SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-K

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

                  For the Fiscal Year Ended December 31, 1995

                         Commission File Number 0-8828

                                OPTELECOM, INC.
             (Exact name of registrant as specified in its charter)
                                    DELAWARE
                        (State or other jurisdiction of
                    incorporation or organization)52-1010850
                    (I.R.S. employer identification number)

                9300 GAITHER ROAD, GAITHERSBURG, MARYLAND 20877
               (Address of principal executive offices)(Zip code)

Registrant's telephone number, including area code:  (301) 840-2121.

Securities registered pursuant to Section 12(b) of the Act:  None.

Securities  registered  pursuant to Section 12(g) of the Act: Common Stock $0.03
Par Value.

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes X No ___

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulations S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

At March 26, 1996,  shares of the  registrant's  Common Stock,  $0.03 Par Value,
held by persons  other than  "affiliates"  of the  registrant  had an  aggregate
market value of $5,576,364, based on the average closing bid and asked prices as
reported by the National  Association of Securities Dealers Automated  Quotation
System for such date.

At March 26, 1996,  the registrant had  outstanding  1,394,091  shares of Common
Stock, $.03 Par Value.

                       DOCUMENT INCORPORATED BY REFERENCE

Part  III of Form  10-K --  Proxy  Statement  for the  1996  Annual  Meeting  of
Stockholders.

                                       1

<PAGE>



                                     PART I

Item 1.     BUSINESS

GENERAL

Optelecom,  Inc. (the Company) is a Delaware  corporation  that was organized in
1972. The Company's business consists primarily of the development, manufacture,
and sale of fiber optic communications products and laser systems for commercial
and military customers.

The Company is  organized  into three  operating  divisions;  the  Research  and
Development  Division,  which  addresses  primarily  Government-related  defense
business; the Communications  Products Division (CPD), which sells optical fiber
based data communication equipment to the commercial marketplace;  and the GLINT
Division,  which is exclusively  focused on business derived from  manufacturing
and support of the semiconductor  laser  illuminator  system for the GLINT night
vision system used on the US Air Force C-130 Gunship.

Fiber optic communication  equipment, the main thrust of the Company's sales, is
an area of unprecedented growth and change.  Technology is developing capability
for ever  increasing  data rates over ever greater  distances.  At the same time
prices of equipment are  decreasing.  The demand for  transmission of high fiber
data rates is increasing even faster.

Most signals,  voice, video and data are in electrical form. The transmission of
electrical  signals  from one point to  another  by  converting  them to optical
(light)  signals has many  advantages  over  electrical  transmissions.  Optical
fibers can  transmit  signals at a much  greater  data rate,  over a much larger
distance and without  disturbance  from electric  machinery,  lightning or other
noise sources.

The  fiber  optic  communication  business  has  many  parts.  A  few  companies
manufacture  optical fiber,  while many more  manufacture  optical fiber cables.
Optelecom  participates  by providing the equipment that  interfaces  electrical
signals to optical signals at the transmitter end of a fiber optic communication
link and provides  complementary  equipment that converts the optical signals to
electrical form at the other end of the communications link. Optelecom sells its
equipment to users of these communication  systems or to system integrators that
install the Company's equipment in large communication nets.

There are a larger number of communication  applications  that require different
communication rates, distances and signal formats.  Optelecom provides equipment
specialized for  transmission of various  combinations of voice,  data and video
required to meet the standards for a range of applications.

The  Company  also  addresses  U.S.   Government  defense  related  markets  for
specialized and proprietary  applications of fiber optic technology that make it
unique among  traditional  fiber optic  communication  equipment  manufacturers.
While  government  business  can  provide  an offset to  periodic  cycles in the
commercial  sector, it is also subject to changing world conditions.  Therefore,
the Company attempts to balance  revenues  generated by both types of markets to
avoid severe changes in its business  posture.  The Company is unable to predict
future  Defense  business  activity  or the  related  impact  on  the  Company's
business.

Because of the  advanced  nature of the  technology  inherent  in the  Company's
products,  the expertise of certain of the  Company's  officers and directors is
one of its principal assets. In particular, Dr. William H. Culver and Mr. Edmund
D. Ludwig, who are officers and directors of the Company, provide the Company

                                       2

<PAGE>



with important technical  expertise and have major  responsibilities in managing
the Company.  Although the Company pays for and is the beneficiary of a $300,000
insurance  policy on the life of each of such persons,  the loss of the services
of either of them,  through death or otherwise,  could have a negative impact on
the Company.  Furthermore,  because of the Company's  relatively small size, the
loss of the  services of certain  other key  employees  could have a  disruptive
effect on the Company's operations.

On March 13, 1996, the Company had 53 employees.

The table below displays the Company's  three-year  revenue and operating income
(loss) by division.

<TABLE>
<CAPTION>
                                     1995                                    1994                                   1993
                  -------------------------------------------------------------------------------------------------------------
Operating                                Income                                 Income                              Income
Divisions           Revenue              (Loss)              Revenue            (Loss)            Revenue           (Loss)
<S>                 <C>                 <C>                 <C>               <C>                <C>               <C>
Company             $6,430,136          $(427,427)          $7,036,069        $ 412,690          $7,083,229        $ 237,868
 Totals

CPD                 $5,319,556          $(470,866)          $5,562,130        $ 174,084          $4,729,781        $ (81,530)

R&D                 $  395,284          $(263,930)          $  554,542        $(175,589)         $  414,170        $(418,960)

GLINT               $  715,296          $ 307,369           $  919,397        $ 414,195          $1,939,278        $ 738,358

</TABLE>

See Note 13 to the financial statements for identifiable assets by segment.

RESEARCH AND DEVELOPMENT DIVISION (R&D)

INTERFEROMETRIC FIBER OPTIC GYROS (IFOGS)

The R&D Division's  business  consists of providing  technology  development and
engineering services to the U.S. Government and its prime contractors, primarily
in  the  field  of  investigating  techniques  for  design  and  manufacture  of
specialized  sensing coils for fiber optic gyros.  A small portion of revenue is
also  derived  from  sales  of  custom  optical  fiber  coils  for  sensing  and
communication applications.

In  1995,  the  division's  activities  continued  to be  primarily  focused  on
interferometric   fiber  optic  gyros  (IFOGs),   which  are  rotation   sensing
instruments that are expected to replace mechanical and laser gyros in aircraft,
missiles,  and other  vehicles.  Optelecom  has used its  expertise  in  winding
high-speed  payout  coils for fiber optic  guided  missiles  to develop  winding
technology for IFOG coils, and to manufacture these coils in limited production.
These complex  coils present key technical and cost  challenges to the future of
IFOG viability.

In prior years,  the R&D division's  activities and major source of revenue were
concentrated on fiber optic missile payout technology,  payout experiments,  and
field demonstrations.  These activities lead to the development of the IFOG coil
winding  capability  and  products.  The U.S.  Department  of Defense  (DoD) has
identified   the  IFOG  as  a  critical   technology   that  will  benefit  from
manufacturing  technology  (MANTECH)  funding and, in 1993, had authorized a $15
million Air Force MANTECH program. In November,  1993, Optelecom was notified by
Litton  Industries  that Litton had been selected as the winning  contractor for
the MANTECH program.  A subcontract with Optelecom was negotiated to perform key
IFOG sensing coil manufacturing  technology development tasks on the program. In
the first  quarter of 1994,  work on this  contract  was  minimal,  awaiting the
resolution  of  various  contractual  issues  between  Litton and the Air Force.
Significant application of effort began during the second quarter and had

                                       3

<PAGE>



continued throughout the year. However, in February 1995, Optelecom was informed
by Litton that the  subcontract was terminated due to redirection of the MANTECH
effort to more pressing technological problems. For 1994, the Company had booked
a $35,000 reserve for  unrecoverable  costs related to this  termination.  These
costs were subsequently recovered in 1995, and were part of the $112,524 revenue
contributed  by this  contract  prior to  termination  of effort.  This contract
termination had a negative effect on divisional revenues in the first quarter of
1995,  and through the balance of the year,  since a major portion of the year's
planned work was associated with the contract.  Although the Company expected to
receive  new  contract  funding  in the  amount of  $261,985  from the  Advanced
Research Projects Agency (ARPA) for similar work beginning in the second quarter
of 1995, award was delayed until the third quarter and was initially funded at a
much lower level than originally  anticipated.  Full-scale funding did not begin
until late in the fourth quarter of 1995. A $127,836  contract for related fiber
optic gyro coil winding work was  received  from a team of Honeywell  and Smiths
Industries  beginning  in  August,  1995.  Both the  ARPA  and  Honeywell/Smiths
contracts are  continuing in 1996 and represent the entire  Division  backlog of
$221,000.  In May,  1995, a $58,176 Phase I Small Business  Innovative  Research
(SBIR)  contract was received to investigate  the  technological  feasibility of
fabricating  an  optical  switch  based on a  piezo-electric-generated  focussed
acoustic wave acting on a fiber grating structure. The work on this contract was
completed in  November,  1995.  Potential  follow-on to this work could occur if
Optelecom can identify a business partner who would be willing to share the cost
risk with the  Government  to develop the  concept  into a  commercially  viable
product. We are currently seeking such a partner.

FIBER OPTIC GUIDED MISSILES AND ROBOTIC VEHICLES

This  business  segment has seen a  continuing  reduction  in revenue  from 1990
levels. This reduction is a result of the lower level of activity in the Defense
Department  for new weapon system  development,  and the Company's  inability to
establish a significant business base in this area. In January,  1995, a $16,800
contract was received from  Allied-Signal to analyze fiber payout dynamics for a
fast-reaction,  close range,  anti-air  threat  defense  missile.  This work was
completed in July, 1995. Other revenues amounting to $2,876 were received from a
foreign  company  for   investigation  of  historical  fiber  payout  technology
development related to patent issues.  There was no backlog at year-end 1995 for
this activity.

GLINT DIVISION

The division  derives its revenues  entirely  from the U.S.  Government  and its
agencies. GLINT is an acronym associated with the U.S. Air Force's C-130 Gunship
laser  illuminator  system supported by Optelecom.  By February,  1995, work was
completed on a $1,315,000 contract which was received in 1994 to fabricate spare
laser array assemblies to support the system.  This effort contributed  $123,849
to 1995  revenues.  In late 1994,  the Division  received a $67,465  contract to
explore  the  feasibility  of  fabricating  a new  type of  semiconductor  laser
illuminator,  which,  if  successful,  could  lead to a  contract  to  develop a
replacement  illuminator  for the  existing  system.  Work on this  contract was
successfully completed in August, 1995, and marketing activities are on-going to
find  applications  for the new  technology.  Also,  in April  1995,  a $409,032
contract to fabricate spare laser array  assemblies was received;  this contract
was completed in October, 1995.

Due to the nature of the  application of this system,  contractual  revenues are
dependent on government budgets, the worldwide political situation, and specific
crew training schedules.  Although there was no backlog at the end of 1995, this
division   expected  to  receive  revenue  by  expanding  its  support  role  on
refurbishment  and repair of existing  laser  illuminator  systems for the C-130
Gunship  application  until a new system is  deployed.  In  January,  1996,  the
Company  received a $6.5  million,  four-year  contract (one base year and three
one-year options) to furnish refurbishment services. Currently funded first year
work  will  exceed  $1.0  million,   and  the  Company  anticipates   additional
refurbishment requirements in the succeeding years.

                                       4

<PAGE>



COMMUNICATION PRODUCTS DIVISION (CPD)

In 1995,  CPD order  booking and  shipment  levels  declined  slightly,  and the
division incurred a loss.

Business Activity           1995              1994             Change
Order Booking           $5.36 million     $5.95 million         -10%
Shipments               $5.32 million     $5.57 million          -5%

The year-end backlog was $724,179, down from $929,000 at year-end 1994.

