<PAGE>   1


                                                                      EXHIBIT 13

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

OVERVIEW

Applied Innovation Inc. ("AI") develops, manufactures, and markets network
mediation and bridging products and related services to the telecommunications
industry. AI's products and services support the operation, maintenance,
administration and provisioning of a variety of switching and transmission
devices used by telecommunications providers to assist in the management of
their customer service network. AI's primary emphasis is on providing integrated
hardware and software solutions to companies in the telecommunications industry.

Through the AISwitch(TM) 180, AIscout(TM), AIflex(TM), AIM(TM), AIspy(TM), and
NEWEB(TM) series products, AI provides the data network needed to monitor and
maintain thousands of pieces of electronic equipment used to deliver
telecommunication services. Telecommunications providers continually upgrade and
expand the equipment they use to provide service to their customers. As each new
piece of equipment is installed, it is connected to a data-monitoring network
that is used to report alarms, gather performance information, provide test
access and reprogram equipment to establish, maintain and improve customer
service. The new equipment, along with the immense installed base of older
equipment, must be connected and integrated to efficiently communicate with the
data-monitoring network. AI's products perform this critical bridging and
mediation function.

COMPARISON OF 1999 TO 1998

Net sales of $49,524,000 for the year ended December 31, 1999 decreased 8% from
$53,628,000 from the prior year. The decrease in sales is largely attributed to
increased competition in markets served by the Company's AI Switch 180, and to a
lesser extent, temporary postponement of orders from certain customers as they
addressed year 2000 issues within their networks. Because of the Company's
concentration of sales to Regional Bell Operating Companies (RBOC's) and long
distance phone companies, a small number of customers have represented
substantial portions of AI's net sales. Two companies accounted for 42% of AI's
net sales in 1999. These two customers contributed 15% and 27% of net sales,
respectively.

Gross profit, as a percentage of net sales, was 58% in 1999, compared to 59% in
1998. The company expects 2000 gross profit, as a percentage of net sales, to be
lower than the 1999 percentage due to competitive pricing pressure in the
Company's markets. Additionally, the Company's recently introduced products have
lower selling prices and are expected to generate slightly lower gross margins
than the Company's products have historically achieved.

Research and development ("R&D") expenses decreased to $7,480,000 (15% of net
sales) in 1999 from $11,980,000 (22% of net sales) in 1998. The decrease was due
to a reduction in R&D expenses associated with Access Products Group ("APG")
development activities and related closure of the Raleigh, North Carolina
facility in September 1998. Excluding $6,263,000 of R&D related to APG
development activities in 1998, AI's R&D expenses increased in 1999 compared to
core product related expenses of $5,717,000 in 1998. This is a result of
increases in staffing to support product development and of resources allocated
to the investigation of potential new products and technologies. The Company
expects 2000 R&D as a percentage of sales to be generally consistent with the
1999 amount.

Selling, general and administrative expenses ("SG&A") decreased to $11,965,000
(24% of net sales) in 1999 from $14,428,000 (27% of net sales) in 1998. The
decrease in SG&A is primarily attributed to a reduction in selling costs and
marketing expenses, as well as rent and other costs associated with the
Company's terminated

<PAGE>   2

Access Products Group. The Company anticipates that SG&A expenses for 2000 will
be higher than 1999 due to increases in sales staff and marketing expenses.

A non-recurring charge of $3.8 million was recorded in 1998 to account for the
termination of the APG development activity. This charge is separately stated on
the Consolidated Statements of Operations and reflects all costs associated with
the termination of the APG. The charge includes $1.1 million of severance
related costs, a charge of $2.2 million to write down specific APG assets and
$0.5 million related to occupancy costs, asset moving costs and other associated
termination costs.

As a result of the above changes in sales and expenses, 1999 income from
operations increased to $9,162,000 from $1,183,000 in 1998. Income from
operations represents 19% of net sales in 1999, compared to 2% of net sales in
1998.

Other income decreased to $924,000 in 1999, versus $1,665,000 in 1998. Net other
income for 1998 included a reversal of a previously accrued third party sales
expense of $1,049,000.

Income before income taxes in 1999 was $10,086,000, compared to $2,848,000 in
1998.

The effective income tax rate was 31% in 1999 compared to 19% in 1998. Relative
to pre-tax income, the amount of tax credits for R&D activities was much higher
in 1998 than in 1999, resulting in a significantly lower effective income tax
rate in 1998 than in 1999.

Net income was $7,005,000, or $0.45 diluted earnings per share in 1999 versus
net income of $2,310,000, or $0.14 diluted earnings per share in 1998. The
diluted weighted average number of shares was 15,647,000 for 1999 compared to
15,963,000 for 1998.

COMPARISON OF 1998 TO 1997

Net sales increased to $53,628,000 for the year ended December 31, 1998 from
$46,661,000 for the year ended December 31, 1997, or an increase of 15%. Most of
the increase resulted from additional unit sales of AI's core product offering,
the AISwitch Series 180. Because sales are concentrated among the RBOCs, a small
number of customers have accounted for a substantial portion of AI's annual net
sales. Five companies accounted for 75% of AI's net sales in 1998. Each of these
five customers contributed between 11% and 21% of net sales. Net sales of the
terminated APG products were less than 1% of total net sales in 1998.

Gross profit increased to 59% in 1998 from 57% in 1997. The improved gross
profit for 1998 was due to higher production volume and cost improvement
programs implemented during 1998.

Research and development ("R&D") expenses decreased to $11,980,000 in 1998 from
$12,897,000 in 1997. The decrease was the result of a reduction in R&D
associated with AI's core product offering and the termination of the APG
development activities and related closure of the Raleigh, North Carolina
facility in September 1998. During 1998 and 1997 AI incurred $5,717,000 and
$6,361,000, respectively, in R&D expenses related to the core product offering
along with $6,263,000 and $6,536,000, respectively, in R&D expenses related to
the terminated APG development activity.

