874)         --
                                                                             ----------    ----------    ----------

Net income (loss) applicable to common stock                                 $  (11,454)   $   (1,830)   $    3,623
                                                                             ==========    ==========    ==========

Basic net income (loss) per share:
     Continuing operations                                                   $    (0.89)   $    (0.05)   $     0.48
     Discontinued operations                                                      (0.01)        (0.12)        (0.13)
                                                                             ==========    ==========    ==========
                                                                             $    (0.90)   $    (0.17)   $     0.35
                                                                             ==========    ==========    ==========

Diluted net income (loss) per share:
     Continuing operations                                                   $    (0.89)   $    (0.05)   $     0.41
     Discontinued operations                                                      (0.01)        (0.12)        (0.11)
                                                                             ==========    ==========    ==========
                                                                             $    (0.90)   $    (0.17)   $     0.30
                                                                             ==========    ==========    ==========

Weighted average common shares outstanding:
     Basic                                                                       12,684        10,594        10,457
                                                                             ==========    ==========    ==========
     Diluted                                                                     12,684        10,594        12,218
                                                                             ==========    ==========    ==========
</TABLE>


              The accompanying notes are an integral part of these
                       consolidated financial statements.

                                      F-4
<PAGE>
 
                             BLUE WAVE SYSTEMS INC.

           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

                 FOR THE FISCAL YEARS ENDED 1998, 1997 AND 1996
                                 (in thousands)


<TABLE>
<CAPTION>
                                                                                 Net Unrealized
                                                                                    Loss on              
                                              Common Stock            Paid-In      Marketable            
                                           Shares      Par Value      Capital      Securities            
                                         ----------    ----------    ----------    ----------
<S>                                      <C>           <C>           <C>           <C> 
BALANCE, beginning of fiscal                  9,186    $       92    $    5,610           $ - 
      year 1996
   Issuance of common shares
     for initial public offering                918             9         7,188             - 
   Initial public offering expenses               -             -          (372)            - 
   Issuance of common shares
     for conversion of debentures               891             9         1,039             - 
   Issuance of common shares
     for exercise of stock options              388             4           206             - 
   Purchase of treasury stock,
     at cost                                      -             -             -             - 
   Payments on employee loans
     for exercise of stock options                -             -            25             - 
   Change in unrealized loss on
     marketable securities                        -             -             -           (66)
   Foreign currency translation                   -             -             -             - 
   Net income                                     -             -             -             - 
                                         ----------    ----------    ----------    ----------
BALANCE, end of fiscal year 1996             11,383           114        13,696           (66)
   Issuance of common shares                     57             1           204             - 
   Issuance of warrants                           -             -           583             - 
   Issuance of common shares
     for exercise of stock options                5             -            11             - 
   Purchase of treasury stock,
     at cost                                   (625)           (7)           (3)            - 
   Purchase of shares for ESOP                    -             -             -             - 
   Payments on employee loans
     for exercise of stock options                -             -             4             - 
   Dividend, accretion and amorti-
     zation of issuance costs                     -             -             -             - 
   Tax effect of disqualifying
     dispositions                                 -             -           263             - 
   Change in unrealized loss on
     marketable securities                        -             -             -            50
   Foreign currency translation                   -             -             -             - 
   Net income                                     -             -             -             - 
                                         ----------    ----------    ----------    ----------
BALANCE, end of fiscal year 1997             10,820           108        14,758           (16)
   Issuance of common shares
     and treasury stock for
     exercise of stock options                  814             8           371             - 
   Loss on issuance of treasury
     shares for option exercises                  -             -             -             - 
   Issuance of common shares
     for exercise of warrants                 1,903            19         5,552             - 
   Purchase of treasury stock,
     at cost                                      -             -             -             - 
   Variable stock option expense                  -             -         2,741             - 
   Write-off of preference share
      issuance costs                              -             -          (449)            - 
   Dividend, accretion and amorti-
     zation of issuance costs                     -             -             -             - 
   Change in unrealized loss on
     marketable securities                        -             -             -            16
   Foreign currency translation                   -             -             -             - 
   Net income from overlapping period
     - LSI quarter ended 9/30/98                  -             -             -             - 
   Dividend, accretion and amorti-
     zation of issuance costs of over-
     lapping period                               -             -             -             - 
   Net income                                     -             -             -             - 
                                         ----------    ----------    ----------    ----------
BALANCE, June 30, 1998                       13,537    $      135    $   22,973           $ - 
                                         ==========    ==========    ==========    ==========

<CAPTION>

                                         Retained      Cumulative                                       
                                         Earnings/     Translation     Treasury                       
                                         (Deficit)     Adjustment       Stock        Total     
                                         ----------    ----------    ----------    ----------
<S>                                      <C>           <C>           <C>           <C> 
BALANCE, beginning of fiscal             $      700    $      154    $     (332)   $    6,224
      year 1996
   Issuance of common shares
     for initial public offering                  -             -             -         7,197
   Initial public offering expenses               -             -             -          (372)
   Issuance of common shares
     for conversion of debentures                 -             -             -         1,048
   Issuance of common shares
     for exercise of stock options                -             -             -           210
   Purchase of treasury stock,
     at cost                                      -             -          (254)         (254)
   Payments on employee loans
     for exercise of stock options                -             -             -            25
   Change in unrealized loss on
     marketable securities                        -             -             -           (66)
   Foreign currency translation                   -           (28)            -           (28)
   Net income                                 3,623             -             -         3,623
                                         ----------    ----------    ----------    ----------
BALANCE, end of fiscal year 1996              4,323           126          (586)       17,607
   Issuance of common shares                      -             -             -           205
   Issuance of warrants                           -             -             -           583
   Issuance of common shares
     for exercise of stock options                -             -             -            11
   Purchase of treasury stock,
     at cost                                 (2,258)            -          (514)       (2,782)
   Purchase of shares for ESOP                    -             -          (810)         (810)
   Payments on employee loans
     for exercise of stock options                -             -             -             4
   Dividend, accretion and amorti-
     zation of issuance costs                  (874)            -             -          (874)
   Tax effect of disqualifying
     dispositions                                 -             -             -           263
   Change in unrealized loss on
     marketable securities                        -             -             -            50
   Foreign currency translation                   -            75             -            75
   Net income (loss)                            (956)            -             -          (956)
                                         ----------    ----------    ----------    ----------
BALANCE, end of fiscal year 1997                235           201        (1,910)       13,376
   Issuance of common shares
     and treasury stock for
     exercise of stock options                    -             -           220           599
   Loss on issuance of treasury
     shares for option exercises               (862)            -           862             -
   Issuance of common shares
     for exercise of warrants                     -             -             -         5,571
   Purchase of treasury stock,
     at cost                                      -             -          (573)         (573)
   Variable stock option expense                  -             -             -         2,741
   Write-off of preference share
      issuance costs                              -             -             -          (449)
   Dividend, accretion and amorti-
     zation of issuance costs                (1,512)            -             -        (1,512)
   Change in unrealized loss on
     marketable securities                        -             -             -            16
   Foreign currency translation                   -          (262)            -          (262)
   Net income from overlapping period
     - LSI quarter ended 9/30/98               (564)            -             -          (564)
   Dividend, accretion and amorti-
     zation of issuance costs of over-
     lapping period                             437             -             -           437
   Net income (loss)                         (9,942)            -             -        (9,942)
                                         ----------    ----------    ----------    ----------
BALANCE, June 30, 1998                   $  (12,208)   $      (61)   $   (1,401)   $    9,438
                                         ==========    ==========    ==========    ==========
</TABLE>


              The accompanying notes are an integral part of these
                       consolidated financial statements.

