<PAGE>   1

================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-K


      Annual Report Pursuant to Section 13 or 15(d) of the Securities and
        Exchange Act of 1934 for the fiscal year ended December 31, 1998


                          STORAGE COMPUTER CORPORATION
             ------------------------------------------------------
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


           DELAWARE                                               02-0450593
---------------------------------                            -------------------
 (State or other jurisdiction                                 (I.R.S.Employer 
of incorporation or organization)                            Identification No.)


11 RIVERSIDE STREET, NASHUA, NEW HAMPSHIRE                        03062-1373
------------------------------------------                   -------------------
 (Address of Principal Executive Offices)                         (Zip Code)


                                 (603) 880-3005
              ----------------------------------------------------
              (Registrant's telephone number, including area code)


SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:


COMMON STOCK $0.001 PAR VALUE                   AMERICAN STOCK EXCHANGE
-----------------------------            --------------------------------------
     (Title or Class)                    (Name of Exchange on which registered)

     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 twelve 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 the disclosure of delinquent filers pursuant to
Item 405 of Regulation S-B is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in a definitive proxy or information
statement incorporated in Part III of this Form 10-K or any amendments to this
Form 10-K.  [X]

The aggregate market value of the Common Stock of the Registrant held by
non-affiliates was approximately $11,699,500 at April 9, 1999.

At December 31, 1998 there were issued and outstanding 11,347,823 shares of the
Registrant's Common Stock, with a par value of $.001.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement relating to the Company's Annual
Meeting of Stockholders to be held on May 17, 1999 are incorporated by reference
into Part III hereof.





<PAGE>   2
                          STORAGE COMPUTER CORPORATION


Securities and Exchange Commission
 Item Numbers and Description
 ----------------------------

                                    PART I                                  Page
                                                                            ----
ITEM 1    Business.........................................................   3
                                                                               
ITEM 2    Properties.......................................................  10
                                                                               
ITEM 3    Legal Proceedings.................................... ...........  10
                                                                               
ITEM 4    Submission of Matters to a Vote of Security Holders..............  11
                                                                               
                                  PART II                                      
                                                                               
ITEM 5    Market for Registrant's Common Equity                                
          and Related Stockholder Matters..................................  12
                                                                               
ITEM 6    Management's Discussion and Analysis of Financial                    
          Condition and Results of Operations..............................  15
                                                                               
ITEM 7    Financial Statements and Supplementary Data......................  20
                                                                               
ITEM 8    Changes in and Disagreements with Accountants                        
          on Accounting and Financial Disclosure...........................  20
                                                                               
                                 PART III                                      
                                                                               
ITEM 9    Directors, Executive Officers, Promoters and Control Persons,        
          Compliance with Section 16(a) of the Exchange Act................  20
                                                                               
ITEM 10   Executive Compensation...........................................  20
                                                                               
ITEM 11   Security Ownership of Certain Beneficial Owners                      
          and Management...................................................  20
                                                                               
ITEM 12   Certain Relationships and Related Transactions...................  20
                                                                               
ITEM 13   Exhibits and Reports on Form 8-K.................................  21
                                                                             

         Inasmuch as the calculation of shares of Registrant's voting stock held
by non-affiliates requires a calculation of the number of shares held by
affiliates, such figure, as shown on the cover page hereof, represents the
Registrant's best good faith estimate for purposes of this Annual Report on Form
10-K, and the Registrant disclaims that such figure is binding for any other
purpose. The aggregate market value of Common Stock indicated is based upon the
closing sale price of the Common Stock ($1.75) as reported by the American Stock
Exchange for trading on April 9, 1999. All outstanding shares beneficially owned
by executive officers and directors of the Registrant or by any shareholder
beneficially owning more than 5% of Registrant's common stock, as disclosed
herein, were considered solely for purposes of this disclosure to be held by
affiliates.



                                       2


<PAGE>   3
                                     PART I

                           FORWARD LOOKING STATEMENTS

ITEM 1.  BUSINESS

THE COMPANY

         Storage Computer Corporation (the "Company" or "SCC") develops and
manufactures software-driven multi-host storage solutions used to drive core
business applications. Storage Computer solves its customers' business problems
through its StorageSuite(TM) product line and patented OmniRAID(TM) and
OmniFORCE(TM) storage software. Based on an open systems, standards-based
architecture, these solutions support highly interactive applications; many
different servers accessing the same data; and multiple users accessing data
from different locations.

         The Company pioneered the RAID 7(R) technology incorporated in its
Virtual Storage Architecture(TM), which forms the basis for its StorageSuite(TM)
product family. Based upon this performance-optimized architecture, the
StorageSuite(TM) family combines intelligent controller, disk drive, and memory
technology with patented memory mapping techniques and a powerful real-time
operating system to deliver high-performance and data protection across the mix
of applications found in today's open system environments.

COMPANY HISTORY

         The Company was incorporated in Delaware in August, 1991 when its core
RAID ("Redundant Array of Independent Disks") technology was transferred from
its predecessor Cab-Tek, Inc. and patented. The Company began shipment of its
first generation StorageSuite products, the RAID 7 Storage Server, to customer
production sites in the second half of 1992.

         Pursuant to the Agreement and Plan of Organization dated October 4,
1994, as amended by a First Amendment to the Agreement and Plan of Organization
dated January 31, 1995, Vermont Research Products, Inc. ("VRP"), a wholly-owned
subsidiary of the Company, acquired the entire business and substantially all
the property and assets of Vermont Research Corporation ("VRC") in exchange for
shares of the Company's Common Stock (the "Reorganization"). The Reorganization
became effective on March 6, 1995 and was accounted for as a pooling of
interests.

         In 1996 and 1997, the Company introduced its second generation
StorageSuite products, the OmniRAID Storage Server and SuperServer, and
OmniFORCE data replication software. Also during this time, the Company was
recognized as one of Business Week magazine's "Hot 100 Growth Companies" for
1996 and 1997, and was named to the US High Technology FAST 500 listing
published by Deloitte & Touche, as well as the New England High Technology FAST
50 in 1998.


INDUSTRY OVERVIEW

         The computer systems market is undergoing a dramatic shift to new
information processing modes, such as client/server computing incorporating
enterprise databases, data warehousing, image processing, multi-media, video-
on-demand, virtual reality processing, and Internet/intranet services. These new
application modes are increasing demand for data storage that is scalable in
terms of capacity, performance, connectivity and manageability. The market for
high performance storage is also driven by host computing platforms which
continue to make quantum leaps in processing performance. The Company believes
that users and networks will increasingly demand high-performance storage
systems to eliminate performance bottlenecks and to take full advantage of
increased server/workstation processing power. International Data Corporation
(IDC), a Framingham, MA based research firm, predicts disk storage compound
annual growth rates of 88.1% for UNIX(R) and 133.8% for Windows NT(R) between
the years 1997 and 2001. The U.S. Department of Commerce predicts that the data
storage market will grow to $1 trillion by the year 2004. Based on the market
estimates of IDC, the Company believes the market space for its products is in
the range of $6 billion to $10 billion annually.



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<PAGE>   4
RAID TECHNOLOGY

         The Company's product line is based on RAID storage technology. RAID
technology links together several industry standard disk drives into a single
large disk drive using a combination of hardware, firmware, and software to
achieve extremely fast data transfer rates, high levels of redundancy, and large
storage capacities at a relatively lower cost than embedded storage solutions.

VIRTUAL STORAGE ARCHITECTURE

         Storage Computer's unique Virtual Storage Architecture (VSA) forms the
basis for all its StorageSuite product families. VSA views the storage area as a
whole, coherent, and extendible space, a "storage fabric," which can be
allocated to multiple hosts concurrently.

         The intelligent storage management system controls the interaction
between the attached host processors and the physical drives. It tracks the
location of every piece of information and allows the host to access that data.
Employing dedicated independent I/O channels for each disk drive, the system
transfers data to the hosts and the processors asynchronously. In the extensions
to the architecture, additional performance optimizations are achieved by fully
distributing the intelligence, memory, parity, and flow control throughout the
array. By controlling data flow, the system reduces or eliminates the processing
bottlenecks inherent in many other storage implementations.

The STORAGESUITE(TM) Product Family

SERIES:70 DESKTOP STORAGE SERVER: Provides flexible high performance storage for
         departmental workgroups and server clusters. An intelligent storage
         solution for applications with smaller storage requirements, the
         DESKTOP STORAGE SERVER scales to 218 GB and supports up to two external
         channels for host connections.

SERIES:71 STORAGE SERVER: Provides high performance storage for large
         departmental workgroups and server clusters. An intelligent storage
         solution for users with medium-to-large storage capacity requirements,
         the STORAGE SERVER scales up to 1 TB+ and supports up to four external
         channels for host connections.