Selling, general and administrative ("SG&A") expenses decreased to $14,428,000
in 1998 from $15,091,000 in 1997. The decrease was primarily attributable to a
$740,000 expense in 1997 for accounts receivable determined to be not
collectible. This type of expense did not occur in 1998.


<PAGE>   3
A non-recurring charge of $3.8 million was taken in the third quarter of 1998 to
account for the termination of the APG development activity. This charge is
separately stated on the Consolidated Statements of Operations and reflects all
costs associated with the termination of the APG. The charge includes $1.1
million of severance related costs, a charge of $2.2 million to write down
specific APG assets and $0.5 million related to occupancy costs, asset moving
costs and other associated termination costs.

As a result of the above changes in sales and expenses, there was income from
operations of $1,183,000 in 1998 compared to a loss from operations of
$1,419,000 in 1997.

Net other income increased to $1,665,000 in 1998 compared to $401,000 in 1997.
Net other income for 1998 included a reversal of a previously accrued third
party sales expense of $1,049,000. Due to a change in the relationship regarding
how a third party is compensated for sales efforts related to AI's products,
both parties agreed that the previously recorded expense would not be paid. AI
previously expensed and accrued $746,000 in 1997 and $303,000 in 1998 related to
these sales efforts.

Income before income taxes in 1998 was $2,848,000 compared to a loss before
income taxes of $1,017,000 in 1997.

The effective income tax rate was 19% in 1998 compared to an income tax benefit
of 37% in 1997. The decrease in the effective income tax rate is the result of
AI receiving tax credits for R&D activities and job creation in the State of
Ohio.

Net income was $2,310,000, or $0.14 diluted earnings per share in 1998, compared
to a net loss of $637,000, or $0.04 diluted loss per share in 1997. The diluted
weighted average number of shares was 15,963,000 for 1998 compared to 15,786,000
for 1997.

LIQUIDITY AND CAPITAL RESOURCES

The Company had $19,071,000 of cash and cash equivalents and short- and
long-term investments at December 31, 1999 compared to $17,211,000 at December
31, 1998. During 1999, operating activities provided cash of $4,588,000.
Additionally, the Company purchased $1,193,000 of equipment to support
operations and purchased $7,162,000 of investment securities.

Net working capital was $22,928,000 at December 31, 1999 and the current ratio
was 4.1:1. AI had no debt in 1999 or 1998.

On October 21, 1999, the Board of Directors approved a one-year extension of the
Company's 1,000,000 share stock repurchase program originally adopted in October
1998. Under this program, the Company has repurchased 448,000 shares through
December 31, 1999, at an average per share price of $3.72.

AI's management believes that its current cash and equivalents and cash
generated from future operations will provide sufficient capital to meet the
business needs of AI through 2000.
<PAGE>   4
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Annual Report, including Management's Discussion and Analysis of Financial
Condition and Results of Operations as well as the Letter to Stockholders and
the discussion of AI's business contains various forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are
intended to be covered by the safe harbors created thereby. These
forward-looking statements include, but may not be limited to, all statements
regarding intent, beliefs, expectations, projections, forecasts, and plans of AI
and its management, and include statements regarding future sales and other
results of operations, any statements regarding the continued historical trends,
any statements regarding the sufficiency of AI's cash balances and cash
generated from operating activities, implementation and financing of the stock
repurchase program, and any statement regarding the future of the
telecommunications industry or AI's business. These forward-looking statements
involve numerous risks and uncertainties, including, without limitation, the
fact that AI may decide to substantially increase R&D expenditures to meet the
needs of its business and customers, currently unforeseen circumstances could
require the use of capital resources, and the various risks inherent in AI's
business and other risks and uncertainties detailed from time to time in AI's
periodic reports filed with the Securities and Exchange Commission, including
AI's Annual Report on Form 10-K. One or more of these factors have affected, and
could in the future affect, AI's business and financial results in future
periods and could cause actual results to differ materially from plans and
projections. Therefore, there can be no assurance that the forward-looking
statements included herein will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by AI, or any other person, that the objectives and plans of AI
will be achieved. All forward-looking statements made herein are based on
information presently available to the management of AI. AI assumes no
obligation to update any forward-looking statements.



<PAGE>   5



                             APPLIED INNOVATION INC.
                           Consolidated Balance Sheets
<TABLE>
<CAPTION>