PRODUCT MIX SALES ANALYSIS

Revenues from sales of data products  decreased  significantly from 1994, due to
our increased  emphasis on video products for the traffic control market.  Also,
shipments of satellite ground link units ceased, due to a premature  termination
of system  installations  by the system prime.  This termination was caused by a
major  down-sizing  implemented by the prime's  customer,  a major shopping mall
retailer.  Sales of RGB video links (i.e.,  Red,  Green,  Blue - a  transmission
standard  for high  quality  video  displays)  were  stable and are  expected to
increase in 1996 with the development of a very-high resolution system. Products
transmitting  standard  video  using  Optelecom's  proprietary  pulse  frequency
modulated  (PFM)  technology  continued to accelerate  their sales growth due to
installation  of systems in new municipal  markets  around  Boston,  and several
cities in Texas,  Georgia,  and  Florida.  Sales of ancillary  products  such as
cables,  connectors,  and  custom-engineered   communication  products  declined
slightly,  as standard  system  configuration  sales became more  dominant.  The
following table summarizes sales by product line to total sales:

Communication Fiber Optic Product Categories   1995     1994     1993
Data Transmission Products                      32%      47%      55%
High Resolution RGB Video                        9%       8%      11%
Standard PFM Video                              50%      33%      20%
Cables/Connectors                                2%       3%       4%
Other                                            7%       9%      10%


MARKET MIX ANALYSIS

The mix of CPD product sales for different  market  segments over the last three
years was as follows:

Markets                                        1995     1994     1993
Government                                      11%      23%      30%
Process Control and Industrial                  18%      11%      23%
International                                   16%      17%      12%
Domestic Resellers                              55%      49%      35%


The  proportion  of sales to  government  organizations  was  reduced  by 12% as
defense  spending  continued to decline.  Process  control and industrial  sales
increased, primarily due to increased sales to our major

                                       5

<PAGE>



OEM customer. International sales decreased slightly; in 1994, one sale to Korea
represented  a  significant  portion of the total,  which  distorted  the modest
steady  progression of increasing sales in prior years. In 1995, sales were more
evenly  distributed  throughout  the  countries  where  we  had  representation.
Currently,  Optelecom has a sales presence in 22 countries through  distributors
and resellers. Revenue from domestic resellers increased 6% and now represents a
majority of total sales. This is due primarily to our efforts to increase market
share in the traffic control and surveillance market.

CUSTOMER MIX ANALYSIS

The mix of customer  types changed  compared to 1994.  OEM  (Original  Equipment
Manufacturers - sales of products to be included in a customer's  product) sales
as a percent of total revenue decreased to 21%, compared to 40% in 1994, and 28%
in  1993.  Of the  total  revenue,  43% was  generated  by  sales  to the top 10
customers for the division;  in 1994 the figure was 53%. This  continued a trend
of a slight shift to a larger pool of customers with smaller  individual  system
requirements.  The largest  single  customer was an OEM account  which  provided
$710,000 of  revenue,  compared  to  $650,000  in 1994.  Other  major  customers
included  organizations  such as AT&T $(230,000) and Physical Optics Corporation
$(115,000).

FINANCIAL INFORMATION RELATING TO COMPANY
SPONSORED RESEARCH AND DEVELOPMENT              1995          1994        1993

Expenditures on Company sponsored research
and development activities                    $538,977      $477,089    $479,888


Research  and  development  of new fiber optic  communication  products is a key
component of the Company's overall business  strategy.  This research is focused
on existing product  improvement and enhancement,  and on adaptation of existing
products to alternative uses. Research into new product technology is focused on
the utilization of fiber optic technology in markets not previously addressed by
the Company's current product offering or development contracts.  During 1995, a
new fiber optic  modem,  compatible  with the 802.4  communication  protocol and
meeting  Electro-magnetic  Compatibility  requirements  as defined  in  European
Directive 89/336/EEC,  was designed,  developed, and qualified for our major OEM
customer.   Beginning   in  1996,   this  modem,   with   improved   performance
characteristics  and a lower cost  design,  will  replace an existing  Optelecom
design  supplied to the customer over the past several  years.  CPD  Engineering
continued  to add  products to the family of systems  developed  for fiber optic
communication  equipment for highway video surveillance and traffic sign message
control. A new, lower cost chassis configuration,  the System 9000, was designed
and introduced. This system will incorporate high-performance,  low cost modules
which  allow the user to  specifically  configure  the  chassis to  provide  the
communication  services required. A prototype ultra-high  resolution Red, Green,
Blue (RGB) communication system was delivered to a customer for evaluation in an
air-traffic  control  application.   Also,   development  work  continued  on  a
Compressed Digital Video system which will have applications in a variety of our
existing and proposed markets.

                                       6

<PAGE>



MARKETING

R&D DIVISION

The division  markets its services to both Government and commercial  customers;
however,  for the past  four  years  essentially  all of its  business  has been
obtained from the Government and its prime contractors.  Successfully  marketing
new  technology  initiatives  directly to the  Government  is  difficult  due to
increased   competition  from  larger  companies  with  far  greater  resources.
Traditionally,  R&D has concentrated on markets providing  research and products
used in fiber optic communication systems for airborne missiles,  ground robotic
vehicles and underwater sensors.  Optelecom had historically  received contracts
from certain key  Government  organizations  whose  budgets have been reduced in
recent  years;  there are few new  development  opportunities  available  in the
technology  areas  pertinent  to the  Company's  expertise.  As a result  of the
utilization of IFOG sensing coil  technology  developed by Optelecom in 1993 and
our prior  experience  with the  development  of fiber  coils for high speed for
payout, we identified  opportunities for the R&D Division in the area of optical
fiber gyro coil winding.  Gyro coils are a defense  related  Government  program
area which we see as receiving  continued focus amid shrinking Defense spending.
Additional  opportunities  to diversify into commercial  markets for fiber optic
amplifiers,  sensors,  and similar components,  have been identified as well. We
continue to seek to develop new markets for R&D  services  and products in these
technical areas.

COMMUNICATION PRODUCTS DIVISION

In  mid-1995,  CPD's  marketing  activities  were  reorganized  to provide  more
emphasis on sales  activities.  A new Director of Sales and Marketing was hired,
the sales function was  emphasized,  and several  personnel were  re-assigned to
direct sales  activities.  An examination of the  effectiveness of outside sales
representative  firms in the U.S. indicated that only a few firms were providing
adequate  value  for  the  commissions  paid.  Therefore,   most  representation
agreements  were  terminated.  The two sales  representative  firms added in the
southeast  region of the U.S in 1994 were  retained,  and a firm in the New York
City area was added.

Since  1992,  CPD has  used  selected  sales  representative  firms  in  foreign
countries  to  promote  and  sell  our  products.  These  firms  have  gradually
established awareness of our products in their respective countries, and we have
seen a trend of increasing business from foreign sources.

GLINT

The only customer for this division is the  Warner-Robins  Air Logistics Support
Center  of  the  U.S.  Air  Force.  Optelecom  maintains  a very  close  working
relationship   with  the  individual   component   item  managers   assigned  at
Warner-Robins.  We insure that these customer support personnel fully understand
Optelecom's  capabilities  and capacity to perform the required  work.  Bids are
carefully reviewed to be sure that the customer's requirements are satisfied.

                                       7

<PAGE>



MANUFACTURING PROCESSES

COMMUNICATION PRODUCTS DIVISION

The Company performs specialized  manufacturing,  assembly,  and product testing
functions in its corporate headquarters.  In past years, routine fabrication had
been subcontracted to other  manufacturers.  During 1995, the Company purchased,
installed  and placed  into  service  equipment  which  automatically  assembles
components onto printed  circuit boards at high speed.  This action was taken to
lower manufacturing costs and reduce the time-to market for new product designs.
The success of this decision has been apparent in the significant  manufacturing
cost  reduction  realized on all assemblies  produced  using the equipment.  The
Company  also  maintains a quality  assurance  function  and  testing  area that
performs optical and electrical testing,  and quality control. Raw materials and
supplies used in the  Company's  business  include  optical  materials,  plastic
products,  and various electronic  components,  most of which are available from
numerous  sources.  The number of  companies  from which the division can obtain
optical  emitters and  detectors  for use in its circuit  assemblies is limited,
however,  Optelecom has negotiated long-term supply contracts with these vendors
and does not anticipate significant supply problems.

R&D DIVISION

In 1991, the Company  developed a winding  machine to fabricate coils of optical
fiber wound in very  specific  configurations  for fiber gyro systems for Smiths
Industries. Additional work in this area through 1995 was conducted to develop a
winding machine concept  directed  toward  automated  techniques for fabricating
similar  fiber gyro  coils.  The  number of  companies  from which the  division
obtains raw materials and optical  fiber is limited;  however,  the Company does
not anticipate any problems with adequate supplies.

GLINT DIVISION

Optelecom has established a specialized facility adjacent to its headquarters to
support  fabrication  and  repair  operations  for the GLINT  laser  illuminator
system.  The processes used to fabricate laser modules for the laser illuminator
system are proprietary to Optelecom and depend on sophisticated understanding of
specific semiconductor  processing  techniques.  Proper use of the equipment and
materials  associated with these activities  depends on highly skilled personnel
whose  technical  knowledge is key to the  successful  fabrication  of the final
product.  The number of companies from which the division  obtains raw materials
is limited;  however the company does not  anticipate any problems with adequate
supplies.

COMPETITION

The Company's  products fall within three (3) separate and distinct markets.  As
such, the  characteristics  of competition in these markets differ greatly.  The
market that the Research & Development Division addresses is dominated by larger
Defense   prime   contractors.   These   companies   have   greater   marketing,
manufacturing,  financial,  research, and personnel resources than Optelecom. In
addition,  as Department  of Defense  contracting  activity has declined,  these
companies  have started to compete in markets which were  previously  limited to
companies with resources similar to Optelecom's.  As a result,  this Division is
at  a  competitive   disadvantage  when  competing  against  prime  contractors.
Optelecom  does feel that its IFOG coil winding  technology is at least equal to
the technology developed by much larger prime contractors and in this market, it
can compete equally.

                                       8

<PAGE>

Optelecom's Communication Products Division competes mainly with other companies
of roughly equal size, having similar  resources.  For low technology  products,
such as fiber optic data modems,  competition is intense, as these products have
reached a commodity  status.  In the areas of engineering  products for specific
applications,  Optelecom  competes against companies of the same size or larger.
Competitors with larger research staffs have an advantage in these markets.

The GLINT Division is a sole-source  provider of the products it supplies to the
U.S. Air Force. Optelecom is not aware of any competition in this market.

SEASONALITY

The Company's products are based on fiber optic technology. As such, seasonality
does not materially affect our revenues.

PATENTS

The Company  holds  certain  patents;  however,  its  business as a whole is not
materially  dependent  upon its ownership of any one patent or group of patents.
The Company does not license any patents from other parties,  nor is it aware of
any restrictions on its current business imposed by patents of other parties.

CONTRACT RENEGOTIATION AND TERMINATION

None of the  Company's  current  contracts  are subject to price  renegotiation.
However,  the Company's contracts with the U.S. Government are always subject to
termination, which is a standard clause in any contract with the government. The
subcontract from Litton Systems was terminated in February, 1995.

Item 2.     PROPERTIES

In 1992,  the Company  moved its  operations  to new leased  facilities  at 9300
Gaither  Road,  Gaithersburg,  Maryland,  near  Washington,  DC. The  facilities
consist of space in two adjacent  buildings,  one occupying  21,000 square feet,
with a ten-year lease term, beginning September 1, 1992, and the other occupying
4,000 square feet,  with a one-year term,  beginning in December,  1992, and two
one-year  options.  Current  monthly  rent is $15,550 on the larger  space,  and
$2,236 on the  smaller  one.  All of the  facilities  are in good repair and are
adequate for the Company's current production requirements.