SERIES:72 OMNIRAID(TM) SERVER: Enables widely diverse applications to share
         centrally managed storage with optimal performance, data protection,
         efficiency, and flexibility. OMNIRAID SERVERS enable multiple data
         protection levels to be set at the logical transaction or data set
         level, independent of the physical array topology. Ideal for regional
         operating divisions, large workgroups, or medium-sized enterprises, the
         OMNIRAID SERVERS scales up to 2 TB+ and supports up to 12 external
         channels for host connections.
                                                                      
SERIES:73 OMNIRAID SUPERSERVER(TM): Provides enterprise-class storage services
         enabling widely diverse applications across an enterprise to share
         centrally managed storage with optimal performance, data protection,
         efficiency, and flexibility. The highest performing storage server in
         the industry, the OMNIRAID SUPERSERVER delivers even higher read and
         write performance than the OMNIRAID STORAGE SERVER. Ideal for both
         high-performance commercial applications and very high bandwidth
         applications, the OMNIRAID SUPERSERVER supports storage environments to
         2 TB+ and 12 external channels for host connections.

SERIES:74 OMNIRAID SUPERSERVER/ES: At the top end of the highest performing
         storage servers in the industry, the OMNIRAID SUPERSERVER/ES delivers
         OMNIRAID SUPERSERVER performance in a clustered environment. Ideal for
         very high bandwidth applications, the OMNIRAID SUPERSERVER/ES supports
         clustered storage environments up to 16 TB and 48 external channels for
         host connections.



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<PAGE>   5
DISASTER RECOVERY AND BUSINESS CONTINUANCE PRODUCTS

         OMNIFORCE is an advanced intelligent software product that runs on the
SERIES:73 OMNIRAID SUPERSERVER/ES: and SERIES:74 OMNIRAID SUPERSERVER/ES. It
provides an online data protection facility to allow primary production sites to
be multi-level mirrored, locally and/or remotely, to ensure "hot recovery" of
critical data to keep the business running with minimal interruption of service.
OMNIFORCE offers scalable data continuity features, such as the ability to
configure multiple concurrent levels of local and remote data protection, based
on data prioritization. OMNIFORCE provides fully user-scalable protection at the
file level, rather than the array level. Six levels of mirroring are supported:
intramirroring, local, cross, remote, replicated, and reflective.

         The Company entered into OEM agreements during 1998 with ATL Products
and Intelliguard Software to offer serverless backup. This combination of
OMNIRAID STORAGE SERVERS with ATL's tape library and Intelliguard's Celestra
backup software will enable the Company's OMNIRAID products to perform realtime
backup, without requiring host intervention, at speeds ranging up to one
terabyte per hour.

STORAGE MANAGEMENT

         STORAGE ADMINISTRATOR(TM) enhances the monitoring and control of the
Company's storage product using an open, standards-based management protocol,
SNMP (Simple Network Management Protocol), the industry-standard IP (Internet)
communications protocol and a built-in Ethernet LAN (local area network)
connection. This "open systems" design allows information from the Storage
Administrator to be accessed through any SNMP management station, and alarm
conditions can be sent to multiple managers simultaneously, anywhere in the
world, over local or remote network connections. Mission-critical applications
requiring uninterrupted access to data on the arrays are protected by
operational controls within the STORAGE ADMINISTRATOR which enable early
detection and automatic alert notification when any user-defined alarm
thresholds are reached. This advanced "Call Home" technology can simultaneously
report locally, regionally and to the Company's global corporate monitoring
center.

CUSTOMERS AND APPLICATIONS

         The Company has an extensive worldwide customer list. Products based
upon the Virtual Storage Architecture have been sold to customers across a broad
range of industries including banking and financial services, education,
technology, telecommunications, military/aerospace, general services,
government, and manufacturing. It is the goal of the Company to continue to
market to existing customers to leverage its multiple product offerings and to
continue to expand its customer base for its high-performance storage solutions.

CUSTOMER SERVICE AND SUPPORT

         The Company offers its customers a full array of customizable support
options and programs. Customers have the option to decide how they want their
service and support structured, so that the maintenance of the customer's data
storage equipment fits into the customer's business model. Storage Computer's
technical services organization comprises a group of skilled support personnel,
located at Storage Computer's corporate headquarters in Nashua, New Hampshire
and in field locations in the United States, Europe, and Asia.

         In addition to the Company's own support engineers and technicians, its
strategic service alliances with third-party service providers enable it to
offer comprehensive, high-quality programs to support customers on a worldwide
basis. Storage Computer's strategic service alliances formed with third-party
providers include some of the largest and most highly respected organizations in
the service industry. Those alliances include IBM Service Organization,




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<PAGE>   6
Technology Service Solutions (a subsidiary of IBM) and DecisionOne. All in-house
and third-party service technicians supporting the Company's customers are
trained by Storage Computer, and service parts are generally stocked in local
service offices. Service technicians are backed by a technical support hotline
staffed by support analysts at Storage Computer. Storage Computer always takes
the initial service call, determines the logistics of the support plan, and
manages the process. Onsite services may be tailored to customer requirements in
terms of hours covered, response times and onsite hardware service providers.

YEAR 2000

         Many current computer systems and software products were not designed
to handle any dates beyond the year 1999. As a result, computer systems and/or
software used by many companies may need to be modified prior to the Year 2000
in order to remain functional. Significant uncertainty exists in the hardware
and software industry concerning the potential effects associated with such
compliance.

         In mid-1998, the Company formed an internal task force to evaluate
those areas of the Company that may be affected by the Year 2000 problem and
devised a plan for the Company to become Year 2000 compliant in a timely manner
(the "Plan"). The Plan focuses on three major areas; the Company's internal
business transaction systems; the products the Company sells and the business
transaction systems of its business partners, including suppliers, customers and
bankers. To date, the Company has executed approximately one-half of its Plan
and anticipates completing the remaining portions of the Plan by the end of
calendar year 1999.

Internal Business Transaction Systems

         The Company has completed a review of its critical business transaction
systems, and its Year 2000 compliance related to business transaction systems is
as follows:

         All of the Company's systems for processing business transactions prior
to and following 12:00 am January 1, 2000 are tested for transaction integrity.
This compliance extends to the underlying hardware, operating systems, and other
software on which the Company's business system operates. This compliance
includes the following transactions and related printed documents: accepting
orders from customers, fulfilling customer orders, invoicing customers,
crediting customer accounts, applying customer payments, refunding customers,
placing orders with vendors, receiving vendor shipments, processing vendor
invoices, and paying vendors.

         The Company is in the process of evaluating certain ancillary PC office
applications (e.g. word processing, spreadsheets, e-mail, etc.) and specialized
PC applications including art, drawing and other creative department
applications, hardware design and other engineering department applications,
software development systems, bank account management, fixed asset management,
and stock option database management. This effort will continue through 1999.

         The Company has incurred to date no incremental material costs
associated with its efforts to become Year 2000 compliant, as the majority of
the costs have occurred as a result of normal upgrade procedures. Based on
current information, the Company does not expect future costs to modify its
information technology infrastructure to be material to its financial condition
or results of operations. However, there can be no assurances that there will
not be interruptions or other limitations of financial and operating systems
functionally or that the Company will not incur significant costs to avoid such
interruptions or limitations.

Products the Company Sells

         The Company has also completed a review of its manufactured product
line, however, the Company is still in the process of evaluating third party
products and software sold by Storage Computer for Year 2000 compliance. The
Company's Year 2000 compliance status related to the products it sells is as
follows:

         Storage Computer Corporation has conducted an extensive review of its
internal and external requirements and believes that our computer systems and
applications will continue to function properly into the Year 2000.



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<PAGE>   7
         All StorageSuite storage products are Y2K compliant. The Company has
now completed its review and test of all products. Current and past products are
Y2K compliant as will be any future product developments. Expenditures related
to this portion of the Company's Y2K plan have been expensed as incurred and are
immaterial in their impact on the Company's operating results.

         SCC is continuing to work with major vendors and suppliers to ensure
that the Company's manufacturing and infrastructure systems will not experience
any difficulties as a result of their products and services. However, there can
be no guarantee that these parties' systems, on which the Company relies, will
be timely converted. Any effects on the Company's results of operations as a
result of such parties' failures are not estimable. Management does not believe
that any individual vendor's failure to comply will have a material effect on
the Company's products, financial condition or continuing operations.

The Company's Business Partners

         The Company's suppliers (particularly sole-source and long lead-time
suppliers), key customers and other key business partners (e.g. bankers) may be
adversely affected by their respective failure to address the Year 2000 issue.
Should any of the Company's suppliers encounter Year 2000 problems that cause
them to delay manufacturing or shipments of key components to Storage Computer,
the Company may be forced to delay or cancel shipments of its products, which
would have a material adverse effect on the Company's results of operations. Any
inability of Storage Computer's key customers to become Year 2000 compliant
which would cause them to delay or cancel substantial purchase orders or
delivery of Storage Computer products would also have a material adverse effect
on the Company's results of operations. Additionally, any inability of the
Company's other key business partners, including the Company's bank, to become
Year 2000 compliant could cause them to become unable to provide critical
business services, such as to provide funding on the Company's line of credit,
and could therefore also have a material adverse effect on the Company.

         The Company is currently in the process of identifying key customers,
vendors and other significant business partners (e.g. bankers) and obtaining
Year 2000 compliance statements. The Company anticipates completion of this
effort by the end of 1999; however, there can be no assurances that any such
efforts will be successful.

