<PAGE>   1
                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                 ---------------

                                   FORM 10-KSB
(Mark One)
           [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                       SECURITIES AND EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                                       OR

          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934
        FOR THE TRANSITION PERIOD FROM ____________ TO _________________

                         Commission file number 1-11686

                            CYCOMM INTERNATIONAL INC.
                 (Name of Small Business Issuer in Its Charter)

           Wyoming                                           54-1779046

(State or other jurisdiction of                           (I.R.S. Employer
incorporation or organization)                           Identification No.)

             1420 Springhill Road, Suite 420, McLean, Virginia 22102
               (Address of Principal Executive Offices) (Zip Code)

         Issuer's telephone number, including area code: (703) 903-9548

         Securities registered under Section 12(b) of the Exchange Act:
                         Common Stock, without par value
                                (Title of Class)

       Securities registered under Section 12(g) of the Exchange Act: None

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [ ]

Issuer's revenues for its most recent fiscal year.  $15,678,667

The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant on March 1, 1998 was approximately $22,297,892
(based on the closing price of $2.38 per share at which the stock was sold on
that date).

The number of shares outstanding of the issuer's class of Common Stock, no par
value, as of March 1, 1998, 10,053,257 shares


                       DOCUMENTS INCORPORATED BY REFERENCE

(1) Definitive Proxy Statement for 1997 Annual Meeting of Stockholders --- Part
III - Items 9, 10, 11 and 12.

Transitional Small Business Disclosure Format (check one):
         Yes               No     X
<PAGE>   2
<TABLE>
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                                TABLE OF CONTENTS
                                                                                                       PAGE
                                                                                                       ----

                                     PART I
<S>                                                                                                    <C>
Item 1.    Description of Business ..............................................................        3

Item 2.    Description of Property...............................................................       18

Item 3.    Legal Proceedings.....................................................................       18

Item 4.    Submission of Matters to a Vote of Security Holders...................................       18

                                     PART II

Item 5.    Market for Common Equity and Related Stockholder Matters..............................       19

Item 6.    Management's Discussion and Analysis or Plan of Operation.............................       20

Item 7.    Financial Statements..................................................................       25


Item 8.    Changes In and Disagreements With Accountants on Accounting
               and Financial Disclosure..........................................................       25

                                    PART III

Item 9.    Directors, Executive Officers, Promoters and Control Persons; Compliance
               with Section 16(a) of the Exchange Act.............................................      26

Item 10.  Executive Compensation.................................................................       26

Item 11.  Security Ownership of Certain Beneficial Owners and Management.........................       26

Item 12.  Certain Relationships and Related Transactions.........................................       26

Item 13.  Exhibits and Reports on Form 8-K.......................................................       27

Signatures.......................................................................................       29
</TABLE>




<PAGE>   3
                                     PART I


ITEM 1.    DESCRIPTION OF BUSINESS

INTRODUCTION

         Cycomm International Inc. (hereinafter referred to as "Cycomm
International" and together with its subsidiaries, the "Company") develops,
manufactures and markets value-added secure computing and telecommunications
products and rugged computer products. The Company's rugged computer products
are designed to function in adverse environments under extreme weather, shock,
moisture and vibration operating conditions. The Company's secure computer
products are designed to protect users against the unauthorized interception of
electromagnetic emissions emanating from computer systems. The Company's secure
telecommunications products are designed to protect users against the
unauthorized interception of wireless conversation from cellular communications.

         The Company's historical business focus had been on developing and
manufacturing products and services that provide security for voice and data
transmission over wireless systems, particularly to cellular telephone end
users. In 1997, the Company shifted its business strategy related to wireless
security from the manufacturing of scrambling and encryption products to an
emphasis on licensing of its existing technology in this area.

         Through its recently acquired subsidiaries, the Company has leveraged
its core competencies to design, manufacture and sell a full line of secure,
ruggedized computer products presently sold into the public safety, U.S.
military, intelligence community, friendly governments and utility markets.
Consequently, the Company has allocated resources to its secure and rugged
computing product line, which has the most near term profitability potential.
During the present fiscal year, the Company will continue to integrate the
various divisions resulting in a single secure, rugged telecommunications and
computing product company.

HISTORY

         The Company was formed on April 30, 1986 by the amalgamation of two
Ontario corporations under the laws of Ontario. Historically, the Company has
operated under various names; however, it changed its name to Cycomm
International Inc. on February 20, 1992. The Company continued its incorporation
on October 31, 1995 from Ontario, Canada to the State of Wyoming pursuant to the
Articles of Continuance.

         At its formation in 1986, the Company was involved in the manufacturing
and marketing of certain sonar activated marine buoyancy devices. In 1987, the
Company became involved in certain technologies related to telecommunication
systems. In May 1990, the Company acquired Cycomm Corporation, an entity engaged
in the development and marketing of specialized voice privacy communications
products for the secure communications market. In November 1993, the Company
acquired Val-Comm, Inc., a company engaged in performing classified government
contracting for various communications projects.
<PAGE>   4
         The Company continued to develop the voice privacy and encryption
technologies through 1996. The Company made two strategic acquisitions that
allowed it to leverage existing technologies and to participate in the larger
mobile and secure computer market. Specifically, the Company acquired XL
Computing Corporation in March 1996 and XL Computing Canada Inc. in June 1996.
XL Computing Corporation is engaged in the design, manufacture and marketing of
secure computer systems. XL Computing Canada is engaged in the design,
manufacture and marketing of rugged mobile computer systems.

         In 1997, the Company recognized that the market for cellular voice
security technologies and products was still immature and would not develop to
the extent required to justify additional development. Additionally, the Company
began to experience the market for its mobile computers growing much faster than
the market for voice privacy technologies. Accordingly, the Company initiated a
strategy which resulted in a shifting of development resources to the mobile
computer products.

                      The Company currently has four active wholly-owned
subsidiaries as follows:

   -  XL Computing Canada Inc. ("XL Canada"), incorporated in Quebec, Canada on
      June 3, 1996.
   -  XL Computing Corporation ("XL Computing"), incorporated in Delaware,
      on February 26, 1996.
   -  Val-Comm, Inc. ("Val-Comm"), incorporated in New Mexico, on July 12, 1984.
   -  Cycomm Corporation ("Cycomm"), incorporated in Oregon, on January 1, 1985.

<TABLE>
<S>                                   <C>                                         <C>                             <C>

                                                    Cycomm International Inc.
                                                        McLean, Virginia
                                                        Executive Office

    (100% owned)                            (100% owned)                             (100% owned)                   (100% owned)
XL Computing Canada Inc.              XL Computing Corporation                       Val-Comm, Inc.               Cycomm Corporation
  Montreal, Canada                       Sebastian, Florida                       Albuquerque, New Mexico          Portland, Oregon
</TABLE>


         EXECUTIVE OFFICE. The Company's principal executive offices are located
in McLean, Virginia. Management of all subsidiaries and the Company's growing
number of strategic relationships is conducted from this location, along with
overall administration, financial, investment, and investor relations
responsibilities.

        XL COMPUTING CANADA INC. Located in Montreal, Canada, this subsidiary
designs, manufactures and markets ruggedized mobile computing and communications
systems primarily to the public safety and utility markets. XL Canada has
expanded the Company's ruggedized computer product line by adding state, local
and commercial markets to XL Computing's core government and military business.

         XL COMPUTING CORPORATION. Located in Sebastian, Florida, this
subsidiary designs, tests, manufactures, and markets ruggedized, TEMPEST
specified computer and communication equipment for niche markets worldwide.
TEMPEST is the name given to the classified specification, NSTISSAM/ 1-95, for
securing computer equipment and peripherals against
<PAGE>   5
electromagnetic eavesdropping on the electromagnetic radiation emanating from
all electronic equipment.


         VAL-COMM, INC. Located in Albuquerque, New Mexico, this subsidiary is a
communications, engineering and consulting company which provides feasibility
studies for possible development projects and custom communications equipment
developed for classified U.S. government agencies. These activities can include
prototype development but generally involve the modification of one or more
products available from unrelated companies into an integrated communications
system to meet its customers' requirements. Such work involves classified U.S.
government contracts for which Val-Comm maintains U.S. government facilities
security clearances.

         CYCOMM CORPORATION. Located in Portland, Oregon, this subsidiary has
developed security products using both encryption and scrambling of voice and
data signals for the wireless and wireline telecommunications industry.

MARKET FOR THE COMPANY'S PRODUCTS AND SERVICES

RUGGEDIZED COMPUTERS. The Company, through its XL Canada subsidiary, has
developed a ruggedized laptop computer called the PCMobile that is specifically
designed for the public safety market. The Company currently markets the
PCMobile to local and state police and fire departments and other public safety
agencies as well as utility, commercial and industrial markets. The PCMobile has
been designed to withstand the specific extreme operating conditions of the
public safety market.

         'Ruggedization' or 'rugged' or 'ruggedized computers' are terms used to
describe computers that are built to withstand certain environmental and
operational hazards with which standard commercial computers functioning indoors
would not typically have to contend. The ruggedization of the computer is an
attempt to protect or insulate it fully from such hazards or at least minimize
their adverse impact so that the computer can function to accomplish the
specific tasks of its operating requirements. Computers are ruggedized by the
selection and mounting of certain components, the design, configuration and
fabrication of enclosures and electronics and the application of special
casings, seals and coatings. The design and fabrication of the computer
encasement and keyboard with tougher materials, full closure and special
sealants also protect it against moisture, humidity, particles and temperature
extremes.

         From a strictly environmental point of view, these hazards are usually
weather-related or climatic in nature and can encompass temperature extremes
ranging from -22 to +140 degrees Fahrenheit, as well as severe moisture and
humidity conditions and the infiltration by flying or wind-borne debris, such as
sand, dust or other particles. In the operational area, the hazards involve
strong vibrations and shocks that result from rough handling and transportation
as well as electric interference or internal thermal conditions. In certain
situations, the signals emitted by other electronic equipment may interfere with
and distort the proper functioning of computers. In addition, as increasingly
more computing power is inserted into small spaces and containers, the heat
generated by the computer itself may cause the processor to malfunction or fail.
<PAGE>   6
         A significant market for ruggedized computers is the public safety
market. New computer and ruggedization technologies have enabled public safety
organizations to advance into mobile computing as a way to increase
effectiveness and efficiency of the officers on the street. It is estimated that
there are approximately 330,000 public safety vehicles in approximately 17,000
local police, sheriff and special police agencies.

         The growth in the public safety market for rugged mobile computers is
driven by several factors. There has been an increase in federal funding made
available to local public safety agencies through the COPS MORE and other
programs which are designed to increase the number of police on the street.
There is also an effort to integrate dispatch, field data and communications
systems. Also, there are currently more rugged mobile computer options,
including the PCMobile, available to public safety organizations. As public
safety officers become more familiar and comfortable with the use and benefits
of new technology, the market will continue to grow.

         COMPUTER SECURITY. All electronic equipment, including computers,
monitors, keyboards, printers and related peripherals produce electromagnetic
emanations through the air or through conductors. As early as the 1950s,
government and industry observers began to become concerned about the
possibility that electronic eavesdroppers could intercept emanations, decipher
them, obtain information about the signals used inside the emanating electronic
equipment, and use this information to reconstruct the data being processed by
the equipment. They speculated that eavesdroppers could breach security even
some distance from the equipment.

         Studies of signal interception and decoding have borne out these
speculations. With virtually no risk of detection, eavesdroppers using
relatively unsophisticated equipment can intercept and decipher signals from an
electronic source. Modern listening devices allow an eavesdropper to detect
emissions and reproduce data streams or video screen images - for example, to
read the computer display screens on the desktops in a remote building. It is
estimated that the components needed to perform such a penetration would cost as
little as $300, would be available at a local electronics store, and would leave
no evidence of penetration during or after the intrusion.

         In the late 1950s, the U.S. government established a program called
TEMPEST aimed at attacking the emanations problem. TEMPEST has become an
umbrella name for the technology that contains or suppresses signal emanations.
An unclassified government publication describes TEMPEST emanations as
"unintentional, intelligence-bearing signals which might disclose sensitive
information transmitted, received, handled, or otherwise processed by an
information processing system."

         Accordingly, users of computer equipment and peripherals that are
processing top secret or classified information use equipment specifically
designed to suppress or contain the electromagnetic emanations of potentially
compromising information. Customers for TEMPEST computers are typically United
States and foreign military and government agencies.

         The Company, through its XL Computing subsidiary, manufactures a full
line of TEMPEST and EMI ("electromagnetic interference) computers, both
stationary and portable, and related products that protect against the
interception of electromagnetic emanations.
<PAGE>   7
         WIRELESS SECURITY. Cellular telephone service is a form of
telecommunications designed to provide high quality wireless telephone service
to a large number of simultaneous users from hand held, vehicle mounted or fixed
radio telephones. Beginning in the early 1990s, public awareness of the ease of
unauthorized cellular telephone monitoring increased. The Company, through its
Cycomm subsidiary, began to develop its cellular security products in 1992 in
response to government and commercial cellular security concerns.

         Between 1992 and 1996, Cycomm introduced a series of cellular security
products incorporating security measures that provide industry leading voice
quality and protection against unwanted eavesdropping on cellular calls. These
products are a critical protection to business, governmental and professional
groups which need to protect industrial secrets and clients' confidential
information. Cycomm's sophisticated voice security technology scrambles or
encrypts cellular and landline calls so that an eavesdropper hears only garbled
speech or "white noise".

        In 1996, Cycomm completed the development of the Slice CSD product,
which provides full encryption over analog cellular systems and is compatible
with the Lucent Telephone Security Device product line. The U.S.
Government purchased a number of Slice CSDs during 1997.

        In 1997, the Company determined that the commercial market for cellular
security had not developed to a degree that demand for the Company's products
would support the continuing engineering required to advance the product line.
In addition, continued U.S. Government restrictions on the export of encryption
technology severely limited the global market potential for these products.
During 1997, Cycomm discontinued development and further production of cellular
security products and is instead concentrating on licensing the patented Slice
design. While two license agreements have been executed, royalty payments during
1998 are expected to remain immaterial as the related products are now only in
the initial phases of market introduction. At this point, the Company's
projected profitability is not dependent on the receipt of substantial royalty
income from any licensing agreements.

THE COMPANY'S PRODUCT LINES AND SERVICES

        The Company manufactures and sells a complete line of secure and rugged
computers and peripherals from a ruggedized laptop computer to an "office in a
suitcase" for the mobile field office market. Transmission options include both
wired and a variety of wireless modes including satellite links and cellular
packet data ("CDPD"). Security options range from encryption to a "TEMPEST"
configuration.

        PCMOBILE. The PCMobile is a "ruggedized" mobile computer specifically
developed for optimal mobility, flexibility and performance under severe
operating conditions. It is ideal for public safety and field service. The
PCMobile is certified to be used almost anywhere, performing reliably in spite
of extreme conditions. The rugged magnesium housing makes the PCMobile spill and
shock-proof and preserves the unit's structural integrity even at high
temperatures. The light blue casing reflects rather than absorbs light, helping
to maintain the electronic circuitry at lower operating temperatures. The
screens are either transflective monochrome or color and can be seen in direct
sunlight. Rubber gaskets are fitted around door
<PAGE>   8
openings and between case mating parts. All external connectors have been
rain-tested. The PCMobile also stands up to vibration and meets the standards
for protection from electrostatic discharge. The 586 model of the PCMobile was
delivered in mid-1997 and the Pentium model of the PCMobile is expected to be
delivered in mid-1998.

         TEMPEST PENTIUM COMPUTER. The TEMPEST Pentium Computers, model
205MX,and 210MX are 133MHz and 166MHz products based on the Intel Pentium TM
microprocessor with the industry standard ISA/PCI bus packaged in the exclusive
XL Computing TEMPEST cabinet. Both products include a 3.5" 1.44MB floppy drive
and can be configured as a desktop, or rack mount unit. It can accommodate up to
4 storage devices including floppy drives, removable IDE and SCSI hard drives,
cartridge drives and tape backup systems. High speed 32 bit I/o is provided by 3
PCI slots.