Item 3.     LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings.

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

No  matters  were  submitted  during  the  fourth  quarter  of 1995 to a vote of
security-holders.

                                       9

<PAGE>


                                     PART II

Item 5.     MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
            MATTERS

The  Company's  Common Stock,  $0.03 par value  (Common  Stock) is traded in the
over-the-counter  market. Set forth below are the highest and lowest closing bid
prices  for  the  Common  Stock  as  reported  by the  National  Association  of
Securities Dealers Automated  Quotation Service (NASDAQ) during each quarter for
the three years ended  December  31,  1995,  1994 and 1993,  respectively.  Such
quotations do not necessarily reflect actual transactions.

                                    Bid Price
Quarter Ended                       High/Low
December 31, 1995                    3     - 2 1/2
September 30, 1995                   4 1/8 - 2 7/8
June 30, 1995                        4 3/4 - 2 7/8
March 31, 1995                       4 1/8 - 3

December 31, 1994                    4 3/4 - 2 7/8
September 30, 1994                   4 1/8 - 2 5/8
June 30, 1994                        3 3/4 - 2 3/4
March 31, 1994                       5 3/8 - 3 1/4

December 31, 1993                    7     - 4 1/4
September 30, 1993                   8 1/2 - 4 1/2
June 30, 1993                       11 3/4 - 6 1/4
March 31, 1993                      16 1/2 - 4 1/2


There are approximately 1,315 record-holders of the Common Stock as of March 18,
1996.

The Company has not declared any  dividends to date and does not expect to do so
in the foreseeable future.

                                       10

<PAGE>



Item 6.     SELECTED FINANCIAL DATA

Set forth below is selected  financial  data for the Company's  most recent five
fiscal years.

<TABLE>
<CAPTION>
                                                                        Year Ended December 31,

                                       1995                 1994               1993               1992               1991
                                  ---------------------------------------------------------------------------------------------
<S>                                 <C>                   <C>                <C>                <C>                <C>
Net Revenue                         $6,430,136            $7,036,069         $7,083,229         $6,001,057         $4,867,790

Net (Loss) Income                    $(208,384)             $382,347            $95,633           $400,274           $122,007

Earnings per Common
and Common Equivalent
Share before
Extraordinary Item and
Accounting Change                        $(.18)                $0.33              $0.06              $0.31              $0.07

Extraordinary Item                   -------               ------             ------                 $0.05              $0.04

Accounting Change                    -------               ------                 $0.02          ------             ------

Net (Loss) Income per                    $(.18)                $0.33              $0.08              $0.36              $0.11
Share

Total Assets                        $3,674,004            $3,617,298         $3,115,032         $2,871,896         $2,249,957

Long-Term Obligations                  $46,426               ------             ------            $158,296           ------

Stockholders' Equity                $2,188,777            $2,384,303         $1,981,821         $1,771,833         $1,353,788

Cash Dividends Declared
per Common Share                      ------                ------             ------             ------             ------


</TABLE>

Item 7.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS

FINANCIAL CONDITION

Due to the nature of the Company's business, the key components of its financial
condition constitute receivables, inventory, fixed assets, accounts payable, and
debt. Trends of key financial indicators show a change in corporate net worth to
$2,188,777  for 1995 compared to $2,384,303 in 1994 and  $1,981,821 in 1993. The
current ratio for 1995 decreased to 2.2 from 2.8 in 1994 and 2.5 in 1993.

Billed  accounts  receivable  at  year-end  1995  was  $1,378,424,  compared  to
$1,574,656 in 1994,  and  $1,495,586 in 1993.  The days  outstanding in accounts
receivable  averaged 69 days in 1995,  66 days in 1994 and 57 days in 1993.  Bad
debt  write-offs  represent  less than 1/10 of one  percent of the total  yearly
revenues. The low level of bad debts is due partly to the percentage of business
the Company does with the U.S. Government and Fortune 500 companies. The Company
also uses a careful  screening  process and  performs  credit  qualification  of
customers before accepting their orders. For any new account,  credit checks are
always  conducted,  and questionable  situations are either placed on a COD or a
letter of credit basis.  Accounts  receivable are closely monitored;  those that
are delinquent are continuously contacted until payment is received.



                                       11

<PAGE>



The overall  composition  of the  inventory  has changed  somewhat over the last
three years as shown in the following chart:


Inventory Composition               1995             1994            1993
Production Materials              $  549,277       $555,981        $499,914
Work In Process                   $  153,203       $155,676        $164,020
Finished Goods                    $  377,861       $ 65,339        $ 67,235
TOTAL                             $1,080,341       $776,996        $731,169


One of the tools the  Company  uses for trend  analysis is a  comparison  of our
inventory  levels to total sales. In 1995, this level was 17% compared to 11% in
1994  and 10% in  1993.  The  value  of the raw  material  and  work in  process
inventory remained stable in 1995 compared to 1994. Although our objective is to
reduce  inventory  levels  as much as  possible,  the  value of  finished  goods
inventory was increased substantially in 1995 to provide products available from
stock.  This action was taken to meet  competitive  pressures as  customers  are
demanding  shorter product  delivery times. We will attempt to reduce the amount
of raw material inventory to partially offset the higher level of finished goods
inventory.  The Company believes that its reserve for inventory  obsolescence is
adequate to properly value any excess quantities of this inventory.

Fixed asset  additions were $289,704 in 1995,  $207,025 in 1994, and $246,106 in
1993.  Capital  expenditures  of  $100,000  are  planned  in 1996  for  test and
manufacturing equipment to lower the direct cost of manufacturing our products.

RESULTS OF OPERATIONS

Combined 1995  revenues were 9% less than both 1994 and 1993 results.  A loss of
$(208,384),  which represented (3%) of revenue for 1995, compares to a profit of
5% for 1994, and 1.3% for 1993.

COMMUNICATION PRODUCTS DIVISION (CPD)

Communication  Products Division revenues decreased by 4% from 1994 revenues and
resulted in an operating loss of $(470,866)  compared to a profit of $174,084 in
1994.  Increased  competition has forced the Company to  significantly  increase
sales  discounts  offered to customers on many products,  and the requirement to
increase  the volume of product  shipments  to  achieve a slightly  lower  total
revenue  compared to 1994 led to severely  lower  margins and the  corresponding
loss.  The Company has  instituted  a program of  implementing  product  designs
specifically intended to be produced by automatic assembly processes to minimize
direct costs;  also, a modification of our sales commission policy was initiated
to motivate the internal  and  external  sales staff to achieve  sales at higher
margins.

Cost of Sales

In 1995,  direct CPD costs in relation to sales increased by 6%. The increase is
attributed to growing competition forcing us to lower our prices.  However,  the
cost  to  produce  products  continued  to  decrease  due to the  investment  in
automated manufacturing facilities. As more of our product designs evolve toward
automated  assembly,  our ability to  successfully  compete at lower sale prices
will  improve.  As  stated  previously,  direct  costs as a percent  of  revenue
increased in 1995 while overhead as a percent of revenue remained constant.

                                       12

<PAGE>



Cost Comparison                     1995              1994              1993
Cost of Sales                    $3,595,328        $3,414,309        $3,067,470
Gross Sales                      $5,319,556        $5,562,130        $4,729,998
Cost as a Percent of Revenue             68%               56%               65%



The CPD division is an engineering driven producer of fiber optic equipment. Few
of its  products  have a long  lifetime.  This  means  new  products  are  being
developed  and released to  production  constantly,  which leads to high initial
production costs and low margins at product  introduction.  Due to the degree of
difficulty  in  proceeding  from a  design  phase  to a  production  phase  in a
relatively short time frame, the Company has, in many instances,  been forced to
perform  engineering  through the  production  phase of the initial  part of the
product life cycle.

Direct Costs Versus Sales           1995             1994               1993
Direct Costs                     $2,472,318        $2,297,661        $2,088,790
Percent of Sales                         46%               41%               44%


Overhead and G&A

Absolute  overhead  costs fell in 1995 by 1%,  although as a percent of revenue,
they were  unchanged  because  1995  revenue  was lower than 1994.  The  Company
believes that some additional  increases in sales can be attained at the current
level of fixed costs.  Included  below is a comparison of overhead costs for the
past three years:


Cost Comparison                            1995            1994          1993
Overhead Costs                          $1,103,323      $1,113,798     $978,680
Overhead Costs as a Percent of Revenue          20%             20%          20%


Applied Overhead

Applied  overhead  allocates  costs in overhead to a final product.  The Company
uses a computation  method in which  overhead  costs are divided by direct labor
costs. This establishes the percent of overhead costs to be applied to the final
product. Examples of these costs include rent, utilities,  telephone,  inventory
variances,  and  depreciation of production  capital  equipment  costs.  Applied
overhead amounts for the past three years were $(571,837) in 1995, $(490,776) in
1994 and $(461,244) in 1993.

Inventory Write-offs

Direct inventory  write-offs increased in 1995 to $92,119 compared to $42,870 in
1994 and $121,855 in 1993.  Generally,  these  write-offs are due to engineering
changes  which  result in  obsolete  raw  materials  and  subassemblies  used on
products we no longer intend to sell. In 1995, a write-off for $71,000 was taken
to recognize the lack of additional  business in our satellite down-link market.
As previously  mentioned,  our major  customer for this  equipment  discontinued
planned  installations when their shopping mall customer  underwent  downsizing.
Although  we make  every  attempt  to  minimize  obsolete  inventory,  the rapid
engineering  evolution  of our  product  line and the changes in our product mix
makes some obsolescence unavoidable.

                                       13

<PAGE>




G&A

General and Administrative costs consist primarily of expenses related to sales,
marketing and engineering activities. Commercial Product engineering development
costs have remained constant,  reflecting stable staff size and workload. During
1995,  development  focused on additions to the product line for highway traffic
monitoring  equipment.  Also,  a new  effort to  develop  video  technology  was
initiated,  which  will  result  in  new  product  introductions  in  1996.  The
three-year  record of these  engineering costs (exclusive of fringe) is $489,771
in 1995, $469,449 in 1994, and $478,000 in 1993.

Early in 1994, the company  implemented changes to the Sales and Marketing staff
to more closely align the technical aspects of the selling process with customer
requirements.   This  led  to  a   reorganization   of  these   departments  and
establishment  of a  customer  support  activity.  The  costs  of  this  effort,
additional  advertising  and trade show costs,  and  commission  payments to the
sales  representative  firms we have appointed  during 1995 are reflected in the
increased G&A expenses for this year, which were $2,205,094. Prior-year costs
were $1,976,637 in 1994 and $1,743,841 in 1993.

RESEARCH AND DEVELOPMENT DIVISION (R&D)

Research and Development  Division 1995 revenues decreased 29% compared to 1994.
The  decrease in revenue was caused by  termination  of work on a contract  from
Litton  Guidance  and Control  Systems.  This  contract was  terminated  for the
convenience of the Government,  and had represented a significant portion of the
total revenue  planned for 1995.  Although  other work was received later in the
year,  it was not of  sufficient  magnitude  to mitigate the effects of the lost
revenue.  Other work included contracts from Smiths Industries for $129,000, and
$261,985 from ARPA for fiber optic technology development.  Division revenue for
the last three years was $395,284 for 1995,  $554,542 for 1994, and $414,170 for
1993.  Comparable period profits (losses) were $(263,930) in 1995, $(175,589) in
1994, and $(418,960) in 1993.