         The Company has incurred to date no incremental material costs
associated with the Year 2000 issue. Based on current information, the Company
does not expect future costs to execute the remainder of its Year 2000
compliance plan to be material to its financial condition or results of
operations. However, there can be no assurances that there will not be
interruptions or other limitations of financial and operating systems
functionally or that the Company will not incur significant costs to avoid such
interruptions or limitations.

         Costs incurred relating to Year 2000 issue will be expensed by the
Company during the period in which they are incurred. The Company's expectations
about future costs associated with the Year 2000 issue are subject to
uncertainties that could cause actual results to have a greater financial impact
than currently anticipated. Factors that could influence the amount and timing
of future costs include but are not limited to the success of the Company's
customers and suppliers in addressing the Year 2000 issue.

COMPETITION

         The information storage market is extremely competitive. Companies such
as Data General Corporation, EMC Corporation, IBM Corporation, Hewlett-Packard,
NCR Corporation, Storage Technology, Sun Microsystems, and more than 100 other
public and private companies provide disk arrays for a wide variety of computer
systems, workstations and PCs. Although SCC is currently unaware of any other
vendor offering an asynchronous transfer RAID disk array, there can be no
assurance that the Company will be able to compete successfully against existing
companies or future entrants to the marketplace. While the Company believes that
the price-performance characteristics of its products are currently competitive,
increased competition including the introduction of new products by the
Company's competitors, could result in price reductions, reduced gross margin
and loss of market share, any of which could materially adversely affect the
Company's business, operating results and financial



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<PAGE>   8
condition. Many of the Company's current and potential competitors have
significantly greater financial, technical, marketing and other resources than
the Company. As a result, they may be able to respond more quickly to new or
emerging technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, sale and support of their products than
the Company. In addition, current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties.
Accordingly, it is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share.

SALES AND MARKETING

         DOMESTIC. The Company's products are sold domestically through a
combination of direct sales personnel, value-added resellers and other
distributors. The Company's direct sales organization coordinates the activities
of the Company's resellers and distributors and seeks to actively participate
with them in selling efforts in order to enable the Company to establish strong
direct ties with its customers and end users.

         INTERNATIONAL. The Company has established several different
operational methods in order to penetrate and develop international markets. The
Company uses distributors and value-added resellers, combined with the selling
efforts of wholly-owned subsidiaries, and affiliated, minority-owned entities,
to penetrate certain international markets and maximize returns on its marketing
and sales efforts.

         Storage Computer Europe, Gmbh, a wholly-owned subsidiary of the Company
located in Kelkheim, Germany, provides sales and product support throughout
Central and Eastern Europe. In September 1992, the Company entered into a joint
venture agreement as a minority shareholder and formed Storage Computer (Asia)
Ltd. for the purpose of selling and servicing the Company's products in Hong
Kong and China. Similarly, in December 1995, the Company made a minority equity
investment in Open Storage Solutions, S.A., in France, for the purpose of
collaborating to sell and service products in France. Storage Computer (UK) Ltd.
manufactures products and supports the sales and service of the Company's
products in certain countries in Western Europe. In October of 1998 the Company
made an additional investment in Open Storage Solutions, S.A., and acquired
majority interest. In February of 1998 the Company formed Storage Computer Pty.,
Ltd. for the purpose of sales and support in Australia.

         The remaining international markets served by the Company are
coordinated and supported from the United States through the use of the
Company's independent distributor network. The Company's distributors are
responsible for penetrating and developing their respective markets, providing
support and maintenance services, and maintaining an inventory of spare parts.
The distributors are also responsible for establishing relationships with
value-added resellers, who sell the Company's products to final end users.

MANUFACTURING

         The Company's manufacturing operations, which are located in Nashua,
New Hampshire, U.S.A. and Leatherhead, England, undertake procurement of
materials, product assembly, product assurance, quality assurance and final
testing. The Company's manufacturing strategy has been to develop close
relationships with its suppliers and subcontractors and to exchange critical
information, in order to minimize capital investment and overhead expenditures
and to control inventories.

         The Company relies upon a limited number of suppliers of several key
components utilized in the assembly of the Company's products. The Company
purchases disk drives and enclosures from a number of major disk drive suppliers
and fabricators. The Company's reliance on its suppliers involves certain risks,
including a potential inability to obtain an adequate supply of required
components, price increases, timely delivery, and component quality. This risk
is particularly significant with respect to suppliers of disk drives because in
order to meet product performance requirements, the Company must obtain disk
drives with extremely high quality and data storage capacity. In addition, there
is currently a significant market demand for disk drives and for semiconductor
memory



                                        8


<PAGE>   9
components, which could result in component shortages, selective supply
allocations and increased prices of such components. Although to date the
Company has been able to purchase its requirements of such components, there is
no assurance that the Company will be able to obtain its full requirements of
such components in the future or that prices of such components will not
increase. In addition, there can be no assurance that problems with respect to
yield and quality of such components and timeliness of deliveries will not
occur. Disruption or termination of the supply of these components could delay
shipments of the Company's products and could have a material adverse effect on
the Company's business, operating results and financial condition.

RESEARCH AND DEVELOPMENT

         Since its inception, the Company has made substantial investments in
research and development. The Company believes that its future performance will
depend in large part on its ability to maintain and enhance its current
products, develop new products that achieve market acceptance, maintain
technological competitiveness and meet an expanding range of customer
requirements. The Company's future growth depends substantially upon the success
of the Company's StorageSuite product line and related products as well as new
products which may be developed; however, there can be no assurance that the
Company's products will attain broad market acceptance. Due to the complexity of
the engineering effort required to produce new data storage subsystem products,
the development and commercial exploitation of new products are subject to
significant technical risks. There can be no assurance that new products will be
introduced on a timely basis or at all. If new products are delayed or do not
achieve market acceptance, the Company's business, operating results and
financial condition will be materially adversely affected. In addition, there
can be no assurance that customers will not defer orders in anticipation of new
product introductions by the Company or its competitors.

         Products like those offered by the Company may contain undetected
software errors or failures when first introduced or as new versions are
released. There can be no assurance that, despite testing by the Company and by
current and potential customers, errors will not be found in new products after
commencement of commercial shipments, resulting in loss of or delay in market
acceptance, which could have a material adverse effect upon the Company's
business, operating results and financial condition.

         The Company's total expenses for research and development for fiscal
years 1998, 1997 and 1996 were $4,258,000, $2,852,000 and $2,785,000
respectively. Future research and development efforts will be focused on
increasing the individual capabilities and performance of existing products and
developing new value added software and hardware products to provide the
Company's installed base with greater functionality, as well as to attempt to
expand that installed base.

PROPRIETARY RIGHTS

         The Company's policy is to protect its technology by, among other
things, filing patent applications with respect to technology considered
important to the development of its business. The Company has been awarded
certain U.S. patents and has additional U.S. patent applications pending.
Foreign counterparts of certain of these applications have been filed or may be
filed at the appropriate time. The Company decides on a case-by-case basis
whether and in what countries it will file foreign counterparts of a U.S. patent
application. Although the Company often seeks patents on its products, the
Company believes that patents are of less significance in its industry than such
factors as innovative skills and technical expertise, frequency of product
enhancements and timeliness and quality of support services provided by the
Company.

         The Company believes that its products, trademarks and service marks do
not infringe on the proprietary rights of third parties. There can be no
assurance, however, that third parties will not assert infringement claims
against the Company in the future. If such a claim is made, the Company will
evaluate the claim as it relates to its products and, if appropriate, may seek a
license to use the protected technology. There can be no assurance that the
Company



                                        9


<PAGE>   10
would be able to obtain a license to use any such protected technology or that
any such license could be obtained on terms that would not have a material
adverse effect on the Company. If the Company or its suppliers are unable to
license any such protected technology, the Company could be prohibited from
incorporating or marketing such products. The Company could also incur
substantial costs to redesign its products or to defend any legal action taken
against it. Should the Company's products be found to infringe protected
technology, the Company could be required to pay damages to the infringed party
or be enjoined from manufacturing and selling such products.

         The Company requires all employees, and technical and other consultants
and advisors to execute confidentiality agreements upon the commencement of
employment or consulting relationships with the Company. These agreements
generally provide that all confidential information developed or made known to
the individual during the course of the individual's relationship with the
Company is to be kept confidential and not disclosed to third parties except in
specific circumstances. All of the Company's key technical employees have also
entered into agreements providing for the assignment of rights to inventions
made by them while in the employ of the Company. Although the Company continues
to take protective measures to protect its proprietary technology, there can be
no assurance that these measures will be successful. In addition, the laws of
certain foreign countries may not protect the Company's rights to the same
extent as U.S. law.

EMPLOYEES

         As of December 31, 1998, the Company had 108 full time employees. Of
the total, 88 were based in North America, 10 in the United Kingdom, and 10 in
Germany. The Company's ability to develop, manufacture and market its products
and to establish and maintain a competitive position in its industry will
depend, in large part, upon its ability to attract and retain qualified
technical, marketing and managerial personnel, of which there can be no
assurance. The Company believes that its relations with its employees are good.
None of the Company's employees are represented by a collective bargaining
agreement.