         TEMPEST PENTIUM LAPTOP COMPUTER. The new XL 425LT uses an Intel Pentium
TM 200MHz MMX microprocessor with an optional upgrade to a 233MHz processor with
memory upgrades up to 128MB. The display is identical to the 405LT. Removable
disk drives available range from 2.1 to 4.0 GB with larger models on the way. In
the tradition of XL Computing's strategy to listen to our customers and design
and build to their needs, the 425LT has two serial ports and supports both the
1.44MB floppy and the 20X CDROM drive simultaneously. Housed in an aluminum
alloy chassis, this laptop is significantly more rugged than standard commercial
units and can be classified as a COTS ("commercial off-the-shelf") Rugged
product.

         TEMPEST LAPTOP COMPUTER. The TEMPEST Pentium Laptop computer, Model
405LT is powered by a 166MHz Intel Pentium TM microprocessor. This laptop has a
12.1" display with 2MB VRAM and 800 x 600 resolution while offering 1280 x 1024
resolution for external monitors. This laptop uses a modular design so a number
of options can be selected to allow for the addition of such options as a CD-ROM
or a second Lithium Ion battery. One of the new features of this model is its
ability to allow user installation of a FORTEZZA card while maintaining TEMPEST
integrity, while also allowing a second communications device. The 405LT meets
the most stringent TEMPEST requirement while operating with AC power, automobile
power, or from the internal battery. Housed in an aluminum alloy chassis, this
laptop is significantly more rugged than standard commercial units and can be
classified as a COTS Rugged product.

         TEMPEST/INKJET PRINTER. The 3416T is the XL TEMPEST version of the
popular HP 340 Inkjet printer. The products supports both monochrome and color
versions. The color capability of this product is 3 pages per minute at 300dpi.
Housed in an aluminum chassis, this printer is significantly more rugged than
standard commercial units and can be classified as a COTS Rugged product.


         TEMPEST COLOR GRAPHIC PORTABLE SCANNER. The 9414T is a high resolution
TEMPEST portable scanner suitable for notebook travel use. It is based on the
UMAX Page Office Color Scanner and connects via the Centronics Parallel
Interface. With it's integrated PageManager bundled software, you can copy, fax,
E-mail and file text and graphics documents with the click of a button. In
addition, complete image editing software allows you to edit 24 bit full color
photos at 300 dpi.
<PAGE>   9
         EMI PENTIUM PERSONAL COMPUTER. The XL 205E delivers the power of a
Pentium CPU with the Industry Standard ISA/PCI bus packaged in CL Computing's
new EMI tested cabinet. It incorporates a 3.5" 1.44MB floppy drive and can be
configured as a desktop, or rack mount unit. It can accommodate up to 4 storage
devices including floppy drives, removable IDE and SCSI hard drives, cartridge
drives and tape backup systems. High speed 32 bit I/O is provided by 3 PCI
slots.

         EMI PENTIUM LAPTOP COMPUTER. The XL 405E delivers the power of Intel
Pentium TM 166MHz MMX microprocessor power combined with a modular design to
allow a wide range of option selection including large hard drives, CD-ROMs and
additional Lithium Ion batteries The design accommodates the user installation
of the FORTEZZA card while still allowing a second communications device. The
405E meets the most stringent EMI requirements while operating with AC power,
vehicle power, or from the internal battery. Housed in an aluminum alloy
chassis, the 405E printer is significantly more rugged than standard commercial
units and can be classified as a COTS Rugged product.

        XL COMPUTING CUSTOMER SERVICE GROUP. XL Computing offers a full range of
security services including our worldwide Customer Service Group. This group has
been providing superior on-site and return-to-factory product support in excess
of twenty (20) years. XL Computing requires that all XL Field Technicians and
Engineers complete "A+ Certification". With A+ Certification as a basis, these
field service personnel are then factory trained to repair all XL Computing
products. XL Computing is an experienced organization in dealing with security
issues in equipment maintenance. As such, all field service personnel are also
trained in the specific requirements of maintenance operations in secure
environments to ensure that the security of the equipment is not compromised. XL
Computing provides 24 hour toll free technical support to ensure our customers'
problems are resolved in a timely manner.

        TEMPEST MONITORS. XL Computing offers a full line of ruggedized TEMPEST
and EMI compliant monitors. The EMI and TEMPEST designs use a combination of
containment and suppression techniques that retain the OEM cabinetry. A high
quality OCLI glass screen with anti-reflective coating is incorporated into the
display providing maximum resolution and brightness.

        MOBILE FIELD OFFICE SYSTEMS. The rugged mobile imaging and
communications system ("MICS") is a portable office that fits into a
lightweight, rugged, suitcase-type carrier suitable for commercial travel. This
self-contained system is easily taken into harsh field environments and provides
personnel with the capability to accomplish their data collection and
transmission tasks using landline, cellular and satellite communications with
state-of-the-art technology in the military environment. Standard peripherals
include a ruggedized computer (486 or Pentium driven) a removable hard disk
drive, modem, fax card, cellular phone, printer, scanner, and a battery backup.
A digital camera is an optional feature allowing the operator to take pictures
or collect data and immediately transfer it to other users or a central
location.

         CELLULAR SECURITY DEVICE ("SLICE CSD"). The Slice CSD incorporates
voice encryption security for use with the Motorola MicroTAC line of cellular
phones. The Slice CSD uses Lucent Surity(TM) encryption technology, licensed
from Lucent in 1995, and is compatible with Lucent's Telephone Security Device
3600 family of products ("TSD"). Encryption technology provides a higher level
of communications security when compared to more common analog
<PAGE>   10
scrambling technologies. Encryption level security is required by most
government and law enforcement users.

         The Company determined in 1997 that the market demand for the Slice CSD
product line was inadequate to support further development. Engineering and
production have been terminated. As of early 1998, the remaining inventory of
new Slice CSD units were completely sold out. Warranty and repair continue to be
supported.

MANUFACTURING AND SUPPLY

         The Company designs and engineers substantially all of its rugged and
secure computers, purchases components from third parties or Original Equipment
Manufacturers ("OEM") and tests and assembles the final products. As part of
this process, the Company specifically designs for its computers (with the
exception of the Company's secure computer, for which the Company uses
commercial products from other manufacturers), the electronics or printed
circuit board, which is the most important, sophisticated and complex element
thereof. At times, the board can be composed of as many as twelve layers. The
Company uses surface mount technology ("SMT") to attach components to the
computer boards which enhances durability and ruggedness over the older mounting
technology. In SMT, the components are glued to the board by means of a chemical
adhesion process and are then soldered instead of being inserted into holes in
the board and soldered. SMT is a more precise manufacturing technique and offers
better insulation against vibration and shock. The Company fabricates the
prototype of the board, tests it, purchases all the necessary components for the
board and then provides them in kit form to a specialized board fabricator for
both pilot and production runs.

         This approach to outsourcing differs from that followed by most other
rugged computer manufacturers which, the Company believes, operate on a turn-key
basis with their board fabricators, who handle the design, testing and purchase
of all components themselves and then furnish the manufacturer with the
completed boards. In contrast, the Company's approach to board fabrication
allows it to maintain better control of the quality and delivery of the boards.
In addition, the Company's personnel serve as on-site inspectors at the plants
of the board fabricator. The fabricator employed by the Company applies surface
mount technology in the fabrication of its printed circuit boards.

         The Company anticipates that it will continue to outsource board
fabrication. Given the rapid changes in computer technology, the Company is not
capable of keeping abreast of the costly purchase requirements for new
production equipment necessary in the precise placement of electronic components
on boards. Outsourcing allows the Company's products to receive the benefit of
the latest technological development at an acceptable cost. Once the boards are
completed, they are tested by the fabricator and, upon satisfactory completion
of such tests, are shipped to the Company. When delivered, the Company further
tests the complete boards and other components and then assembles the computers.
Apart from the printed circuit boards, the components that the Company purchases
from external sources include chassis, wire harnesses, computer chips,
keyboards, displays and metal cases.

         The Company does not assemble its products on a continuous
mass-production basis. Instead, its computers are usually assembled on a batch
basis in which products move irregularly from station to station. Because the
Company's production runs rarely reach the volume levels
<PAGE>   11
of commercial production, there are no or few economies of scale and related
cost reductions that are achievable. Tests are performed at various stages of
the process according to the Company's standards or as requested by specific
customers. Further testing of products is generally accomplished at the end of
the assembly process. The Company's manufacture of computers is done pursuant to
specific purchase orders or for general inventory purposes.

         The Company utilizes modern equipment for the design, engineering,
assembly and testing of its products. The Company has utilized a portion of the
funds from various financings to acquire additional equipment to enhance its
operating efficiency in such areas and to increase its capacity in order to
facilitate increased production, when and if required, as well as to obtain
better control of quality, inventory and order processing.

         Generally, the Company is not a party to any formal written contract
regarding the deliveries of its hardware, supplies and components or their
fabrication. It usually purchases such items pursuant to written purchase orders
of both individual and blanket variety. Blanket purchase orders usually entail
the purchase of a larger amount of items at fixed prices for delivery and
payment on specific dates.

         The Company relies on one board fabricator located within the same
geographical area as its design, engineering and assembly facilities. Certain
components used in its computers are obtained from sole sources, such as LG
Technologies and Northern Die Cast. The Company has also licensed its software
from sole sources, including Microsoft and Phoenix Technology. The Company has
occasionally experienced delays in deliveries of components and may experience
similar problems in the future. In an attempt to minimize such problems, the
Company has developed and keeps an inventory of parts that are generally more
difficult to obtain. However, any interruption, suspension or termination of
component deliveries from the Company's suppliers could have a material adverse
effect on it business. Although management believes that in nearly every case
alternate sources of supply can located, inevitably a certain amount of time
would be required to find substitutes. During any such interruption in supplies,
the Company may have to curtail the production and sale of its computers for an
indefinite period.

         The Company's design, engineering and assembly facilities are located
in Brossard, Quebec, Canada for the rugged PCMobile laptops and Sebastian,
Florida for the secure computer products. The Sebastian, Florida facility
complies with certain classified contracts specifications necessary for the
manufacture and assembly of products supplied and meets the quality management
and assurance standards of an international rating organization (ISO-9001). Some
measures, such as the installation of a new business computer system, have been
taken by the Company to improve such standards. During 1997, the Company has
expended significant effort in implementing new structures, procedures and
disciplines that contribute towards the goal of achieving more efficient
manufacturing operations.

         The Company has entered into licensing arrangements for certain
hardware and software elements contained in, or used in conjunction with, its
computers. These agreements are usually non-exclusive, provide for minimum fees
and royalties related to sales to be paid by the Company to the particular
licenser, run for a limited term and are subject to other terms, conditions and
restrictions.
<PAGE>   12
         The Company receives its basic operating software system MS-DOS with
various Windows versions from Microsoft, Inc. pursuant to such licensing
arrangements. It also obtains from Phoenix Technologies, Inc. its BIOS (Basic
Input/Output System) pursuant to a separate license agreement. Under either
arrangement, the Company may modify such software and occasionally alter the
BIOS for special situations. The termination, suspension or curtailment of these
or other licensing arrangements to which the Company is a party may have a
material adverse impact on its business and operations.

   Although the Company relies on a limited number of companies in the
manufacture of its products, it believes that the specific parts employed in the
manufacturing process are available from a variety of suppliers. Further, the
Company believes that additional manufacturing sources could be found if
necessary. The Company believes its relationship with its suppliers is
satisfactory.

MARKETING AND SALES

         The Company markets and sells its secure computer products through an
internal sales force of two individuals, approximately five resellers in the
United States and approximately ten resellers abroad. The Company markets and
sells its rugged products through an internal sales force of nine individuals,
approximately thirty resellers in the United States and approximately four
resellers abroad. Its resellers cover approximately all fifty states, including
Washington, DC, and its foreign distributors operate in ten countries, including
England, France, Japan, Germany, South Korea and Portugal.

         The Company's relationship with its resellers is generally governed by
a written contract, terminable on 30 days' prior notice. These contracts usually
provide for non-exclusive territorial and product representation and discounts
of between 20% to 30% of the list price on standard products based on the
individual resellers annual sales volume. Discounts on non-standard products and
custom engineering are usually subject to negotiation between the parties in
accordance with the terms of the contract and are priced on a case-by-case basis
dependent upon the level of effort in design, test, manufacture, warranty and
support. However, they tend to range from 25% to 35% in practice. The Company's
reseller contracts are subject to certain other terms and conditions.

         The Company's resellers typically purchase the Company's products and
then resell them to their customers. These resellers accounted for an aggregate
of approximately 90% of the Company's secure computer and rugged computer sales.
The Company has reseller agreements with Ericcson, GE Capital, PRC, Unisys, NTT,
GTE and Matra for its rugged computers. The Company has reseller agreements with
Dulles Networking, Office Solutions, EDS Ltd., Bedriftssystemer, Boeing and GTE
for its secure computers. The loss of certain of such resellers may have a
material negative effect on the Company's business.

         Sales of the Company's products or services to foreign resellers are
also generally made pursuant to written contracts. Under such contracts, the
distributor is granted either an exclusive or non-exclusive territorial and
product representation as well as discounts based on the list price ranging from
20% to 30%, depending on the type or annual amount of products sold. In some
cases, there are minimum order requirements. Due to the custom nature of the
Company's products and specifically U.S. Governmental International Traffic in
Arms Regulation (ITAR)
<PAGE>   13
controls for secure computing products, its foreign resellers generally do not
keep its computer in their inventory until specific orders are obtained. The
term of these agreements generally run from 1 to 3 years but are terminable on
60 days advance notice. Payment is due in U.S. dollars within 30 days after
delivery. These contracts are subject to other terms and conditions. No one
international distributor accounted for a material portion of the Company's
total sales in any period referred to above.

         The Company promotes its rugged and secure computer products through
the dissemination of product literature, attendance and exhibition at trade
shows and the distribution of news releases on special developments to trade
magazines and newsletters to an extensive customer list. The Company does some
advertising in trade periodicals. Management believes that, to date, most of the
Company's sales leads have been generated by trade shows, its web sites and
word-of-mouth referrals. The Company intends to expand its sales and marketing
efforts in all of its markets as follows: (i) increase its presence at trade
shows with larger booths and more extensive exhibits; (ii) increase the number
of trade shows in which Company personnel attend and products are presented;
(iii) hire additional sales personnel and consultants to gather leads and
promote sales; (iv) expand sales and marketing activities in the utility and
commercial markets; and (v) invest in research and development in order to
increase its product offering.

         In the public safety and government market, the sales cycle for the
Company's products usually entails a number of complicated steps and can take
from three months to one year. Sales to the public safety and government markets
are greatly influenced by special budgetary and spending factors pertinent to
these organizations.

WARRANTY AND CUSTOMER SERVICE

         The Company usually provides one-year warranties on all its products
covering both parts and labor, however extended warranties may be purchased by
customers. Additionally, the Company offers a lifetime warranty on the cases of
the PCMobile. At its option, the Company repairs or replaces products that are
defective during the warranty period if the proper usage and preventive
maintenance procedures have been followed by its customers. Repairs that are
necessitated by misuse of such products or are required beyond the warranty
period are not covered by its normal warranty.

         In cases of defective products, the customer typically returns them to
the Company's facility. Service personnel replace or repair the defective items
and ship them back to the customer. Generally, all servicing is done at the
Company's plant and customers are charged a fee for those service items that are
not covered by warranty. In addition to its extended warranties, the Company
offers its customers maintenance and service contracts on both its PCMobile and
TEMPEST products.