Cost of Sales

The cost of sales as a percent of revenue has increased significantly due to the
severe  erosion of revenue  caused by the  termination  of the Litton  contract.
Given below are the last three years' results:

Cost Comparison                        1995           1994             1993
Cost of Sales                        $440,411       $521,539         $549,238
Gross Sales                          $395,284       $554,542         $414,170
Cost as a Percent of Revenue              111%            94%             133%


OVERHEAD AND G&A

Overhead

Overhead costs for the R&D Division were $316,493 in 1995, $369,342 in 1994, and
$437,264 in 1993.  Overhead  expenses  have  decreased  due to lower labor costs
within the division and a lower corporate  expense  allocation.  These costs are
apportioned  as  a  percent  of  floor  space  assigned  to  revenue  generating
activities and have been reduced as the size of the Division has declined.



                                       14

<PAGE>



G&A

G&A expenses  for the  division  were  $218,801 in 1995,  $208,592 in 1994,  and
$283,892 in 1993.  These numbers  reflect a slightly higher expense in 1995, due
to the impact of the Litton  contract  termination and the costs of marketing as
the  division  has sought to obtain  other  business  to replace the lost Litton
revenue. We expect additional business in 1996 from these efforts,  primarily in
fiber optic gyroscope coil winding.

GLINT DIVISION

1995 was  another  successful  year for the GLINT  Division.  At this  time,  it
appears that the Air Force will require  ongoing  support for the Gunship for at
least the next  several  years.  While it is  difficult to quantify the level of
potential business, it does seem likely that Optelecom will provide products and
maintenance  support  during that  period.  Divisional  revenue for the year was
$715,296  compared to $919,397 in 1994 and $1,939,278 in 1993.  Prior to the 4th
quarter of 1992, the financial results of this division were included in the R&D
Division as the GLINT laser array was in the final  development  phase.  Profits
were $307,369 for 1995,  $414,195 for 1994,  and $738,358 for the fourth quarter
of 1993.  The decline in revenue in 1995 compared to 1994 was due to a change in
the  composition of the type of business  addressed by this  division.  In 1994,
contract work consisted of fabrication of complete illuminator systems; in 1995,
work consisted  essentially  of fabrication of spare laser arrays,  with a small
additional  effort  associated  with  contract  development  work.

In the fourth quarter the division's  revenues declined to $13,094,  and the
division incurred an operating loss of $(64,000). The decline was due solely to
the effects of the Government  shutdowns  which  occurred  during  that
quarter.  These  shutdowns impacted the planned  award of a new contract  for
repair and  refurbishment  of laser  illuminator  systems  which was  eventually
received in early  1996.  In anticipation  of the imminent  award of that
contract,  the staff was retained, thus incurring costs in excess of revenue.

Cost of Sales

The cost of sales as a percent of revenue  remained  constant  compared to 1994,
reflecting a balanced application of manpower to specific work requirements.

Cost Comparison                        1995            1994              1993
Cost of Sales                        $305,769        $389,924        $1,088,622
Gross Sales                          $715,296        $919,397        $1,939,278
Cost as a Percent of Revenue               43%             42%               56%



OVERHEAD AND G&A

Overhead

Overhead  costs for the GLINT  Division were  $118,197  compared to $125,382 for
1994, and $143,127 for 1993.  Overhead expenses have decreased slightly due to a
lower level of revenue activity compared to 1994.

G&A

The general and  administrative  expenses  were  $102,158 in 1995,  $115,278 for
1994, and $112,298 for 1993.



                                       15

<PAGE>



OTHER OPERATING EXPENSES

Overall  advertising costs increased  substantially in 1995. These costs include
advertising  in trade  magazines,  participation  in trade  shows,  and  product
literature,  including  catalogs  and  specification  sheets.  Compared to prior
years,  the type of  advertising  changed  as a result of a  redirection  of our
advertising emphasis.  Advertising expenditures increases occurred mainly in the
areas of magazines and trade shows.  The costs of advertising for the last three
years were $225,675 in 1995, $162,706 in 1994, and $158,612 in 1993. These costs
are attributed  specifically  to the  Communications  Products  Division and are
included in its operating results.

Interest expense of $6,497  decreased  significantly in 1995 compared to $22,646
in 1994 and $22,335 in 1993.  This  decrease was a direct result of the positive
cash flow from operations in the first three quarters of the year, which allowed
us to fund operations without borrowing.

Income tax  (benefit)  expense was  $(233,756)  in 1995,  $188,000 in 1994,  and
$136,000 in 1993. The effective tax rate was (53%) in 1995 primarily as a result
of  realizing  tax benefit of carrying  back the current  year loss to the prior
year. Accordingly,  the Company recorded a $215,693 income tax refund receivable
in 1995 for amounts expected to be received in 1996.

Impact of Inflation

Inflation has not had any  significant  effect on the  operations of the Company
during 1995, and we do not expect it to have any significant effect during 1996.

LIQUIDITY AND CAPITAL RESOURCES

The Company's  liquidity  requirements are largely  generated by working capital
needs.  These needs are primarily focused on financing  inventories and accounts
receivable.

As a result of a net  operating  loss and increases in inventory  balances,  net
cash used in operational  activities was  $(110,497).  Non-cash  outlays such as
depreciation and amortization were $212,470.  Cash used in investing  activities
was $287,854,  and included expenditures for capital equipment for manufacturing
operations, facility upgrades, and general office equipment. In order to finance
these  activities,  Optelecom used existing cash flows,  borrowing in short term
notes and long term borrowings for equipment.  No other material changes in cash
flow are expected.  The Company has the ability,  provided  there are sufficient
eligible receivables,  to borrow up to $1,000,000 under its line of credit as of
December 31, 1995. The Company also has the ability to borrow funds for specific
capital asset  purchases to a maximum of $150,000  from a local bank.  Loans for
these assets are collateralized by the specific equipment asset and payable over
no more than 5 years.  During 1995,  the Company  borrowed  $120,000 to purchase
capital  equipment  for the  manufacturing  operation.  At the end of 1995,  the
outstanding balance on this loan was $81,245.

                                       16

<PAGE>



EFFECTS OF RECENTLY ISSUED ACCOUNTING STANDARDS

In October 1995, the Financial  Accounting  Standards Board issued  Statement of
Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
Compensation."  The new standard  defines a fair value method of accounting  for
stock-based employee compensation plans. Under this method, compensation cost is
measured  based on the  fair  value  of the  stock  award  when  granted  and is
recognized as an expense over the service  period,  which is usually the vesting
period.  This standard  will be effective for the Company  beginning in 1996 and
requires measurement of awards made beginning in 1995.

The  new  standard   permits   companies  to  continue  to  account  for  equity
transactions  with  employees  under  existing  accounting  rules,  but requires
disclosure in a note to the financial statements of the pro forma net income and
earnings  per share as if the company had applied the new method of  accounting.
The Company intends to implement these disclosure  requirements  beginning 1996.
Adoption of the new standard will not impact reported net income or cash flows.

In March 1995,  the Financial  Accounting  Standards  Board issued  Statement of
Financial  Accounting  Standards  No. 121,  "Accounting  for the  Impairment  of
Long-Lived  Assets and for  Long-Lived  Assets to be Disposed of." This standard
will be effective for the Company  beginning in 1996 and is not expected to have
a significant impact on the Company's financial statement.

                                       17

<PAGE>





              ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



                                       18

<PAGE>





INDEPENDENT AUDITORS' REPORT


To the Board of Directors and
   Stockholders of Optelecom Inc.:

We have  audited  the  accompanying  balance  sheet of  Optelecom,  Inc.,  as of
December 31,  1995,  and the related  statements  of  operations,  stockholders'
equity,  and cash flows for the year then  ended.  Our audit also  included  the
financial  statement schedule listed in the accompanying  index. These financial
statements  and schedule as of and for the year ended  December 31, 1995 are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements and schedule based on our audit.

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

In our  opinion,  such  financial  statements  present  fairly,  in all material
respects,  the financial position of Optelecom,  Inc., at December 31, 1995, and
the  results  of its  operations  and its cash  flows for the year then ended in
conformity with generally accepted accounting principles.  Also, in our opinion,
such  financial  statement  schedule as of and for the year ended  December  31,
1995, when considered in relation to the basic financial  statements  taken as a
whole,  presents  fairly,  in all material  respects,  the information set forth
therein.



Deloitte & Touche LLP

Washington, D.C.
March 1, 1996



                                       19

<PAGE>



OPTELECOM, INC.
BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
--------------------------------------------------------------------------------
ASSETS                                                 1995             1994

CURRENT ASSETS:
    Cash and cash equivalents                        $   62,436      $  316,183
    Contract receivables                              1,411,209       1,715,689
    Inventories                                       1,080,341         776,996
    Prepaid expenses and other receivables              108,960          68,629
    Income tax refund receivable                        215,693              --
                                                      -----------    -----------
                     Total current assets             2,878,639       2,877,497
PROPERTY AND EQUIPMENT - At cost less accumulated
    depreciation and amortization                       795,365         721,801

DEFERRED TAX ASSET                                           --          18,000
                                                      --------------  ----------

TOTAL ASSETS                                         $3,674,004      $3,617,298
                                                      ==========      ==========

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
    Demand note payable to bank                      $   60,000      $       --
    Accounts payable                                    800,409         375,505
    Accrued payroll                                      95,956         100,684
    Accrued annual leave                                 89,210         106,604
    Accrued income taxes                                     --          45,000
    Other current liabilities                           152,962         391,951
    Current portion of notes payable                     34,819              --
                                                      ------------   -----------
                     Total current liabilities        1,233,356       1,019,744

LONG-TERM LIABILITIES:
     Note Payable                                        46,426              --
     Other long-term liabilities                        205,445         213,251
                                                      -----------     ----------
                     Total long-term liabilities        251,871         213,251
                                                      -----------     ----------

COMMITMENTS AND CONTINGENCIES
                     Total liabilities                1,485,227       1,232,995
                                                      -----------     ---------

STOCKHOLDERS' EQUITY:
    Common stock, $.03 par - shares
        authorized, 5,000,000; issued and
        outstanding 1,171,042 and 1,166,672              35,131          35,000
                                                        (11,161)        (11,161)
                                                      1,898,239       1,885,512
    Discount on common stock                            266,568         474,952
    Additional paid-in capital                        -----------     ---------
    Retained earnings                                 2,188,777       2,384,303
                                                      ----------      ---------
                     Total stockholders' equity      $3,674,004      $3,617,298
                                                      ==========      ==========
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY


See notes to financial statements.

                                       20

<PAGE>

<TABLE>
<CAPTION>

OPTELECOM, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
----------------------------------------------------------------------------------------------------------------------------------

                                                                             1995                 1994                  1993
<S>                                                                       <C>                   <C>                  <C>
REVENUE:
    Product sales                                                         $6,034,852            $6,481,527           $6,669,059
    Engineering services                                                     395,284               554,542              414,170
                                                                          -----------           -----------          -----------

                 Total revenue                                             6,430,136             7,036,069            7,083,229
                                                                           ----------            ----------           ----------

COSTS AND EXPENSES:
    Direct labor                                                             211,419               299,470              326,599
    Other direct costs                                                     2,582,075             2,414,880            2,819,660
    Overhead                                                               1,538,015             1,608,522            1,559,071
    General and administrative                                             2,526,054             2,300,507            2,140,031
                                                                           ----------             ---------            ---------

                 Total costs and expenses                                  6,857,563             6,623,379            6,845,361
                                                                           ----------             ---------            ---------

(Loss) income from operations                                              ( 427,427)              412,690              237,868

OTHER INCOME (EXPENSE):
    Gain from claims settlement                                                   --               209,012                    --
    Loss on sale of investment                                                    --               (20,000)                   --
    Interest                                                                  (3,763)              (22,643)             (22,335)
    Other                                                                    (10,950)               (8,712)             (13,900)
                                                                         ------------           -----------          -----------

                 Total other (expense) income                                (14,713)              157,657              (36,235)
                                                                         ------------             ---------          -----------

(LOSS) INCOME BEFORE (BENEFIT) PROVISION
    FOR INCOME TAXES AND CUMULATIVE
    EFFECT OF CHANGE IN ACCOUNTING
    PRINCIPLE                                                               (442,140)              570,347              201,633

(BENEFIT) PROVISION FOR INCOME TAXES                                        (233,756)              188,000              136,000
                                                                         ------------           -----------          -----------

(LOSS) INCOME BEFORE CUMULATIVE EFFECT
     OF CHANGE IN ACCOUNTING PRINCIPLE                                      (208,384)              382,347               65,633
CUMULATIVE EFFECT ON PRIOR PERIODS OF
     CHANGE IN ACCOUNTING FOR INCOME
     TAXES                                                                        --                    --               30,000
                                                                        -------------           ------------        -----------

NET (LOSS) INCOME                                                         $ (208,384)           $  382,347           $   95,633
                                                                          ===========            =========            =========
(LOSS) EARNINGS PER COMMON AND
COMMON EQUIVALENT SHARE:
    (Loss) earnings before accounting change                              $    (0.18)           $     0.33           $     0.06
    Accounting change                                                             --                    --                 0.02
                                                                        -------------           ----------          -----------
(LOSS) EARNINGS PER COMMON AND
    COMMON EQUIVALENT SHARE                                               $    (0.18)           $     0.33           $     0.08
                                                                         ============            ==========           ==========
WEIGHTED AVERAGE NUMBER OF
    SHARES OUTSTANDING                                                     1,171,048             1,162,660            1,141,725
                                                                           ==========             =========           =========
See notes to financial statements.