                                                                                                 At December 31,
                                                                                                 ---------------
                                         Assets                                               1999            1998
                                         ------                                               ----            ----
<S>                                                                                   <C>              <C>
Current assets:
    Cash and cash equivalents                                                            $ 11,928,868    $ 17,211,499
    Short-term investments                                                                  1,794,581            --
    Accounts receivable, net of allowance of $317,547 in 1999 and $256,117 in 1998         10,990,025       7,698,250
    Inventory                                                                               3,913,432       3,620,655
    Other current assets                                                                      577,091         295,923
    Deferred income taxes                                                                   1,231,000       1,410,000
                                                                                         ------------    ------------
                      Total current assets                                                 30,434,997      30,236,327
                                                                                         ------------    ------------
Property, plant and equipment:
    Land                                                                                    1,639,303       1,639,303
    Building                                                                                4,986,714       4,875,476
    Equipment                                                                               5,984,287       6,238,173
    Furniture                                                                               1,974,332       1,949,575
                                                                                         ------------    ------------
                                                                                           14,584,636      14,702,527
    Less accumulated depreciation                                                           5,941,568       5,276,287
                                                                                         ------------    ------------
                      Property, plant and equipment, net                                    8,643,068       9,426,240
Investments                                                                                 5,347,377            --
Other assets                                                                                  168,887         107,106
                                                                                         ------------    ------------
                                                                                         $ 44,594,329    $ 39,769,673
                                                                                         ============    ============
                          Liabilities and Stockholders' Equity
                          ------------------------------------
Current liabilities:
    Accounts payable                                                                     $  2,224,460    $  1,051,922
    Accrued expenses:
       Warranty                                                                             1,877,731       2,644,738
       Income taxes                                                                         1,405,010       2,250,554
       Payroll and related expenses                                                           835,789       1,062,453
       Royalties                                                                              177,019         272,269
       Property taxes                                                                         364,361         382,315
       Access Products termination charge                                                     288,613         387,478
    Deferred revenue                                                                          333,682          11,261
                                                                                         ------------    ------------
                      Total current liabilities                                             7,506,665       8,062,990
Deferred income taxes                                                                            --            64,000
                                                                                         ------------    ------------
                      Total liabilities                                                     7,506,665       8,126,990
                                                                                         ------------    ------------
Stockholders' equity:
    Common stock, $.01 par value; authorized 30,000,000 shares; issued and outstanding
       15,371,932 shares in 1999 and 15,786,132 shares in 1998                                153,719         157,861
    Additional paid-in capital                                                              6,801,476       8,337,154
    Retained earnings                                                                      30,152,749      23,147,668
    Accumulated other comprehensive loss - net                                                (20,280)           --
                                                                                         ------------    ------------
                      Total stockholders' equity                                           37,087,664      31,642,683
                                                                                         ------------    ------------
                                                                                         $ 44,594,329    $ 39,769,673
                                                                                         ============    ============
</TABLE>


See accompanying notes to consolidated financial statements.



<PAGE>   6



                             APPLIED INNOVATION INC.

                      Consolidated Statements of Operations
<TABLE>
<CAPTION>

                                                                         Years Ended December 31,
                                                               -------------------------------------------
                                                                   1999            1998           1997
                                                               ------------    ------------   ------------
<S>                                                            <C>             <C>            <C>
Net sales                                                      $ 49,523,619    $ 53,627,516   $ 46,661,054
Cost of sales                                                    20,917,459      22,236,650     20,091,096
                                                               ------------    ------------   ------------
    Gross profit                                                 28,606,160      31,390,866     26,569,958
                                                               ------------    ------------   ------------
Operating expenses:
Selling, general and administrative                              11,965,059      14,428,447     15,091,470
Research and development                                          7,479,496      11,979,875     12,897,072
Non-recurring charge                                                   --         3,800,000           --
                                                               ------------    ------------   ------------
    Total operating expenses                                     19,444,555      30,208,322     27,988,542
                                                               ------------    ------------   ------------
    Income (loss) from operations                                 9,161,605       1,182,544     (1,418,584)
                                                               ------------    ------------   ------------
Other income (expense):
    Interest income                                                 992,665         614,705        535,409
    Other income                                                       --         1,049,100           --
    Gain (loss) on disposal of assets                               (68,189)          1,303       (134,020)
                                                               ------------    ------------   ------------
    Total other income, net                                         924,476       1,665,108        401,389
                                                               ------------    ------------   ------------
    Income (loss) before income taxes                            10,086,081       2,847,652     (1,017,195)
Income taxes                                                      3,081,000         538,000       (380,000)
                                                               ------------    ------------   ------------
    Net income (loss)                                          $  7,005,081    $  2,309,652   $   (637,195)
                                                               ============    ============   ============
Earnings (loss) per share:
    Basic earnings (loss) per share                            $        .45    $        .15   $       (.04)
                                                               ============    ============   ============
    Diluted earnings (loss) per share                          $        .45    $        .14   $       (.04)
                                                               ============    ============   ============
    Weighted average shares outstanding for basic earnings
      (loss) per share                                           15,598,143      15,804,608     15,786,332
                                                               ============    ============   ============
    Weighted average shares outstanding for diluted earnings
      (loss) per share                                           15,647,050      15,962,846     15,786,332
                                                               ============    ============   ============
</TABLE>


See accompanying notes to consolidated financial statements.



<PAGE>   7
                             APPLIED INNOVATION INC.

                 Consolidated Statements of Stockholders' Equity

<TABLE>
<CAPTION>
                                      COMMON STOCK
                                  ----------------------
                                    Number                  Additional   Deferred                        Accumulated
                                   of shares                  Paid-in     Compen-       Retained         other compre-
                                  outstanding    Amount       Capital     sation        Earnings         hensive loss    Totals
                                  -----------    ------       -------     ------        --------         ------------    ------
<S>                               <C>          <C>          <C>          <C>          <C>               <C>           <C>
Balance-December 31, 1996          15,764,632   $157,646     $8,360,502  $(51,501)     $21,475,211       $      --    $29,941,858

Stock options exercised                26,200        262         16,863        --               --              --         17,125
Tax benefit associated with
    exercise of stock options              --         --         29,693        --               --              --         29,693
Amortization of deferred
    compensation                           --         --             --    51,501               --              --         51,501
Net loss                                   --         --             --        --         (637,195)             --       (637,195)
                                   ----------   --------     ----------  --------      -----------       ----------   -----------
Balance-December 31, 1997          15,790,832    157,908      8,407,058        --       20,838,016              --     29,402,982

Stock options exercised                29,100        291         49,982        --               --              --         50,273
Tax benefit associated with
    exercise of stock options              --         --          8,079        --               --              --          8,079
Common stock repurchased              (33,800)      (338)      (127,965)       --               --              --       (128,303)
Net income                                 --         --             --        --        2,309,652              --      2,309,652
                                   ----------   --------     ----------  --------      -----------       ----------   -----------
Balance-December 31, 1998          15,786,132    157,861      8,337,154        --       23,147,668              --     31,642,683