                                      F-5
<PAGE>
 
                             BLUE WAVE SYSTEMS INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                FOR THE FISCAL YEARS ENDED 1998, 1997 AND 1996
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                                  For the Fiscal Years
                                                                              1998        1997        1996
                                                                            --------    --------    --------
<S>                                                                         <C>         <C>         <C>     
CASH FLOWS FROM OPERATING ACTIVITIES:
     Net income (loss)                                                      $ (9,942)   $   (956)   $  3,623
     Adjustments to reconcile net income (loss) to net cash
        provided (used) by operating activities -
           Depreciation                                                        1,391       1,256       1,013
           Loss on disposal of fixed assets                                      151        --          --
           Variable stock option charge                                        2,741        --          --
           Deferred tax provision (benefit)                                      (42)       (230)       (984)
     Changes in assets and liabilities -
           Accounts receivable, net                                            2,867      (2,069)       (654)
           Inventories, net                                                      446        (253)       (490)
           Prepaid expenses and other                                            914        (651)        841
           Accounts payable and accrued liabilities                          ( 1,181)      2,641        (501)
                                                                            --------    --------    --------
                         Net cash provided (used) by operating activities     (2,655)       (262)      2,848
                                                                            --------    --------    --------

CASH FLOWS FROM INVESTING ACTIVITIES:
           Purchases of machinery and equipment                               (1,233)     (1,842)       (881)
           Proceeds from dispositions of machinery and equipment
               and assets held for sale                                         --            98         529
           Purchases of marketable securities                                   --        (3,398)    (11,526)
           Proceeds from maturities of marketable securities                   5,561       3,903       1,114
           Proceeds from sales of marketable securities before maturity         --         1,360        --
                                                                            --------    --------    --------
                         Net cash provided (used) by investing activities      4,328         121     (10,764)
                                                                            --------    --------    --------

CASH FLOWS FROM FINANCING ACTIVITIES:
           Sale of common stock (net of expenses)                               --          --         6,834
           Proceeds from sales of preference shares                             --         8,914        --
           Payment of preference shares issuance costs                          --          (827)       --
           Purchase of ESOP shares                                              --          (810)       --
           Redemption of preferred shares                                    (10,023)       --          --
           Exercise of stock warrants and options (net of employee loans)      6,170          15         235
           Proceeds from debt borrowings                                       2,302         810         500
           Restricted cash in escrow                                            --          (810)       --
           Purchase of treasury stock                                           (573)     (2,782)       (486)
           Net payments on long-term debt, capital lease obligations, and
             subordinated debentures                                            (284)     (3,796)     (1,405)
                                                                            --------    --------    --------
                         Net cash provided (used) by financing activities     (2,408)        714       5,678
                                                                            --------    --------    --------

           Effect of translation rates on cash                                   (47)         88         (32)
           Effect of overlapping period                                         (564)       --          --

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                          (1,346)        661      (2,270)
CASH AND CASH EQUIVALENTS, beginning of year                                   2,406       1,745       4,015
                                                                            --------    --------    --------
CASH AND CASH EQUIVALENTS, end of year                                      $  1,060    $  2,406    $  1,745
                                                                            ========    ========    ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
           Cash paid for interest                                           $    130    $    206    $    411
           Cash paid for income taxes                                            263       1,090         568
           Assets acquired under capital leases                                 --          --           257
           Common stock issued in conversion of convertible debentures          --          --         1,048
           Tax effect of disqualifying dispositions on stock options            --           263        --
</TABLE>


              The accompanying notes are an integral part of these
                       consolidated financial statements.

                                      F-6
<PAGE>
 
                            BLUE WAVE SYSTEMS INC.


                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       FISCAL YEARS 1998, 1997, AND 1996


1.   ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     Blue Wave Systems Inc. (formerly Mizar, Inc.) (a Delaware corporation) (the
"Company", "Blue Wave" or "BWS Inc.") designs, develops and markets
multiprocessor Digital Signal Processing ("DSP") computing sub-systems that are
used in a variety of real-time image and signal processing applications
including communications, machine vision, and radar.  The Company's products are
typically sold to original equipment manufacturers, research organizations, and
military contractors who integrate the Company's products into special purpose
computing platforms.  The Company continues to sell its prior generation of non-
DSP computing sub-systems primarily to existing commercial customers for
industrial automation applications.  The Company was formed in April 1998 upon
the combination of Mizar, Inc. ("Mizar") and Loughborough Sound Images Limited
("LSI"), a company based in the United Kingdom.

     Blue Wave Systems Limited ("Blue Wave Sub" or "Sub") (formerly Loughborough
Sound Images Limited or "LSI") was incorporated in England in 1983 and is
registered as a private limited company.  Blue Wave Sub, and its wholly owned
subsidiaries, are collectively referred to herein as "Sub."

     Certain previously reported amounts have been reclassified to conform with
current year presentation.

Basis of Presentation

     The accompanying consolidated financial statements of the Company have been
prepared to give retroactive effect, for all periods presented, to the
combination with Sub on April 27, 1998, which has been accounted for as a
pooling of interests (see Note 2).    These financial statements are the
historical consolidated financial statements of Blue Wave because they cover the
date of consummation of the business combination.  The financial statements
presented for fiscal years prior to 1998 have been restated to reflect the
business combination.

     The accompanying restated consolidated balance sheet as of June 30, 1997,
combines Blue Wave's historical balance sheet as of June 30, 1997 with the
corresponding Sub historical balance sheet as of September 30, 1997 (as combined
"at fiscal year-end 1997").

     The accompanying restated consolidated statements of operations,
stockholders' equity and cash flows combine Blue Wave's historical statements of
operations, stockholders' equity and cash flows for each of the two years in the
period ended June 30, 1997, with the corresponding Sub historical statements of
operations, stockholders' equity and cash flows for each of the two years in the
period ended September 30, 1997 (as combined, the "fiscal years 1997 and 1996").
The restated consolidated statements of stockholders' equity for each of the two
years in the period ended June 30, 1997 reflect the exchange of each Sub common
share for 94.632 shares of Blue Wave common stock (see Note 2).