         The Company's customer service personnel answer technical questions
from customers and offer solutions to their specific applications problems. In
certain instances, other personnel receive and process orders for product
demonstrations, disseminate pricing information and accept purchase orders for
computers.
<PAGE>   14
BACKLOG

         On December 31, 1997, the Company had a backlog of contracts and
purchase orders of approximately $7.6 million in its computer equipment segment
as compared to $3.3 million at December 31, 1996. This backlog consists of
contracts and purchase orders for computer equipment and peripherals to be
manufactured and delivered usually during the upcoming 12 months. The contracts
and purchase orders define the price and specifications of the equipment to be
delivered. However, due to the nature of the business, the backlog at any
particular date may not be indicative of the Company's revenues or other
operating results for any subsequent fiscal period. The Company cannot,
therefore, assure that the backlog will be realized as revenue. Subsequent to
December 31, 1997, the Company received contracts and purchase orders of
approximately $5.3 million for computer equipment which is not included in the
above backlog amount.

        On December 31, 1997, the Company had a backlog of purchase orders and
contracts of approximately $1.0 million in its communications security products
segment as compared to $635,000 at December 31, 1996. This segment also includes
backlog as a prime or subcontractor on several government contracts.

RELIANCE UPON CERTAIN CUSTOMERS

        The Company is not dependent upon any single customer that purchases its
products. However, sales to two major customers comprise 9% and 9% respectively,
of sales for the year ended December 31, 1997. Sales to two major customers
comprise 30% and 25% respectively, of sales for the seven months ended December
31, 1996. Sales to three major customers comprise 25%, 20% and 9% respectively,
of sales for the year ended May 31, 1996.

RESEARCH AND DEVELOPMENT

        The markets served by the Company are characterized by rapid
technological advances, changes in customer requirements and frequent new
product introductions and enhancements. The Company's business requires
substantial ongoing research and development efforts and expenditures. Its
future success will depend in large measure on its ability to enhance its
current products, and develop and introduce new products that keep pace with
technological developments in response to evolving customer requirements. The
Company's research and development activities are primarily accomplished on an
in-house basis, sometimes supplemented by third-party subcontractors and
consultants.

        During fiscal year 1997, the Company continued to make relatively large
research and development investments on the PCMobile product line. These
significant changes mainly focused on redesigns to implementing faster
processors such as 586 and Pentium chips, new functionality and new screens. The
Company also invested in the development of a new secure laptop computer
product.
<PAGE>   15
        During the year ended December 31, 1997, seven months ended December 31,
1996 and the fiscal year ended May 31, 1996, the Company spent $1,307,720,
$841,103 and $749,041, respectively, on research and product development,
primarily for development of new products and products complementary to the
existing line of secure and rugged computer products. The Company anticipates
additional research and development expenditures on future development of
products.

INTELLECTUAL PROPERTY AND PATENTS

        Proprietary information and technical know-how are important to the
Company's success. The Company holds various patents, as detailed below, and has
certain trademark protections for its products. The Company currently has patent
protection for certain of its principal proprietary technologies. There can be
no assurance that any patents issued are or will be valid, or that others will
not develop functionally equivalent or superior technology that does not
infringe the Company's patents. There can also be no assurance that the
Company's existing patents will go unchallenged.

        Cycomm is the assignee of U.S. Patent No. 4,864,566 issued on September
5, 1989, entitled "Precise Multiplexed Transmission and Reception of Analog and
Digital Data Through a Narrow-Band Channel." This patent covers the basic
synchronization that makes it possible to achieve a certain level of voice
quality and security. Cycomm voice privacy products are partially protected by
this patent because an adaptation of the synchronization technique is used.
Furthermore, protection is enhanced by utilizing large amounts of microcode
embedded in microprocessor chips that are dependent upon semi-custom gate array
circuits. Both microcode and circuits are proprietary.

        On January 20, 1998, Cycomm received, as assignee, U.S. Patent No.
5,711,013 entitled "Conforment Compact Portable Cellular Phone Case System and
Connector." This patent covers Cycomm's Slice packaging and functionality, as it
applies to a number of potential applications for the Motorola MicroTAC line of
cellular phones. Cycomm's Slice products, the Series 300 Slice HPU and Series
500 Slice CSD, now have full patent protection. The Company plans to pursue
licensing opportunities to exploit the Slice technology, and to protect against
any infringement of the Slice patent.

        During 1997, the Company let two prior patents, Patent Nos. 4,864,566
and 4,972,479 expire due to a lack of any further technical utility. The
technologies covered in these patents were superseded by advances in
communications hardware and encryption technology.

REGULATORY APPROVALS

        Certain of the Company's products are subject to approval by the Federal
Communications Commission ("FCC") in the United States. The FCC requires that
products not exceed certain levels of radio wave emanation so that they will not
interfere with other electronic equipment. Furthermore, telephone products must
meet certain standards for interfacing into the telephone line, such as
impedance matching and isolation. All of the Company's products have received
FCC approval for both radiation and telephone connection.
<PAGE>   16
        In general, the FCC and its approval process is objective. Product
designs are required to meet these objective criteria and specifications. In the
event that a Company privacy product failed a test, the introduction of the
product would be delayed.

         Under certain circumstances, the Company is also subject to certain
U.S. State Department and U.S. Department of Commerce requirements involving
prior clearance of foreign sales. Such export control laws and regulations
either ban the sale of certain equipment to specified countries or require U.S.
manufacturers and others to obtain necessary federal government approvals and
licenses prior to export. As a part of this process, the Company generally
requires its foreign distributors to provide documents that indicate that the
equipment is not being transferred to, or used by, unauthorized parties abroad.

         The Company and its agents are also governed by the restrictions of the
Foreign Corrupt Practices Act of 1977, as amended ("FCPA"), which prohibits the
promise or payments of any money, remuneration or other items of value to
foreign government officials, public office holders, political parties and
others with regard to the obtaining or preserving of commercial contracts or
orders. These restrictions may hamper the Company in its marketing efforts
abroad.

        To date, the Company has been able to comply with all governmental
requirements without incurring significant costs. However, the Company cannot
determine the extent to which future earnings may be affected by new legislation
or regulations affecting its industry.

COMPETITION

         The Company competes in the rugged portable and secure computer
business with a wide variety of computer manufacturers and repackagers, some of
which are larger, better known and have more resources in finance, technology,
manufacturing and marketing. The Company competes based on customization
capabilities, price, performance, delivery and quality. In some situations, the
Company is the highest priced bidder.

         Typically, the companies that market and sell ruggedized computers are
repackagers having little or no input in the design of their electronics and the
selection and mounting of components on printed circuit boards. They usually
purchase the computer boards and sub-assemblies in an "as is" condition from
commercial manufacturers. The major contribution of the repackagers to the
protection of the computer is a tougher box in which the computer is housed.
However, in many cases even this stronger covering fails to shield the computer
from the penetration of rain, snow, fog, dust or other particles. In contrast,
the Company uses industrial-type or highly selected commercial components for
most of its computers rather than strictly ordinary commercial ones, as do many
of its competitors. The company also applies SMT to the fabrication of most of
its computer boards. In addition, the Company designs such boards, the
computer's outer case, keyboards, subassemblies and other elements in order to
maximize the ruggedness of its products, to furnish customization of electronics
and software to give the customer greater control over configuration and
components.

         With respect to its secure computer business, the Company encounters
competition from Wang Laboratories, Secure Computer Systems, and NAI. As for its
PCMobile rugged laptops, the Company encounters competition from Panasonic and
Badger. Certain large manufacturers of commercial notebook computers such as
Panasonic and IBM have introduced commercial
<PAGE>   17
notebooks that have been sealed and ruggedized to some extent. These companies
are presently offering such products at prices from approximately one-third to
one-half the Company's more rugged versions.

         Management believes that the Company's ability to increase market
penetration in the commercial sector will be limited substantially by the entry
of such manufacturers into the ruggedized computer market.

         In the public safety and secure computer markets, the Company will
often be engaged, directly or indirectly, in the process of seeking competitive
bid or negotiated contracts with government departments and agencies. These
government contracts are subject to specific rules and regulations with which
the Company must comply. However, the Company is often one of only a few
companies whose products meet the required specifications designated by such
customers.

         In most cases, the Company tends to be the higher priced bidder for
public safety bids. The reasons for this situation are numerous. The Company
designs its computers on an overall basis to assure their ruggedness and use in
the most demanding circumstances. Accordingly, it generally employs more
expensive components than its competitors. These generally more expensive
components consist of industrial or higher-level commercial type instead of
ordinary commercially available parts. The Company's computers are enclosed in
sealed containers. Moreover, the Company makes extensive modifications and
refinements of its computers for its customers pursuant to their specifications
and special needs. Consequently, the Company's products generally function at a
higher level of performance and reliability than its competitors.

         For those applications in which harsh environmental and operational
conditions prevail, customers are sometimes willing to pay higher prices,
especially where few, if any, other companies offer similar devices. In those
less demanding circumstances, the Company's products sell at a competitive
disadvantage and often are not purchased because the applications do not justify
its higher prices.

ENVIRONMENTAL ISSUES

        Compliance cost with environmental laws is not expected to materially
adversely affect the business of the Company.

EMPLOYEES

        The Company currently employs approximately 156 people, of which
approximately 101 are employed in the United States and 55 in Canada.
Approximately 28 employees work in customer sales and service, 24 employees work
in administration, 33 employees work in research and development and 71
employees work in manufacturing.

         None of its employees is covered by a collective bargaining agreement
or is represented by a labor union. The Company considers its relationship with
its employees to be satisfactory.

         The design and manufacture of the Company's equipment requires
substantial technical capabilities in many disparate disciplines from mechanics
and computer science to electronics
<PAGE>   18
and mathematics. While management believes that the capability and experience of
its technical employees compares favorably with other similar manufacturers,
there can be no assurance that it can retain existing employees or attract and
hire the highly capable technical employees necessary in the future on terms
deemed favorable to the Company, if at all.

ITEM 2.  DESCRIPTION OF PROPERTY

As of December 31, 1997, the Company leased the following facilities:
<TABLE>
<CAPTION>
                                                                              Approximate
   Location                 Type of Facility                 Condition         Square Ft.
   --------                 ----------------                 ---------         ----------
<S>                        <C>                               <C>                <C>
McLean, VA                 Executive Office                  Excellent           4,000
Sebastian, FL              Manufacturing, R&D                Excellent          44,000
                           and Distribution
Montreal, QB               Manufacturing, R&D and            Excellent          10,300
                           Distribution
Portland, OR               Corporate Office                  Excellent           1,000
Albuquerque, NM            Manufacturing, R&D                Excellent           7,500
                           and Sales
</TABLE>

         Management believes that its manufacturing facilities at Sebastian, FL
and Montreal, QB will meet its operational needs for the foreseeable future. In
the event that additional facilities are needed to accommodate the continued
growth in revenues and market share, such facilities are available in the
immediate vicinity of the current locations.

ITEM 3.  LEGAL PROCEEDINGS

         The Company is not a party to any pending legal proceedings against it
other than routine litigation that is incidental to the business of the Company.

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

         The Company did not submit any matters to a vote of security holders
during the fourth quarter of the fiscal year ended December 31, 1997.
<PAGE>   19
                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
         MATTERS

         The Company's common stock is traded on The American Stock Exchange
("AMEX") under the symbol "CYI". The following tables set forth the reported
high and low sales prices as reported by AMEX for the periods indicated:
<TABLE>
<CAPTION>
                                                          High               Low
                                                          ----               ---
<S>                                                      <C>               <C>
YEAR ENDED MAY 31, 1996
         First quarter *                                 $11.25            $ 4.38
         Second quarter*                                   6.75              3.75
         Third quarter                                     5.63              3.19
         Fourth quarter                                    7.25              2.88

SEVEN MONTHS ENDED DECEMBER 31, 1996
         First quarter                                   $ 7.31            $ 3.25
         Second quarter                                    5.44              3.13
         Month of December 1996                            3.69              2.56

YEAR ENDED DECEMBER 31, 1997
         First quarter                                   $ 4.00            $ 2.63
         Second quarter                                    3.31              2.00
         Third quarter                                     3.50              2.50
         Fourth quarter                                    2.69              1.25
</TABLE>

         * restated to reflect the 1 for 5 Reverse Split of the outstanding
shares of common stock, effective October 19, 1995.

         On March 1, 1998, as reported by the Company's transfer agent, shares
of common stock were held by 1,072 persons, based on the number of record
holders, including several holders who are nominees for an undetermined number
of beneficial owners.

         The Company has not paid any dividends and has no present intention of
paying dividends on the common stock in the foreseeable future as it intends to
retain any future earnings to fund operations and the continued development of
its business. The declaration and payment of dividends and the amount paid, if
any, is subject to the discretion of the Company's Board of Directors and will
be dependent on the earnings, financial condition, and capital requirements of
the Company and any other factors the Company's Board of Directors may consider
relevant. However, the Company was required to pay an 8% cumulative dividend on
all outstanding Series A Preferred Stock. As of September 30, 1996, all
outstanding shares of Series A Preferred Stock have been converted to common
stock.

<PAGE>   20
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

         In December 1996, the Company changed its fiscal year ended May 31 to a
fiscal year ended December 31. The following comparisons are based on the
company's new fiscal year end. The seven month transition period ended December
31, 1996 bridges the gap between the Company's old and new fiscal year ends. A
comparison of this transition period to the similar period in 1995 is presented
beginning on page 20. In addition, a comparison of the years ended May 31, 1996
and 1995 is also presented beginning on page 21.

         Financial information relating to the year ended December 31, 1997 has
been derived from the audited financial statements. The results of operations
for periods ended November 30, 1996 and 1995 have been restated from the
previous May 31 year end to produce comparable period to the new fiscal year
basis. These restated periods are unaudited and are presented for informational
purposes only.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED NOVEMBER 30, 1996

<TABLE>
<CAPTION>
                                          Year Ended          Year Ended
                                         December 31,         November 30,
                                             1997                 1996
                                             ----                 ----
<S>                                     <C>                  <C>
Sales                                    $ 15,678,667         $ 11,816,319
Cost of Sales                              11,257,321            8,613,571
                                         ------------         ------------
Gross Profit                                4,421,346            3,202,748
                                         ------------         ------------

Selling, general & administrative           6,653,643            7,611,766
Research & development                      1,307,720            1,110,153
Depreciation & amortization                 1,050,998            1,279,848
Other                                             658              871,185
                                         ------------         ------------
                                            9,013,019           10,872,952
                                         ------------         ------------

Loss from operations                       (4,591,673)          (7,670,204)

Interest expense                             (946,235)          (2,638,080)
Other income, net
                                              115,255              265,994
                                         ------------         ------------
                                             (830,979)          (2,373,086)
                                         ------------         ------------
Net loss                                 $ (5,422,652)        $(10,042,290)
                                         ============         ============
Net loss per share                       $      (0.59)        $      (1.78)
                                         ============         ============
</TABLE>


         The revenues for the year ended December 31, 1997 were $15,678,667
which represents an increase of 33% over revenues of $11,816,319 for the prior
period. The increased revenues are partially related to the inclusion of a full
year of the revenues of XL Computing and XL Canada which were acquired in March
1996 and June 1996, respectively. Of these revenues, sales of the PCMobile
rugged laptop computers accounted for $7,978,366 as compared to $602,956 in the
prior period. However, sales of secure computing products decreased to
$5,873,586 as compared to $9,741,887 in the prior period. These recently
acquired subsidiaries
<PAGE>   21
accounted for $13,851,952, or 88% of total revenues. The remaining revenue of
$1,832,631 related to the communications security products segment and reflected
an approximate 25% increase from the prior period.