Comprehensive income:
     Net income                            --         --             --        --        7,005,081              --      7,005,081
     Unrealized loss on
          investments, net                 --         --             --        --               --         (20,280)       (20,280)
                                                                                                                      -----------
Total comprehensive income                 --         --             --        --               --              --      6,984,801

Common stock repurchased             (414,200)    (4,142)    (1,535,678)       --               --              --     (1,539,820)
                                   ----------   --------     ----------  --------      -----------       ----------   -----------

Balance-December 31, 1999          15,371,932   $153,719     $6,801,476  $     --      $30,152,749       $ (20,280)   $ 37,087,664
                                   ==========   ========     ==========  ========      ===========       ==========   ============
</TABLE>


See accompanying notes to consolidated financial statements.



<PAGE>   8



                             APPLIED INNOVATION INC.

                      Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>

                                                                                    Years Ended December 31,
                                                                                    ------------------------
                                                                             1999            1998            1997
                                                                         ------------    ------------    ------------
<S>                                                                      <C>             <C>             <C>
Cash flows from operating activities:
    Net income (loss)                                                    $  7,005,081    $  2,309,652    $   (637,195)
    Adjustments to reconcile net income (loss) to net cash
       provided by operating activities:
           Depreciation                                                     1,883,381       2,658,968       2,448,009
           (Gain) loss on disposal of assets                                   68,189          (1,303)        134,020
           Provision for deferred compensation                                   --              --            51,501
           Deferred income tax expense (benefit)                               80,000        (477,000)         80,000
           Write down of assets related to termination of
                 Access Products development activity                            --         2,322,634            --
           Effects of changes in operating assets and liabilities:
              Accounts receivable                                          (3,291,775)      4,246,442      (4,298,175)
              Inventory                                                      (292,777)       (861,343)       (170,378)
              Other current assets                                           (281,168)          2,439         (27,751)
              Other assets                                                    (26,781)          6,990           3,340
              Accounts payable                                              1,172,538      (2,313,893)      1,848,624
              Accrued expenses                                             (2,051,284)      2,369,887         843,750
              Deferred revenue                                                322,421         (21,570)         32,831
                                                                         ------------    ------------    ------------
                      Net cash provided by operating activities             4,587,825      10,241,903         308,576
                                                                         ------------    ------------    ------------
Cash flows from investing activities:
    Purchases of property, plant and equipment                             (1,193,200)     (1,216,487)     (4,453,540)
    Purchases of available for sale investments                           (32,071,575)           --              --
    Maturities of available for sale investments                           11,478,082            --              --
    Sale of available for sale investments                                 13,431,255            --              --
    Proceeds from sale of property, plant and equipment                        24,802          60,878          15,210
                                                                         ------------    ------------    ------------
                      Net cash used by investing activities                (8,330,636)     (1,155,609)     (4,438,330)
                                                                         ------------    ------------    ------------
Cash flows from financing activities:
    Common stock repurchased                                               (1,539,820)       (128,303)           --
    Tax benefit associated with exercise of stock options                        --             8,079          29,693
    Proceeds from issuance of common stock                                       --            50,273          17,125
                                                                         ------------    ------------    ------------
                      Net cash provided (used) by financing activities     (1,539,820)        (69,951)         46,818
                                                                         ------------    ------------    ------------
Increase (decrease) in cash and cash equivalents                           (5,282,631)      9,016,343      (4,082,936)
Cash and cash equivalents-beginning of year                                17,211,499       8,195,156      12,278,092
                                                                         ------------    ------------    ------------
Cash and cash equivalents-end of year                                    $ 11,928,868    $ 17,211,499    $  8,195,156
                                                                         ============    ============    ============
SUPPLEMENTAL CASH FLOW DISCLOSURE:
    Income taxes paid                                                    $  3,846,544    $      1,232    $     75,801
                                                                         ============    ============    ============
</TABLE>




See accompanying notes to consolidated financial statements.



<PAGE>   9



                             APPLIED INNOVATION INC.
                   Notes to Consolidated Financial Statements

                           December 31, 1999 and 1998

   (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        The following accounting principles and practices of Applied Innovation
            Inc. and subsidiary (the Company) are set forth to facilitate the
            understanding of data presented in the consolidated financial
            statements:

              DESCRIPTION OF BUSINESS ACTIVITY

              The Company is a leading provider of network solutions for
                  telecommunications service providers. The Dublin, Ohio, based
                  company designs and manufactures products for network
                  management, protocol conversion, mediation and data
                  communication between network elements and operations support
                  systems. The Company's products enable operations systems to
                  manage all the elements in multivendor, multiprotocol
                  telecommunications networks. The majority of the Company's
                  customers are regional bell operating companies, long distance
                  phone companies and competitive access providers.

              PRINCIPLES OF CONSOLIDATION

              The consolidated financial statements include the accounts of
                  Applied Innovation Inc. and its wholly owned subsidiary. All
                  significant intercompany balances and transactions have been
                  eliminated in consolidation.

              CASH EQUIVALENTS

              Cash equivalents represent short-term investments with original
                  maturities of three months or less. At December 31, 1999 and
                  1998, cash equivalents of $10,080,163 and $11,524,611,
                  respectively, were invested in corporate notes and commercial
                  paper and taxable and tax exempt bonds with original
                  maturities of three months or less.