Accounting Convention

     The accompanying consolidated financial statements have been prepared in
accordance with United States generally accepted accounting principles.

                                      F-7
<PAGE>
 
Foreign Currency Translation

     The functional currency of Sub is the United Kingdom pound sterling ("pound
sterling") and the functional currency of BWS Inc. is the US dollar.

     The historical financial statements of Sub have been translated into US
dollars ("$") from pound sterling ("(Pounds)") using the exchange rate at each
balance sheet date for assets and liabilities and average exchange rate for each
period for net sales, costs, expenses and other income and expenses.
Translation adjustments have been recorded as a separate component of
stockholders' equity.

Principles of Consolidation

     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions are eliminated in consolidation.

Cash and Cash Equivalents

     Cash and cash equivalents includes cash placed in money market funds or
investments in highly liquid securities with original maturities of three months
or less.

Restricted Cash

     In connection with the establishment of an employee stock ownership plan
("ESOP"), Sub has guaranteed the debt of the ESOP.  The guarantee required Sub
to place cash in escrow in an amount equal to the debt.  Such cash has been
reflected as restricted cash in the accompanying consolidated financial
statements (see Note 13).

Marketable Securities

     The Company has determined that all of its marketable securities should be
classified as available for sale and reflected in the accompanying consolidated
balance sheets at their respective market values.  The Company's results of
operations include earnings from such securities as calculated on a yield-to-
maturity basis.  Unrealized gains and losses from the changes in fair value are
excluded from income and are reported as an adjustment to stockholders' equity,
net of the deferred tax effect.  The Company's marketable securities consist of
direct and implied obligations of the US Government, certificates of deposit,
and investment grade corporate debt securities.

     The Company does not invest in or use derivative financial instruments
other than currency hedging transactions. In 1998, the Company did not enter
into any currency hedging transactions.

Inventories

     Inventories are stated at the lower of cost (including direct materials,
labor, and applied overhead) or market using the first-in, first-out method
(FIFO).  The Company periodically reviews inventory items on hand and provides
allowances, if necessary, to reduce inventory to its estimated realizable value.

Property, Plant, and Equipment

     Property, plant and equipment, including assets under capital lease, are
carried at cost and depreciated using the straight-line method over the
estimated economic lives of the assets as follows:

     Buildings/leasehold improvements            7 - 25 years
     Equipment                                   3 - 5 years
     Furniture and fixtures                      2 - 5 years
     Software                                    1 - 3 years

                                      F-8
<PAGE>
 
     Repair and maintenance expenditures are charged to expense as incurred, and
expenditures for major renewals and betterments are capitalized.

     When property, plant and equipment are sold or otherwise retired, the cost
and accumulated depreciation applicable to such assets are eliminated from the
accounts, and any resulting gain or loss is reflected in current operations.

     The Company assesses the realizability of long-lived assets in accordance
with Statement of Financial Accounting Standard (SFAS) No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." This statement requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable.

Revenue Recognition

     Revenue from product sales is recorded only when the earnings process is
completed, which is principally when the product is shipped.

Research and Development

     Research and development costs are included in and inseparable from product
development and engineering expenses and are charged to expense as incurred.

Income Taxes

     The Company uses the liability method to determine deferred taxes. Deferred
tax assets and liabilities are based on the estimated future tax effects of
differences between the financial statement and tax bases of assets and
liabilities given the provisions of enacted tax law. Management continually
evaluates the realizability of the net deferred tax assets and the need for
additional valuation allowances on such assets.

Net Income (Loss) Per Share

     Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings
Per Share" (SFAS No. 128). This statement established a new methodology for
calculating earnings per share ("EPS"). All periods presented in the
accompanying consolidated financial statements have been restated to conform
with the requirements of SFAS No. 128 (see Note 8).

     The Company has elected to follow the proforma disclosure requirements
promulgated by SFAS No. 123 and has opted to continue to account for the stock
option plan under APB Opinion No. 25, under which no compensation cost has been
recognized in the accompanying consolidated statements of operations.  The
proforma disclosure can be found in Note 13 to the consolidated financial
statements.

Initial Public Offering

     On September 28, 1995, the Company completed an initial public offering
("IPO") of 918,000 shares of common stock.  Proceeds from the offering, net of
expenses, aggregated $6,834,000 and were used to retire $856,000 of debt and
fulfill a commitment, as well as an option, to purchase the Company's common
stock owned by United Technologies, Inc. ("UTC"), and to add to working capital.

     The Company sold John G. Kinnard and Company, Incorporated, as an
underwriter of the IPO, a five-year warrant to purchase up to 15,000 shares of
the Company's common stock, exercisable at $10.20 per share. As of June 30,
1998, this warrant had not been exercised.

                                      F-9
<PAGE>
 
Use of Estimates
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the 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.

Fair Value of Financial Instruments

     Management believes the recorded values of financial instruments
approximate their current fair values as such items are current in nature and/or
generally bear variable interest rates which adjust yield to derive current
market value.

New Accounting Pronouncements

     The Financial Accounting Standards Board has issued SFAS No. 130,
"Reporting Comprehensive Income" (SFAS No. 130). SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. Comprehensive income is
defined as the total of net income and all other non-owner changes in equity.
The adoption of SFAS No. 130 is required for fiscal years beginning after
December 15, 1997. The Company currently has two types of non-owner changes in
equity, excluding net income, including foreign currency translation gains and
losses and unrealized gains and losses on investments.

     The Financial Accounting Standards Board has issued SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information" (SFAS No.
131). This pronouncement changes requirements under which public businesses must
report segment information. The objective of the pronouncement is to provide
information about a company's different types of business activities and
different economic environments. SFAS No. 131 requires companies to select and
report segments based on their internal reporting system. The adoption of SFAS
No. 131 is required for fiscal years beginning after December 15, 1997. The
Company is evaluating what impact SFAS No. 131 will have on the Company's
disclosures.

     The Financial Accounting Standards Board has issued SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits" (SFAS
No. 132). This pronouncement revises employers' disclosures about pension and
other postretirement benefit plans. It does not change the measurement or
recognition of those plans, however, it does require additional information on
changes in the benefit obligations and fair values of plan assets in order to
facilitate financial analysis. The adoption of SFAS No. 132 is required for
fiscal years beginning after December 15, 1997. The Company currently does not
have any pension or postretirement benefit plans.

     The Financial Accounting Standards Board has issued SFAS No. 133,
"Accounting for Derivative and Similar Financial Instruments For Hedging
Activities" (SFAS No. 133). This pronouncement revises the accounting for
derivative financial instruments. It requires entities to recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. The adoption of this statement is required for
fiscal years beginning after December 15, 1997. Historically, the Company has
not invested in derivatives nor hedged any significant risks with the use of
derivative financial instruments.