ITEM 2.  PROPERTIES

         The Company currently leases, from an affiliate, a 35,000 sq. ft.
facility which is occupied by its light manufacturing, research and development
and office operations in Nashua, New Hampshire. In 1998, the Company paid total
rent of $200,400 to lease this facility. The 1999 monthly rental is $18,800
which the Company believes is comparable to rentals of similar properties in the
area and indicative of the fair market rental which could be obtained from an
unrelated third party in an arm's-length transaction. See "Item 12 - Certain
Relationships and Related Transactions." The Company leases all of its domestic
and international outside sales offices. All Company properties and premises are
adequately protected by insurance coverage. The Company believes that its
existing facilities are adequate for its current needs and that additional space
will be available as needed.

ITEM 3.  LEGAL PROCEEDINGS

         On April 28, 1998, the Superior Court, Cheshire County, New Hampshire,
rendered its decision in the suit brought by Raul Kacirek (Dkt. No. 94-E-0102)
seeking specific performance to have the Company issue up to 300,000 shares of
its common stock. The Court found in favor of the Company on all claims in this
action. The Company does not believe that its involvement in, the judicial
decisions rendered or the final resolution of this legal proceeding, has had a
material effect upon the Company's business, operating results or financial
condition.




                                       10


<PAGE>   11
         One of the Company's suppliers of disk drives, Micropolis (USA) Inc.,
filed for a plan of reorganization under Chapter 11 of the Bankruptcy Code. If
the Bankruptcy Court does not approve the Plan, then the likelihood is that the
case would be converted to one under Chapter 7 of the Bankruptcy Code.

         The Company believes that the disk drives supplied by Micropolis,
together with its inability to support the disk drives supplied, caused the
Company material and adverse damages in 1998. These damages include, but are not
limited to, lost sales, deferred sales, substantial field and factory expenses,
loss of reputation, and inventory writeoffs.

         The Company has filed various proof of claims against Micropolis (USA)
Inc. in the United States Bankruptcy Court in the Central District of California
and against its parent, Micropolis (S) Limited, in the court in Singapore. The
Company cannot estimate what its continuing involvement in, any judicial
decision rendered or the resolution of this set of claims will have upon the
Company's business, operating results or financial condition.

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

         No matters were submitted to a vote of the Company's security holders 
during the fourth quarter of the fiscal year ended December 31, 1998.




                                       11


<PAGE>   12
PART II

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

         The Company's Common Stock is traded on the American Stock Exchange
under the symbol "SOS".

         The following table sets forth the range of the high and low closing
sales prices for the Common Stock of the Company for the fiscal years ended
December 31, 1998 and 1997, as reported by the American Stock Exchange.

<TABLE>
<CAPTION>
         FISCAL 1998                                        High        Low  
         -----------                                        ----        ---  
         <S>                                               <C>       <C>     
         First Quarter..................................   $ 9.62    $ 5.50  
         Second Quarter.................................   $ 7.38    $ 3.63   
         Third Quarter..................................   $ 4.38    $ 2.44   
         Fourth Quarter.................................   $ 5.00    $ 1.00  
                                                                             
                                                                             
         FISCAL 1997                                        High        Low  
         -----------                                        ----        ---  
         First Quarter..................................   $19.63    $11.25  
         Second Quarter.................................   $14.38    $10.88  
         Third Quarter..................................   $14.00    $10.75  
         Fourth Quarter.................................   $12.00    $ 5.00
</TABLE>

         On December 31, 1998, there were 650 holders of record of the Company's
Common Stock. The Company believes the actual number of beneficial owners of the
Common Stock is greater than the stated number of holders of record because a
large number of the shares of the Company's Common Stock is held in custodial or
nominee accounts for the benefit of persons other than the record holders.

         The Company has never paid any cash dividends and does not anticipate
paying any cash dividends in the foreseeable future. The Company is also
restricted from paying cash dividends under the terms of its bank credit
facility.



                                       12


<PAGE>   13
                             SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                     1998              1997             1996            1995             1994
                                 ------------      -----------      -----------      -----------      -----------
<S>                              <C>               <C>              <C>              <C>              <C>        

Revenue                          $ 17,051,749      $37,146,103      $31,011,429      $23,130,413      $14,522,887
Product cost                       11,838,657       18,152,978       15,326,909       12,054,265        6,295,256
                                 ------------      -----------      -----------      -----------      -----------
Gross margin                        5,213,092       18,993,125       15,684,520       11,076,148        8,227,631
                                 ------------      -----------      -----------      -----------      -----------
Operating expenses
  Research and development          4,258,249        2,851,739        2,785,280        2,116,542        1,901,091
  Selling and marketing             8,871,805        7,959,521        6,117,947        5,469,238        3,280,186
  General and administrative        2,387,748        1,526,477        1,186,239        1,089,797        1,295,858
  Write down of investment          2,094,134                0                0                0                0
                                 ------------      -----------      -----------      -----------      -----------
  Total                            17,611,936       12,337,737       10,089,466        8,675,577        6,447,135
                                 ------------      -----------      -----------      -----------      -----------
Operating income (loss)           (12,398,844)       6,655,388        5,595,054        2,400,571        1,750,496
                                 ------------      -----------      -----------      -----------      -----------
Other income (expense)               (636,668)        (399,635)         (92,523)          58,986         (520,971)
                                 ------------      -----------      -----------      -----------      -----------
Income (loss) before
  income taxes                    (13,035,512)       6,255,753        5,502,531        2,459,557        1,229,525
                                 ------------      -----------      -----------      -----------      -----------
Provision (benefit) for
  income taxes                     (2,145,020)       2,364,000          440,980          (27,038)       1,046,540
                                 ------------      -----------      -----------      -----------      -----------
Net income (loss)                $(10,890,492)     $ 3,891,753      $ 5,061,551      $ 2,486,595      $   182,985
                                 ============      ===========      ===========      ===========      ===========
Net income (loss) per
  diluted share                  $       (.97)     $       .36      $       .43      $       .21      $       .02
                                 ============      ===========      ===========      ===========      ===========
Total assets                     $ 22,899,902      $30,811,953      $20,935,309      $14,767,614      $10,728,315
                                 ============      ===========      ===========      ===========      ===========
Long term obligations            $    710,000      $   710,000      $   742,672      $   971,594      $ 1,565,100
                                 ============      ===========      ===========      ===========      ===========

</TABLE>





                                       13


<PAGE>   14
QUARTERLY FINANCIAL INFORMATION

         The following selected financial information is derived from the
Company's financial statements and should be read in conjunction with those
statements.

<TABLE>
<CAPTION>
                                                             1998 Quarter Ended
                                        -------------------------------------------------------------
                                         March 31        June 30        September 30      December 31
                                        ----------     -----------      ------------     ------------
<S>                                     <C>            <C>              <C>              <C>         

Revenue                                 $7,016,310     $ 3,275,639      $ 3,198,182      $  3,561,618
Gross margin                             3,527,789       1,144,206          429,307           111,790
Income (loss) before taxes                 477,487      (2,686,666)      (3,206,709)       (7,619,624)
Net income (loss)                          310,487      (1,749,666)      (2,080,709)       (7,370,604)
Net income (loss) per diluted share     $      .03     $      (.16)     $      (.18)     $       (.66)

<CAPTION>
                                                             1997 Quarter Ended
                                        -------------------------------------------------------------
                                         March 31        June 30        September 30      December 31
                                        ----------     -----------      ------------     ------------
<S>                                     <C>            <C>              <C>              <C>         

Revenue                                 $8,454,913     $ 9,660,453      $ 7,647,253      $ 11,383,484
Gross margin                             4,307,757       4,915,497        3,854,838         5,915,033
Income before taxes                      1,138,143       1,878,959          400,872         2,837,779
Net income                                 928,143       1,095,359          114,472         1,753,779
Net income per diluted share            $      .08     $       .09      $       .01      $        .15

</TABLE>

         Based on year-end analysis and information available at that time, the
Company recorded certain adjustments that affected the fourth quarter of 1998.
Inventory was written down in the amount of approximately $1,500,000 to reflect
anticipated obsolescence of items due to shifts in product configuration. An
investment in a limited liability company was written down by approximately
$2,100,000 due to the potential for a long delay in recovering the Company's
investment in that company and the risks associated with delay. Accounts
receivable in the amount of approximately $580,000 were written off because the
Company determined those accounts to be uncollectible.


                                       14


<PAGE>   15


ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES

Cash flow

         The cash flow for operating activities is impacted by the timing of
product shipments and inventory purchases to support new product development and
revenue fluctuations.

Accounts Receivable

         The reduction in accounts receivable from December 31, 1997 to December
31, 1998 of approximately $8,723,000 is due to the reduced level of revenue
during the 1998 year and additional allowances made for doubtful accounts.