              INVESTMENTS

              Since the Company does not intend to hold its investments in debt
                  and equity securities until maturity and does not actively
                  trade the securities to maximize trading gains, the Company
                  classifies these securities as "available-for-sale" and,
                  accordingly, reports such securities at fair value plus
                  accrued interest. The fair value of debt securities is
                  determined from public quotations for such securities as of
                  the reporting date. Any temporary excess (deficiency) of fair
                  value over (under) the underlying cost of the investment, net
                  of taxes, is excluded from current period earnings and is
                  reported as unrealized gains (losses) as a separate component
                  of stockholders' equity.

              REVENUE RECOGNITION

              Sales revenue is recognized when products are shipped, except in
                  situations where the customer directs the Company to hold the
                  products. In such situations, revenue is recognized when all
                  other terms and obligations of the sale are met, including the
                  transfer of title and risk of loss. Field service revenue is
                  recognized as projects are completed. Revenue under annual
                  maintenance agreements is recognized straight-line over the
                  period of the agreement.

<PAGE>   10
              INVENTORY

              Inventory is stated at the lower of cost or market using the
                  first-in, first-out method.

              PROPERTY, PLANT AND EQUIPMENT

              Property, plant and equipment are recorded at cost. Depreciation
                  is provided on the straight-line method over the estimated
                  useful lives as follows:

<TABLE>
<CAPTION>

                                                         Lives (in years)
                                                         ---------------
<S>                                                          <C>
                           Building                             40
                           Equipment                            3-5
                           Furniture                             7

</TABLE>


              WARRANTY

              The Company warrants its products for a minimum of one year after
                  sale and up to five years as negotiated under contract.
                  Additionally, the Company may agree to repair, replace or
                  service its products beyond the warranty period. Accordingly,
                  the Company accrues the estimated costs of such warranties and
                  services.

              INCOME TAXES

              Income taxes are accounted for under the asset and liability
                  method. Deferred tax assets and liabilities are recognized for
                  the future tax consequences attributable to differences
                  between the financial statement carrying amounts of existing
                  assets and liabilities and their respective tax bases and
                  operating loss and tax credit carryforwards. Deferred tax
                  assets and liabilities are measured using enacted tax rates
                  expected to apply to taxable income in the years in which
                  those temporary differences are expected to be recovered or
                  settled. The effect on deferred tax assets and liabilities of
                  a change in tax rates is recognized in income in the period
                  that includes the enactment date.

              STOCK OPTION PLANS

              The Company applies the intrinsic value-based method of accounting
                  prescribed by Accounting principles Board ("APB") Opinion No.
                  25, Accounting for Stock Issued to Employees, and related
                  interpretations, in accounting for its fixed plan stock
                  options. As such, compensation expense would be recorded on
                  the date of grant only if the current market price of the
                  underlying stock exceeded the exercise price. Statement of
                  Financial Accounting Standards ("SFAS") No. 123, "Accounting
                  for Stock-Based compensation," established accounting and
                  disclosure requirements using a fair value-based method of
                  accounting for stock-based employee compensation plans. As
                  allowed by SFAS No. 123, the Company elected to continue to
                  apply intrinsic value-based method of accounting described
                  above, and has adopted the disclosure requirements of SFAS
                  123.

              RESEARCH AND DEVELOPMENT

              Research and development costs are expensed when incurred.
<PAGE>   11
              GENERAL CREDIT RISK

              The Company grants credit on open account to its customers,
                  substantially all of whom are in the telecommunications
                  industry.

              USE OF ESTIMATES

              The preparation of financial statements in conformity with
                  generally accepted accounting principles requires management
                  to make estimates and assumptions that affect the reported
                  amounts of assets and liabilities and disclosure of contingent
                  assets and liabilities at the date of the financial statements
                  and the reported amounts of revenue and expenses during the
                  reporting period. Estimates are used for, but not limited to,
                  the accounting for doubtful accounts, inventory obsolescence,
                  depreciation and amortization, sales returns, warranty costs,
                  taxes, and contingencies. Actual results could differ from
                  these estimates.

   (2)   INVENTORY

        Major classes of inventory at December 31, 1999 and 1998 are summarized
below:
<TABLE>
<CAPTION>
                                                                                       1999           1998
                                                                                       ----           ----
<S>                                                                              <C>            <C>
             Raw materials                                                       $   2,739,379  $   2,280,652
             Work-in-process                                                           142,030        235,062
             Finished goods                                                          1,192,023      1,264,941
                                                                                 -------------  -------------
                                                                                     4,073,432      3,780,655
             Reserve for obsolescence                                                 (160,000)      (160,000)
                                                                                 -------------  -------------
                                                                                 $   3,913,432  $   3,620,655
                                                                                 =============  =============
</TABLE>


   (3)   INVESTMENTS

        The fair values of all financial instruments, excluding investments,
            approximate carrying values because of short maturities of those
            instruments.

        The following summarizes the Company's investments in securities at
            December 31, 1999. The Company had no investments at December 31,
            1998.
<TABLE>
<CAPTION>
                                                                     Gross           Gross
                                                  Amortized       Unrealized      Unrealized       Fair
                                                    Cost             Gains          Losses         Value
                                               ----------------  --------------  -------------- ------------
<S>                                            <C>               <C>            <C>            <C>
              U.S. agency obligations               $1,935,335        $     50       $(45,703)  $ 1,889,682
              U.S. government obligations              277,064              --         (5,966)      271,098
              Corporate obligations                  4,171,350          44,923        (22,696)    4,981,178
                                               ----------------  --------------  -------------- ------------
              Total                                 $7,171,350        $ 44,973       $(74,365)  $ 7,141,958
                                               ================  ==============  ============== ============
              Reported as:
              Short-term investments                                                            $ 1,794,581
              Investments                                                                         5,347,377
                                                                                                ------------
              Total                                                                             $ 7,141,958
                                                                                                ============
</TABLE>

<PAGE>   12


        The Company's debt securities at fair market value mature as follows:
            $1,794,581 in less than one year, $4,216,794 after one year but less
            than five years, and $1,130,583 in five or more years.