2.  COMBINATION WITH SUB:

     On April 27, 1998, Mizar, Inc. and Sub completed the combination
announced in November 1997.  Mizar changed its name to Blue Wave Systems Inc.
and trades on the Nasdaq National Market tier of The Nasdaq Stock Market/sm
/under the symbol "BWSI."  Sub is a leading supplier of embedded DSP products to
the telecommunications, defense, and test and measurement markets.  The
combination was completed via a share exchange with the Company issuing
7,876,964 common shares of the Company (the "Common Stock") to Sub

                                      F-10
<PAGE>

shareholders in exchange for all outstanding Sub shares. BWS Inc. also issued
options exercisable for approximately 564,000 shares of Common Stock in exchange
for the outstanding Sub options. The foregoing issuances were based upon the
exchange ratio of 94.632 shares of Common Stock for each ordinary share of Sub
transferred to the Company, including shares issuable under options. The Company
incurred significant costs and expenses to consummate this complex, cross-border
transaction. Also, in conjunction with the merger, the Company realigned its
business operations in order to better meet the needs of its customers,
eliminate duplicate facilities and functions, and to strategically focus the
Company on the growing telecommunications market. The Company recorded an
$8,426,000 pre-tax non-recurring charge for these merger and realignment
expenses. Approximately $4,100,000 of the total charge has or will result in
cash outlay by the Company, while approximately $4,300,000 of the charge will
not result in cash outlay. Approximately $2,700,000 of these charges were paid
in fiscal 1998 and $1,400,000 is expected to be paid in fiscal 1999. The merger
expenses consist of professional and statutory fees including legal, accounting,
investment banking and printing fees for both companies, as well as a statutory
transaction-based tax in the UK and public filings fees in the US. These charges
also include travel costs, employment severance, and duplicate lease space.
Merger expenses also include a non-cash charge of approximately $2,700,000 for
variable stock options of Sub that vested at the date of consummation of the
merger. The realignment of the business operations consists of reducing support
for certain product-lines and combining certain functions. The realignment
expenses include approximately $900,000 for the write-down of inventory
associated with duplicate or competing products, fixed assets, and severance
associated with the termination of employees. The realignment plan was committed
to by the Board of Directors subsequent to the combination, and is expected to
be completed in the first half of fiscal 1999. The following table presents a
summary of the remaining reserves for these expenses, as of June 30, 1998.

            Balance Sheet Classification                     Amount
            ----------------------------                     -------
Inventory, net                                            $  566,000
Accumulated Depreciation                                     170,000
Reserves included in other current liabilities             1,902,000
Accrued compensation                                         438,000

     In conjunction with completion of the business combination, there was a
redemption, in cash, of redeemable preference shares of Sub owned by Boston
Holdings Limited as well as an exercise of warrants for common stock of Sub,
also owned by Boston Holdings Limited, which were then exchanged into
approximately 1,904,000 shares of Common Stock.  The preference shares and
warrants of Sub were mandatorily redeemable on the sale or merger of Sub (see
Note 15).  The resultant net impact of these transactions with Boston Holdings
Limited on cash to the combined companies was an outlay of approximately
$4,500,000.

     The table below presents a reconciliation of revenues and net income, as
reported in the consolidated statements of income with those previously reported
by the Company.  The references to Blue Wave in this table are to the Company's
historical operating results prior to the acquisition of Sub (amounts in table
are in thousands).
 
                                                      Fiscal Years Ended
                                                      -------------------
                                                  1998       1997       1996
                                                 -------    -------    -------
  REVENUES:                                    
  Blue Wave                                      $12,111    $11,507    $14,052
  Sub                                             20,568     22,881     21,142
                                                 -------    -------    -------
       Total consolidated revenues               $32,679    $34,388    $35,194
                                                 =======    =======    =======
                                               
  NET INCOME (LOSS):                           
  Blue Wave                                      $(5,677)   $   179    $ 3,274
  Sub                                             (4,265)    (1,135)       349
                                                 -------    -------    -------
       Total consolidated net income (loss)      $(9,942)   $  (956)   $ 3,623
                                                 =======    =======    =======


     Included in the net income (loss) of Sub for fiscal years 1998, 1997, and
1996 are losses from discontinued operations of $137,000, $1,248,000 and
$1,341,000 respectively (net of income tax benefits of $62,000, $560,000 and
$661,000 respectively). See Note 10.

                                      F-11
<PAGE>
 
3.   INVENTORIES:

     Net inventories at fiscal year-end 1998 and 1997, consisted of the
following (in thousands):

 
                                       1998               1997
                                 -----------------  -----------------
     Raw materials                     $1,908             $2,047
     Work-in-process                    1,969              1,729
     Finished goods                     1,893                826
     Reserves                          (1,614)                 -
                                       ------             ------
     Inventories, net                  $4,156             $4,602
                                       ======             ======


4.   OTHER CURRENT LIABILITIES:

     At fiscal year-end 1998 and 1997, other current liabilities consisted of
the following (in thousands):
 
                                                 1998     1997
                                                -------  ------
 
Sales representative commissions                 $   53  $   19
Property tax                                         43      34
Warranties                                          360     278
Accrued franchise tax and income tax payable        152     218
Professional services and other                     233     194
Merger and realignment                            1,902      --
Miscellaneous accrued expenses                      472   1,250
Distributor settlement payable                       --     668
Taxes payable, other than income                    351     407
Other current liabilities                           425     286
                                                 ------  ------
                                                 $3,991  $3,354
                                                 ======  ======

     The distributor settlement payable relates to an amount due pursuant to the
settlement of a dispute concerning the termination of an agreement.


5.   ROYALTIES:

     During the fiscal years 1998, 1997, and 1996, the Company paid royalties of
$105,000, $235,000 and $360,000 primarily related to license agreements with
Texas Instruments Incorporated ("TI"). The license agreements allow the Company
to use certain products in its DSP sub-system business.  The royalties due
pursuant to the majority of these licensing agreements were fully paid up in
fiscal 1997.  On July 11, 1997, TI completed the sale of its DSEG group to
Raytheon Company.  TI and the Company have executed an agreement whereby all of
TI's rights and interests in the licensing agreements have been assigned to
Raytheon Company.