         Cost of sales for the year ended December 31, 1997 were $11,257,332 as
compared to cost of sales of $8,613,571 for the prior period. The increase is
partially related to the acquisitions of XL Computing and XL Canada with the
remaining increase due to increased sales volumes. These subsidiaries, which
form the computer products segment, contributed $10,068,659 to total cost of
sales which resulted in a gross margin of 27% for sales in this segment as
compared to 28% in the prior period. The current period gross margin is lower
than desired as a result of the Company's efforts to establish market share
through pricing and certain inventory adjustments. The gross margin for sales in
the communications security products segment was 36%, as compared to 22% in the
prior period. The increase in gross margin in the communications products
segment is due to the sale of higher margin products in the current period.

         Operating expenses decreased to $9,013,018 for the year ended December
31, 1997 as compared to $10,872,952 for the prior period. The decrease is mainly
due to certain non-recurring charges in the prior period. Selling, general and
administrative ("SG&A") expenses decreased to $6,656,270 for the period ended
December 31, 1997 as compared to $7,611,766 from the prior period. This decrease
is due in part to management's cost reduction efforts offset by increased
personnel, facilities and operating costs. Research and development costs
increased 18% to $1,307,720 for the period ended December 31, 1997. This
increase reflects the Company's expenditures on the enhancements of the TEMPEST
line of computers and the development of the PCMobile computer. Depreciation and
amortization decreased 18% to $1,050,998 for the year ended December 31, 1997
and reflects the increased depreciation and amortization of capital assets and
goodwill related to the acquisitions offset by accelerated goodwill amortization
in the prior period.

         Interest expense for the year ended December 31, 1997 was $946,235 as
compared to $2,638,080 for the prior period. This decrease is due to reduced
non-cash interest expense offset by increased debt financing obtained by the
Company in the form of convertible debentures, acquisition debt and credit
lines. Included in interest expense are charges of $478,720 and $2,256,347 for
the years ended December 31, 1997 and November 30, 1996, respectively. These are
non-recurring, non-cash charges related to convertible debt financing that give
effect to beneficial conversion features.

         The net loss of $5,422,652, or ($0.59) per share, for the year ended
December 31, 1997 represents a decrease from $10,042,290, or ($1.78) per share
for the year ended November 30, 1996. The decrease is net loss in largely due to
the losses generated in the prior periods by the acquired subsidiaries and the
non-recurring write-downs of inventories and the non-recurring interest charges.
The loss per share is computed on weighted average number of shares outstanding
of 5,632,800 at November 30, 1996 and 9,108,335 December 31, 1997.
<PAGE>   22
SEVEN MONTHS ENDED DECEMBER 31, 1996 COMPARED TO SIX MONTHS ENDED NOVEMBER 30,
1995

         The Company has changed its fiscal year end from May 31 to December 31
effective December 31, 1996. Accordingly, the results of operations reported for
the transition period of the seven months ended December 31, 1996 are compared
to the most applicable period from the previous fiscal year which is the six
months ended November 30, 1995.


<TABLE>
<CAPTION>
                                         Seven Months          Six Months
                                            ended                ended
                                         December 31,         November 30,
                                            1996                 1995
                                            ----                 ----
<S>                                     <C>                 <C>
Sales                                    $ 8,588,845         $   852,428
Cost of Sales                              6,763,463             448,298
                                         -----------         -----------
Gross Profit                               1,825,382             404,130
                                         -----------         -----------

Selling, general & administrative          4,462,434           1,942,806
Research & development                       841,103             289,059
Depreciation & amortization                  535,162             276,567
Other                                      1,033,653             368,591
                                         -----------         -----------
                                           6,872,352           2,877,023
                                         -----------         -----------

Loss from operations                      (5,046,970)         (2,472,893)

Interest expense                          (1,499,781)           (524,195)
Other income, net                             55,148              12,934
                                         -----------         -----------

                                          (1,444,633)           (511,261)
                                         -----------         -----------

Net loss                                 $(6,491,603)        $(2,984,154)
                                         ===========         ===========

Net loss per share                       $     (0.92)        $     (0.83)
                                         ===========         ===========
</TABLE>


         The revenues for the seven months ended December 31, 1996 were
$8,588,845 which represents an increase of 907% over revenues of $852,428 for
the prior period. The increased revenues are related to the inclusion of the
revenues of XL Computing and XL Canada from March 1996 and June 1996,
respectively. These newly acquired subsidiaries accounted for $7,705,374, or 90%
of total revenues. The remaining revenue of $883,471 related to the
communications security products segment and reflected an approximate 4%
increase from the prior period.

         Cost of sales for the seven months ended December 31, 1996 were
$6,763,463 as compared to cost of sales of $448,298 for the prior period. The
increase is related to the acquisitions of XL Computing and XL Canada. These
subsidiaries, which form the computer products segment, contributed $6,240,046
to total cost of sales which resulted in a gross margin of 19% for sales in this
segment. The current period gross margin is low as a result of non-recurring
write-offs of certain deferred project costs and certain inventory adjustments.
The gross margin for sales in the communications security products segment was
41%, as compared to 47% in the prior period. The decrease in gross margin in the
communications products segment is due to the sale of written down products in
the prior period.
<PAGE>   23
         In connection with the Company's goal of achieving profitable
operations, the Company elected to incur certain expenses and one time charges
in the period ended December 31, 1996. Operating expenses increased to
$5,046,970 for the seven months ended December 31, 1996 as compared to
$2,472,893 for the prior period. The increase is mainly due to the acquisition
of XL Computing and XL Canada. Selling, general and administrative ("SG&A")
expenses increased to $4,462,434 for the period ended December 31, 1996 as
compared to $1,942,806 from the prior period. This increase is due to the
acquisitions and represents increased personnel, facilities and operating costs.
Research and development costs increased 191% to $841,103 for the period ended
December 31, 1996. This increase reflects the Company's expenditures developing
the CSD cellular security device, the enhancements on the TEMPEST line of
computers and the development of the PCMobile computer. Depreciation and
amortization increased 94% to $535,162 for the seven months ended and reflects
the increased depreciation and amortization of capital assets and goodwill
related to the acquisitions. During the seven months ended December 31, 1996,
the Company recorded a write-down of inventories in the communications security
segment totaling $476,099. The write-downs covered certain raw materials and
finished goods related to analog scrambling products no longer produced.
Additionally, the Company recorded a write-down of $544,648 related to the sale
of its investment in Galactica. This write-down reflects the full reserve of a
contingent promissory note received as consideration in the sale of Galactica.
However, it is possible the Company will receive payment on all or a portion of
the contingent promissory note in the future and is expected to account for this
as other income at the time of receipt.

         Interest expense for the seven months ended December 31, 1996 was
$1,499,781 as compared to $524,195 for the prior period. This increase is due to
increased debt financing obtained by the Company in the form of convertible
debentures, acquisition debt and credit lines. Included in interest expense are
charges of $1,235,125 and $466,666 for the seven months ended December 31, 1996
and the six months ended November 30, 1995, respectively. These are
non-recurring, non-cash charges related to convertible debt financing that give
effect to beneficial conversion features.

         The net loss of $6,491,603, or ($0.92) per share, for the seven months
ended December 31, 1996 represents an increase from $2,984,154, or ($0.83) per
share for the six months ended November 30, 1995. The increase in net loss is
largely due to the losses generated by the acquired subsidiaries and the
non-recurring write-downs of inventories and the investment in Galactica and the
non-recurring interest charges. The loss per share has remained relatively
steady as the weighted average number of shares outstanding has increased from
3,613,192 at November 30, 1995 to 7,040,356 December 31, 1996.

YEAR ENDED MAY 31, 1996 COMPARED TO MAY 31, 1995

         Sales increased to $4,985,036 from $1,283,081 during the same period
for the prior year. The increase is attributable to the aggressive
commercialization of Cycomm's privacy product line and revenue generated by XL
Computing which was acquired as of March 15, 1996. XL Computing's revenue during
the period was $3,396,294. For the year ended May 31, 1996, the Company
experienced a loss of $9,444,651, an increase of $4,814,205 from the loss of
$4,630,446 experienced for the year ended May 31, 1995.
<PAGE>   24
         For the year ended May 31, 1996, cost of sales was $3,634,254, an
increase from $855,414 for fiscal year 1995. Administrative and operating
expenses increased to $8,943,261, an increase of $3,870,347 from the fiscal 1995
total of $5,072,914. The increase in cost of sales is due to the inclusion in
cost of sales of $2,774,646 attributable to XL Computing. The increase in
administrative and operating expenses is due in part to the inclusion of XL
Computing expenses of $808,442. Severance cost made up the balance of the
difference. Depreciation and amortization increased by $853,311 largely due to
the accelerated write-off of $501,523 of goodwill in the Communications Security
Product segment related to the Datotek acquisition. Inventory write-downs
increased by $677,560 versus fiscal 1995 due to obsolescence of certain secure
communications inventory. Consulting fees increased by $454,631 due to costs
associated with hiring a public relations firm and retaining a sales and
marketing consulting group for the Communications Security Products segment.
Salaries, benefits and management fees increased by approximately $1,000,000.
Most of the increase is due to XL Computing costs for the period. The remaining
increase is attributable to administrative services.

         Research and product development costs increased by $246,536 due to
development and preproduction costs associated with Slice CSD technology and
upgrading existing product lines.

         Interest expense for the year ended May 31, 1996 was $1,895,236 as
compared to $41,767 for the prior period. Included in interest expense for the
year ended May 31, 1996 is a non-recurring, non-cash charge of $1,660,046
related to convertible debt financings that give effect to beneficial conversion
features.

         Notes payable and convertible debentures increased by $3,273,892. This
debt was incurred to fund working capital obligations. In addition, $1,500,000
of preferred stock was issued to help fund the acquisition of XL Computing.

LIQUIDITY AND CAPITAL RESOURCES

         The Company has satisfied working capital requirements through cash on
hand, available lines of credit and various debt and equity related financings.
At December 31, 1997, the Company had cash and cash equivalents of $617,636.

         In the year ended December 31, 1997, cash used in operations amounted
to $4,947,861. Cash used in investing activities was $194,387 during the year
ended December 31, 1997 with the major activity being the sale of the Company's
investment in Galactica which generated cash of $513,000 offset by capital
expenditures and an increase in notes receivable. Cash provided by financing
activities was $4,539,340. The issuance of convertible debentures resulted in
net proceeds of $2.7 million. Additionally, the Company obtained equity
financing of $180,000 in the form of a private placement. The Company obtained a
new secured credit facility in an aggregate amount of $4.0 million in December
1997 which included a credit line of $3,432,000 secured by accounts receivable
and inventory and a term loan of $568,000 secured by machinery and equipment.
The Company utilized the proceeds of the new credit facility to repay existing
bank lines in an amount of $2.1 million and for working capital. At December 31,
1997, an amount of $3.2 million was outstanding under the new credit facility.
Various notes payable of $329,401 related to acquisitions were repaid during the
year ended December 31, 1997.
<PAGE>   25
         The Company's net working capital decreased to $3,000,652 at December
31, 1997, from $4,451,698 at December 31, 1996, as short-term debt was incurred
to fund working capital for the growth of the manufacturing operations.

         Significant items affecting cash and cash equivalents subsequent to
December 31, 1997, include the issuance of $1.0 million in convertible preferred
stock. The proceeds will provide working capital for operations during the 1998
fiscal year.

         The Company has restructured the operations of secure communications
products so that this business segment will not require material additional
financing through funding from other subsidiaries activities, borrowings or
issuance of equity and debt securities. The Company expects its computer
equipment segment to be able to fund operations from working capital, secured
lines of credit and funding from the parent company. However, until the Company
can operate the computer products divisions profitability and manage the working
capital requirements of significant growth, it may require additional funding.
The Company believes that it has the capital resources to raise funds through
additional debt and equity financings, to develop and market its products and to
make acquisitions. In this regard, the Company believes that it will be able to
meet its obligations during the remainder of the present fiscal year. There can,
however, be no assurance that the above will be successfully accomplished, or
will be possible on terms acceptable to the Company.

IMPACT OF YEAR 2000

        Management is beginning to study the implications of the Year 2000 on
its information systems. However, based on the business risk associated with the
Company's information systems, management does not anticipate that the Year 2000
will have a significant impact on its information systems or result in a
significant commitment of resources to resolve potential problems associated
with this event.

ITEM 7. FINANCIAL STATEMENTS

         The financial statements of the Company are set forth in a separate
section of this Annual Report on Form 10-KSB. See Item 13. Exhibits and Reports
on Form 8-K and the Financial Statements commencing on page F-1 of this Annual
Report on Form 10-KSB.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

None.
<PAGE>   26
                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(a) OF THE EXCHANGE ACT

         The information required by Item 9 relating to directors of the Company
is presented under the caption "Nomination and Election of Directors" of the
Company's definitive Proxy Statement for the 1997 Annual Meeting of Shareholders
to be filed with the Securities and Exchange Commission (the "Commission") no
later than April 30, 1998, and is incorporated by reference herein.

SECTION 16 REPORTS

         The information required by this Item is present under the caption
"Other Matters -- Compliance with Section 16(a) of the Exchange Act" of the
Company's definitive Proxy Statement to be filed with the Commission no later
than April 30, 1998, and is incorporated by reference herein.

ITEM 10. EXECUTIVE COMPENSATION

         The information required by Item 10 is presented under the caption
"Executive Compensation" of the Company's definitive Proxy Statement to be filed
with the Commission no later than April 30, 1998, and is incorporated by
reference herein.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by Item 11 is present under the caption
"Security Ownership of Certain Beneficial Owners and Management" of the
Company's definitive Proxy Statement to be filed with the Commission no later
than April 30, 1998, and is incorporated by reference herein.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by Item 12 is presented under the caption
"Certain Transactions" of the Company's definitive Proxy Statement to be filed
with the Commission no later than April 30, 1998, and is incorporated by
reference herein.
<PAGE>   27
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a)      Exhibits

         (1) See the financial statements of the Company and the report thereon
         included in Item 7 of Part II of this Annual Report on Form 10-KSB.

         (2) The following exhibits are filed as part of this Annual Report on
         Form 10-KSB and incorporated by reference herein to the extent
         possible.


<TABLE>
<CAPTION>
                                                                                             Page Number
                                                                                             -----------
<S>               <C>      <C>                                                               <C>
                  1.1      Certificate of Incorporation                                          (1)

                  1.2      Certificate of Incorporation on Change of Name                        (1)

                  1.3      Certificate of Continuance                                            (1)

                  1.4      Amended Articles of Incorporation                                     ___

                  10.1     Agreement by and between Cycomm Corporation and                       (2)
                           Cycomm International Inc. and Datotek, Inc. and
                           AT&T Corp.

                  10.2     Management Services Agreement - Peter Hickey                          (1)

                  10.3     Management Services Agreement - Rick E. Mandrell                      (5)

                  10.4     Management Services Agreement - Gordon Collett                        (1)

                  10.5     Stock Purchase Agreement by and among the Company                     (3)
                           and XL Vision Inc. and XL Computing Corporation
                           dated March 21, 1996

                  10.6     Asset Purchase Agreement among and between                            (4)
                           9036-8028 Quebec, Inc., Cycomm International Inc.
                           and M3i Technologies, Inc. and M3i Systems Inc.
                           date June 21, 1996

                  10.7     Management Services Agreement - Albert I. Hawk                        (5)

                  10.8     Employment Agreement - Michael R. Skoff                               (6)

                  10.9     Management Services Agreement - Rick E. Mandrell                      ___

                  10.10    Management Services Agreement - G.T. Gangemi                          ___

                  10.11    Commercial Revolving Loan, Additional Loan and
                           Security Agreement by and among the Company
                           and American Commercial Finance Corp.                                 ___

                  10.12    Cycomm International Inc. 1997 Stock Option Plan                      ___

                  10.13    Stock Purchase Agreement and Certificate of
                           Designation of Series B Convertible Redeemable
</TABLE>
<PAGE>   28
<TABLE>
<CAPTION>
<S>               <C>      <C>                                                                  <C>
                           Preferred Stock                                                       ___
                  21.1     Subsidiaries of the Registrant                                        ___
                  27       Financial Data Schedule                                               ___
</TABLE>

(1)      Previously filed as an Exhibit to Form 20-F Registration Statement (as
         amended), Form 20-F Annual Reports and Form 6-K Reports of Foreign
         Issuer and incorporated by reference herein.