   (4)   EARNINGS (LOSS) PER SHARE

        The calculations of earnings (loss) per share for the years ended
            December 31, 1999, 1998, and 1997 are based upon the weighted
            average shares outstanding during the periods and, when applicable,
            those stock options that are dilutive, using the treasury stock
            method. Reconciliations of the numerators and denominators of the
            basic and diluted earnings (loss) per share calculations follow:

<TABLE>
<CAPTION>

                                                                              Year ended December 31, 1999
                                                                     --------------------------------------------
                                                                        Income           Shares        Per share
                                                                      (numerator)     (denominator)     Amount
                                                                      -----------     -------------     ------
<S>                                                                   <C>               <C>            <C>
             Basic  earnings per share-
                   Net income available to common stockholders        $7,005,081        15,598,143     $    .45
                                                                                                       =========
             Effect of dilutive securities-
                 Stock options                                                --            48,907
                                                                     -----------        ----------
             Dilutive earnings per share
                 Net income available to common stockholders
                      including assumed conversions                   $7,005,081        15,647,050     $    .45
                                                                     ===========        ==========     =========
</TABLE>

<TABLE>
<CAPTION>
                                                                              Year ended December 31, 1998
                                                                      -----------------------------------------
                                                                        Income           Shares        Per share
                                                                      (numerator)     (denominator)     Amount
                                                                      -----------     -------------     ------
<S>                                                                   <C>               <C>            <C>
             Basic earnings per share-
                 Net income available to common stockholders          $2,309,652        15,804,608     $    .15
                                                                                                       =========
             Effect of dilutive securities-
                 Stock options                                                --           158,238
                                                                     -----------        ----------
             Diluted earnings per share-
                 Net income available to common stockholders
                    including assumed conversions                    $ 2,309,652        15,962,846     $    .14
                                                                     ===========        ==========     =========
</TABLE>

<TABLE>
<CAPTION>
                                                                              Year ended December 31, 1997
                                                                     ------------------------------------------

                                                                          Loss            Shares      Per share
                                                                      (numerator)     (denominator)     Amount
                                                                     -----------        ----------    ---------
<S>                                                                <C>                   <C>          <C>
             Basic and diluted loss per share                      $    (637,195)        15,786,332   $   (.04)
                                                                     ===========        ==========    =========
</TABLE>



        Stock options which are antidilutive under the treasury stock method
            have been excluded from the above earnings (loss) per share
            calculations.

   (5)   MAJOR CUSTOMERS

        Revenues to major customers comprised 42%, 75%, and 76% of net sales for
            1999, 1998 and 1997, respectively. The number of major customers
            previously referred to were two, five, and five for 1999, 1998 and
            1997, respectively, with trade accounts receivable balances of
            $3,173,344 and $4,746,738 at December 31, 1999 and 1998,
            respectively.

<PAGE>   13

   (6)   STOCK OPTION PLANS

        The Company's 1996 Stock Option Plan (the 1996 Plan) was adopted by the
            Board of Directors on February 1, 1996 and approved by the
            stockholders of the Company as of April 25, 1996, with 1,000,000
            shares of common stock reserved for issuance under the 1996 Plan.
            The 1996 Plan was amended by the Board of Directors and approved by
            the stockholders of the Company on April 23, 1998 to increase the
            shares available for issuance under the 1996 Plan from 1,000,000 to
            2,000,000. Options granted under the 1996 Plan may be either
            incentive stock options or nonstatutory stock options, with maximum
            terms of ten years. The exercise price of each incentive stock
            option must be at least 100% of the fair market value per share of
            the Company's common stock as determined by the Stock Option and
            Compensation Committee on the date of grant.

        Previously, the Company had adopted the 1986 Incentive Stock Option Plan
            and the 1986 Non-statutory Stock Option Plan (the 1986 Plans).
            Options granted under the 1986 Plans have maximum terms of ten
            years. The exercise price of each incentive stock option must be at
            least 100% of the fair market value per share of the Company's
            common stock as determined by the Stock Option and Compensation
            Committee on the date of grant.

        Tax benefits realized by the Company for deductions in excess of
            compensation expense under these plans are credited to additional
            paid-in capital.

        Effective March 1, 1997, the Company repriced all stock options
            outstanding with exercise prices exceeding the fair market value per
            share of the Company's common stock on that date. The stock options
            were repriced at $5, the fair market value on March 1, 1997.

        At December 31, 1999, there were 1,172,600 additional shares available
            for grant under the 1996 Plan. The per share weighted-average fair
            value of stock options granted during 1999, 1998, and 1997 was
            $2.36, $4.15, and $2.35, respectively, on the date of grant using
            the Black Scholes option-pricing model with the following
            weighted-average assumptions used for grants in the years ended
            December 31, 1999, 1998, and 1997, respectively: dividend yield of
            0% for all years; expected volatility of 71%, 71%, and 67%;
            risk-free interest rate of 6% for all years; and expected life of
            4.5, 4.5, and 4.2 years.