                                      F-12
<PAGE>
 
6.  MARKETABLE SECURITIES:

     A summary of the amortized cost, unrealized gains and losses, and fair
values of available for sale marketable securities at fiscal year-end 1998 and
1997 consisted of the following (in thousands):

<TABLE>
<CAPTION>
                                         1998                           1997
                             ------------------------------  ---------------------------
                              Gross                           Gross
                            Unrealized  Holding             Unrealized Holding
                             Amortized  Gains       Fair    Amortized   Gains     Fair
Type of Security               Cost     (Losses)    Value     Cost    (Losses)   Value
--------------------------  ----------  --------  ---------  -------  --------  -------
<S>                         <C>         <C>       <C>        <C>      <C>       <C>
 
  US government                 $1,840      $ 3      $1,843   $4,160     $ (3)   $4,157
  Corporate bonds                1,221       (2)      1,219    4,358      (22)    4,336
  Certificate of deposit             -        -           -      105        -       105
                                ------      ---      ------   ------     ----    ------
 
  Totals                        $3,061      $ 1      $3,062   $8,623     $(25)   $8,598
                                ======      ===      ======   ======     ====    ======
</TABLE>

     Net of the tax effect, the unrealized gain (loss) on securities available
for sale is $0 and $(16,000), respectively, which is included in stockholders'
equity.

     A comparison of the amortized cost and fair value of the Company's
available for sale marketable securities at fiscal year-end 1998 were due in one
year or less and approximated $3,061,000 and $3,062,000 at amortized cost and
fair value, respectively.


7.   DEBT:

Line of Credit

     The Company makes short-term borrowings under a credit facility made
available by a commercial bank. At fiscal year-end 1998, the Company had
$2,302,000 outstanding, and had approximately $5,000,000 in aggregate
availability under such credit facility. The credit facility bears interest at
the bank's reference rate plus 1.75% (7.50% at fiscal year-end 1998), is due
on demand and expires during fiscal 1999. The Company expects to renew this 
facility during fiscal 1999.

Long-term Debt

     Long-term debt (including capital lease obligations) consists of the
following (in thousands):
 
                                                                 1998    1997
                                                                ------  ------
  Note payable to a commercial bank, interest at the bank's    
     base rate, plus 1.75% (7.25% at fiscal year-end 1998);    
     payable in 2002; secured by escrow of $835 cash            $ 835   $  810
  Capital lease obligations, secured by related equipment           -      284
                                                                -----   ------
                                                                  835    1,094
  Less- Current maturities                                          -     (284)
                                                                -----   ------
                                                                $ 835   $  810
                                                                =====   ======
 

                                      F-13
<PAGE>
 
     The debt agreements related to the above contain warranties and covenants
and require maintenance of certain financial ratios. Default on any warranty or
covenant could, if not waived or corrected, accelerate the maturity of any
borrowings outstanding. Management believes the Company is in compliance with
such warranties and covenants.


8.  INCOME PER SHARE:

     In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share."  The Statement establishes standards for computing
and presenting earnings per share ("EPS").  It replaces the presentation of
primary EPS with a presentation of basic earnings per share.  Additionally, it
requires presentation of diluted EPS which is similar to fully diluted EPS,
pursuant to APB Opinion No. 15.  The net income (loss) per share information for
the three fiscal years ended 1998 have been restated to reflect the new
standard.

     Basic net income (loss) per share for the three fiscal years ended 1998
were computed by dividing net income (loss) applicable to common stock by the
weighted average number of shares of common stock outstanding during the periods
presented, as adjusted, on a historical basis, for the exchange ratio in the
Acquisition (Note 2). Diluted net income per share for the fiscal year ended
1996, was computed by dividing net income applicable to common stock by the
weighted average number of shares of common stock outstanding and other dilutive
securities outstanding during the periods presented, as adjusted for the
exchange ratio for the Acquisition (Note 2). Diluted net loss per share for the
two fiscal years in the period ended June 30, 1998, were computed by dividing
net loss applicable to common stock by the weighted average number of shares of
common stock outstanding; other dilutive securities outstanding during these
periods were anti-dilutive to the net loss per share. Other dilutive securities
included in diluted net income per share are stock options calculated under the
treasury stock method using the prevailing average market price for the period
presented. Shares used in basic and diluted net income (loss) per share
calculations for the fiscal years 1998, 1997, and 1996 are presented below (in
thousands):

                                                                BASIC
                                                        ----------------------
                                                        1998    1997     1996
                                                       ------  -------  ------
     Weighted average common stock outstanding          
         during the period                             12,684   10,594  10,457
                                                       ======   ======  ======

                                                               DILUTED
                                                       -----------------------
     Weighted average common stock outstanding         
         during the period                             12,684   10,594  10,457
     Other dilutive securities of stock                                        
         option/warrant programs                            -        -   1,761 
                                                       ------   ------  ------ 

     Shares used in net income per share calculation   12,684   10,594  12,218
                                                       ======   ======  ======

     Dilutive securities equivalent to 940 and 1,199 shares of common stock were
outstanding during 1998 and 1997, respectively, but were not included in the 
computation of diluted EPS because the Company incurred net losses attributable 
to common shareholders. The inclusion of these options would have been 
anti-dilutive to diluted EPS.

                                      F-14
<PAGE>
 
9.   COMMITMENTS AND CONTINGENCIES:

     The Company leases certain buildings and equipment under operating leases.
Rent expense applicable to operating leases was $1,337,000, $1,093,000 and
$705,000 for the fiscal years 1998, 1997, and 1996, respectively.  At fiscal
year-end 1998, the future minimum lease payments required by operating leases
were as follows:
 
  1999          $ 1,312
  2000            1,090
  2001            1,015
  2002              986
  2003              876
  Thereafter     14,659

     In prior periods, the Company has been party to certain legal proceedings
incidental to its business.  The Company accrues for claims that are both
probable and for which expected loss can be reasonably estimated.  Currently,
there are no known claims pending against the Company.


10.  DISCONTINUED OPERATIONS:

     In April 1997, Sub adopted a plan to discontinue its Video Multimedia Group
("VMG") operations in order to focus resources on its digital signal processing
products. The VMG operations principally designed, manufactured, and sold
products for the video conferencing industry.  These activities operated as a
distinct business segment the results of which have been separately disclosed as
discontinued operations in the accompanying consolidated statements of
operations.  The VMG operations were fully abandoned by September 30, 1997.
There were no sales of VMG in fiscal 1998, and $277,000 and $1,462,000 sales of
VMG for fiscal years 1997 and 1996, respectively.


11.  SIGNIFICANT CUSTOMERS, RECEIVABLES, AND CONCENTRATION OF CREDIT RISK:

     The following table summarizes sales by major customer group and gross
accounts receivable by major customer group for the fiscal years 1998, 1997, and
1996 (in thousands):
 
                                              1998      1997      1996
                                            --------  --------  --------
  SALES BY CUSTOMER GROUP:
  Commercial and other                       $25,135   $27,433   $28,179
  Prime contractors to the US government       7,544     6,955     7,015
                                             -------   -------  --------
                                             $32,679   $34,388   $35,194
                                             =======   =======  ========
 
                                               1998      1997
                                             -------   -------
  ACCOUNTS RECEIVABLE BY CUSTOMER GROUP:
  Commercial and other                       $ 4,090   $ 7,555
  Prime contractors to the US government       1,221       593
                                             -------   -------
                                             $ 5,311   $ 8,148
                                             =======   =======

     During 1998, one customer accounted for 13% of net sales.  During 1997, one
customer accounted for 14% of net sales.  During 1996, no customer individually
accounted for more than 10% of net sales.