Inventory

         Inventory increased approximately $384,000 from December 31, 1997 to
December 31, 1998. During fourth quarter 1998 the Company instituted programs to
reduce the level of component parts in inventory. The investment in inventory is
impacted by several factors, including, but not limited to, new product and
product enhancement introduction; the higher cost of parts associated with
larger storage units; the timing of purchased component parts such as disk
drives; inventory increases due to evaluation units; the timing of inventory
reductions due to intercompany transfers; and increased inventory locations
throughout the United States and Europe.

Borrowing Arrangements

         In April 1999, the Company negotiated an amended loan agreement with 
its bank for the working capital needs of the Company. The initial negotiated 
line of $10,300,000 has been reduced to a new line of $8,700,000 through the 
application of tax refunds received by the Company in 1999 and will be further 
reduced by certain other proceeds received by the Company including additional 
tax refunds and equity investments. The amended loan agreement requires, among 
other things, maintenance of a defined minimum working capital ratio. 
Borrowings against the credit facility bear interest at the bank's prime rate 
plus one percent. Under the agreement, the Company has also agreed to 
undertake certain actions to reduce the line of credit with the bank during 
1999. The credit line expires on January 4, 2000.

         The Company's working capital at December 31, 1998 was approximately
$3,399,000. In Management's opinion, the Company's current working capital
position, together with the available credit facility and other financing
arrangements, will be sufficient to accommodate working capital requirements
through 1999.




                                       15


<PAGE>   16
RESULTS OF OPERATIONS

         The following table presents the Company's consolidated statement of
operations stated as a percentage of revenue for the years ended December 31,
1998, 1997, 1996, 1995 and 1994.

<TABLE>
<CAPTION>
                                                    1998       1997       1996       1995       1994
                                                   ------     ------     ------     ------     ------  
<S>                                                <C>        <C>        <C>        <C>        <C>     

Revenue ........................................   100.00%    100.00%    100.00%    100.00%    100.00% 
Product cost ...................................    69.43      48.87      49.42      52.11      43.35  
                                                   ------     ------     ------     ------     ------  
Gross margin ...................................    30.57      51.13      50.58      47.89      56.65  
                                                   ------     ------     ------     ------     ------  
Operating expenses                                                                                     
     Research and development ..................    24.97       7.68       8.98       9.15      13.09  
     Selling and marketing .....................    52.03      21.43      19.73      23.65      22.59  
     General and administrative ................    14.00       4.11       3.83       4.71       8.92  
     Write down of investment ..................    12.28          0          0          0       0.00  
                                                   ------     ------     ------     ------     ------  
     Total .....................................   103.28      33.22      32.54      37.51      44.60  
                                                   ------     ------     ------     ------     ------  
Operating income (loss) ........................   (72.71)     17.91      18.04      10.38      12.05  
                                                   ------     ------     ------     ------     ------  
Other income (loss) (expense) ..................    (3.73)     (1.08)      (.30)      0.26      (3.59) 
                                                   ------     ------     ------     ------     ------  
Income (loss) before income taxes ..............   (76.44)     16.83      17.74      10.64       8.46  
                                                   ------     ------     ------     ------     ------  
Provision for income taxes                                                                             
     Current tax ...............................   (12.58)      5.44       6.00       3.76       7.21  
     Deferred tax (benefit) ....................        0        .93      (4.58)     (3.88)      0.00  
                                                   ------     ------     ------     ------     ------  
     Total .....................................   (12.58)      6.37       1.42      (0.12)      7.21  
                                                   ------     ------     ------     ------     ------  
Net income (loss) ..............................   (63.86)%    10.46%     16.32%     10.76%      1.25% 
                                                   ------     ------     ------     ------     ------  
</TABLE>

                                                            
REVENUE

         Revenue for the year ended December 31, 1998 was $17,051,000 reflecting
an approximate decrease in combined product sales of $20,095,000 or 54%,
compared with the year ended December 31, 1997. Revenue for the year ended
December 31, 1997 was $37,146,000, reflecting an increase in combined product
sales of approximately $6,135,000 or 20% compared with the year ended December
31, 1996.

         In East Asia, which historically has contributed approximately 25% to
total revenue, the Company experienced a decline in revenue to approximately 22%
due to that geographical area's economic problems. North American and European
revenues were soft due to deferral or loss of customer orders due to delays in
the introduction of enhanced hardware and software features.

         During the fourth quarter of 1998 the Company undertook the following
actions to facilitate the cohesive focus towards revenue growth: appointed a
Senior Vice President of Sales and Marketing and commenced a restructuring,
including the expansion of North America territories from three designated
regions to five regions, and consolidation of the European sales, marketing and
service organizations; implemented strategic marketing programs and product
repositioning and pricing directives with respect to the Company's existing
products offerings.



                                       16


<PAGE>   17
         Revenue by geographic region expressed as a percentage is as follows:

<TABLE>
<CAPTION>
                                    Year Ended            Year Ended          Year Ended
                                December 31, 1998     December 31, 1997    December 31, 1996
                                -----------------     -----------------    -----------------
<S>                                     <C>                  <C>                  <C>

North America..................        54%                  50%                  47%
Far East.......................        22%                  23%                  28%
European Sales.................        22%                  26%                  23%
Other Regions..................         2%                   1%                   2%

</TABLE>

         The increase in the percentage of North American revenue results from
increased maintenance sales, the expansion of the United States direct sales
force and a decrease in revenue in the Far East.

         All United States export sales are denominated in United States dollars
to limit the amount of foreign currency risk. Export sales from the European
sales offices are denominated in United States dollars. Sales which occur
through the Company's subsidiaries located in England and Germany are conducted
in the local functional currency.

PRODUCT COST

         Product cost for the years ended December 31, 1998, 1997 and 1996 was
$11,839,000, $18,153,000 and $15,327,000, or 69%, 49%, and 49% of revenue,
respectively.

         For 1997 and 1996 the product cost percentage remained constant at 49%.
The increase in product cost in 1998 is attributable to shifts in product
configuration, a lower dollar product margin contribution to cover non-variable
expenses associated with product production and support, based on the decline in
revenue, and increased provisions for inventory obsolescence.

RESEARCH AND DEVELOPMENT

         Research and development expenses for the years ended December 31,
1998, 1997 and 1996 were $4,258,000, $2,852,000 and $2,785,000, or 25%, 8% and
9% of revenue, respectively.

         In 1998 the Company increased its expenditures for research and
development in order to maintain the technology advantage for its software, and
to develop new hardware packaging . These increased expenditures resulted from
the Company's emphasis on completion of new hardware and from continued
prototype and piece-part costs and payments to contractors for out-sourced
design and development costs associated with the project.

SALES AND MARKETING

         Sales and marketing expenses for the years ended December 31, 1998,
1997 and 1996 were $8,872,000, $7,960,000, and $6,118,000 or 52%, 21% and 20% of
revenue, respectively. 

         The increase in absolute dollar expenditures from 1998 to 1997 was due
to increased headcount and resulting support expense associated with the
company's expansion of the direct sales force and implementation of strategic
marketing programs introduced in the fourth quarter of 1998, and increased
allowance for doubtful accounts.

GENERAL AND ADMINISTRATIVE

         General and administrative expenses for the years ended December 31,
1998, 1997 and 1996 were approximately $2,388,000 $1,526,000 and $1,186,000, or
14.0%, 4.1% and 3.8% of revenue, respectively. The absolute dollar increases in
each year result primarily from employee-related costs and administrative cost
associated with foreign affiliates.





                                       17

<PAGE>   18
WRITE DOWN OF INVESTMENT

         In August 1998, the Company and another organization formed a limited
liability company named HVVR, LLC ("HVVR"). The purpose of HVVR was to hold
ownership of a new product technology developed by a former customer of the
Company (the "Developer"). The owners of HVVR contributed approximately $6
million in cash and other property (of which approximately $2.3 million was
contributed by the Company), which was transferred to the Developer in exchange
for the product technology. The Company's investment in HVVR was the end result
of a series of transactions as follows: During the third quarter of 1997 the
Company entered into negotiations to secure certain trade receivables due from
the Developer. In March of 1998 the parties agreed to convert the accounts
receivable to registered convertible preferred stock. When the Developer failed
to file a timely registration statement for the preferred stock, the Company
entered into new negotiations with the Developer resulting in the transactions
described above.

         HVVR granted an exclusive license to the Developer to manufacture the
new product that provides for royalty payments to HVVR. Should the Developer be
sold or merged with another company, the agreement provides for conversion of
the license to a non-exclusive basis, unless HVVR receives a minimum guaranteed
payment.

         The License Agreement may be terminated by HVVR on thirty (30) days
notice upon default by the Developer of its obligations under the license,
including, among others, the obligation to market the new product technology,
and provides for automatic termination if the Developer voluntarily files for
bankruptcy protection.

         The Developer is experiencing severe financial difficulties which
raises substantial uncertainty as to its ability to complete the product, bring
it into volume production, and market the products in large quantity to generate
royalty payments to HVVR sufficient to support the initial value of the
investment.

         Neither HVVR nor the Company has available the resources to pursue the
research, production, and marketing of the product at this time. In view of the
potential for a long delay in recovering the Company's investment in HVVR
through royalty payments and the associated risks of that delay, the Company
decided to write its investment down to $100,000.