        The Company applies APB Opinion No. 25 in accounting for its plans and,
            accordingly, no compensation cost has been recognized for its stock
            options in the financial statements. Had the Company determined
            compensation cost based on the fair value at the grant date for its
            stock options under SFAS No. 123, including the impact of the
            options repriced in 1997, the Company's net income (loss) and
            earnings (loss) per share, net of related income tax effects, would
            have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
                                                                            1999           1998            1997
                                                                            ----           ----            ----
<S>                                                   <C>            <C>             <C>             <C>
                Net income (loss)                     As reported     $   7,005,081  $   2,309,652   $    (637,195)
                                                      Pro forma           6,519,016      1,877,467      (1,664,539)

                Basic earnings (loss) per share       As reported     $      .45     $      .15      $     (.04)
                                                      Pro forma              .42            .12            (.11)

                Diluted earnings (loss) per share     As reported     $      .45     $      .14      $     (.04)
                                                      Pro forma              .42            .12            (.11)
</TABLE>

<PAGE>   14
        Pro forma net income (loss) reflects only options granted since January
            1, 1995. Therefore, the full impact of calculating compensation cost
            for stock options under SFAS No. 123 is not reflected in the pro
            forma net income (loss) amounts presented above because compensation
            cost is reflected over the options' vesting period, and compensation
            cost for options granted prior to January 1, 1995 is not considered.

        A summary of stock option activity follows:

<TABLE>
<CAPTION>
                                                                               Number of         Weighted-average
                                                                                shares            exercise price
                                                                                ------            -------------

<S>                                                                            <C>              <C>
             Balance at December 31, 1996                                        702,400          $    10.26
                 Granted                                                       1,179,150                5.20
                 Exercised                                                       (26,200)                .65
                 Canceled/expired                                               (821,100)               9.98
                                                                               ---------
             Balance at December 31, 1997                                      1,034,250                4.96
                 Granted                                                         349,250                6.87
                 Exercised                                                       (29,100)               1.73
                 Canceled/expired                                               (409,750)               5.73
                                                                               ---------
             Balance at December 31, 1998                                        944,650                5.43
                 Granted                                                         515,000                3.68
                 Exercised                                                            --                  --
                 Canceled/expired                                               (354,350)               4.78
                                                                               ---------
             Balance at December 31, 1999                                      1,105,300                4.82
                                                                               =========
</TABLE>


<PAGE>   15



The following table summarizes information about options outstanding at December
31, 1999:
<TABLE>
<CAPTION>
                                             Options outstanding                        Options exercisable
                               -------------------------------------------------    --------------------------
                                                      Weighted-
                                                       average       Weighted-                       Weighted-
                                                      remaining       average                         average
                 Range of           Number of       contractual      exercise        Number of       exercise
              exercise prices        Shares             life           price          shares           price
              ---------------        ------          ----------        -----          ------           -----
<S>          <C>                   <C>               <C>             <C>             <C>             <C>
             $  3.44 - 4.81           388,750           6.8             $3.64           56,700         $3.48
             $         5.00           510,800           2.5              5.00          412,320          5.00
             $  5.63 - 6.81           145,750           5.6              6.46           35,150          6.33
             $  7.00 - 7.53            60,000           4.4              7.05           55,200          7.01
                                   ----------                                         --------
                                    1,105,300           4.6              4.82          559,370          5.13
                                   ==========                                         =========
</TABLE>


   (7)   DEFINED CONTRIBUTION PLAN

        The Company sponsors a defined contribution 401(k) and profit sharing
            plan that covers all eligible employees. Since October 1, 1999, the
            Company matched 50% of each participant's contribution, up to 6% on
            that participant's contribution. From April 1, 1998 to October 1,
            1999, the Company matched 35%, and prior to April 1, 1998, the
            Company matched 25%. The Company may also make profit sharing
            contributions at the discretion of the Board of Directors. For 1999,
            1998, and 1997, the profit sharing contribution was $250,000,
            $100,000, and $0, respectively, and the total expense related to the
            plan was $475,373, $329,918, and $141,798, respectively.

   (8)  INCOME TAXES

        Income tax expense (benefit) consists of:
<TABLE>
<CAPTION>

                                                  Current         Deferred        Total
                                                 -----------    -----------    -----------
<S>                                              <C>            <C>            <C>
                 Year ended December 31, 1999:
                     Federal                     $ 2,663,000    $    74,000    $ 2,737,000
                     State and local                 338,000          6,000        344,000
                                                 -----------    -----------    -----------
                                                 $ 3,001,000    $    80,000    $ 3,081,000
                                                 ===========    ===========    ===========
                 Year ended December 31, 1998:
                     Federal                     $   912,000    $  (438,000)   $   474,000
                     State and local                 103,000        (39,000)        64,000
                                                 -----------    -----------    -----------
                                                 $ 1,015,000    $  (477,000)   $   538,000
                                                 ===========    ===========    ===========
                 Year ended December 31, 1997:
                     Federal                     $  (460,000)   $    36,000    $  (424,000)
                     State and local                    --           44,000         44,000
                                                 -----------    -----------    -----------
                                                 $  (460,000)   $    80,000    $  (380,000)
                                                 ===========    ===========    ===========
</TABLE>


<PAGE>   16



        A reconciliation of income tax expense (benefit) at the expected
            federal statutory rate (34%) to income tax expense (benefit) at the
            Company's effective rates for continuing operations is as follows:
<TABLE>
<CAPTION>

                                                                           1999              1998           1997
                                                                           ----              ----           ----
<S>                                                                  <C>                   <C>           <C>
                 Computed tax at the expected federal statutory rate    $ 3,429,000        $968,000      $(346,000)
                 State and local income taxes, net of federal income
                    tax effect                                              223,000          29,000         43,000
                 Meals and entertainment expenses                            37,000          40,000         66,000
                 Research and experimentation credit                       (585,000)       (464,000)      (104,000)
                 Tax-exempt interest income                                 (33,000)        (36,000)       (43,000)
                 Other                                                       10,000           1,000          4,000
                                                                       --------------  -------------  ------------
                                                                        $ 3,081,000        $538,000      $(380,000)
                                                                       ==============  =============  =============
</TABLE>