                                      F-15
<PAGE>
 
12.  GEOGRAPHICAL INFORMATION:

     The Company's net sales, operating income and identifiable assets by
geographic region were as follows (in thousands):
 
                           North      Outside of
                          America   North America     Total
                         ---------  --------------  ---------
  1998
-----------------------
  Net sales               $13,332         $19,347   $ 32,679
 
  Operating income        $(7,217)        $(2,919)  $(10,136)
 
  Identifiable assets     $10,125         $10,419   $ 20,544
 
  1997
-----------------------
  Net sales               $11,307         $23,081   $ 34,388
 
  Operating income        $  (822)        $ 1,028   $    206
 
  Identifiable assets     $16,955         $14,600   $ 31,555
 
  1996
-----------------------
  Net sales               $13,458         $21,736   $ 35,194
 
  Operating income        $ 2,267         $ 2,848   $  5,115
 
  Identifiable assets     $16,095         $11,898   $ 27,993
 

13.  EMPLOYEE BENEFIT PLANS:

Bonus Plan

     Most full-time employees of the Company are eligible to participate in a
bonus program in which yearly bonus amounts are calculated on a predetermined
performance formula. There were $26,000, $23,000 and $15,000 of bonuses earned
in 1998, 1997, and 1996, respectively. Bonuses, if earned, are included in
accrued compensation in the accompanying consolidated financial statements.

Stock Option Plan

     The Company has a stock option plan, which includes nonqualified and
incentive stock options, for directors and employees. The total number of shares
underlying options is approximately 2,500,000 and the options are granted at
fair value as determined by the Board of Directors. Options are exercisable on a
schedule determined by the Board of Directors and expire 10 years after the date
of grant or earlier, in accordance with the terms of the plan.

     In fiscal 1997, the Company adopted SFAS No. 123, "Accounting for Stock-
Based Compensation." The Company accounts for the stock option plan under APB
Opinion No. 25, under which no compensation cost has been recognized in the
accompanying consolidated statements of operations. Had compensation cost been
determined pursuant to the fair value recognition provisions of SFAS No. 123,
the cost would have been $250,000, $131,000 and $66,000 for fiscal 1998, 1997
and 1996, respectively. The Company's proforma net (loss) income for fiscal
1998, 1997 and 1996 would have been $(11,704,000), $(1,087,000) and $3,557,000
respectively, resulting in diluted earnings (loss) per share of $(0.92), $(0.19)
and $0.29, respectively. 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

                                      F-16
<PAGE>
 
used for options granted in fiscal 1998, 1997 and 1996: risk-free interest rate
of 5.64%, 6.14% and 5.69%, respectively; expected volatility of 67.09%, 69.3%
and 46.8%, respectively; expected dividend yield of zero and expected lives of 3
years.

     All options are granted at fair value on the date of grant. There have been
no grants of equity instruments other than options in the periods presented. The
following summarizes the activity under the plan (number of shares in
thousands):
<TABLE>
<CAPTION>
 
                                           1998                   1997                  1996                        
                                     ----------------      -----------------    ------------------------            
                                              Weighted              Weighted              Weighted                  
                                              Average               Average               Average                   
                                              Exercise              Exercise              Exercise                  
                                     Options   Price       Options   Price      Options    Price                    
                                     -------  --------     -------  --------    -------   --------                  
<S>                                  <C>      <C>          <C>       <C>        <C>        <C>                      
       Options outstanding,                                                                                         
            beginning of the year      2,173    $2.11        2,147    $2.18      1,816      $ .74   
      Options granted                    224     4.68          286     4.21        803       7.52   
      Options exercised               (1,095)     .55           (5)    2.21       (388)       .54   
      Options forfeited                  (48)    5.37         (255)    5.12        (84)      1.45   
                                      ------                 -----              ------              
      Options outstanding,                                                                          
          end of year                  1,254     2.17        2,173     2.11      2,147       2.18   
                                      ======                 =====              ======              
      Options exercisable,                                                                          
          end of year                    864     1.18        1,170     1.16      1,055        .86   
                                      ======                 =====              ======               
     Exercise price range               $.15 to $9.13         $.15 to $9.13       $.15 to $9.13
</TABLE>

  The following table summarizes information about the outstanding and
exercisable stock options at fiscal year-end 1998 (number of shares in
thousands):
 
                      Stock Options Outstanding        Stock Options Exercisable
                  -----------------------------------  -------------------------
                                  Weighted       
                    Weighted      Average                 Weighted
  Shares             Average     Remaining    Shares        Average
 Range of           at Fiscal    Exercise  Contractual     at Fiscal    Exercise
Exercise Prices   Year-End 1998    Price       Life      Year-End 1998    Price
---------------   -------------  --------- -----------   -------------  --------
                   
$ .15 to $2.55          779       $  .46    4.8 years         755         $ .45
$3.63 to $4.88          308         4.07    9.1 years          29          4.49
$5.00 to $6.75          118         5.86    7.8 years          51          5.93
$8.38 to $9.13           49         8.44    6.9 years          29          8.45
                      -----                                 -----
                   
                      1,254                                   864
                      =====                                 =====
Defined Contribution Plan and Employee Savings Plan

     The Company maintains a defined contribution profit sharing and retirement
plan for substantially all US employees.  Participants may elect to contribute
up to the lesser of the statutory maximum or 20% of total compensation.  The
Company made total contributions to this plan of $35,000, $15,000, and $0 in
1998, 1997, and 1996, respectively.


                                      F-17
<PAGE>
 
Employee Stock Ownership Plan

     In April 1997, Sub established an employee stock ownership plan (the
"ESOP") for the benefit of employees of Sub. The ESOP borrowed (Pounds)500,000
($835,000) from a commercial bank and used the proceeds to purchase 2,358 shares
(approximately 223,000 equivalent Blue Wave shares) of Sub's ordinary shares
from a director of Sub at (Pounds)212 (approximately $343) per share which was
estimated to be the fair value of Sub's ordinary shares. Sub has guaranteed the
debt of the ESOP and has placed in escrow cash in an equal amount of the debt.
Sub has reflected the guaranteed ESOP debt and a corresponding amount of
guaranteed ESOP obligations as a reduction of stockholders' equity in the
consolidated balance sheet at fiscal year-end 1998 and 1997. None of the shares
acquired had been allocated to the participants of the ESOP. Interest payments
in 1998 and 1997 were $127,000 and $35,000 respectively.