OTHER INCOME(EXPENSE)

         The major component of other income(expense) is interest expense, which
aggregated $648,000, $466,000 and $209,000 in the years 1998, 1997 and 1996,
respectively. The increase in interest expense from 1996 to 1998 is the result
of increased short-term borrowing under the Company's line of credit to
$9,313,000.

FEDERAL AND STATE INCOME TAXES

         The effective tax rate (benefit) for 1998, 1997 and 1996 was (16.5%),
37.8% and 8.%, respectively. Changes in effective tax rates have been
significantly affected by the establishment and reserve of the deferred tax
assets related to net operating loss carryforwards. At December 31, 1998 the
Company's financial statements reflect net deferred tax assets of $2,194,000
which the Company expects to recover through future operations.

FOREIGN CURRENCY TRANSACTIONS

         Management does not currently utilize any derivative products to hedge
its foreign currency risk. The Company's foreign subsidiaries' obligations to
their parent are denominated in United States dollars. There is a potential for
a foreign currency gain or loss based upon fluctuations between the United
States dollar and its subsidiaries' functional currencies, currently the German
mark and the British pound. This exposure is limited to the period between the
time of accrual of such liability to the parent in the subsidiaries' functional
currency and the time of its payment.

         Other than the intercompany balances noted above, the Company does not
believe it has material unhedged monetary assets, liabilities or commitments
which are denominated in a currency other than the operations' functional
currency. Management expects such exposure to continue until its foreign
subsidiaries reach a more mature level of operation. Management currently has no
plans to utilize any derivative products to hedge its foreign currency risk.





                                       18


<PAGE>   19
THE EURO CONVERSION

         During the year, the Company investigated the impact of the euro
conversion on its subsidiaries in the United Kingdom and in Germany. Because
Germany is a participating country, the Company has purchased accounting
software in order to accommodate the dual currency requirements for the
transition period. The purchase of that software has been accounted for in
accordance with the Company's accounting policy for asset capitalization. The
Company does not expect the euro conversion to have a material impact on its
business or its financial condition.

INFLATION

         The Company does not believe that inflation has had a material impact
on its operations.

FORWARD-LOOKING STATEMENTS

         The Private Securities Litigation Reform Act of 1996 contains certain
safe harbors regarding forward-looking statements. From time to time,
information provided by the Company or statements made by its directors,
officers or employees may contain "forward-looking" information subject to
numerous risks and uncertainties. Any statements made herein that are not
statements of historical fact are forward- looking statements including, but not
limited to, statements concerning the characteristics and growth of the
Company's markets and customers, the Company's objectives and plans for future
operations and products and the Company's expected liquidity and capital
resources. Such forward-looking statements are based on a number of assumptions
and involve a number of risks and uncertainties, and, accordingly, actual
results could differ materially. Factors that may cause such differences
include, but are not limited to: the continued and future acceptance of the
Company's products; the rate of growth in the industries of the Company's
products; the presence of competitors with greater technical, marketing and
financial resources; the Company's ability to promptly and effectively respond
to technological change to meet evolving customer needs; risks associated with
sales in foreign countries; and the Company's ability to successfully expand its
operations.




                                       19


<PAGE>   20
ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         See Index to Financial Statements (Page 24).

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

         Effective April 1, 1998, the Boston office of Richard A. Eisner &
Company, LLP ("RAE") was merged into the Boston office of BDO Seidman, LLP
("BDO"). This merger resulted in RAE no longer having an office in the Boston
area. The Company concluded that it would be appropriate to select BDO as the
new accounting firm. By unanimous consent of the Board of Directors of the
Company on May 18, 1998, it was voted to retain BDO to serve as the Company's
independent auditors. During the Company's two most recent fiscal years prior to
May 18, 1998 (1997 and 1996) and any subsequent interim period to May 18, 1998,
there have been no disagreements between the Company and Richard A. Eisner &
Company, LLP, on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure which, if not resolved to
the satisfaction of Richard A. Eisner & Company, LLP, would have caused it to
make reference to the subject matter of the disagreement in connection with its
report on the audited financial statements.


                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS

         The information required by this item may be found under the sections
captioned "Election of the Directors;"and "Executive Officers," in the Company's
Proxy Statement (the "1999 Proxy Statement") for the Company's Annual Meeting of
Stockholders to be held on May 17, 1999, and is incorporated herein by
reference.

ITEM 10. EXECUTIVE COMPENSATION

         The information required by this item may be found under the section
captioned "Executive Compensation" in the Company's 1999 Proxy Statement and is
incorporated herein by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by this item may be found under the section
captioned "Principal and Management Stockholders" in the Company's 1999 Proxy
Statement and is incorporated herein by reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by this item may be found under the section
captioned "Certain Relationships and Related Transactions" in the Company's 1999
Proxy Statement and is incorporated herein by reference.




                                       20


<PAGE>   21
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a)  The following documents are included as part of the report:

     (1)  Financial Statements

          The following financial statements of the Company and the reports of
the independent auditors are filed as part of this report:

          Index to Financial Statements
          Reports of Independent Auditors
          Statement of Consolidated Financial Position
          Statement of Consolidated Operations
          Statement of Consolidated Stockholders' Equity
          Statement of Consolidated Cash Flows
          Notes to Consolidated Financial Statements

     (2)  Financial Statement Schedules

          None

     (3)  Exhibits

          Certain of the exhibits listed hereunder have been previously filed
with the Commission as exhibits to certain prior registration statements and
periodic reports as indicated in the footnotes below. The location of each
document so incorporated is indicated by footnote.

* 3.1    Restated Articles of Organization (Incorporated by reference as Exhibit
         3.1 to the Company's Form S-4, Registration No. 33-87028, as filed on
         December 2, 1994).

* 3.2    Amended and Restated By-Laws (Incorporated by reference as Exhibit 3.2
         to the Company's Form S-4, Registration No. 33-87028, as filed on
         December 2, 1994).

* 4.1    Specimen Common Stock Certificate (Incorporated by reference as Exhibit
         4.1 to the Company's Form S-4, Registration No. 33-87028, as filed on
         December 2, 1994).

*10.1    Restated and Amended Stock Incentive Plan. (Incorporated by reference
         as Exhibit 4.1 to the Company's Form S-8, Registration No. 333-31297,
         as filed on July 14, 1998).

*10.2    Form of Restated and Amended Stock Incentive Plan, Stock Award
         (Incorporated by reference as Exhibit 4.2 to the Company's Form S-8,
         Registration No. 333-31297, as filed on July 14, 1998)

*10.3    Promissory Note in the principal amount of $710,000 dated December 6,
         1997 made payable to Theodore J. Goodlander.

*10.4    Letter Agreement dated July 14, 1994 between the Registrant and Eddie
         Lu Hwang (Incorporated by reference as Exhibit 10.8 to the Company's
         Form S-4, Registration



                                       21


<PAGE>   22
         No. 33-87028, as filed on December 2, 1994).

*10.5    Joint Venture Agreement between the Registrant, Micro Research Computer
         Limited and Eddie Lu Hwang (Incorporated by reference as Exhibit 10.6
         to the Company's Form S-4, Registration No. 33-87028, as filed on
         December 2, 1994).

*10.5b   Amended and Restated 1992 Stock Incentive Plan (Incorporated by
         reference as Exhibit 10.5 to Amendment No. 4 to the Company's Form S-3,
         Registration No. 333-04145, as filed on September 13, 1997).

*10.6    Amendment dated August 20, 1997, to the Revolving Credit Agreement
         dated August 6, 1996 between the Company and State Street Bank and
         Trust Company.

*10.7    $10,000,000 Line of Credit Note from Registrant to State Street Bank
         and Trust Company dated August 20, 1997.

*10.8    Loan Agreement dated August 6, 1996 between the Company and State
         Street Bank and Trust Company (Incorporated by reference to Exhibit
         10.2 to Amendment No. 4 to the Company's Form S-3, Registration No.
         333-04145, as filed on September 13, 1997.

*21      Subsidiaries of the Company.

 23.1    Consent of BDO Seidman, LLP.

 23.2    Consent of Richard A. Eisner & Company, LLP.

 27      Financial Data Schedule.

*99      "Safe Harbor" Statement under Private Securities Litigation Reform Act
         of 1996.

----------
* previously filed


(b)  Reports on Form 8-K

     None.



                                       22

<PAGE>   23
                                   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, in Nashua, New
Hampshire, on the    day of March, 1999.