(2)      Previously filed as an Exhibit to Form F-1 Registration Statement filed
         on May 9, 1995 and incorporated by reference herein.

(3)      Previously filed as an Exhibit to Form 8-K dated March 21, 1996 and
         incorporated by reference herein.

(4)      Previously filed as an Exhibit to Form 8-K dated June 21, 1996 and
         incorporated by reference herein.

(5)      Previously filed as an Exhibit to Form 10-KSB for the year ended May
         31, 1996 dated September 12, 1996 and incorporated by reference herein.

(6)      Previously files as an Exhibit to form 10-KSB for the seven months
         ended December 31, 1996 dated April 11, 1997 and incorporated by
         reference herein.


(b)      Reports on Form 8-K:

         The Company did not file any Reports on Form 8-K during the fourth
quarter of the fiscal year ended December 31, 1997.
<PAGE>   29
                                   SIGNATURES

         In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant had duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.


                                       CYCOMM INTERNATIONAL INC.


Date:    March 31, 1998                By:   /s/   Albert I. Hawk
                                          -------------------------------------
                                          Albert I. Hawk
                                          President and
                                          Chief Executive Officer
                                          (Principal Executive Officer)


                                       By: /s/  Michael R. Skoff
                                          -------------------------------------
                                          Michael R. Skoff
                                          Chief Financial Officer
                                          (Principal Financial Officer and
                                          Principal Accounting Officer)


         In accordance with the requirements of the Exchange Act, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
<S>                                                         <C>
By:      /s/      Albert I. Hawk                            March 31, 1998
      -----------------------------------------------
         Albert I. Hawk, President and
         Chief Executive Officer

By:    /s/        Hubert Marleau                            March 31, 1998
     ------------------------------------------------
         Hubert Marleau, Director

By:      /s/      Rick E. Mandrell                          March 31, 1998
     ------------------------------------------------
         Rick E. Mandrell, Secretary and
         Director

By:      /s/      Ret. Gen. Thomas A. Stafford              March 31, 1998
     -------------------------------------------------
         Ret. Gen. Thomas A. Stafford, Director
</TABLE>
<PAGE>   30
                                   SIGNATURES

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


                                       CYCOMM INTERNATIONAL INC.


Date:    March __, 1998                By:
                                          -------------------------------------
                                          Albert I. Hawk
                                          President and
                                          Chief Executive Officer
                                          (Principal Executive Officer)


                                       By:
                                          -------------------------------------
                                          Michael R. Skoff
                                          Chief Financial Officer
                                          (Principal Financial Officer and
                                          Principal Accounting Officer)


         In accordance with the requirements of the Exchange Act, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
<S>                                                                  <C>
By:                                                                  March _, 1998
      --------------------------------------------------------
         Albert I. Hawk, President and
         Chief Executive Officer

By:                                                                  March __, 1998
     ---------------------------------------------------------
         Hubert Marleau, Director

By:                                                                  March _, 1998
    ----------------------------------------------------------
         Rick E. Mandrell, Secretary and
         Director

By:                                                                  March _, 1998
     ----------------------------------------------------------
         Ret. Gen. Thomas A. Stafford, Director
</TABLE>
<PAGE>   31
                   CYCOMM INTERNATIONAL INC. AND SUBSIDIARIES
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                      FOR THE YEAR ENDED DECEMBER 31, 1997,
                      SEVEN MONTHS ENDED DECEMBER 31, 1996
                         AND THE YEAR ENDED MAY 31, 1996



<TABLE>
<CAPTION>
<S>                                                                 <C>
Report of Independent Auditors                                      F-2
Consolidated Statements of Operations                               F-3
Consolidated Balance Sheets                                         F-4
Consolidated Statements of Cash Flows                               F-5
Consolidated Statements of Stockholders' Equity                     F-6
Notes to Consolidated Financial Statements                          F-7
</TABLE>

                                       F-1
<PAGE>   32
                         REPORT OF INDEPENDENT AUDITORS

To the Shareholders of
CYCOMM INTERNATIONAL INC. AND SUBSIDIARIES



         We have audited the accompanying consolidated balance sheets of Cycomm
International Inc. and subsidiaries as of December 31, 1997 and December 31,
1996 and the related consolidated statements of operations, stockholders' equity
and cash flows for the year ended December 31, 1997, the seven months ended
December 31, 1996 and the year ended May 31, 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Cycomm International Inc. and subsidiaries at December 31, 1997 and December 31,
1996 and the consolidated results of their operations and their cash flows for
the year ended December 31, 1997, the seven months ended December 31, 1996 and
the year ended May 31, 1996, in conformity with generally accepted accounting
principles.

         The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company has incurred recurring
losses from operations and has an accumulated deficit that raises substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.

         As discussed in Note 2, the Company's consolidated financial statements
for the year ended May 31, 1996, have been restated to reflect a change in their
method of accounting for their convertible debentures.



Vienna, Virginia
March 20, 1998                                    /s/ Ernst & Young LLP

                                       F-2
<PAGE>   33
                   CYCOMM INTERNATIONAL INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS



<TABLE>
<CAPTION>
                                                                                  SEVEN MONTHS
                                                            YEAR ENDED               ENDED             YEAR ENDED
                                                            DECEMBER 31,          DECEMBER 31,           MAY 31,
                                                               1997                 1996                  1996
                                                               ----                 ----                  ----
                                                                                                    (Restated Note 2)
<S>                                                         <C>                  <C>                  <C>
Sales                                                       $ 15,678,667         $  8,588,845         $  4,985,036
Cost of sales                                                 11,257,321            6,763,463            3,634,254
                                                            ------------         ------------         ------------
Gross profit                                                   4,421,346            1,825,382            1,350,782
                                                            ------------         ------------         ------------

Expenses:
   Selling, general and administrative                         6,653,643            4,462,434            5,730,671
   Research and product development                            1,307,720              841,103              749,041
   Depreciation and amortization                               1,050,998              535,162            1,228,295
   Foreign exchange loss(gain)                                       658               12,906               14,797
   Write-down of inventories to net realizable value                --                476,099            1,220,457
   Write-down of investments to net realizable value                --                544,648                 --
                                                            ------------         ------------         ------------
                                                               9,013,019            6,872,352            8,943,261
                                                            ------------         ------------         ------------
LOSS FROM OPERATIONS                                          (4,591,673)          (5,046,970)          (7,592,479)
                                                            ------------         ------------         ------------

OTHER INCOME (EXPENSE)

   Interest income                                                55,046               51,540               64,345
   Interest expense                                             (946,235)          (1,499,781)          (1,895,236)
   Gain (loss) on sale of fixed assets                              --                   (898)             (27,300)
   Realized gain (loss) on investments                            38,825                 --                   --
   Other income                                                   21,385                4,506                6,019
                                                            ------------         ------------         ------------
                                                                (830,979)          (1,444,633)          (1,852,172)
                                                            ------------         ------------         ------------
NET LOSS                                                    $ (5,422,652)        $ (6,491,603)        $ (9,444,651)
                                                            ============         ============         ============

NET LOSS PER SHARE                                          $      (0.59)        $      (0.92)        $      (2.36)
                                                            ============         ============         ============

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING           9,168,335            7,040,356            4,002,289
                                                            ============         ============         ============
</TABLE>

                            (See accompanying notes)

                                       F-3
<PAGE>   34
                   CYCOMM INTERNATIONAL INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                              DECEMBER 31,         December 31,
                                                                                 1997                 1996
                                                                                 ----                 ----
<S>                                                                          <C>                  <C>
ASSETS
Current assets:
   Cash and cash equivalents                                                 $    617,636         $  1,220,544
   Accounts receivable, less allowance for doubtful accounts of
      $41,000 and $12,000, respectively                                         5,171,402            2,170,518
   Inventories                                                                  5,374,511            5,819,852
   Prepaid expenses                                                                96,029               76,785
                                                                             ------------         ------------
      Total current assets                                                     11,259,578            9,287,699
                                                                             ------------         ------------

Fixed assets, net                                                               1,582,475            1,663,176

Goodwill, net of accumulated amortization of $1,676,574 and
   $1,398,555, respectively                                                     2,534,733            1,673,835

Other assets:
   Notes receivable - affiliates                                                  183,185               41,521
   Long-term investments                                                             --                513,500
   Deferred technology costs, net of accumulated amortization of
      $971,345 and $927,620, respectively                                           6,502               50,227
   Deferred financing costs, net of accumulated amortization of
      $234,878 and $42,675, respectively                                          179,460              264,825
   Unearned discount                                                               13,889              159,276
   Other                                                                          191,454               94,699
                                                                             ------------         ------------
                                                                                  574,490            1,124,048
                                                                             ------------         ------------
                                                                             $ 15,951,276         $ 13,748,758
                                                                             ============         ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable - trade                                                  $  3,386,543         $  1,871,815
   Accrued liabilities                                                          1,481,427            1,167,337
   Due to affiliate                                                               318,603              160,321
   Dividends payable on preferred stock                                              --                 86,667
   Current portion of capital lease obligations                                    29,468               81,527
   Revolving credit facility                                                    2,629,308            1,138,933
   Current portion of notes payable and convertible debentures                    413,575              329,401
                                                                             ------------         ------------
      Total current liabilities                                                 8,258,924            4,836,001
                                                                             ------------         ------------

Capital lease obligations, less current portion                                    54,294               71,869

Notes payable and convertible debentures, less current portion                  3,394,425            3,074,999

Deferred credit                                                                      --                620,466

Commitments

Stockholders' equity:
   Common stock, no par value, unlimited authorized shares, 9,816,877
      and 8,050,401 shares issued and outstanding at December 31,
      1997 and December 31, 1996, respectively
                                                                               47,491,611           42,970,749
   Accumulated deficit                                                        (43,247,978)         (37,825,326)
                                                                             ------------         ------------
      Total stockholders' equity                                                4,243,633            5,145,423
                                                                             ------------         ------------
                                                                             $ 15,951,276         $ 13,748,758
                                                                             ============         ============
</TABLE>

                            (See accompanying notes)

                                      F-4
<PAGE>   35
                   CYCOMM INTERNATIONAL INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS



<TABLE>
<CAPTION>
                                                                                               SEVEN MONTHS
                                                                            YEAR ENDED            ENDED            YEAR ENDED
                                                                            DECEMBER 31,       DECEMBER 31,          MAY 31,
                                                                               1997                1996                1996
                                                                               ----                ----                ----
<S>                                                                        <C>                 <C>             <C>
Operating activities                                                                                           (Restated -  Note 2)
   Net loss                                                                $(5,422,652)        $(6,491,603)        $(9,444,651)
   Adjustments to reconcile net loss to net cash
     used in operating activities:
         Depreciation and amortization                                       1,050,998             535,162           1,228,295
         Loss (gain) on sale of fixed assets                                      --                   898              27,300
         Realized loss (gain) on marketable securities                         (38,825)               --                  --
         Write-down of inventories to net realizable value                        --               476,099           1,220,457
         Write-down of investments to net realizable value                        --               544,648                --
         Non-cash expenses                                                     533,081           1,360,125           1,835,046
         Deferred technology costs                                              43,725             107,527             184,333
   Change in operating assets and liabilities                               (1,114,188)         (1,405,538)            609,653
                                                                           -----------         -----------         -----------
   Cash used in operating activities                                        (4,947,861)         (4,872,682)         (4,339,567)
                                                                           -----------         -----------         -----------

INVESTING ACTIVITIES
   Increase in long-term investments                                          (106,500)               --                  --
   Decrease in long-term investments                                           513,500             117,711                --
   Acquisition of fixed assets                                                (473,449)           (192,425)           (135,907)
   Proceeds on disposal of fixed assets                                        127,086               5,997              24,389
   Payment for acquisitions, net of cash acquired:
       - XL (Canada) Inc.                                                         --            (1,000,000)               --
       - XL Computing Corporation                                                 --                  --            (2,150,000)
   Increase in notes receivable                                               (184,000)            (15,000)            (20,000)
   Decrease in notes receivable                                                 49,167              42,661               1,427
   Other                                                                      (120,191)            (90,820)              5,466
                                                                           -----------         -----------         -----------
   Cash used in investing activities                                          (194,387)         (1,131,876)         (2,274,625)
                                                                           -----------         -----------         -----------

FINANCING ACTIVITIES
   Issuance of common stock                                                    180,000             830,100                --
   Net borrowings under revolving credit facilities                          2,058,375                --                  --
   Borrowings under notes payable                                                 --             1,138,933              38,349
   Repayment of notes payable and convertible debentures                      (329,401)           (703,541)           (315,336)
   Borrowings under convertible debentures                                   3,000,000           3,900,000           8,425,000
   Deferred financing costs on convertible debentures                         (300,000)           (390,000)           (842,500)
   Repayment of obligations under capital leases                               (69,634)            (27,657)             (5,774)
                                                                           -----------         -----------         -----------
   Cash provided by financing activities                                     4,539,340           4,747,835           7,299,739
                                                                           -----------         -----------         -----------

   Increase (decrease) in cash and cash equivalents
      during the period                                                       (602,908)         (1,256,723)            685,547
   Cash and cash equivalents, beginning of period                            1,220,544           2,477,267           1,791,720
                                                                           -----------         -----------         -----------
   Cash and cash equivalents, end of period                                $   617,636         $ 1,220,544         $ 2,477,267
                                                                           ===========         ===========         ===========
</TABLE>

                            (See accompanying notes)

                                      F-5
<PAGE>   36
                   CYCOMM INTERNATIONAL INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY




<TABLE>
<CAPTION>
                                             PREFERRED         PREFERRED            COMMON            COMMON          ACCUMULATED
                                               SHARES            STOCK              SHARES            STOCK             DEFICIT
                                               ------            -----              ------            -----             -------
<S>                                        <C>               <C>                  <C>              <C>              <C>
BALANCE, MAY 31, 1995                              ---                ---          3,594,316        $26,606,192      $(21,802,405)

Net loss                                                                                                               (9,444,651)
Issuance of preferred stock
   on acquisition of XLCC                       30,000       $  3,000,000
Issuance of common stock:
   Issued in payment for services
                                                                                      63,000            300,000
   Issued in settlement of liabilities
                                                                                      76,978            363,455
   Conversion of debentures                                                        1,809,477          4,814,655
   Conversion of preferred stock
                                               (15,000)        (1,500,000)           400,000          1,500,000
Beneficial conversion feature of
   convertible debt
                                                                                                      2,159,234
Dividends on preferred stock                                                                                              (46,000)
                                             ---------       ------------          ---------       ------------      ------------
BALANCE, MAY 31, 1996                           15,000          1,500,000          5,943,771         35,743,536       (31,293,056)
                                             ---------       ------------          ---------       ------------      ------------

Net loss                                                                                                               (6,491,603)
Issuance of common stock:
   Conversion of debentures                                                        1,393,186          3,911,880
   Conversion of preferred stock               (15,000)        (1,500,000)           400,000          1,500,000
   Private placement                                                                 195,331            530,100
   Exercise of options                                                               100,000            300,000
   Acquisition earn-out                                                               18,113             90,020
Beneficial conversion feature of
   convertible debt
                                                                                                        895,213
Dividends on preferred stock                                                                                              (40,667)
                                             ---------       ------------          ---------       ------------      ------------
BALANCE, DECEMBER 31, 1996                        --                 --            8,050,401         42,970,749       (37,825,326)
                                             ---------       ------------          ---------       ------------      ------------

Net Loss                                                                                                               (5,422,652)
Issuance of common stock:
   Conversion of debentures                                                        1,219,727          2,742,753
   Private placement                                                                 120,000            180,000
   Acquisition earn-out                                                              426,749          1,264,776
Beneficial conversion feature
   of convertible debt                                                                                  333,333
                                             ---------       ------------          ---------       ------------      ------------
BALANCE, DECEMBER 31, 1997                        --         $       --            9,816,877       $ 47,491,611      $(43,247,978)
                                             =========       ============          =========       ============      ============
</TABLE>

                            (See accompanying notes)

                                      F-6
<PAGE>   37
CYCOMM INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997



NOTE 1:  NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Cycomm International Inc. (the "Company") is a manufacturer of value added,
secure, ruggedized computer equipment and communications systems, and a provider
of related services. The Company is based in McLean, Virginia, with wholly-owned
subsidiaries in Montreal, Quebec, Sebastian, Florida, Albuquerque, New Mexico
and Portland, Oregon.