Other

     Certain officers of the Company, including its Chief Executive Officer, 
have entered into employment contracts with the Company. These agreements 
define, among other items, the terms of employment, remuneration, and notice 
periods for termination.

     David Irwin, former President and CEO of the Company, who resigned in June
1997, had an employment agreement that provided for one year of compensation for
termination under certain circumstances. The Company accrued approximately
$250,000 in the fiscal year ended 1997, related to Mr. Irwin's resignation from
the aforementioned positions.


14.  INCOME TAXES:

     At fiscal year-end 1998, Blue Wave had net operating loss (NOL)
carryforwards of approximately $8,300,000 which begin to expire in 2002.
Research and development tax credit carryforwards of approximately $41,000 at
fiscal year ended 1998, were also available to reduce future federal income
taxes. Pursuant to Section 382 of the Internal Revenue Code, a change in
ownership occurred with the initial public offering of Blue Wave. As a result,
Blue Wave was subject to a $2,300,000 annual net operating loss utilization
limitation. A change in ownership pursuant to Section 382 also occurred with the
combination. As a result, Blue Wave will be subject to a $1,373,000 annual net
operating loss utilization limitation.

     Blue Wave had net deferred tax assets of $511,000 (composed primarily of
the tax effect of NOL's) at fiscal year ended 1998 and 1997. In accordance with
the criteria contained in SFAS No. 109, "Accounting for Income Taxes," a
valuation allowance associated with Blue Wave's NOL was reduced in 1996 and a
deferred tax asset of $790,000 was recognized. In fiscal 1997, the net deferred
tax asset was increased $463,000 primarily as a result of the tax benefit
recorded as a result of the disqualifying dispositions of employee incentive
stock options. Blue Wave believes it is more likely than not that it will be
able to realize the benefit of this net asset.

     The components of the income tax provisions in the accompanying
consolidated statements of operations consisted of the following (in thousands):
 
                                                   1998     1997     1996
                                                  -------  -------  -------
  CONTINUING OPERATIONS:
  State-
  Current                                          $  31    $  70   $   63
  Deferred                                             -        -      108
  Federal-
  Current                                              -      557    1,033
  Deferred                                          (443)    (182)    (123)
  Foreign                                            224        -        -
  Increase (reduction) in valuation allowance        443      (48)    (790)
                                                   -----    -----   ------
  Provision for income taxes                         255      397      291
  DISCONTINUED OPERATIONS - Federal current          (62)    (560)    (661)
                                                   -----    -----   ------
                                                   $ 193    $(163)  $ (370)
                                                   =====    =====   ======
 
     
                                      F-18
<PAGE>
 
     The difference between the federal statutory tax rate and the effective tax
rate for continuing operations is reconciled as follows (in thousands):

 
                                    1998     %     1997      %    1996     %
                                  -------  ----    -----   ----   -----   ----
Income (loss)  tax provision at                                          
 statutory rate                   $(3,247)  (34)%  $222     32%  $1,789    34%
Utilization of NOL                      -     -     (61)    (9)    (920)  (17)
Deduction for state taxes              31     -      70     10       63     1
Increase (reduction) in valuation                                        
 allowance                            443     5     (48)    (7)    (790)  (15)  
Unrecognized losses                                 332     48           
Capital allowance on ineligible                                          
 property                               -     -     (57)    (8)      18     -
Foreign losses not tax benefited    1,317    14       -      -        -     -
Non-deductible merger costs         1,538    16       -      -        -     -
Other                                 173     2     (61)    (8)     131     3
                                  -------  ----   -----   ----   ------  ----
                                  $   255     3%   $397     58%  $  291     6%
                                  =======  ====   =====   ====   ======  ====
                                           
                                                                        
     Deferred taxes are determined based on the estimated  future tax effects of
differences between the financial reporting and tax bases of assets and
liabilities given the provisions of the enacted tax laws.  The net deferred tax
asset (liability) is comprised of the following (in thousands):
 
                                   1998    Change     1997
                                 --------  -------  --------
  DEFERRED TAX ASSETS:
  Current-
   Merger related costs          $   291    $ 291   $    -
   Nondeductible allowances          530      234       296
   UCC adjustment                      -       (7)        7
   Other                             280      (56)      336
 
  Noncurrent-
   Nondeductible accruals              -      (74)       74
   Depreciation                       71       21        50
   Disqualifying dispositions          -     (263)      263
   Net operating losses            2,857      503     2,354
   Other                               -      (26)       26
                                 -------    -----   -------
 
                                   4,029      623     3,406
   Valuation allowance            (2,648)    (443)   (2,205)
                                 -------    -----   -------
                                   1,381      180     1,201
   DEFERRED TAX LIABILITY:
  
  Current-
   Accrued state taxes                 -        -         - 
   Current deferred gain               -      (58)      (58)
  Noncurrent - 
   Noncurrent depreciation          (870)     238      (632)
   Rent credit                         -        -         - 
                                 -------    -----   -------
                    
                                 $  (870)   $ 180   $  (690)
                                 -------    -----   -------

Net Deferred Tax Asset           $   511    $   0   $   511
                                 =======    =====   =======

                                      F-19
<PAGE>
 
     The Company believes it is more likely than not that it will realize the
net deferred tax asset of $511,000 recorded in the balance sheet as of June 30,
1998 and accordingly no valuation allowance has been provided on this portion of
the asset. This conclusion is based on (1) changes in operations that have
recently occurred, including the acquisition of LSI, which management believes
will expand its product capabilities and customer base, (2) cost reduction or
synergies to be gained from the combination of Mizar and LSI, (3) the
realignment of the Company including its strategy to expand its markets in the
telecommunications industry, (4) the introduction of systems based upon the C6x
technology, (5) limitation of the net operating loss carryforwards, as described
above, related to the LSI merger, and (6) projections of sufficient taxable US
income to fully realize the net recognized deferred tax asset by the end of
calendar year 2000. Management continually evaluates the realizability of the
net deferred tax assets and the need for a valuation allowance on such assets.


15.  CAPITAL STOCK:

Common stock

     In May 1997, Blue Wave announced a plan to repurchase up to $1,000,000
worth of the common stock outstanding. As of fiscal year-end 1997, 144,400
shares had been repurchased for a total of $509,000. In August 1997, Blue Wave
announced a $1,000,000 expansion to its common stock repurchase plan. As of
September 12, 1997, a total of 281,900 shares had been repurchased for a total
of $1,081,000 since the commencement of the program in May. In the second
quarter of fiscal 1998, the Board of Directors canceled the stock repurchase
plan.