        The tax effects of temporary differences that give rise to significant
            portions of the deferred tax assets and deferred tax liabilities at
            December 31, 1999 and 1998 are presented below:
<TABLE>
<CAPTION>
                                                                                           1999            1998
                                                                                           ----            ----
<S>                                                                                     <C>             <C>
                Deferred tax assets:
                    Warranty reserve                                                    $  695,000      $  979,000
                    Accounts receivable allowance                                          117,000          95,000
                    Inventory, principally due to additional costs inventoried for
                       tax purposes                                                        189,000         189,000
                    Access Products termination charge                                     107,000         144,000
                    Deferred revenue                                                       123,000              --
                    Property, plant and equipment, principally due to differences in
                       depreciation                                                         35,000              --
                    Other                                                                       --           3,000
                                                                                         ---------       ---------
                                      Total gross deferred tax assets                    1,266,000       1,410,000
                                                                                         ---------       ---------
                Deferred tax liabilities:
                    Property, plant and equipment, principally due to differences in
                       depreciation                                                             --          64,000
                                                                                         ---------       ---------
                                      Total gross deferred tax liabilities                      --          64,000
                                                                                         ---------       ---------
                                      Net deferred tax asset                            $1,266,000      $1,346,000
                                                                                        ==========      ==========
</TABLE>

        In assessing the realizability of deferred tax assets, management
            considers whether it is more likely than not that some portion or
            all of the deferred tax assets will not be realized. The ultimate
            realization of deferred tax assets is dependent upon the utilization
            of loss carrybacks or the generation of future taxable income during
            the periods in which those temporary differences become deductible.
            Management considers the scheduled reversal of deferred tax
            liabilities, projected future taxable income, and tax planning
            strategies in making this assessment. Based upon the level of
            historical taxable income and projections for future taxable income
            over the periods which the deferred tax assets are deductible,
            management believes that it is more likely than not the Company will
            realize the benefits of these deductible differences and, therefore,
            no valuation allowance has been provided.

<PAGE>   17

   (9)   OTHER INCOME

        In 1998, there was a change in the Company's business relationship with
            a third party regarding compensation to the third party for sales
            efforts related to the Company's products. The change in the
            relationship resulted in both parties agreeing that certain
            obligations due the third party by the Company would not be paid.
            The Company previously expensed and accrued $745,875 in 1997 and
            $303,225 in 1998 related to the sales efforts. As a result of the
            change, the Company reversed the accrued liability and recognized
            other income of $1,049,100 in the fourth quarter of 1998.

  (10)   LEASE COMMITMENTS

        The Company is obligated for office space in Colorado, North Carolina,
            and Texas under various operating leases, which expire over the next
            three years. The Company's North Carolina property is sublet through
            the term of the lease.

        Future minimum lease payments and related sublease receipts under the
            operating leases as of December 31, 1999 are:

<TABLE>
<CAPTION>
                                                                             Lease        Sublease
                           Year ending December 31:                         Payments      Receipts
                                                                            --------      --------
<S>                            <C>                                        <C>            <C>
                               2000                                       $    353,862   $(249,990)
                               2001                                            360,006    (249,990)
                               2002                                            110,986     (27,082)
                                                                          --------------------------
                           Total minimum lease payments                   $    824,855   $(527,063)
                                                                          ==========================
</TABLE>

        Total rent expense in 1999, 1998, and 1997 was $92,222, $349,889,
            and $283,040, respectively. Costs associated with the Company's
            North Carolina lease were accrued in 1998 as a component of the
            non-recurring charge. Accordingly, such costs have been excluded
            from 1999 rent expense.

  (11)   STOCK REPURCHASE PROGRAM

        On October 21, 1999, the Company's Board of Directors approved a one
            year extension of the Company's 1,000,000 share stock repurchase
            program originally adopted in October 1998. Under this program, the
            Company has repurchased 448,000 shares through December 31, 1999.



<PAGE>   18



  (12)   NON-RECURRING CHARGE

        In September of 1998, the Company terminated all product development
            and related activities of its Access Products Group due to an
            unsuccessful search for a strategic partner The termination resulted
            in a one-time non-recurring charge of $3.8 million which was
            recorded in the third quarter of 1998. This charge accounted for all
            costs associated with the termination of the Access Products Group,
            including the closing of the Raleigh, North Carolina facility. The
            charge resulted in $1.1 million of severance related costs, a charge
            of $2.2 million to write down specific assets and $.5 million
            related to occupancy and other associated termination costs.

  (13)   QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

        A summary of quarterly financial information follows (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
              1999                                          Q1           Q2          Q3           Q4
                                                        ----------   ----------  -----------  ----------
<S>                                                     <C>          <C>         <C>          <C>
              Net sales                                 $   10,854   $   12,523  $    11,779  $   14,368
              Gross profit                                   6,589        7,178        7,060       7,780
              Income before income taxes                     1,979        2,629        2,359       3,119
              Net income                                     1,267        1,682        1,510       2,547
              Net income per share                      $      .08   $      .11  $       .10  $      .16
</TABLE>
<TABLE>
<CAPTION>


              1998                                          Q1           Q2          Q3           Q4
                                                        ----------   ----------  -----------  ----------
<S>                                                     <C>          <C>         <C>          <C>
              Net sales                                 $   11,518   $   14,784  $    14,020  $   13,306
              Gross profit                                   6,653        8,272        8,422       8,044
              Income (loss) before income taxes               (176)         434       (2,101)      4,691
              Net income (loss)                               (116)         286       (1,386)      3,526
              Net income (loss) per share               $     (.01)  $      .02  $      (.09) $      .22
</TABLE>