The Company's consolidated financial statements have been prepared on a going
concern basis which contemplates the realization of assets and the settlement of
liabilities and commitments in the normal course of business. The Company
incurred a net loss of $5,422,652 for the year ended December 31, 1997 and as of
that date had an accumulated deficit of $43,247,978. These factors raise
substantial doubt about the Company's ability to continue as a going concern.

The Company anticipates that operations will be funded from working capital,
secured lines of credit and from additional financing through borrowings or
sales of equity securities.

These consolidated financial statements do not give effect to any adjustments
which would be necessary should the Company be unable to continue as a going
concern and therefore be required to realize its assets and discharge its
liabilities in other than the normal course of business and at amounts different
from those reflected in the accompanying consolidated financial statements.

NOTE 2:  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

RESTATEMENTS

On October 12, 1995, the Company received shareholder approval to redomicile,
effective November 1, 1995, to the United States from Canada. The change was
made as the Company's operations at that time were conducted primarily in the
United States. As a result, the Company has adopted the U.S. dollar as its
functional and reporting currency. This change represents a change in
circumstance and the consolidated financial statements have been translated into
U.S. currency effective June 1, 1994.

The Company has restated their May 31, 1996 financial statements to recognize a
position by the staff of the Securities and Exchange Commission regarding the
accounting for the issuance of debt that can be converted at a discount to the
market price of the Company's common stock. In this regard, the implicit return
provided by the conversion terms of the debt is accounted for as additional
interest expense and accreted over the period between the date of issuance of
the debt and the date the debt first become convertible. This prior period
adjustment resulted in additional interest expense of $1,660,046 in the year
ended May 31, 1996 or $0.41 per share.

FISCAL YEAR

Effective December 31, 1996, the Company changed its fiscal year end from May 31
to December 31. Accordingly, the Company has reported its results of operations,
stockholders' equity and cash flows for the twelve months ended December 31,
1997, the transition period of the seven months ended December 31, 1996 and the
twelve months ended May 31, 1996.

BASIS OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries after elimination of inter-company accounts and
transactions.

CASH AND CASH EQUIVALENTS

The Company considers all short-term deposits with a maturity of three months or
less to be cash equivalents.



                                      F-7
<PAGE>   38
INVENTORIES

Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method. Market is determined by the replacement cost
method for raw materials and the net realizable value method for work in process
and sub-assemblies and finished goods. Inventories also include certain
capitalized project costs and demonstration equipment which are stated at
amortized cost, which approximates net realizable value.

USE OF ESTIMATES IN THE PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS

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

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of cash, accounts receivable, accounts payable, accrued
liabilities, capital lease obligations, notes payable and convertible debentures
approximate their fair values.

FIXED ASSETS AND DEPRECIATION

Fixed assets are carried at the lower of cost or market less accumulated
depreciation and amortization. Depreciation is calculated on a straight line
basis over the estimated useful lives of the fixed assets as follows:

<TABLE>
<CAPTION>
<S>      <C>                                                  <C>
         Equipment under capital lease                        Term of the respective lease
         Furniture and fixtures                               5 to 7 years
         Research equipment                                   3 to 10 years
         Computer equipment                                   3 to 7 years
         Marketing equipment                                  2 to 7 years
         Office equipment                                     5 to 7 years
         Manufacturing equipment                              3 to 7 years
</TABLE>

Amortization of leasehold improvements is calculated on a straight line basis
over the term of the respective lease.

RESEARCH AND PRODUCT DEVELOPMENT COSTS

Research and product development costs are expensed as incurred.

TECHNOLOGY COSTS

Costs relating to obtaining technology are deferred when management is
reasonably certain the costs will be recovered. Such costs are amortized to
operations on a straight line basis over five years. If management determines
that such costs exceed net recoverable value, the unamortized balance is charged
to operations.

DEFERRED FINANCING COSTS

Costs relating to obtaining debt financing are deferred and amortized on a
straight line basis over the term of the debt. The unamortized portion of the
deferred financing costs related to convertible debentures is recorded against
stockholders' equity at the time of conversion.

LEASES

Fixed assets acquired under leases which transfer substantially all of the
benefits of ownership to the lessee are recorded as the acquisition of assets
and the assumption of a related obligation. Under this method, assets are
depreciated over their expected useful lives, and obligations, including
interest thereon, are extinguished over the life of the lease.

All other leases are accounted for as operating leases wherein rental payments
are charged to operations as incurred.

                                      F-8
<PAGE>   39
REVENUE RECOGNITION

Product sales, less estimated returns and allowances, are recorded at the time
of shipment.

PRODUCT WARRANTY

Warranties of twelve months from date of sale are provided for most products
sold, with limited lifetime warranties on certain components. A reserve is
established to cover estimated warranty costs during this period.

FOREIGN CURRENCY TRANSLATION

The financial statements of foreign subsidiaries have been translated into U.S.
dollars in accordance with generally accepted accounting principles. Assets and
liabilities denominated in foreign currencies are translated to U.S. dollars at
the exchange rate on the balance sheet date. Revenues, costs and expenses are
translated at the average rates of exchange prevailing during the year.
Translation adjustments resulting from this process are shown separately in
stockholders' equity. Exchange adjustments from foreign currency transactions
are recognized in income.

GOODWILL

The excess of the purchase price over the fair market value of the net assets of
subsidiaries acquired is being amortized on a straight line basis over periods
varying from three to ten years. Goodwill is written down to fair value when
declines in value are considered to be other than temporary based upon an
assessment of undiscounted future cash flows of the respective subsidiaries.

NEW ACCOUNTING PRONOUNCEMENTS

In February 1997, the Financial Accounting Standards Board issued Statement No.
128, "Earnings per Share", which was required to be adopted on December 31,
1997. Under the new standard, companies are required to report basic earnings
per share (EPS) and diluted EPS, instead of the primary and fully diluted
earning EPS disclosures which were previously required. Basic EPS is calculated
by dividing net earnings by the weighted average number of common shares
outstanding during the year. Diluted EPS is calculated by dividing net earnings
by the weighted average number of common shares outstanding during the year plus
the incremental shares that would have been outstanding upon the assumed
exercise of eligible stock options, warrants and the conversion of certain
debenture issues. For the periods ended December 31, 1997, December 31, 1996 and
May 31, 1996, the effect of the exercise of stock options, warrants and the
conversion of debentures would be anti-dilutive, and therefore, diluted earnings
(loss) per share is equal to basic earnings (loss) per share as disclosed in the
consolidated statements of operations.

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (Statement 131), which is effective for
years beginning after December 15, 1997. Statement 131 establishes standards for
the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports. It also establishes standards for related disclosures about products
and services, geographic areas, and major customers. Statement 131 is effective
for financial statements for fiscal years beginning December 15, 1997, and
therefore the Company will adopt the new requirements retroactively in 1998.
Management has not completed its review of Statement 131, but does not
anticipate that the adoption of this statement will have a significant effect on
the Company's reported segments.

RECLASSIFICATION

Certain items previously reported in specific financial statement captions have
been reclassified to conform with the December 31, 1997 presentation.

NOTE 3:  ACQUISITIONS

XL COMPUTING (CANADA) INC.

On June 21, 1996, the Company completed the Asset Purchase Agreement by and
among the Company and 9036-8028 Quebec, Inc., a wholly-owned subsidiary, and M3i
Technologies Inc. and M3i Systems Inc. (collectively the "Seller") whereby
9036-8028 Quebec, Inc. acquired substantially all of the assets of M3i
Technologies Inc., for an

                                      F-9
<PAGE>   40
aggregate purchase price, subject to earn-out provisions, of a maximum of
$5,000,000. Subsequent to the asset acquisition, 9036-8028 Quebec, Inc. was
renamed XL Computing Canada, Inc. ("XL Canada"). XL Canada is based in Montreal,
Quebec and is engaged in the design, manufacture, sale and support of
ruggedized, mobile computing and communications systems.

The aggregate purchase price consisted of cash of $1,000,000 and common stock of
the Company valued at a maximum of $4,000,000 for an aggregate purchase price,
subject to earn-out provisions, of a maximum of $5,000,000. The amount of the
common stock is subject to earn-out provisions based on the achievement of
certain unit sales volumes for a five year period. Any common stock issued under
the earn-out provisions will be issued at the average current market price of
the last month for the quarter in which it was earned.

The acquisition of the assets by XL Canada was accounted for as a purchase.
Accordingly, the purchase price was allocated to the net assets acquired based
on their estimated fair market value. The fair market value of the monetary and
nonmonetary assets acquired was $2,182,527 and the fair value of the liabilities
assumed was $147,160. After an allocation to reduce nonmonetary assets acquired
to zero, the remaining excess of the estimated fair market value of net assets
acquired over the purchase price amounted to $1,035,367, which has been
accounted for as a deferred credit and is being amortized over ten years using a
straight line basis. The value of common stock issued to the Seller as the
contingent consideration is earned subject to the earn-out provisions has been
recorded against the deferred credit. For the period ended December 31, 1997,
the contingent consideration earned was $1,594,640 which was paid in 332,995
shares of common stock issued in the year ended December 31, 1997 and 224,809
shares of common stock to be issued subsequent to December 31, 1997. The
computation of the earn-out consideration is subject to interpretation regarding
eligible units requiring earn-out payments. There exists a potential dispute
between the Company and the Seller regarding the amount of earn-out
consideration due. The Company has recorded the full amount of earn-out based on
its interpretation of the Asset Purchase Agreement. The accompanying
consolidated statements of operations reflect the operating results of XL Canada
since the effective date of the acquisition.

Pro forma unaudited consolidated operating results of the Company and XL Canada
for the year ended May 31, 1996, assuming the acquisition had occurred as of
June 1, 1995, are summarized below:


<TABLE>
<CAPTION>
                                                          Year Ended
                                                           May 31,
                                                            1996
                                                            ----
<S>                                                   <C>
                   Sales                                 $6,951,715
                   Net Loss                           $(10,645,943)
                   Net Loss per Share                       $(2.66)
</TABLE>

The pro forma financial information is for illustrative purposes only, and does
not purport to be indicative of the actual results which would have occurred had
the XL Canada acquisition been completed as of June 1, 1995, nor is it
necessarily indicative of future operating results.

XL COMPUTING CORPORATION

Effective March 15, 1996, the Company acquired 100% of the stock of XL Computing
Corporation ("XLCC") of Sebastian, Florida. The purchase price consisted of
$2,000,000 in cash, a $635,165 promissory note, 30,000 shares of Series A
Convertible Redeemable Preferred Stock valued at $3,000,000 and acquisition
costs of $150,000, for an aggregate purchase price of $5,785,165. The Company
also granted warrants to purchase 500,000 common shares of the Company at $3.75
to the seller. XLCC is engaged in the design, manufacture, sale and support of
secure, ruggedized computer equipment and related services.

The acquisition of XLCC was accounted for as a purchase. Accordingly, the
purchase price was allocated to the net assets acquired based on their estimated
fair market value. The excess of purchase price over the estimated fair value of
net assets acquired amounted to $1,814,584, which has been accounted for as
goodwill and is being amortized over ten years using a straight line basis. The
accompanying consolidated statements of operations reflect the operating results
of XLCC since the effective date of the acquisition.

Pro forma unaudited consolidated operating results of the Company and XLCC for
the year ended May 31, 1996, assuming the acquisition had occurred as of June 1,
1995, are summarized below:

                                      F-10
<PAGE>   41
<TABLE>
<CAPTION>
                                                        Year Ended
                                                           May 31,
                                                            1996
                                                            ----
<S>                                                  <C>
                     Sales                              $11,770,363
                     Net Loss                         $(10,101,999)
                     Net Loss per Share                     $(2.52)
</TABLE>


The pro forma financial information is for illustrative purposes only, and does
not purport to be indicative of the actual results which would have occurred had
the XLCC acquisition been completed as of June 1, 1995, nor is it necessarily
indicative of future operating results.

NOTE 4:  INVENTORIES

Inventories by categories are as follows:

<TABLE>
<CAPTION>
                                        DECEMBER 31,    DECEMBER 31,
                                           1997             1996
                                           ----             ----
<S>                                     <C>             <C>
Raw materials                           $1,988,897      $3,859,242
Work in process and sub-assemblies       2,591,442       1,593,705
Finished goods                             794,172         366,905
                                        ----------      ----------
                                        $5,374,511      $5,819,852
                                        ==========      ==========
</TABLE>


NOTE 5:  FIXED ASSETS

Fixed assets and accumulated depreciation and amortization by categories are as
follows:

<TABLE>
<CAPTION>
                                                        ACCUMULATED
                                                     DEPRECIATION AND       NET BOOK
                                         COST           AMORTIZATION         VALUE
                                         ----           ------------         -----
<S>                                   <C>            <C>                  <C>
DECEMBER 31, 1997

Land                                  $   48,000        $     --          $   48,000
Equipment under capital leases           121,328            60,379            60,949
Furniture and fixtures                    41,467            18,623            22,844
Research equipment                       490,586           110,566           380,020
Computer equipment                       400,053            99,994           300,059
Office equipment                         165,926            99,885            66,041
Manufacturing equipment                  926,783           274,532           652,251
Leasehold improvements                    66,498            14,187            52,311
                                      ----------        ----------        ----------
                                      $2,260,641        $  678,166        $1,582,475
                                      ==========        ==========        ==========

DECEMBER 31, 1996

Land                                  $   48,000        $     --          $   48,000
Equipment under capital leases           206,913           117,755            89,158
Furniture and fixtures                   163,107            40,556           122,551
Research equipment                       773,218           274,619           498,599
Computer equipment                       569,615           266,892           302,723
Marketing equipment                       61,432            26,999            34,433
Office equipment                          89,148             9,843            79,305
Manufacturing equipment                  640,568           178,049           462,519
Leasehold improvements                    33,462             7,574            25,888
                                      ----------        ----------        ----------
                                      $2,585,463        $  922,287        $1,663,176
                                      ==========        ==========        ==========
</TABLE>


Depreciation expense for the year ended December 31, 1997, the seven months
ended December 31, 1996 and the year ended May 31, 1996 was $636,702, $274,049
and $177,874, respectively.

                                      F-11
<PAGE>   42
NOTE 6:  OTHER ASSETS

LONG-TERM INVESTMENTS

<TABLE>
<CAPTION>
                                                                             DECEMBER 31,         DECEMBER 31,
                                                                                 1997                 1996
                                                                                 ----                 ----
<S>                                                                          <C>                  <C>
Sistemas de Reception de Satellite Galactica C.A. ("Galactica")                  ---                $513,500
</TABLE>

During 1993 and 1994, the Company acquired for total consideration of
$1,117,950, a 25.5% interest in Galactica, a telecommunication systems
integration and distribution company. In March 1997, the Company sold its
investment in Galactica to the majority shareholder for an aggregate
consideration of $1,027,000, consisting of $513,500 cash at closing and a
$513,500 Contingent Promissory Note (the "Note"). The payment of the Note is
contingent on the future earnings of Galactica. While management currently
believes that the Note will be fully paid, the contingencies that require
payments on the Note are undeterminable and not controllable by the Company.
Therefore, the Company fully reserved for the Note and an amount of $513,500 was
included in the results of operations for the seven months ended December 31,
1996.