</TABLE>

                                       21

<PAGE>



<TABLE>
<CAPTION>

OPTELECOM, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
----------------------------------------------------------------------------------------------------------------------------------
                                                               Additional Capital
                                                 -------------------------------------------------

                                     Number                                                                            Total
                                       of           Common         Discount on        Paid-in          Retained     Stockholders'
                                     Shares          Stock         Common Stock       Capital          Earnings        Equity
<S>                                <C>              <C>              <C>             <C>              <C>            <C>
BALANCE, JANUARY 1, 1993           1,111,455        $33,344          $11,161         $1,752,678       $  (3,028)     $1,771,833

 Common stock issued                  47,574          1,427               --            112,928              --         114,355
 Net income                               --             --               --                 --          95,633          95,633
                                  -------------     ---------        ----------     ------------      ---------       -----------

BALANCE, DECEMBER 31, 1993         1,159,029         34,771           11,161          1,865,606          92,605       1,981,821

 Common stock issued                   7,643            229               --             19,906              --          20,135
 Net income                               --             --               --                 --         382,347         382,347
                                  ------------       --------      ----------     --------------       ---------      -----------

BALANCE, DECEMBER 31, 1994         1,166,672         35,000           11,161          1,885,512         474,952       2,384,303

 Common stock issued                   4,370            131               --             12,727              --          12,858
 Net loss                                 --             --               --                 --        (208,384)       (208,384)
                                  ------------      --------         --------    --------------       ----------     -----------

BALANCE, DECEMBER 31, 1995         1,171,042        $35,131          $11,161         $1,898,239        $266,568      $2,188,777
                                   =========        ========         =======   ==========              ========       ==========
</TABLE>

See notes to financial statements.

                                       22

<PAGE>

<TABLE>
<CAPTION>

OPTELECOM, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
-----------------------------------------------------------------------------------------------------------
                                                                    1995          1994          1993
<S>                                                             <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net (loss) income                                           $(208,384)     $ 382,347      $  95,633
    Adjustments to reconcile net (loss) income to net cash
        (used in) provided by operating activities:
        Depreciation and amortization                             212,470        201,187        194,887
        Gain or loss on sale of assets                              1,821             --             --
        Deferred tax provision                                     18,000         12,000             --
        Deferred rent                                              (7,806)        39,817         92,353
        Common stock issued for services                            9,497          8,113         36,943
        Cumulative effect of accounting change                         --             --        (30,000)
        Provision for inventory obsolescence                      105,722         83,803        116,498
        Reserve for HydraLite, Inc.                                    --        (71,000)        71,000
        Loss on sale of HydraLite, Inc.                                --         20,000             --
    (Increase) decrease in assets:
        Contract receivables                                      304,480        (99,777)       (43,326)
        Income tax refund receivable                             (215,693)            --             --
        Inventories                                              (409,066)      (129,630)      (292,862)
        Prepaid expenses and other receivables                    (40,331)       (16,888)       (11,178)
        Other assets                                                   --             --             --
    Increase (decrease) in liabilities:
        Accounts payable                                          424,904        134,591       (262,675)
        Accrued payroll                                            (4,728)         8,569         17,857
        Accrued annual leave                                      (17,394)        (1,449)        12,410
        Accrued income taxes                                      (45,000)         5,038         25,962
        Other current liabilities                                (238,989)       298,218        (39,888)
                                                                 ---------       --------      ----------
          Net cash (used in) provided by operating activities    (110,497)       874,939        (16,386)
                                                                 ---------       --------      ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
        Capital expenditures                                     (287,854)      (207,025)      (246,106)
        Investment in and advances to HydraLite, Inc.                  --        (21,000)       (71,000)
        Cash proceeds from sale of investment                          --         30,000             --
                                                                 -----------    --------      ------------
          Net cash used in investing activities                  (287,854)      (198,025)      (317,016)
                                                                 ---------      ---------      ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
        Borrowings (payments) on note payable to bank              60,000       (385,000)       385,000
        Proceeds from exercise of stock options                     3,359         12,022         77,322
        Repayments of long-term debt                              (23,212)            --       (197,870)
        Borrowings of long-term debt                              104,457             --             --
                                                                 ---------      -----------   ------------
          Net cash provided by (used in) financing activities     144,604       (372,978)       264,452
                                                                 ---------      ---------      ---------
(DECREASE) INCREASE IN CASH                                      (253,747)       303,936        (68,950)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                      316,183         12,247         81,197
                                                                 ---------      ---------      ---------
CASH AND CASH EQUIVALENTS, END OF YEAR                          $  62,436      $ 316,183      $  12,247
                                                                 =========      ========       =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
  INFORMATION:
        Cash paid during the year for interest                  $   6,497       $ 22,646      $  22,335
        Cash paid during the year for taxes                     $  59,653       $170,962      $ 112,111

See notes to financial statements.

</TABLE>

                                       23

<PAGE>



OPTELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
--------------------------------------------------------------------------------



1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business - Optelecom,  Inc.  (the  Company) is a Delaware  corporation
which was organized in 1972. The Company's  business  consists  primarily of the
development,  manufacture,  and sale of fiber optic communications  products and
laser systems for commercial and military customers.

The Company is  organized  into three  operating  divisions:  the  Research  and
Development  Division,  which consists of providing  development and engineeirng
services to the US  Government  and its prime  contractors;  the  Communications
Products  Division  (CPD),  which sells optical  fiber based data  communication
equipment  to the  commercial  marketplace;  and the  GLINT  Division,  which is
exclusively  focused on business derived from  manufacturing  and support of the
semiconductor laser illuminator system for the GLINT night vision system used on
the U.S. Air Force C-130  Gunship.  The majority of the  Company's  revenues are
generated  from  the CPD  division.  The  principal  markets  for the  Company's
products and services are located in  California  and several  Southeastern  and
Southwestern regions of the United States. Additionally, the Company generates a
portion of its revenues from several countries in Europe.

Basis of  Presentation - Certain  estimates used by management are  particularly
susceptible to significant  changes in the economic  environment.  These include
estimates  of   percentage-of-completion   on  long-term  contracts,   inventory
obsolescence, and valuation allowances for contract receivables and deferred tax
assets. Each of these estimates,  as well as the related amounts reported in the
financial statements,  are sensitive to near-term changes in the factors used to
determine them. A significant change in any one of those factors could result in
the  determination  of amounts  different  than those  reported in the financial
statements. Management believes that as of December 31, 1995, the estimates used
in the financial  statements  are adequate  based on the  information  currently
available.

Revenue Recognition - Revenues from cost-plus-fixed-fee contracts are recognized
to the extent of costs incurred during the period plus a proportionate amount of
the fee earned.  Revenues  from  fixed-price  contracts  are  recognized  on the
percentage-of-completion  method  based on costs  incurred  in relation to total
estimated costs. Revenues from time-and-materials contracts and sales orders are
recognized at the time completed units are delivered.

Contract costs include all direct labor and material  costs,  all indirect costs
related to contract performance,  such as indirect labor, rent, depreciation and
supplies,  and  selling,  general and  administrative  costs,  such as officers'
salaries and professional  fees.  Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are determined.

Inventories  -  Production  materials  are valued at the lower of cost or market
applied on a weighted  average  cost basis.  Work-in-process  represents  direct
labor,  materials,  and  overhead  incurred on products  not  delivered to date.
Finished goods inventories are valued at the lower of cost or market, cost being
determined  using  standards  that   approximate   actual  cost  on  a  specific
identification basis.

Property,  Equipment,  and  Depreciation  - Property and equipment are stated at
cost and include additions and major replacements and betterments.  Depreciation
is computed using the  straight-line  method over the estimated  useful lives of
the assets, which range from 5 to 10 years. Leasehold improvements are amortized
over the terms of the  respective  leases or the  service  lives of the  assets,
whichever is shorter.

                                       24

<PAGE>



Research and Development  Costs - Research and development costs are expensed as
incurred.  The Company  incurred  research  and  development  costs of $538,977,
$479,888,  and $472,305 for the years ended  December 31, 1995,  1994, and 1993,
respectively.

Earnings  Per  Share - The  computation  of  earnings  per share is based on the
weighted  average  number of  outstanding  common shares during the period plus,
when their effect is dilutive,  common stock  equivalents  consisting of certain
stock  options.  The primary  weighted  average  number of common and equivalent
shares outstanding was 1,177,048,  1,162,660,  and 1,150,262 for 1995, 1994, and
1993,  respectively.  Primary and fully diluted earnings per share were the same
in 1995, 1994, and 1993.

Income  Taxes - The  Company  files the Federal and  Maryland  state  income tax
returns.  Certain income and expense items are  recognized in different  periods
for income tax purposes than for financial reporting purposes.

Effective January 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 109,  "Accounting  for Income Taxes" (SFAS 109). SFAS 109 requires
the liability method, whereby deferred tax assets and liabilities are recognized
for the estimated future tax consequences  attributable to temporary differences
between the financial statement carrying amounts and their respective tax basis.
The recognition of net deferred assets is reduced, if necessary,  by a valuation
allowance for the amount of any tax benefits that, based on available  evidence,
are not expected to be realized (see Note 9). The cumulative  effect of adopting
SFAS 109 as of January 1, 1993, was $30,000.

Forward Exchange  Contracts - The Company enters into forward exchange contracts
to hedge certain firm purchase  commitments  denominated in foreign  currencies.
The purpose of the Company's foreign currency hedging activity is to protect the
Company from the risk that the eventual cash flows  resulting from the purchases
from foreign suppliers will be adversely  affected by changes in exchange rates.
Gains and losses resulting from the forward exchange  contracts are deferred and
accounted  for as part of the  underlying  transactions.  In entering into these
contracts,  the Company has assumed the risk that might arise from the  possible
inability of counterparties to meet the terms of the contracts. The Company does
not expect any losses as a result of counterparty defaults.

Cash and Cash Equivalents - For the purpose of presentation in the statements of
cash flows,  cash and cash  equivalents are defined as cash and investments with
original maturities of three months or less.