     The combination was completed via a share exchange whereby Mizar issued
7,876,964 common shares in exchange for all of the outstanding capital stock of
LSI.

Preference Shares

     On April 10, 1997, Sub entered into an agreement with Boston Holdings
Limited ("BHL"), a subsidiary of BancBoston Capital Limited, to sell to BHL at a
subscription price of (Pounds)5,500,000 approximately ($8,914,000), 5,500,000
preference shares, one "B" ordinary share, and warrants to acquire an additional
20,115 "B" ordinary shares. The warrants were exercisable in whole or in part
through March 31, 2012, at a price determined by a formula, which at the time of
the combination was (Pounds)165 per share. Under the terms of Sub's Articles of
Association, any proceeds resulting from the exercises of the warrants was to be
used to redeem the preference shares. Contemporaneously with the combination,
this warrant was exercised for (Pounds)3,318,975 (or approximately $5,571,000)
and was converted into 1,903,522 common shares of Blue Wave Systems.

     Sub valued the warrants at (Pounds)360,000 approximately ($583,000) and
reflected such amount of the proceeds noted above as an increase to additional
paid-in capital.  In addition, Sub incurred approximately $1,032,000 in costs
($827,000 cash and the issuance of 601 ordinary shares valued at $205,000) to
issue the preference shares.  Such amount was reflected as a reduction of the
preference shares.  Both the value of the warrants and the issuance costs were
amortized to retained earnings.  The preference shares, net of the unamortized
value of the warrants and the issuance costs, have been reflected in the
accompanying restated consolidated financial statements as mandatorily
redeemable preference shares.

     The preference shares and accrued dividends thereon ranked first in
liquidation priority over all other equity shares and accrued first preference
cumulative dividends of 6% per annum beginning on April 1, 1998, such dividends
being payable in cash biannually on March 31 and September 30.  The preference
shares also accrued a second preference cumulative dividend of 8% per annum
until March 31, 1998, and 2% per annum thereafter, and such dividends were paid
as one additional preference share for each pound sterling 1 in dividends due on
March 31 and September 30.  Dividends accrued between March 31, 1998 and the
date of redemption were paid in cash.

                                      F-20
<PAGE>
 
16.  QUARTERLY FINANCIAL INFORMATION (UNAUDITED):

     A summary of the unaudited quarterly results of operations follows (in
thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                     Three Months Ended
                                                                     ------------------
                                                    September 30,  December 31,    March 31,      June 30,
                                                       1997           1997           1998           1998(2)
                                                     --------       --------       --------       --------
<S>                                                  <C>            <C>               <C>         <C>     
Net sales                                            $ 10,286       $  7,371          8,004       $  7,018
Gross margin                                            6,004          3,892          4,376          3,012
Income (loss) from continuing operations before
   provision (benefit) for income taxes                 1,209           (932)          (160)        (9,667)(1)
Net income (loss) applicable to common stock              442         (1,166)          (511)       (10,219)
Diluted net income (loss) per share                  $   0.03        $ (0.11)         (0.05)         (0.79)
</TABLE>

<TABLE>
<CAPTION>
                                                                    Three Months Ended
                                                                    ------------------
                                                   September 30,   December 31,  March 31,     June 30,
                                                       1996  1/2      1966 2/3     1997          1997 (2)
                                                     -------        -------       -------       -------
<S>                                                  <C>            <C>           <C>           <C>    
Net sales                                            $ 8,374        $ 8,742       $ 8,145       $ 9,973
Gross margin                                           3,764          3,960         3,894         5,863
Income (loss) from continuing operations before
   provision (benefit) for income taxes                  566            764          (709)          927
Net income (loss) applicable to common stock             485            435        (1,771)          188
Diluted net income (loss) per share                  $  0.04        $   .03       $ (0.18)      $  0.02
</TABLE>

(1)  The loss from continuing operations before taxes includes a merger and 
     realignment charge of $8,426,000.

(2)  The accompanying restated consolidated statements of operations,
     stockholders' equity and cash flows combine Blue Wave's historical
     statements of operations, stockholders' equity and cash flows for each of
     the two years in the period ended June 30, 1997, with the corresponding Sub
     historical statements of operations, stockholders' equity and cash flows
     for each of the two years in the period ended September 30, 1997 (as
     combined, the "fiscal years 1997 and 1996"). The restated consolidated
     statements of stockholders' equity for each of the two years in the period
     ended June 30, 1997 reflect the exchange of each Sub common share for
     94.632 shares of Blue Wave common stock (see Note 2).

                                      F-21
<PAGE>
 
                                                                     Schedule II

                            BLUE WAVE SYSTEMS INC.

                       VALUATION AND QUALIFYING ACCOUNTS

                         JUNE 30, 1996, 1997 AND 1998
                                (in thousands)


<TABLE>
<CAPTION>
                                       Balance at      Charged to
                                       Beginning       Costs and                       Balance at
            Description                of Period        Expenses       Deductions    End of Period
            -----------                ---------        --------       ----------    -------------
               1996
               ----
<S>                                    <C>              <C>             <C>          <C>          
Allowance for doubtful accounts        $     188        $     97        $     (38)   $         247
                                                        
Allowance for excess and
     obsolete inventory                      268             444             (158)             554
Allowance for product returns                  -              90                -               90

               1997
               ----
Allowance for doubtful accounts              247             132             (133)             246
Allowance for excess and
     Obsolete inventory                      554             452             (486)             520
Allowance for product returns                 90              66              (96)              60

               1998
               ----
Allowance for doubtful accounts              246              91             (127)             210
Allowance for excess and
     obsolete inventory                      520           1,413             (320)           1,613
Allowance for product returns                 60             104              (38)             126
Merger and realignment expenses                -           8,426           (6,086)           2,340
</TABLE>


                                      F-22
<PAGE>
 
                                EXHIBIT  INDEX


2.1      Share Purchase Agreement, dated November 17, 1997, between the Company
         and Loughborough Sound Images Limited (formerly Loughborough Sound
         Images plc). (2)
2.2      Letter Agreement dated March 24, 1998, between the Company and
         Loughborough Sound Images Limited.  (2)
3.1      Certificate of Incorporation of the Company, as amended.  (1)
3.2      Bylaws, as amended, of the Company.  (3)
10.1     Form of Indemnification and Hold Harmless Agreement.  (3)
11       Computation of per share net income (loss).  (4)
23       Consent of Arthur Andersen, LLP.  (4)
27       Financial Data Schedule.  (4)


(1)      Incorporated by reference to Exhibits in the Company's Registration
         Statement on Form S-3.
(2)      Incorporated by reference to Exhibits in the Company's Current Report
         on Form 8-K dated May 12, 1998.
(3)      Incorporated by reference to Exhibits in the Company's Registration
         Statement on Form S-1.
(4)      Filed herewith.