NOTE 7:  NOTES PAYABLE AND CONVERTIBLE DEBENTURES

Notes payable and convertible debentures are as follows:

<TABLE>
<CAPTION>
                                                               DECEMBER 31,      DECEMBER 31,
                                                                  1997             1996
                                                                  ----             ----
<S>                                                          <C>               <C>
10% convertible debentures, due February 28, 1999              $3,000,000        $     --

10% convertible debentures, due June 11, 1998                     200,000           350,000

10% convertible debentures, due May 29, 1998                       40,000           275,000

10% convertible debentures, due October 18, 1998                     --           2,000,000

10% convertible debentures, due September 30, 1998                   --             400,000

9.5% convertible debentures, due March 19, 1998                      --              49,999

12% promissory note payable, due December 31, 1996                   --             230,000

7% promissory note payable, due December 31, 1996                    --              99,401

Revolving credit facility, prime + 11/2%, due on demand              --           1,138,933

Revolving credit facility, prime + 3%                           2,629,308              --

Term note payable, prime + 3%, due January 1, 2001                568,000              --
                                                               ----------        ----------
                                                                6,437,308         4,543,333
Less current portion                                            3,042,883         1,468,334
                                                               ----------        ----------
                                                               $3,394,425        $3,074,999
                                                               ==========        ==========
</TABLE>

                                      F-12
<PAGE>   43
Scheduled maturities of notes payable and convertible debentures are as follows:

YEAR ENDING DECEMBER 31,

<TABLE>
<CAPTION>
<S>                                            <C>
1998                                            $3,042,883
1999                                             3,189,324
2000                                               189,324
2001                                                15,777
                                                ----------
                                                $6,437,308
                                                ==========
</TABLE>

On February 28, 1997, the Company issued $3,000,000 of 10% convertible
debentures due February 28, 1999 which are convertible at the option of the
holders into common stock of the Company at 10% of the average closing bid price
of the Company's common stock prior to conversion provided, however the
conversion price shall not be greater than $6.00 per share nor less than $3.00
per share. The debentures are fully eligible for conversion after February 28,
1998.

On June 11, 1996, the Company issued $1,500,000 of 10% convertible debentures
due June 11, 1998 which are convertible at the option of the holders into common
stock of the Company at the lesser of $5.34 per share or a range of 79% to 85%
of the average closing bid price of the Company's common stock prior to
conversion. The debentures were fully eligible for conversion after October 9,
1996. During the year ended December 31, 1997, principal and accrued interest in
an amount of $162,425 were converted into 79,006 shares of common stock. During
the seven months ended December 31, 1996, principal and accrued interest in an
amount of $1,183,932 were converted into 385,617 shares of common stock.

On May 29, 1996, the Company issued $475,000 of 10% convertible debentures due
May 29, 1998 which are convertible at the option of the holders into common
stock of the Company at the lesser of $6.00 per share or a range of 80% to 82%
of the average closing bid price of the Company's common stock prior to
conversion. The debentures were fully eligible for conversion after September 2,
1996. During the year ended December 31, 1997, principal and accrued interest in
an amount of $259,912 were converted into 142,674 shares of common stock. During
the seven months ended December 31, 1996, principal and accrued interest in an
amount of $207,908 were converted into 78,272 shares of common stock.

On October 18, 1996, the Company issued $2,000,000 of 10% convertible debentures
due October 18, 1998 which are convertible at the option of the holders into
common stock of the Company at the lesser of $4.50 per share or a range of 80%
to 82% of the average closing bid price of the Company's common stock prior to
conversion. The debentures were fully eligible for conversion after February 20,
1997. During the year ended December 31, 1997, principal and accrued interest in
an amount of $ 2,070,556 were converted into 800,507 shares of common stock.

On September 30, 1996, the Company issued $400,000 of 10% convertible debentures
due September 30, 1998 which are convertible at the option of the holders into
common stock of the Company at the lesser of $4.80 per share or a range of 80%
to 82% of the average closing bid price of the Company's common stock prior to
conversion. The debentures were fully eligible for conversion after February 2,
1997. During the year ended December 31, 1997, principal and accrued interest in
an amount of $413,895 were converted into 167,523 shares of common stock.

On March 19, 1996, the Company issued $1,800,000 of 9.5% convertible debentures
due March 19, 1998 which are convertible at the option of the holders into
common stock of the Company at the lesser of $3.125 per share or a range of 79%
to 81% of the average closing bid price of the Company's common stock prior to
conversion. During the year ended December 31, 1997, principal and accrued
interest in an amount of $57,300 were converted into 30,017 shares of common
stock. During the seven months ended December 31, 1996, principal and accrued
interest in an amount of $960,891 were converted into 325,992 shares of common
stock. During the year ended May 31, 1996, principal and accrued interest in an
amount of $828,459 were converted into 262,634 shares of common stock.

The 12% promissory note payable was incurred in conjunction with the acquisition
of certain assets from Datotek and was due on April 12, 1996. The Company
restructured the note payable so that principal, and accrued interest thereon,
was due in installments of $100,000 due on April 11, 1996, July 11, 1996 and
October 11, 1996, with the remaining $130,000 principal due on December 31,
1996. This note was collateralized by all the assets acquired in the Datotek
acquisition. The Company paid this note in full on July 1, 1997.

The 7% promissory note payable was incurred in conjunction with the acquisition
of XLCC. This note was collateralized by certain accounts receivable of XLCC.
Principal payments, with accrued interest thereon, were due in the amount of
$75,000 each month from July 21, 1996 to October 21, 1996, with the remaining
principal balance of $335,165 due on

                                      F-13
<PAGE>   44
December 31, 1996. This note was restructured and the final payment of $99,401
was paid on January 31, 1997.

The Company obtained a revolving credit facility from a lender under which the
Company may, at its option, borrow and repay amounts up to a maximum of
$3,432,000, of which $2,629,308 was outstanding at December 31, 1997. Borrowings
under this credit facility bear interest at prime plus 3%. The credit facility
is collateralized by trade accounts receivable and inventory and restricts the
Company from paying dividends in certain circumstances. In conjunction with this
credit facility, the Company obtained a term loan in the amount of $568,000
collateralized by certain machinery and equipment. This term loan bears interest
at prime plus 3% and is payable in equal installments of $15,777 per month
through January 1, 2001.

Subsequent to December 31, 1997, convertible debentures and accrued interest
thereon in an amount of $278,625 were converted into 236,380 shares of common
stock.

NOTE 8:  COMMITMENTS

LEASE COMMITMENTS

The Company leases equipment, included in fixed assets, under leases which are
classified as capital leases. Total payments under these capital leases are due
in monthly installments including imputed interest from 7.86% to 13.33% through
December 31, 2003. The Company occupies office space at various locations under
non-cancellable operating leases. Certain leases contain escalation clauses and
require the Company to pay its share of any increase in operation expenses and
real estate tax. Future minimum lease payments under the Company's capital and
non-cancellable operating leases are as follows:


<TABLE>
<CAPTION>
                                                                CAPITAL                    OPERATING
YEAR ENDING DECEMBER 31,                                         LEASES                      LEASES
                                                                 ------                      ------
<S>                                                            <C>                        <C>

1998                                                            $34,991                   $  475,544
1999                                                             19,133                      404,914
2000                                                             19,133                      388,414
2001                                                             19,133                      148,045
2002                                                              4,867                          ---
2003                                                              1,333                          ---
                                                                -------                   ----------
                                                                 98,590                   $1,416,917
                                                                (14,828)                  ==========
Less:  amount representing interest on capital leases           $83,762
Present value of future minimum capital lease payments          =======
</TABLE>


Long-term interest on capital leases amounted to $9,307, $4,271 and $6,315 for
the year ended December 31, 1997, the seven months ended December 31, 1996 and
the year ended May 31,1996, respectively. Total rental expense under the various
operating leases amounted to $623,010, $309,982 and $224,376 for the year ended
December 31, 1997, the seven months ended December 31, 1996 and the year ended
May 31, 1996, respectively.

NOTE 9:  CAPITAL STOCK

AUTHORIZED CAPITAL

The authorized capital of the Company consists of an unlimited number of common
shares without par value and an unlimited number of preferred shares without par
value, issuable in series.

COMMON STOCK

The issued common stock of the Company consisted of 9,816,877 and 8,050,401
shares as of December 31, 1997 and December 31, 1996, respectively. In October
1995, the Company effected a 1 for 5 reverse stock split. All per share
information has been adjusted to reflect the stock split. Basic loss per
share is calculated based on the weighted average number of common shares
outstanding during each period. Diluted net loss per share was equal to basic
loss per share in each of the periods presented as the effect of potentially
dilutive securities was antidilutive.

During the twelve months ended December 31, 1997, convertible debentures and
accrued interest thereon were converted into 1,219,727 shares of common stock.
Subsequent to December 31, 1997, convertible debentures and accrued interest

                                      F-14
<PAGE>   45
thereon were converted into 236,380 shares of common stock. If these conversions
had occurred on January 1, 1997, the reported net loss per common share for the
twelve months ended December 31, 1997 would have decreased $(.02) to $(.57) per
share.

PREFERRED STOCK

In March 1996, the Company issued 30,000 shares of Series A Convertible
Redeemable Preferred Stock ("Series A Preferred Stock"). The Series A Preferred
Stock had a Conversion Value, as defined, of $100 per share. The holder of each
share of Series A Preferred Stock was entitled to receive dividends at a rate of
8% of the Conversion Value per annum, such dividends to be cumulative from the
date of issuance. The holder of the Series A Preferred Stock had no voting
rights with respect to any vote of the common stockholders of the Company. The
Company may redeem any or all shares of Series A Preferred Stock at a redemption
price per share equal to the Conversion Value. The holder of any shares of
Series A Preferred Stock had the right to convert all or part into common stock
of the Company at $3.75 per share of common stock. As of September 30, 1996, the
holder of the 30,000 shares of Series A Preferred Stock had converted all shares
to common stock pursuant to the conversion terms.

NOTE 10:  STOCK OPTIONS AND WARRANTS

STOCK OPTIONS

The Company has historically granted non-qualified stock options to directors,
officers, employees and other parties which generally become exercisable
immediately and have expiration terms ranging from two to five years. The
options are granted at an exercise price that equals the fair market value on
the date each option is granted.

In November 1997, the Company adopted the 1997 Stock Option Plan ("1997 Plan")
under which a maximum aggregate of 1,000,000 shares were reserved for grant to
all eligible employees of the Company. The stock options granted under the 1997
Plan are exercisable at the fair market value of the common stock on the date of
grant with 25% vesting on each of the four successive anniversary dates from the
date of grant. The stock options have a term of ten years. In the year ended
December 31, 1997, a total of 240,000 stock options under the 1997 Plan were
granted and 760,000 stock options were available.

The following table summarizes the activity in common shares subject to options
for the relevant periods ended December 31, 1997:

<TABLE>
<CAPTION>
                                                  SHARES            OPTION PRICE RANGE
                                                  ------            ------------------
<S>                                            <C>                  <C>
BALANCE, MAY 31, 1995                             447,367             $4.05 - $14.58

     Granted                                      980,000             $3.00 - $6.00
     Exercised                                        ---                   ---
     Terminated                                 (113, 367)            $5.87 - $14.58
                                                ---------

BALANCE, MAY 31, 1996                           1,314,000             $3.00 - $10.95

     Granted                                      597,500             $3.50 - $4.00
     Exercised                                   (100,000)                 $3.00
     Terminated                                  (410,000)            $5.00 - $10.00
                                                ---------

BALANCE, DECEMBER 31, 1996                      1,401,500             $3.00 - $10.95

     Granted                                    1,395,000             $2.00 - $3.31
     Exercised                                        ---                  ---
     Terminated                                 (344,000)             $3.50 - $10.95
                                                ---------

BALANCE, DECEMBER 31, 1997                      2,452,500             $2.00 - $8.10
                                                =========
</TABLE>

The number and exercise price of all options outstanding have been retroactively
adjusted to recognize the effects of the 1 for 5 reverse stock split which was
approved by stockholders in October 1995. Options were exercisable with respect
to 1,532,500 shares at December 31, 1997. Subsequent to December 31, 1997, a
total of 70,000 options to purchase common shares with an exercise price of
$2.38 and an expiration date of March 2, 2001 were granted.

                                      F-15
<PAGE>   46
The Company adopted Financial Accounting Standard No. 123 entitled "Accounting
for Stock-Based Compensation" ("FAS 123") as of June 1, 1995. The provisions of
FAS 123 allow companies to either expense the estimated fair value of stock
options or to continue their current practice but disclose the pro forma
effects on net income and earnings per share had the value of the options been
expensed. The Company has elected to continue its practice of recognizing
compensation expense for its stock option and warrant incentive plans using the
intrinsic value based method of accounting and to provide the required pro
forma information for stock options and warrants granted after June 1, 1995.
Under the terms of the intrinsic value method, compensation cost is the excess,
if any, of the quoted market price of the stock at the grant date, or other
measurement date, over the amount an employee must pay to acquire stock. Had
compensation expense for the Company's stock options and warrants granted after
June 1, 1995 been determined based on the fair value at the grant dates for
awards under those plans, the Company's pro forma net loss and net loss per
share for the reported periods would have been as follows:

<TABLE>
<CAPTION>
                                  YEAR ENDED       SEVEN MONTHS ENDED      YEAR ENDED
                              DECEMBER 31, 1997    DECEMBER 31, 1996      MAY 31, 1996
                              -----------------    -----------------      ------------
<S>                           <C>                  <C>                  <C>
Net loss                        $ (5,422,652)        $ (6,491,603)        $ (9,444,651)
Compensation expense              (1,130,679)          (1,113,273)          (1,360,318)
                                ------------         ------------         ------------
Pro forma net loss              $ (6,553,331)        $ (7,604,876)        $(10,804,969)
                                ============         ============         ============

Pro forma loss per share        $      (0.71)        $      (1.08)        $      (2.70)
                                ============         ============         ============
</TABLE>


The effects on pro forma net loss per share of expensing the estimated fair
value of stock options and warrants are not necessarily representative of the
effects on reported net income for future years due to such things as the
vesting period of the stock options and warrants and the potential for issuance
of additional stock options and warrants in future years.

The fair value of options and warrants granted after June 1, 1995, used as a
basis for the above pro forma disclosures, was estimated at the date of grant
using the Black-Scholes option pricing model. The option and warrant pricing
assumptions include a dividend yield of 0%; an expected volatility of .787; a
risk free interest rate within a range of 5.84% to 6.38%; and an expected life
of half the period from grant to expiration.