                                    STORAGE COMPUTER CORPORATION

                                    BY:
                                        ---------------------------------------
                                        Theodore J. Goodlander
                                        Chairman of the Board of Directors, CEO
                                        (Principal Executive Officer)


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


     Signature                       Capacity                         Date
     ---------                       --------                         ----


                         Chairman of the Board of Directors,      April 15, 1999
-----------------------  CEO (Principal Executive Officer)
Theodore J. Goodlander  


/s/ Shigeho Inaoka       Director                                 April 15, 1999
-----------------------
Shigeho Inaoka 


/s/ Steven S. Chen       Director                                 April 15, 1999
-----------------------
Steven S. Chen






                                       23


<PAGE>   24
                          STORAGE COMPUTER CORPORATION

                                  - I N D E X -



                                                                           Page
                                                                          Number
                                                                          ------

Reports of Independent Auditors..........................................   25

Consolidated Financial Position at December 31, 1998 
and December 31, 1997....................................................   27

Statement of Consolidated Operations for the Years Ended 
December 31, 1998, December 31, 1997 and December 31, 1996...............   28

Statement of Consolidated Stockholders' Equity for the Years 
Ended December 31, 1998, December 31, 1997 and December 31, 1996 ........   29

Statement of Consolidated Cash Flows for the Years Ended 
December 31, 1998, December 31, 1997 and December 31, 1996...............   30

Notes to Consolidated Financial Statements ..............................   31




                                       24


<PAGE>   25
                         REPORT OF INDEPENDENT AUDITORS


To the Board of Directors
Storage Computer Corporation
Nashua, New Hampshire 03062

         We have audited the accompanying consolidated financial position of
Storage Computer Corporation as at December 31, 1998, and the related statements
of consolidated operations, stockholders' equity, and cash flows for the year
ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.

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

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Storage
Computer Corporation at December 31, 1998, and the consolidated results of their
operations and their consolidated cash flows for the year ended December 31,
1998 in conformity with generally accepted accounting principles.



BDO Seidman,  LLP
Boston, Massachusetts
March 19,1999,
except for Note E, which is as of April 12, 1999




                                       25


<PAGE>   26
                         REPORT OF INDEPENDENT AUDITORS


To the Board of Directors
Storage Computer Corporation
Nashua, New Hampshire  03062


         We have audited the accompanying consolidated financial position of
Storage Computer Corporation as at December 31, 1997, and the related statements
of consolidated operations, stockholders' equity, and cash flows for each of the
years ended December 31, 1997, and 1996. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.

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

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Storage
Computer Corporation at December 31, 1997, and the consolidated results of their
operations and their consolidated cash flows for each of the years in the
two-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.





Richard A. Eisner & Company, LLP
New York, New York
February 25, 1998





                                       26


<PAGE>   27
                          STORAGE COMPUTER CORPORATION

                         CONSOLIDATED FINANCIAL POSITION

<TABLE>
<CAPTION>
                                                                             December 31,
                                                                      --------------------------
                                                                         1998           1997
                                                                      -----------    -----------
<S>                                                                   <C>            <C>        
                                 ASSETS
Current assets:
     Cash and cash equivalents ....................................   $   925,259    $ 1,113,379
     Accounts receivable (net of allowance for                                                  
       doubtful accounts) (Note L) ................................     5,187,351     13,910,001
     Income tax refund receivable .................................     2,160,211               
     Inventories (Note B) .........................................     8,263,040      7,879,485
     Other current assets .........................................       707,300        554,804
     Deferred tax asset (Note I) ..................................                      350,000
                                                                      -----------    -----------
          Total current assets ....................................    17,243,161     23,807,669
                                                                      -----------    -----------
Property and equipment (Note C) ...................................     2,742,252      2,520,774
Deferred tax asset (Note I) .......................................     2,194,000      1,844,000
Other assets (Note D) .............................................       720,489      2,639,510
                                                                      -----------    -----------
          Total ...................................................   $22,899,902    $30,811,953
                                                                      ===========    ===========
                                                                                                
                     LIABILITIES AND STOCKHOLDERS' EQUITY                                       
Current liabilities:                                                                            
     Notes payable (Note E) .......................................   $ 9,336,377    $ 6,442,701
     Accounts payable .............................................     2,298,655      1,980,721
     Accrued expenses .............................................     2,209,232      2,149,871
     Accrued Income Taxes .........................................                      628,510
                                                                      -----------    -----------
          Total current liabilities ...............................    13,844,264     11,201,803
                                                                      -----------    -----------
Long-term debt (Note E) ...........................................       710,000        710,000
                                                                      -----------    -----------
Commitments and contingencies (Notes F, G and J)                                                
Stockholders' equity (Note H):                                                                  
     Preferred stock, par value $.001; authorized                                               
       1,000,000 shares; none issued and outstanding                                            
     Common stock par value $.001; authorized 25,000,000                                        
       shares; issued and outstanding 11,347,823                                                
       shares (1998) and 11,149,016 shares (1997) .................        11,348         11,149
     Additional paid-in capital ...................................    13,721,021     13,385,240
     Retained earnings (accumulated deficit) ......................    (5,386,731)     5,503,761
                                                                      -----------    -----------
          Total stockholders' equity ..............................     8,345,638     18,900,150
                                                                      -----------    -----------
          Total ...................................................   $22,899,902    $30,811,953
                                                                      ===========    ===========
</TABLE>



    The accompanying notes are an integral part of the financial statements.


                                       27

<PAGE>   28
                          STORAGE COMPUTER CORPORATION

                      STATEMENT OF CONSOLIDATED OPERATIONS


<TABLE>
<CAPTION>
                                                               Year Ended December 31,
                                                    ----------------------------------------------
                                                        1998              1997            1996
                                                    ------------      -----------      -----------
<S>                                                 <C>               <C>              <C>        

Revenue .........................................   $ 17,051,749      $37,146,103      $31,011,429
Product cost ....................................     11,838,657       18,152,978       15,326,909
                                                    ------------      -----------      -----------
     Gross margin ...............................      5,213,092       18,993,125       15,684,520
                                                    ------------      -----------      -----------
Operating expenses:
     Research and development ...................      4,258,249        2,851,739        2,785,280
     Selling and marketing ......................      8,871,805        7,959,521        6,117,947
     General and administrative .................      2,387,748        1,526,477        1,186,239
     Write down of investment ...................      2,094,134
                                                    ------------      -----------      -----------
     Total Operating Expenses ...................     17,611,936       12,337,737       10,089,466
                                                    ------------      -----------      -----------
Operating income (loss) .........................    (12,398,844)       6,655,388        5,595,054
                                                    ------------      -----------      -----------
Other income (expense):
     Interest expense, net (Note E) .............       (647,557)        (438,649)        (177,822)
     Other income ...............................         10,889           39,014           85,299
                                                    ------------      -----------      -----------
     Total ......................................       (636,668)        (399,635)         (92,523)
                                                    ------------      -----------      -----------
Income (loss) before income taxes (benefit) .....    (13,035,512)       6,255,753        5,502,531
                                                    ------------      -----------      -----------
Provision for income taxes (benefit) (Note I):
     Current tax (benefit) ......................     (2,145,020)       2,020,000        1,861,533
     Deferred tax (benefit) .....................                         344,000       (1,420,553)
                                                    ------------      -----------      -----------
     Total ......................................     (2,145,020)       2,364,000          440,980
                                                    ------------      -----------      -----------
Net income (loss) ...............................   $(10,890,492)     $ 3,891,753      $ 5,061,551
                                                    ============      ===========      ===========
Net income (loss) per basic share ...............   $      (0.97)     $      0.36      $      0.47
                                                    ============      ===========      ===========
Net income (loss) per diluted share . ...........   $      (0.97)     $      0.33      $      0.43
                                                    ============      ===========      ===========
Basic shares ....................................     11,254,557       10,825,043       10,672,764
                                                    ============      ===========      ===========
Diluted shares ..................................     11,254,557       11,960,546       11,891,373
                                                    ============      ===========      ===========
</TABLE>


    The accompanying notes are an integral part of the financial statements.



                                       28


<PAGE>   29
                          STORAGE COMPUTER CORPORATION

                 STATEMENT OF CONSOLIDATED STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                     COMMON STOCK            
                                                 ----------------------      ADDITIONAL        RETAINED
                                                                   PAR         PAID-IN         EARNINGS
                                                   SHARES         VALUE        CAPITAL         (DEFICIT)
                                                 ----------      -------     -----------      -----------
<S>                                              <C>              <C>         <C>             <C>        

Balance - December 31, 1995 ...................  10,636,341       10,636      12,223,860      (3,449,543)
Exercise of stock options .....................      65,000           65          66,385                
Net income ....................................                                                5,061,551
                                                 ----------      -------     -----------     -----------
Balance - December 31, 1996 ...................  10,701,341       10,701      12,290,245       1,612,008
Exercise of stock options .....................     447,675          448         655,163                
Tax benefit from stock options  (Note K) ......                                  439,832                
Net income ....................................                                                3,891,753
                                                 ----------      -------     -----------     -----------
Balance - December 31, 1997 ...................  11,149,016       11,149      13,385,240       5,503,761
Exercise of stock options .....................     174,800          175         141,980                
Stock issued to 401(k) plan (Note K) ..........      24,007           24          73,801                 
Tax benefit from stock options (Note K) .......                                  120,000                 
Net loss ......................................                                              (10,890,492)
                                                 ----------      -------     -----------     -----------
                                                                                                        
Balance - December 31, 1998 ...................  11,347,823      $11,348     $13,721,021     $(5,386,731)
                                                 ==========      =======     ===========     =========== 
</TABLE>

                                                       

    The accompanying notes are an integral part of the financial statements.