                                       25

<PAGE>



2.      CONTRACT RECEIVABLES

        Contract  receivables  at December  31, 1995 and 1994,  consisted of the
following:


                                                     1995            1994
Billed                                             $1,378,424      $1,574,656
Unbilled-net of cumulative progress billings of
    $210,820 for 1995 and $1,297,753 for 1994          32,785         141,033
                                                   -----------     -----------
                                                    1,411,209       1,715,689
                                                   ==========      ===========
Billed contract receivables are due from
the following:

US Government Agencies                             $   49,888      $   52,325
Prime contractors on U.S.
    Government contracts and
    commercial customers, net                       1,361,321       1,522,331
                                                   -----------     -----------
Total                                              $1,411,209      $1,574,656
                                                   ==========      ==========



      Unbilled  receivables  include  estimated  (loss)  earnings  of $(804) and
      $290,445 in 1995 and 1994, respectively.

      Approximately 26% of the Company's  revenues in 1995, 26% in 1994, and 42%
      in 1993 were derived from  contracts  with  agencies of the United  States
      Government and their prime contractors.  The Company performs the services
      and ships equipment  according to the specific  contract terms.  Contracts
      with the United States  Department  of Defense allow the Defense  Contract
      Audit  Agency  (DCAA)  to  audit  the  contract  costs  and the  Company's
      compliance with the Federal Acquisition Regulations.  The DCAA has audited
      the costs under  contracts for years through  1993.  The Company  believes
      that the ultimate  outcome of future DCAA audits for subsequent years will
      not have a material  effect on the financial  statements.  Generally,  the
      contract  terms  for both  government  and  commercial  customers  require
      payment of invoices in 30 days.

      On January 25, 1995, the Company was notified that a contract with a prime
      contractor in the amount of $1,020,232 was terminated for convenience.  As
      a result  of the  termination,  the  Company  recorded  an  allowance  for
      uncollectible  costs of $34,711 in 1994. During 1995 the Company collected
      all  amounts  due  under  this  contract,  and  accordingly  reversed  the
      allowance for uncollectible costs.

      Included in the billed  receivables  at December 31, 1995,  is a retainage
      receivable  of  approximately  $178,000,  which is expected to be received
      upon completion of the project in 1997.

                                       26

<PAGE>



3.    INVENTORIES

      Inventories at December 31, 1995 and 1994, consist of the following:

                                         1995                1994
      Production materials            $  549,277           $555,981
      Work in process                    153,203            155,676
      Finished goods                     377,861             65,339
                                     -----------          ---------
                                      $1,080,341           $776,996
                                      ==========           ========


4.    PROPERTY AND EQUIPMENT

      Property  and  equipment  at December  31,  1995 and 1994,  consist of the
following:


                                                1995             1994
      Laboratory equipment                  $ 1,034,058       $  867,138
      Office equipment                          576,675          512,474
      Furniture and fixtures                     26,366           26,366
      Leasehold improvements                    367,876          317,155
                                             -----------      -----------
                                              2,004,975        1,723,133

      Less accumulated depreciation and
        amortization                         (1,209,610)      (1,001,332)
                                             ------------      -----------
      Net property and equipment            $   795,365       $  721,801
                                             ==========        ==========



5.    DEMAND NOTE PAYABLE TO BANK

      The Company has a credit  agreement with a bank,  whereby it may borrow up
      to  $1,000,000  with interest at the bank's prime rate plus 3/4% (9.25% at
      December 31, 1995). The total amount of borrowings that may be outstanding
      at  any  given  time  is  based  upon a  percentage  of  certain  eligible
      receivables.  The  amount  available  under  the  credit  agreement  as of
      December 31, 1995, was $1,000,000, less $60,000, which was outstanding.

      The weighted average interest rate for short-term borrowings for the years
      ended December 31, 1995, 1994, and 1993, are as follows:

                                             1995        1994        1993
      Weighted average interest rate         9.75%       7.67%       7.00%


      The Company  computed the weighted  average  interest rate by dividing the
      sum of the weighted average  interest rates on all borrowings  outstanding
      during  the  period  by the  total  number  of days  the  borrowings  were
      outstanding.

                                       27

<PAGE>



6.    NOTES PAYABLE

      During 1995, Optelecom entered into a promissory note agreement to finance
      the purchase of  equipment.  The  equipment  serves as  collateral  on the
      promissory  note. The principal  amount of the note was $104,458,  and the
      amount outstanding at December 31, 1995, was $81,245.  The promissory note
      is payable at $2,902 a month until April 1998. Principal amounts due under
      the  note in  1996,  1997  and 1998  are  $34,824,  $34,824  and  $11,547,
      respectively. Interest is payable at prime plus 3/4%. The weighted average
      interest  rate during 1995 was 9.59%.  The fair value of this note payable
      is approximately equal to its carrying value.

7.    FINANCIAL INSTRUMENTS

      In October  1995,  the Company  entered  into a foreign  exchange  forward
      contract  to  purchase  approximately  372,000  Netherlands  guilders  for
      approximately  $237,000.  The foreign  exchange  contract was  exercisable
      between January 1, 1996,  through  February 2, 1996. The fair value of the
      foreign  exchange  forward contract at December 31, 1995, was estimated by
      obtaining quotes for futures  contracts with similar terms. As of December
      31,  1995,  the  fair  value  of  foreign   exchange   forward   contracts
      approximated its carrying value.

8.    STOCK OPTIONS

      In March 1991,  the Board of Directors  adopted the 1991 Stock Option Plan
      (the "1991 Plan") under which options to purchase up to 133,333  shares of
      common  stock may be  granted  to  officers  (including  officers  who are
      directors)  other key employees of, and consultants  to, the Company.  The
      1991 Plan  superseded and replaced the Incentive Stock Option Plan and the
      Non-Qualified Stock Option Plan that the Company had in operation prior to
      the adoption of the 1991 Plan. Options  outstanding in prior years for the
      previous  plans are  included in the 1991 Plan  information  as  presented
      below.

      The  exercise  price of each  option may not be less than 100% of the fair
      market value of the stock on the date of grant for incentive stock options
      or 85% of such fair  market  value for  non-qualified  stock  options,  as
      determined by the Board.  Options are  exercisable in whole or in part any
      time after one year from the date of grant.  Options  expire  three  years
      after  the  date  of  grant  and,  in  most  cases,  upon  termination  of
      employment.  The  1991  Plan  will  terminate  on  May  31,  2001,  unless
      terminated sooner by the Board.

                                       28

<PAGE>





      The following table relates to options  outstanding,  granted,  exercised,
      and canceled, during 1995, 1994, and 1993 under the 1991 Plan:

                                        Number         Option Price
      Options                          of Shares         Per Share
      Exercisable at:
          December 31, 1993             36,800                   $6.50
          December 31, 1994             40,750          $2.88 to $6.50
          December 31, 1995             34,500          $2.88 to $6.50
      Granted:
          During 1993                   38,050                   $6.50
          During 1994                   38,750          $2.88 to $3.38
          During 1995                    7,500          $3.00 to $3.63
      Exercised:
          During 1993                   23,410          $ .94 to $2.63
          During 1994                       --                --
          During 1995                       --                --
      Canceled:
          During 1993                    1,583          $2.13 to $6.50
          During 1994                   34,800                   $6.50
          During 1995                    6,250          $3.13 to $6.50


      On December 19,  1988,  the Board of  Directors  approved the  Directors
      Stock Option Plan (1988  Directors  Plan) under which each  non-employee
      director  who attends a meeting  of the Board of  Directors  is, at his
      election,  granted an option to purchase  333 shares of common  stock in
      lieu of receiving a certain dollar value of common  stock.  The options
      have an exercise  price  equivalent to the market value of the stock on
      the date of such Board meeting.  The options are exercisable  upon grant
      and  expire  three  years  thereafter.  This plan was  terminated  as of
      December  31,  1992,  and  accordingly,  no more options will be granted
      under this plan.

                                       29

<PAGE>



      The following table relates to options outstanding,  granted, exercised,
      and canceled  during 1995,  1994,  and 1993 under the  terminated  1988
      Directors Plan:

                                       Number             Option Price
                     Options          of Shares            Per Share
      Exercisable at:
          December 31, 1993             9,657            $1.03 to $3.88
          December 31, 1994             2,997            $1.59 to $3.88
          December 31, 1995                --                  --
      Granted:
          During 1993                      --                  --
          During 1994                      --                  --
          During 1995                      --                  --
      Exercised:
          During 1993                   3,996            $1.03 to $2.25
          During 1994                   4,329            $1.03 to $3.00
          During 1995                   1,332            $1.59 to $3.00
      Canceled:
          During 1993                      --                  --
          During 1994                   2,331            $1.88 to $3.00
          During 1995                   1,665            $3.00 to $3.88




      On December 7, 1992, the Board of Directors  approved the 1993  Directors'
      Stock Option  Plan  (1993  Directors'  Plan),  which  replaces  the  1988
      Directors' Plan. Under this plan, each non-employee director who attends a
      meeting of the Board of Directors is, at his  election,  granted an option
      to  purchase  450 shares of common  stock in lieu of  receiving  a certain
      dollar value of the stock on the date of such Board  meeting.  The options
      are exercisable upon grant and expire three years thereafter.

      The  following  table  relates to options  outstanding and granted during 
      1995, 1994 and 1993 under the 1993 Directors' Plan.

                                       Number             Option Price
                       Options        of Shares              Per Share
      Exercisable at:
          December 31, 1993             4,500             $6.12 to $7.25
          December 31, 1994            17,500             $2.88 to $7.25
          December 31, 1995            27,450             $2.75 to $7.25
      Granted:
          During 1993                  45,000             $6.12 to $7.25
          During 1994                  13,050             $2.88 to $4.63
          During 1995                   9,900             $2.75 to $4.50




      No options were exercised or canceled during 1995, 1994 and 1993.

                                       30

<PAGE>



      In  June  1990,  the  Board  of  Directors  adopted  a stock  option  plan
      (Chairman's)   under  which  the   Chairman  of  the  Board  is  the  sole
      participant.  On each January 1, the  Participant  is granted an option to
      purchase  1,666 shares of common stock at a price  equivalent  to the fair
      market value at that date. Each option granted under this plan will expire
      three years  after  the date of  grant.  On the date of  adoption,  3,332
      options were granted to the  participant  under the plan. The total amount
      of shares available  under this plan is 13,328.  The plan terminates when
      the participant ceases to be employed by the Company or December 31, 1996,
      whichever is earlier.

      The following table relates to options outstanding, granted, and exercised
      during 1995, 1994 and 1993 under the Chairman's Plan.


                                      Number             Option Price
      Options                        of Shares             Per Share
      Exercisable at:
          December 31, 1993            3,332              $1.69 to $5.00
          December 31, 1994            3,332              $4.88 to $5.00
          December 31, 1995            4,998              $3.13 to $5.00
      Granted:
          During 1993                  1,666                       $5.00
          During 1994                  1,666                       $4.88
          During 1995                  1,666                       $3.13
      Exercised:
          During 1993                  4,999              $1.13 to $2.06
          During 1994                  1,666                       $1.69
          During 1995                     --                    --



      No options were canceled in 1995, 1994, and 1993.

      In January,  1991, the Board of Directors  approved a special  arrangement
      for the  granting  of a total of 30,000  stock  options  to the  Company's
      president (President's  Plan).  Under  the  arrangement,   the  president
      receives  10,000 options  on  January 1 of each  year at a  predetermined
      price. The options expire four years from the date of grant.

                                       31

<PAGE>



      The following table relates to options outstanding,  granted and exercised
      during 1995, 1994, and 1993 under the President's Plan.


                                     Number             Option Price
      Options                       of Shares            Per Share
      Exercisable at:
          December 31, 1993          20,000             $3.00 to $4.50
          December 31, 1994          20,000             $3.00 to $4.50
          December 31, 1995          20,000             $3.00 to $4.50
      Granted:
          During 1993                10,000                      $4.50
          During 1994                    --                   --
          During 1995                    --                   --
      Exercised:
          During 1993                10,000                      $1.50
          During 1994                    --                   --
          During 1995                    --                   --



      No options were cancelled during 1995, 1994 and 1993.