The weighted average fair values and exercise prices are as follows:

<TABLE>
<CAPTION>
                                                            YEAR ENDED            SEVEN MONTHS ENDED         YEAR ENDED
                                                         DECEMBER 31, 1997        DECEMBER 31, 1996          MAY 31, 1996
                                                         -----------------        -----------------          ------------
<S>                                                      <C>                      <C>                      <C>
Weighted-average fair value per option granted                $1.53                     $2.02                    $2.09

Weighted-average exercise price per option granted            $2.34                     $3.51                    $3.88
</TABLE>


COMMON SHARE PURCHASE WARRANTS

The Company has granted common share purchase warrants to directors, officers
and other parties which become exercisable immediately and have expiration terms
ranging from one year to five years. The warrants are generally granted at an
exercise price that equals fair market value of the common stock at the date
each warrant is granted. However, certain warrants are granted with an exercise
price in excess of the fair market value of the common stock at the date each
warrant is granted. At December 31, 1997, the following warrants to purchase the
Company's common stock were outstanding:

                                      F-16
<PAGE>   47
<TABLE>
<CAPTION>
                             EXERCISE       EXPIRATION
              SHARES           PRICE           DATE
              ------           -----           ----
<S>          <C>            <C>            <C>
                  75,000      $ 4.63       December 4, 1998
                 500,000      $ 3.75       March 20, 1999
                 100,000      $ 3.65       May 16, 1999
                 281,100      $ 8.00       June 11, 1999
                   5,000      $ 4.75       November 30, 2000
                  75,000      $ 3.38       February 28, 1999
               ---------
               1,036,100
               =========
</TABLE>

The number and exercise price of all common share purchase warrants have been
retroactively adjusted to recognize the effects of the 1 for 5 reverse stock
split which was approved by stockholders in October 1995. Subsequent to December
31, 1997, a total of 70,000 warrants to purchase common shares with an exercise
price of $2.50 and an expiration date of February 26, 2000 were granted.

NOTE 11:  SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information for the relevant periods are summarized as
follows:

<TABLE>
<CAPTION>
                                                                                      SEVEN MONTHS
                                                                   YEAR ENDED             ENDED           YEAR ENDED
                                                                  DECEMBER 31,         DECEMBER 31,         MAY 31,
                                                                      1997                1996               1996
                                                                      ----                ----               ----
<S>                                                              <C>                 <C>                 <C>
Cash flow effects of changes in operating assets and
liabilities, net of acquisitions:
      Accounts receivable                                         $(3,007,716)        $  (202,709)        $  (395,301)
      Purchases of marketable securities                             (267,991)               --                  --
      Proceeds on sale of marketable securities                       306,816                --                  --
      Inventories                                                     245,341          (1,686,255)            402,985
      Prepaid expenses                                                (19,244)            (15,334)             27,651
      Accounts payable - trade                                      1,514,729             125,724             500,081
      Accrued liabilities                                              42,262             272,844             (31,892)
      Due to affiliate                                                158,282             100,192              60,129
      Dividends payable on preferred stock                            (86,667)               --                46,000
                                                                  -----------         -----------         -----------
                                                                  $(1,114,188)        $(1,405,538)        $   609,653
                                                                  ===========         ===========         ===========

Non-cash investing and financing activities:
   Conversion of convertible debentures to common stock           $ 2,742,753         $ 3,911,880         $ 4,814,655
   Conversion of preferred stock to common stock                         --             1,500,000           1,500,000
   Conversion of notes receivable to long-term investments               --                  --               120,063
   Capital lease obligations incurred                                    --                84,482                --
   Acquisition earn-out                                             1,264,776             380,656                --

Details of acquisitions:
   Fair value of assets acquired                                         --           $ 2,182,527         $ 7,513,966
   Liabilities assumed                                                   --              (147,160)         (1,728,801)
   Stock issued                                                          --                  --            (3,000,000)
   Note payable to seller                                                --                  --              (635,165)
   Deferred credit                                                       --            (1,035,367)               --
                                                                  -----------         -----------         -----------
   Cash paid for acquisition                                      $      --           $ 1,000,000         $ 2,150,000
                                                                  ===========         ===========         ===========

Cash paid during the period:
   Interest paid                                                  $   370,691         $    82,643         $    32,128
   Income taxes paid                                                     --                  --                  --
</TABLE>

                                      F-17
<PAGE>   48
NOTE 12:  INCOME TAXES

The Company accounts for income taxes under the liability method required by FAS
Statement No. 109, "Accounting for Income Taxes". Deferred income taxes reflect
the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes. For consolidated financial statement purposes, a change in
valuation allowance has been recognized to offset certain deferred tax assets
for which realization is uncertain. Significant components of the Company's
deferred tax liabilities and assets as of December 31 and May 31 are as follows:

<TABLE>
<CAPTION>
                                                      DECEMBER 31,        DECEMBER 31,             MAY 31,
                                                         1997                 1996                  1996
                                                         ----                 ----                  ----
<S>                                                  <C>                  <C>                  <C>
Deferred tax liabilities
   Inventory adjustment                               $       --           $       --           $    103,338
   Bad debt expense                                           --                   --                  5,136
                                                      ------------         ------------         ------------
Total deferred tax liabilities                                --                   --                108,474
                                                      ------------         ------------         ------------

Deferred tax assets
   Book over tax depreciation and amortization             303,813              286,523               11,794
   Inventory capitalization and reserves                   620,765              751,066              771,430
   Net operating loss carryforward                      12,954,863           10,546,180            7,702,742
   Investment reserves                                        --                206,966                 --
   Other                                                    85,383               80,223                9,066
                                                      ------------         ------------         ------------
Total deferred tax assets                               13,964,824           11,870,958            8,701,901
Valuation allowance for deferred tax assets            (13,964,824)         (11,870,958)          (8,593,427)
                                                      ------------         ------------         ------------
Net deferred tax asset                                        --                   --                108,474
                                                      ------------         ------------         ------------

Net deferred tax                                      $       --           $       --           $       --
                                                      ============         ============         ============
</TABLE>


There was no provision for income taxes in the year ended December 31, 1997,
seven months ended December 31, 1996 and the year ended May 31, 1996 as the
Company incurred losses in those years.

A reconciliation between federal statutory income tax rates and the effective
tax rate of the Company at December 31 and May 31 is as follows:

<TABLE>
<CAPTION>
                                                                         DECEMBER 31,          DECEMBER 31,           MAY 31,
                                                                             1997                  1996                1996
                                                                             ----                  ----                ----
<S>                                                                      <C>                  <C>                  <C>
US federal statutory benefit rate                                           (35.0)%              (35.0)%              (35.0)%
Tax net operating loss carryovers                                            39.0                 39.0                 39.0
US state tax benefit, net of federal income tax effect                       (4.0)                (4.0)                (4.0)
                                                                            -------              ------               ------
Effective rate on operating loss                                              ---                  ---                  ---
                                                                            =======              ======               ======
</TABLE>


The Company has US net operating loss carryfowards available at December 31,
1997 of approximately $33,200,000 for US tax purposes to offset income in future
years. These carryfowards will expire in the years 2000 through 2012, unless
previously utilized. The tax attributes identified above may be subject to
limitation arising from changes of ownership over the three year statutory
testing period. The Company has Canadian net operating loss carryforwards
available at December 31, 1997 of approximately $621,000; these carryforwards
will expire in the years 2003 and 2004 if not used.

In addition, the Company has future deductible research and development costs
for Canadian federal tax purposes of $480,000. These costs have an indefinite
carryover period.

NOTE 13:  RELATED PARTY TRANSACTIONS

Pursuant to the terms of the acquisition of XLCC in March 1996, XLCC leases a
manufacturing facility from an affiliate of XL Vision, Inc., the seller who is a
current stockholder of the Company. Additionally, XLCC and XL Vision, Inc.
provide certain administrative and manufacturing services to each other with
services charged on a reasonable basis. During the year ended December 31, 1997,
the seven months ended December 31, 1996 and the year ended May 31, 1996, XLCC

                                      F-18
<PAGE>   49
incurred $900,085, $674,407 and $302,244, respectively, of rental expense and
administrative services due to XL Vision, Inc. XL Vision, Inc. incurred $77,015,
$277,219 and $111,532, respectively, of rental expenses and administrative
services due to XLCC. The balance due to XL Vision, Inc. is $318,603 at December
31, 1997.

In April 1997, the Company loaned certain officers, directors and employees an
aggregate of $184,000 in order to purchase 92,000 shares of the Company's common
stock in a private transaction. The loans are secured by the common stock, bear
interest at 5.9% and are due April 30, 2000. At December 31, 1997, amounts
outstanding under these loans total $172,354 in principal and $6,831 in accrued
interest receivable.

The Company retained the consulting services of Corstone Corporation which
previously employed the current Chief Executive Officer and Chief Financial
Officer. The current Chief Executive Office and Chief Financial Officer have no
direct or indirect ownership interest in Corstone Corporation. These consulting
services included financial, legal and administrative services. The consulting
services had been provided to the Company during the twelve months ended
December 31, 1997, the seven month period ended December 31, 1996 and the year
ended May 31, 1996 both prior to and after the appointment of the current Chief
Executive Officer on May 15, 1996. Consulting fees paid to this entity were
$26,750, $150,000, and $329,000 during the twelve months ended December 31,
1997, the seven months ended December 31, 1996 and the year ended May 31, 1996,
respectively. Additionally, a finder's fee of $150,000 was paid to this
consulting firm in conjunction with the acquisition of XLCC in the year ended
May 31, 1996.

The Company paid management and consulting fees to entities affiliated with
certain officers and directors in an amount $527,373 for the fiscal year ended
May 31, 1996.


NOTE 14:  INDUSTRY SEGMENT AND GEOGRAPHIC AREA INFORMATION

The Company is in the business of providing security for voice and data
transmission over wireless systems, primarily to cellular phone users. In
addition, the Company develops, manufactures and markets a full line of secure,
ruggedized computer equipment. These products have been classified into the
following business segments:

Communications Security Products - Included are an integrated set of products
and services that provide a complete privacy solution for individuals,
corporations, government and law enforcement agencies and cellular carriers.

Computer Equipment - Included are a broad array of ruggedized computer equipment
communications systems and related services to the military and government and
law enforcement agencies, primarily through third party resellers and original
equipment manufacturers.

                                      F-19
<PAGE>   50
In the following tables, financial information is presented by industry segment
and geographic region.


<TABLE>
<CAPTION>
INDUSTRY SEGMENT DATA                             DECEMBER 31,         DECEMBER 31,          MAY 31,
                                                     1997                 1996                1996
                                                     ----                 ----                ----
<S>                                              <C>                  <C>                  <C>
Sales
         Communications security products        $  1,826,715         $    883,471         $  1,588,742
         Computer equipment                        13,851,952            7,705,374            3,396,294
                                                 ------------         ------------         ------------
                                                 $ 15,678,667         $  8,588,845         $  4,985,036
                                                 ============         ============         ============

Loss from Operations
         Communications security products        $   (269,142)        $ (1,830,906)        $ (5,205,988)
         Computer equipment                        (2,805,146)          (1,655,341)            (222,125)
         Corporate                                 (1,517,385)          (1,560,723)          (2,164,366)
                                                 ------------         ------------         ------------
                                                 $ (4,591,673)        $ (5,046,970)        $ (7,592,479)
                                                 ============         ============         ============

Identifiable Assets
         Communications security products        $    819,104         $    756,004         $  1,334,272
         Computer equipment                        12,349,194           11,306,491            7,093,937
         Corporate                                  2,782,978            1,013,487            2,699,354
         Non-consolidated investments                    --                513,500            1,194,302
                                                 ------------         ------------         ------------
                                                 $ 15,951,286         $ 13,589,482         $ 12,321,865
                                                 ============         ============         ============

Depreciation and Amortization
         Communications security products        $     37,683         $    210,991         $  1,042,187
         Computer equipment                           844,151              227,547               91,266
         Corporate                                    169,164               96,624               94,842
                                                 ------------         ------------         ------------
                                                 $  1,050,998         $    535,162         $  1,228,295
                                                 ============         ============         ============
Capital Expenditures
         Communications security products        $      7,326         $     34,484         $    123,137
         Computer equipment                           420,126              157,655               10,524
         Corporate                                     45,997                  286                2,246
                                                 ------------         ------------         ------------
                                                 $    473,449         $    192,425         $    135,907
                                                 ============         ============         ============



GEOGRAPHIC REGION DATA                           DECEMBER 31,         DECEMBER 31,              MAY 31,
                                                     1997                 1996                 1996
                                                     ----                 ----                 ----

Sales
         United States                           $ 12,583,557         $  7,877,913         $  4,985,036
         Canada                                     3,095,110              710,932                 --
                                                 ------------         ------------         ------------
                                                 $ 15,678,667         $  8,588,845         $  4,985,036
                                                 ============         ============         ============

Loss from Operations
         United States                           $ (3,999,957)        $ (4,496,970)        $ (7,592,479)
         Canada                                      (591,716)            (550,000)                --
                                                 ------------         ------------         ------------
                                                 $ (4,591,673)        $ (5,046,970)        $ (7,592,479)
                                                 ============         ============         ============

Identifiable Assets
         United States                           $  9,933,593         $  9,206,469         $ 11,127,563
         Canada                                     6,017,683            3,869,513                 --
         South America                                   --                513,500            1,194,302
                                                 ------------         ------------         ------------
                                                 $ 15,951,276         $ 13,589,482         $ 12,321,865
                                                 ============         ============         ============
</TABLE>


Included in United States sales are export sales of $3,986,814, $3,708,531 and
$2,326,063 for the twelve months ended December 31, 1997, the seven months ended
December 31, 1996 and the year ended May 31, 1996, respectively.

                                      F-20
<PAGE>   51
NOTE 15:  MAJOR CUSTOMERS

The Company operates in two major lines of business, the developing and
marketing of communications security products and the manufacturing and
marketing of computer equipment. Sales to major customers in the computer
equipment segment comprise of 9% and 9%, respectively of consolidated sales for
the twelve months ended December 31, 1997. Sales to two major customers in the
computer equipment segment comprise 30% and 25%, respectively, of consolidated
sales for the seven months ended December 31, 1996. Sales to three major
customers in the computer equipment segment comprise 25%, 20% and 9%,
respectively, of consolidated sales for the year ended May 31, 1996.

NOTE 16:  CREDIT RISK

Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally trade receivables. Concentration of credit risk
with respect to trade receivables exists at year end as approximately $2.4
million or 46% of the outstanding accounts receivable related to four customers.
The Company performs ongoing credit evaluations of its customers and maintains
allowances for potential credit losses which, when realized, have been within
the range of management's expectations.

NOTE 17:  EMPLOYEE 401(K) PLAN

The Company maintains an employee 401(k) plan. The plan, which covers all
permanent U.S. employees 21 years of age or older, stipulates that participating
employees may elect to contribute up to 20% of their total compensation to the
plan, not to exceed the maximum amount allowable by Internal Revenue Service
regulations. The Company matches these contributions in an amount up to 3% of
the employee's salary. Participants contributions vest immediately and Company
contributions vest over a six year period. Company contributions to the plan
charged to operations for the year ended December 31, 1997, the seven months
ended December 31, 1996 and the year ended May 31, 1996 totalled $77,030,
$55,784 and $38,721, respectively.

NOTE 18:  SUPPLEMENTAL INFORMATION OF RESULTS OF OPERATIONS

In conjunction with the change in fiscal year end from May 31 to December 31, as
follows is supplemental unaudited information of the results of operations for
the year ended November 30, 1996, a period in the previous fiscal year that best
approximates the current fiscal year period:

<TABLE>
<CAPTION>
                                                YEAR ENDED
                                                NOVEMBER 30,
                                                    1996
                                                    ----
                                          (Unaudited and Restated)
<S>                                       <C>
Sales                                            $11,816,319
Gross profit                                       3,202,748
Loss from operations                             (7,670,204)
Net loss                                        (10,042,290)
Loss per share                                       ($1.78)
</TABLE>



NOTE 19:  SUBSEQUENT EVENTS

In February 1998, the Company issued $1,000,000 of Series B Convertible
Redeemable Preferred stock ("Series B Preferred"). The Series B Preferred has no
voting rights and will pay a cumulative dividend of 10% per annum. After May 27,
1998 up to 25% of the Series B Preferred is convertible into common stock of the
Company at the lesser of $2.38 per common share or the average closing bid of
the Company's common for the five trading days preceding the conversion with up
to a further 25% convertible every thirty days thereafter. The Series B
Preferred is redeemable at the option of the Company at an amount equal to the
conversion value. Net proceeds to the Company were $900,000, after commission.

                                      F-21