9.    INCOME TAXES

      The  components of the (benefit)  provision for income taxes for the years
      ended December 31, 1995, 1994, and 1993, are summarized as follows:


                              1995             1994             1993
      Current              $(251,756)        $176,000         $136,000
      Deferred                18,000           12,000               --
                           ---------         --------         --------
                           $(233,756)        $188,000         $136,000
                           ==========        ========         ========


      The Company's 1995 tax provision  includes the benefit of the carryback of
      the current year loss to the prior year. Accordingly, an income tax refund
      receivable of $215,693 has been recorded as of December 31, 1995.

                                       32

<PAGE>



      The difference  between the Federal  income tax expense  (benefit) and the
      amount  computed  applying the statutory  Federal  income tax rate for the
      years ended December 31, 1995, 1994, and 1993, are summarized as follows:


                                                  1995         1994      1993
      Federal income tax at statutory rates       (34%)         34%       34%

      Increase (reduction) of taxes:
         State taxes, net of federal benefit       (7)           5        10
         Utilization of tax credits                 --          (6)      (30)
         Valuation allowance related to net
               deferred tax assets                 (8)          --        51
         Other                                     (4)          --         2
                                                 -------       ----      ---

      Effective income tax rate                   (53%)         33%       67%
                                                  =====         ===       ===


      Deferred income taxes reflect the net tax effects of temporary differences
      between the amount of assets and  liabilities for income tax and financial
      reporting purposes.  The components of deferred income tax liabilities and
      assets as of December 31, 1995 and 1994 are as follows:


                                                     1995          1994
      Deferred tax liabilities:
          Retainage receivable on long-term
              contracts                            $(67,275)   $        --
                                                   ---------     ----------

      Gross deferred tax liabilities                (67,275)            --
                                                   ---------     ----------

      Deferred tax assets:
          Excess book depreciation                    5,389          8,934
          Capitalized overhead and inventory
              obsolescence reserve                   58,874         52,970
          Accrued vacation                           27,386         34,189
          Deferral of rent expense                   77,309         87,433
          General business tax credits and capital
              losses                                 48,317         17,890
                                                   ---------      --------

      Gross deferred tax assets                     217,275        201,416
                                                   --------        -------

      Less:  Valuation allowance                    150,000        183,416
                                                   --------        -------

      Net deferred tax assets                      $     --    $    18,000
                                                   ==========      =======


      A valuation  allowance  is provided to reduce the deferred tax assets to a
      level  that more  likely  than not,  under the rules in SFAS 109,  will be
      realized.  General  business  tax  credits and  capital  losses  expire in
      varying amounts through December 31, 2010.

                                       33

<PAGE>



10.   EMPLOYEE BENEFIT PLANS

      The Company has a noncontributory  Profit-Sharing Retirement Plan covering
      substantially  all  employees.  Vesting  occurs over a period of six years
      from  date  of  entry  into  the  plan.  Under  the  plan,  the  Company's
      contribution  is  determined  annually  by the Board of  Directors  and is
      funded  as  accrued.  The  accrual  for  1995,  1994,  and 1993 was  $-0-,
      $115,354, and $39,466, respectively.

      The Company has  established  a combined  tax-qualified  cash and deferred
      profit sharing plan under Section 401(k) of the Internal  Revenue Code for
      all of the Company's full-time employees. The Company instituted a plan in
      1993 that matched employee contributions to the plan to a maximum of 2.5%.
      Total   contributions   were   $60,163  and  $52,139  in  1995  and  1994,
      respectively.

11.   COMMITMENTS AND CONTINGENCIES

      Operating Lease - During 1992, the Company moved its corporate  office and
      manufacturing  facilities  and entered  into a new  10-year  noncancelable
      operating  lease  expiring  August 31, 2002. As an inducement to enter the
      new lease, the Company received certain  incentives such as rent abatement
      and assumption of existing lease obligations.  Additionally, the new lease
      provides  for  scheduled  rent  increases  in  the  future.   These  lease
      incentives  will be amortized  over the new lease period.  Rent expense is
      being  recognized  on a  straight-line  basis.  In  addition  to the basic
      rentals,  the lease  agreement  provides for increases based on payment by
      the Company of its share of real estate and insurance taxes.

      As of December 31, 1995, future net minimum rental payments required under
      operating  leases that have initial or remaining  noncancellable  terms in
      excess of one year are as follows:


           Year Ended December 31,
                           1996                        $  195,126
                           1997                           200,980
                           1998                           207,009
                           1999                           213,220
                           2000                           219,616
                           Later years                    379,994
                                                       -----------
                                                       $1,415,945


      Rental  expense was $216,566,  $211,867,  and $208,469 in 1995,  1994, and
      1993, respectively.

      Employment  Agreement - The Company has an  employment  agreement  with an
      officer. In the event of his death while employed, the officer's salary is
      to be paid for one year. Additionally, he earns a bonus of 1,666 shares of
      common stock for each twelve-month period of the term of employment (which
      began January 1, 1984),  but no such stock shall be issued directly to him
      until  January 2, 1999. A total of 11,663  shares has been issued in trust
      through December 31, 1995. An additional 1,666 shares were issued in trust
      subsequent to December 31, 1995. All of the shares earned through December
      31, 1995, are to be transferred to the officer in the future.  The Company
      recorded  expense of $4,948,  $4,998,  and $8,130 in 1995, 1994, and 1993,
      respectively in connection with this agreement.

                                       34

<PAGE>



      Employee  Cash/Stock Bonus Plan - In 1980, the Company adopted an employee
      cash/stock bonus plan for which 8,333 shares of the Company's common stock
      have  been set  aside to be  issued  to  employees  at the  discretion  of
      management.  Through  1989,  1,533 shares had been issued.  No shares were
      issued in 1995, 1994, and 1993.

12.   INVESTMENT IN HYDRALITE, INC.

      In May,  1993,  the  Company  agreed to make a 14%  equity  investment  in
      HydraLite,  Inc.,  a  start-up  telecommunications  company  under a stock
      purchase agreement.  As of December 31, 1993, the Company had paid a total
      of  $50,000  for  the  stock  and  provided  an   additional   $75,345  in
      administrative,   research  and  development  and  marketing   support  to
      HydraLite of which $21,000 was recorded as a receivable. The Company had a
      commitment  at  December  31,  1993,  to pay  an  additional  $21,000  for
      administrative  assistance until HydraLite's  first-round equity financing
      was completed.  Due to delays in the completion of HydraLite's  financing,
      management  recorded a  valuation  reserve for the entire  receivable  and
      investment at December 31, 1993.

      In April 1994, HydraLite received its first-round equity financing and the
      Company  reversed  the  reserve for the  investment  and  receivable.  The
      Company also  recorded a $42,000  receivable  for repayment of the amounts
      advanced to HydraLite for  administrative  support.  In December 1994, the
      Company  sold its  stock to the  individual  investors  of  HydraLite  for
      $30,000  and  recorded a loss on the sale of  $20,000.  In  addition,  the
      Company and HydraLite  settled various claims against each other and, as a
      result, the Company recognized a gain of $209,012.

13.   SEGMENT INFORMATION

      Segment information by major business segment is presented below:


<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31, 1995
                                                                      RESEARCH AND COMMUNICATION
                                         ---------------------------------------------------------------------------
                                          Research and         Communications
                                           Development            Products             GLINT
                                            Division              Division             Division           Totals                   
<S>                                       <C>                    <C>                   <C>             <C>
Revenues                                  $ 395,284              $5,319,556            $715,296        $6,430,136
Operating income (loss)                    (263,930)               (470,866)            307,369          (427,427)

Identifiable assets                         101,103              $3,117,177            $ 68,635        $3,286,915
Corporate assets                                 --                      --                  --           387,089
                                           --------               ---------             -------         ---------

Total assets                              $ 101,103              $3,117,177            $ 68,635        $3,674,004
                                           ========               =========             =======         =========

Gross additions to property and
equipment:
     Identifiable                         $      --              $  289,704            $     --        $  289,704
     Corporate                                   --                      --                  --                --
                                           --------               ---------             -------         ---------
             Total                        $      --              $  289,704            $     --        $  289,704
                                           ========               =========             =======         =========

Depreciation and amortization:
    Identifiable                          $      --              $  212,470            $     --        $  212,470
    Corporate                                    --                      --                  --                --
                                           --------               ---------             -------         ---------
             Total                        $      --              $  212,470            $     --        $  212,470
                                           ========               =========            ========         =========

</TABLE>
                                       35

<PAGE>



<TABLE>
<CAPTION>
                                     YEAR ENDED DECEMBER 31, 1994
                                  ---------------------------------------------------------------------
                                     Research and       Communication
                                     Development         Products         GLINT
                                      Division           Division       Division            Total
<S>                                 <C>               <C>               <C>              <C>
Revenue                             $ 554,542         $5,562,130        $919,397         $7,036,069
Operating income (loss)              (175,589)           174,084         414,195            412,690

Identifiable assets                   488,915          2,538,970         189,501          3,217,386
Corporate assets                           --                 --              --            399,912
                                    ---------         ----------        --------         ----------

Total assets                        $ 488,915         $2,538,970        $189,501         $3,617,298
                                     ========         ==========        ========          =========

Gross additions to property
  and equipment:
     Identifiable                   $  82,810         $  124,215        $     --         $  207,025
     Corporate                             --                 --              --                 --
                                    ---------         ----------        --------         ----------
             Total                  $  82,810         $  124,215        $     --         $  207,025
                                    =========         ==========        ========         ==========
Depreciation and amortization:
    Identifiable                    $  80,475         $  120,712        $     --         $  201,187
    Corporate                              --                 --              --                 --
                                    ---------         ----------        --------         ----------
             Total                  $  80,475         $  120,712        $     --         $  201,187
                                    =========         ==========        ========         ==========


</TABLE>

<TABLE>
<CAPTION>
                                        YEAR ENDED DECEMBER 31, 1993
                                 -----------------------------------------------------------------
                                  Research and   Communication
                                  Development     Products           GLINT
                                  Division        Division          Division             Total
<S>                               <C>             <C>              <C>                <C>
Revenues                          $ 414,170       $4,729,781       $1,939,278         $7,083,229
Operating income (loss)            (418,960)         (81,530)         738,358            237,868

Identifiable assets                 399,036        2,354,054          267,954          3,021,044
Corporate assets                         --               --               --             93,988
                                   --------        ---------        ---------          ---------

Total assets                      $ 399,036       $2,354,054       $  267,954         $3,115,032
                                   ========        =========        =========          =========

Gross additions to property
   and equipment:
     Identifiable                 $  98,442       $  147,664       $       --         $  246,106
     Corporate                           --               --               --                 --
                                   --------        ---------        ---------          ---------
             Total                $  98,442       $  147,664       $       --         $  246,106
                                   ========        =========        =========          =========
Depreciation and amortization:
    Identifiable                  $  77,954       $  116,933       $       --         $  194,887
    Corporate                            --               --               --                 --
                                   --------        ---------        ---------          ---------
             Total                $  77,954       $  116,933       $       --         $  194,887
                                   ========        =========        =========          =========

</TABLE>


                                       36

<PAGE>



      The Company is engaged primarily in the development, manufacture, and sale
      of optical communications  products and laser systems.  Revenue represents
      shipments  and  services  provided to third  parties.  Contract  costs and
      operating expenses directly traceable to individual segments were deducted
      from revenue to arrive at operating income. Identifiable assets by segment
      are  those  assets  that  are  used in the  Company's  operations  in each
      segment. Corporate assets consist primarily of cash, prepaid expenses, and
      long-term assets.

14.   SIGNIFICANT CUSTOMERS AND FOREIGN EXPORTS

      The Company's primary business activity is with the U.S.  Government,  its
      prime contractors,  and customers  providing  communications  products and
      services.  During 1995, the Company made sales to two commercial customers
      that  accounted for  approximately  10% and 9% of revenues,  respectively.
      During 1994,  the Company made sales to  individual  commercial  customers
      which accounted for approximately  12% and 10% of revenues,  respectively.
      During 1993,  the Company made sales to  individual  commercial  customers
      which  accounted  for 12% and 11% of revenues,  respectively.  In 1995 and
      1994,  the  Company  had  export  sales  to  foreign  customers   totaling
      approximately  $860,000  and  $923,000,  respectively.  In 1993,  sales to
      foreign  customers  were less than 10% of revenues.  At December 31, 1995,
      contract  receivables  from three customers  represented 13%, 10%, and 9%,
      respectively, of total contract receivables outstanding.

15.   RECENT ACCOUNTING STANDARDS

      In October 1995, the Financial Accounting Standards Board issued Statement
      of Financial  Accounting  Standards No. 123,  "Accounting  for Stock-Based
      Compensation."  The new standard defines a fair value method of accounting
      for  stock-based   employee   compensation   plans.   Under  this  method,
      compensation  cost is measured  based on the fair value of the stock award
      when  granted and is  recognized  as an expense  over the service  period,
      which is usually the vesting  period.  This standard will be effective for
      the Company  beginning  in 1996 and  requires  measurement  of awards made
      beginning in 1995.

      The new  standard  permits  companies  to  continue  to account for equity
      transactions with employees under existing  accounting rules, but requires
      disclosure  in a note to the  financial  statements  of the pro  forma net
      income and earnings per share as if the company had applied the new method
      of  accounting.   The  Company  intends  to  implement  these   disclosure
      requirements  beginning 1996. Adoption of the new standard will not impact
      reported net income or cash flows.


                                   * * * * * *


                                       37

<PAGE>

<TABLE>
<CAPTION>

OPTELECOM, INC.
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED DECEMBER 31, 1995, 1994 AND 1993                                                SCHEDULE II
                                                                                   BALANCE             CHARGED
------------------------------------------------------------------------------------------------------------------       
                                          Balance         Charged
                                             at              to                                        Balance
                                          Beginning       Costs and      Other                          at End
DESCRIPTION                               Of Period       Expenses      Changes      Deductions        of Period
<S>                                       <C>             <C>              <C>      <C>                  <C>
Year Ended December 31, 1993

  Reserves and allowances
  deducted from asset accounts:
    Obsolescence reserve for
      inventory                           $47,826         $116,498         --       $(121,855)1/         $42,469
    Reserve for investment                     --          (71,000)        --              --             71,000

Year Ended December 31, 1994

  Reserves and allowances
  deducted from asset accounts:
    Obsolescence reserve for
      inventory                           $42,469         $ 83,803         --       $ (42,870)1/         $83,402
    Allowance for uncollectible
      contract costs                           --           34,711         --              --             34,711
    Reserve for investment                 71,000          (71,000)        --              --                 --

Year Ended December 31, 1995

   Reserves and allowances
   deducted from asset accounts:
    Obsolescence reserve for
      inventory                           $83,402         $105,722         --       $ (92,119)           $97,005
    Allowance for uncollectible
      contract costs                       34,711          (34,711)        --              --                 --

</TABLE>

1/Scrap Inventory




                                       38

<PAGE>

<TABLE>
<CAPTION>


OPTELECOM, INC.                                                                     EXHIBIT 11
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
-----------------------------------------------------------------------------------------------------------------
                                                            1995               1994              1993
<S>                                                      <C>               <C>                <C>
Primary Earnings Per Share:
    (Loss) earnings before accounting change             $ (208,384)       $   382,347        $    65,633
    Accounting change                                            --                 --             30,000
                                                          ---------         ----------         ----------

               Net (loss) earnings                         (208,384)       $   382,347        $    95,633
                                                          =========         ==========         ==========

Weighted average common and common
    equivalent shares                                     1,170,393          1,162,660          1,141,725
Adjustment to options using average year
     price when dilutive                                      6,655                352              8,537
                                                          ---------         ----------         ----------

Primary shares                                            1,177,048          1,163,012          1,150,262
                                                          =========         ==========         ==========
(Loss) earnings per share:
    Earnings before accounting change                    $    (0.18)       $      0.33        $      0.06
    Accounting change                                            --                 --               0.02
                                                          ---------         ----------         ----------

                                                         $    (0.18)       $      0.33        $      0.08
                                                          =========         ==========         ==========
Fully Diluted Earnings Per Share:
    (Loss) earnings before accounting change             $ (208,384)       $   382,347        $    65,633
    Accounting change                                            --                 --             30,000
                                                          ---------         ----------         ----------

               Net earnings                              $ (208,384)       $   382,347        $    95,633
                                                          =========         ==========         ==========

Weighted average common and common
    equivalent shares                                     1,170,393          1,162,660          1,141,725
Adjustment to options using year
    end price when dilative                                   8,214                352              9,521
                                                          ---------         ----------         ----------

Fully diluted shares                                      1,178,607          1,163,012          1,151,246
                                                          =========         ==========         ==========
Earnings per share:
    (Loss) earnings before accounting change             $    (0.18)       $      0.33        $      0.06
    Accounting change                                            --                 --               0.02
                                                          ---------         ----------         ----------

                                                         $    (0.18)       $      0.33        $      0.08
                                                          =========         ==========         ==========

</TABLE>

                                       39

<PAGE>



CONSENT OF INDEPENDENT AUDITORS


Optelecom, Inc.
Gaithersburg, Maryland

We  hereby  consent  to  the  incorporation  by  reference  in the  Registration
Statement on Form S-8 for the  Optelecom,  Inc. 1991 Stock Option Plan, the 1993
Directors Stock Option Plan, the Stock Option Plan for William H. Culver and the
1996  Directors  Stock Option Plan,  respectively,  of our report dated March 1,
1996,  relating to the  financial  statements  and schedule of  Optelecom,  Inc.
appearing  in the  Company's  Annual  Report  on Form  10-K for the  year  ended
December 31, 1995.

Deloitte & Touche LLP



Washington, D.C.
March 28, 1996






<PAGE>




Item 9.     CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING
            AND FINANCIAL DISCLOSURE

            The  submitted  Form 8-K  which was  submitted  on May 2, 1995 is as
follows:

            Item 4 Changes in Registrant's Certifying Accountant.

            Item 304    Changes and Disagreements with Accountants on Accounting
                        and Financial Disclosure

            (a)(1)(i)   The Registrant's  informed BDO Seidman,  by letter dated
                        on April  24,  1995,  that its  Board of  Directors  had
                        approved  termination  of its  engagement as independent
                        auditors, effective immediately.

            (a)(1)(ii)  BDO  Seidman's  report on the financial  statements  for
                        each  year in the two year  period  ended  December  31,
                        1994,   did  not  contain  an  adverse,   qualified   or
                        disclaimer of opinion nor did it contain an  explanatory
                        paragraph due to a material uncertainty.

            (a)(1)(iv)       (A) Set forth below are certain matters, related to
                             the  financial   statements   for  the  year  ended
                             December 31, 1994, which were disagreements as that
                             term  is  used  in  instruction  4 to  Item  304 of
                             Regulation S-K. Each of these matters was resolved,
                             to  the  satisfaction  of  BDO  Seidman,  prior  to
                             issuance of its report on the financial  statements
                             for the year ended December 31, 1994.

                    1.   Expense  rework  cost   improperly   capitalized  as  a
                         component of inventory cost - $16,585.

                    2.   Increase the reserve for obsolete inventory - $15,492.

                    3.   Establish a warranty reserve - $17,500.

                    4.   Establish a specific warranty reserve for known product
                         repairs/replacements - $10,000.

                    5.   Establish  a  reserve  for  claims   incurred  but  not
                         reported  related to Registrant's  self insured medical
                         plan - $20,346.

                    6.   Valuation  allowance  related to deferred  tax assets -
                         $183,416.

                        (B)  BDO Seidman discussed each of the matters set forth
                             above  with the  Board of  Directors  in a  special
                             meeting on March 14, 1995.

                        (C)  The   Registrant  has  authorized  BDO  Seidman  to
                             respond  fully to the  inquiries  of the  successor
                             accountant concerning the matters set forth above.

            (a)(1)(v)        (A)  BDO  Seidman  advised  the  Registrant,  in  a
                             memorandum dated March 10, 1995, that is considered
                             the  failure to  properly  estimate  and accrue for
                             warranty costs a material weakness as defined under
                             standards  established by the American Institute of
                             Certified Public Accountants.



                                       41

<PAGE>



            3.    The  Registrant  has  provided BDO Seidman with a copy of this
                  disclosure  and has  requested  that BDO  Seidman  furnish the
                  Registrant  with a  letter  addressed  to the  Securities  and
                  Exchange  Commission  stating  whether BDO Seidman agrees with
                  the statement set forth above.


                                                       PART III

Item 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

            1.    Directors of the Company

                  See the Company's Proxy  Statement,  incorporated by Reference
            as Part III of this Form 10-K,  under the  heading  "Proposal  1 and
            Miscellaneous."

            2.    Executive Officers of the Company

                  See the Company's Proxy  Statement,  incorporated by Reference
            as Part III of this Form 10-K,  under the  heading  "Proposal  1 and
            Miscellaneous."

Item 11.    EXECUTIVE COMPENSATION

            See the Company's Proxy Statement, incorporated by Reference as Part
            III of this Form  10-K,  under  the  heading  "Summary  Compensation
            Table."

Item 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

            See the Company's Proxy Statement, incorporated by Reference as Part
            III of this Form 10-K, under the heading "Proposal 1."

Item 13.    CERTAIN RELATIONSHIPS AND RELATED PARTIES

            See the Company's Proxy Statement, incorporated by Reference as Part
            III of this Form 10-K, under the heading "Miscellaneous."

                                       42

<PAGE>



                                                        PART IV
Item 14.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

               1. Financial Statements and Financial Statement Schedules

                  Report of Independent Certified Public Accountants

                  Statements

                  Balance Sheets as of December 31, 1995 and 1994

                  Statements of Income for the Years Ended December 31, 1995,
                  1994, and 1993

                  Statements of Stockholders' Equity for the Years Ended
                  December 31, 1995, 1994, and 1993

                  Statements of Cash Flows for the Years Ended December 31,
                  1995, 1994, and 1993

                  Summary of Accounting Policies

                  Notes to Financial Statements

               2. Financial Statement Schedules

                  Schedule II      Valuation and Qualifying Accounts, Years
                  Ended December 31, 1995 and 1994

            Other  schedules  are omitted  because  they are not  applicable  or
            information is shown elsewhere in the financial  statements or notes
            thereto.

               3. Exhibits

                  Item 3(i)(1) Restated Certificate of Articles of Incorporation
                  of Optelecom, Inc. as in effect March 14, 1994.

                  Item 3(i)(2) Certificate of Amendment of Articles of
                  Incorporation

                  Item 11 - Statement Regarding Computations of Per Share
                  Earnings

                  Item 24 - Consent of Independent CPA

               4. Reports on Form 8-K

                  No 8-Ks were filed during this period.



                                       43

<PAGE>


                                   SIGNATURES

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


                                            OPTELECOM, INC.


Date:                                       By
                                            William H. Culver, Chairman
                                            and Treasurer


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


                                            OPTELECOM, INC.


Date:                                       By
                                            William H. Culver, Chairman
                                            and Treasurer


Date:                                       By
                                            Edmund D. Ludwig, Director and
                                            President


Date:                                       By
                                            John A. Jamieson, Director


Date:                                       By
                                            Joseph H. Sharlitt, Director and
                                            Secretary


Date:                                       By
                                            Gordon A. Smith, Director