                                       29

<PAGE>   30
                          STORAGE COMPUTER CORPORATION
                      STATEMENT OF CONSOLIDATED CASH FLOWS
                                    (NOTE K)


                
<TABLE>
<CAPTION>
                                                                             YEAR ENDED DECEMBER 31,
                                                                   ---------------------------------------------
                                                                       1998             1997             1996
                                                                   ------------     -----------      -----------
<S>                                                                <C>              <C>              <C>        
Cash flows from operating activities:                                               
     Net income (loss) .........................................   $(10,890,492)    $ 3,891,753      $ 5,061,551
     Reconciliation to operating cash flows:                                      
     Depreciation and amortization .............................        620,552         382,836          310,505
     Stock issued to 401(k) plan ...............................         73,825   
     Write down of investment ..................................      2,094,134   
     Deferred tax provision  (benefit) .........................                        344,000       (1,420,553)
     Foreign currency translation loss (gain) ..................                         29,423          (29,407)
     Changes in operating assets and  liabilities:                                
     Accounts receivable .......................................      8,722,650      (4,885,160)      (1,818,864)
     Income tax refund receivable ..............................     (2,160,211)  
     Inventories ...............................................       (383,556)     (1,605,241)      (1,694,178)
     Other current assets ......................................       (152,496)       (451,008)           2,955
     Accounts payable and accrued expenses .....................       (138,570)       (536,998)       1,102,092
                                                                   ------------     -----------      -----------
        Net cash provided (used) in operating activities .......     (2,214,164)     (2,830,395)       1,514,101
                                                                   ------------     -----------      -----------
Cash flows from investing activities:                                             
     Capital expenditures ......................................       (842,030)     (1,823,608)        (483,058)
     Other assets ..............................................       (175,113)     (2,583,960)
                                                                   ------------     -----------      -----------
        Net cash  used in investing activities .................    (1,017,143)     (4,407,568)        (483,058)
                                                                   ------------     -----------      -----------
Cash flows from financing activities:                                             
     Net proceeds from credit line .............................      2,870,706       5,866,280          176,448
     Reduction of other long-term liabilities ..................         22,970                         (298,352)
     Net proceeds from issuance of common stock ................        142,155         655,611           66,450
                                                                   ------------     -----------      -----------
        Net  cash provided (used) in financing activities ......      3,035,831       6,521,891          (55,454)
                                                                   ------------     -----------      -----------
Effect of exchange rate changes on cash ........................          7,356         (23,311)           6,072
                                                                   ------------     -----------      -----------
Net increase (decrease) in cash and cash equivalents ...........       (188,120)       (739,383)         981,661
Cash and cash equivalents - beginning of year ..................      1,113,379       1,852,762          871,101
                                                                   ------------     -----------      -----------
Cash and cash equivalents - end of year ........................   $    925,259     $ 1,113,379      $ 1,852,762
                                                                   ============     ===========      ===========

</TABLE>
                                                                  



    The accompanying notes are an integral part of the financial statements.


                                       30

<PAGE>   31
                          STORAGE COMPUTER CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE A - SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

         The consolidated financial statements include the accounts of the
Company and its wholly-owned and majority owned subsidiaries, Storage Computer
Europe Gmbh, Vermont Research Products, Inc., Storage Computer UK Ltd., and Open
Storage Solutions, S.A. The percentage ownership of Open Storage Solutions
increased from 20% to 51% in 1998. All significant intercompany accounts and
transactions have been eliminated. The Company also has 20% ownership of Storage
Computer (Asia) Ltd. and a 45% ownership of HVVR, LLC., which are accounted for
by the equity method.

         The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Cash and Cash Equivalents

         The Company considers all highly liquid instruments with a maturity of
three months or less, when acquired, to be cash equivalents.

Inventories

         Inventories are stated at the lower of average cost (first-in,
first-out method) or market.

Property and Equipment

         Property and equipment are stated at cost. Depreciation of property and
equipment is computed utilizing the same accelerated methods for both financial
and tax reporting over a period not to exceed 5 years.

Fair Value of Financial Instruments

         The carrying amounts of cash, accounts receivable, other current
assets, accounts payable and accrued expenses approximate fair value because of
the short maturity of those instruments. The fair value of long-term receivables
and investments are based on management's estimates. Long-term debt is based on
comparison to the Company's line of credit.

Revenue Recognition

         The Company recognizes revenue from hardware and software sales at the
time of shipment. Service revenue is recognized over the contracted period or as
the services are provided.

Research and Development

         Research and development costs are expensed as incurred.

Foreign Currency Translations

         The functional currency for the Company's foreign operation is the U.S.
dollar. The translation from the applicable foreign currencies to U.S. dollars
is performed for balance sheet accounts using current exchange rates in effect
at the balance sheet date and for revenue and expense accounts using a weighted
average exchange rate during the period. The resulting translation adjustments
and gains or losses resulting from foreign currency transactions are included in
the Company's statement of operations.

Income Taxes

         The Company follows Statement of Financial Accounting Standards No. 109
(SFAS 109) "Accounting for Income



                                       31


<PAGE>   32
Taxes." Under the asset and liability method of SFAS 109, deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases.

Earnings (Loss) per Share

         In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share" which
replaced the calculation of primary and fully diluted earnings or loss per share
with basic and diluted earning per share. Basic earnings per share is determined
utilizing only the weighted average of outstanding common shares. The effect of
potentially dilutive options, warrants and convertible securities is included in
the calculation of diluted earnings per share. There is no difference in the
numerator between the basic and diluted calculation and the only difference in
the denominator is the effect of dilutive stock options, warrants and
convertible securities.

Stock-Based Compensation

         The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards No. 123, ("SFAS 123"), "Accounting for Stock
Based Compensation" which requires disclosure of pro forma effects as if SFAS
123 had been adopted. The Company has adopted the disclosure only requirements
of SFAS 123 and accounts for its employee stock option plans under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees".

Recent Accounting Standards

         In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 requires companies
to recognize all derivative contracts at their fair values as either assets or
liabilities on the balance sheet. If certain conditions are met a derivative may
be specifically designated as a hedge, the objective of which is to match the
timing of gain or loss recognition on the hedging derivative with the
recognition of (1) the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk or (2) the earnings effect of
the hedged forecasted transaction. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in income in the period of change.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999.

         Historically, the Company has not entered into derivative contracts
either to hedge existing risks or for speculative purposes. Accordingly, the
Company does not expect the adoption of the new standard to affect its financial
statements.

NOTE B - INVENTORIES

         At December 31, 1998 and 1997 inventories consisted of raw materials of
$2,306,290 and $1,710,997; work in process of $2,065,647 and $2,631,078, and
finished goods of $3,891,104 and $3,537,410, respectively.

NOTE C - PROPERTY AND EQUIPMENT

         Property and equipment are summarized as follows:


<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                   ------------------------
                                                      1998          1997
                                                   ----------    ----------
<S>                                                <C>           <C>       

     Machinery and equipment.....................  $2,165,279    $1,772,452
     Office furniture and fixtures...............     463,298       324,160
     Research and development equipment..........   2,091,344     1,706,103
     Other property..............................     150,241       225,417
                                                   ----------    ----------
          Total..................................   4,870,162     4,028,132
     Less accumulated depreciation...............   2,127,910     1,507,358
                                                   ----------    ----------
          Net  property and equipment............  $2,742,252    $2,520,774
                                                   ==========    ==========
</TABLE>



                                       32


<PAGE>   33
NOTE D - OTHER ASSETS

         In August 1998, the Company and another organization formed a limited
liability company named HVVR, LLC ("HVVR"). The purpose of HVVR was to hold
ownership of a new product technology developed by a former customer of the
Company (the "Developer"). The owners of HVVR contributed approximately $6
million in cash and other property (of which approximately $2.3 million was
contributed by the Company), which was transferred to the Developer in exchange
for the product technology. The Company's investment in HVVR was the end result
of a series of transactions as follows: During the third quarter of 1997 the
Company entered into negotiations to secure certain trade receivables due from
the Developer. In March of 1998 the parties agreed to convert the accounts
receivable to registered convertible preferred stock. When the Developer failed
to file a timely registration statement for the preferred stock, the Company
entered into new negotiations with the Developer resulting in the transactions
described above.

         HVVR granted an exclusive license to the Developer to manufacture the
new product that provides for royalty payments to HVVR. Should the Developer be
sold or merged with another company, the agreement provides for conversion of
the license to a non-exclusive basis, unless HVVR receives a minimum guaranteed
payment.

         The License Agreement may be terminated by HVVR on thirty (30) days
notice upon default by the Developer of its obligations under the license,
including, among others, the obligation to market the new product technology,
and provides for automatic termination if the Developer voluntarily files for
bankruptcy protection.

         The Developer is experiencing severe financial difficulties which
raises substantial uncertainty as to its ability to complete the product, bring
it into volume production, and market the products in large quantity to generate
royalty payments to HVVR sufficient to support the initial value of the
investment.

         Neither HVVR nor the Company has available the resources to pursue the
research, production, and marketing of the product at this time. In view of the
potential for a long delay in recovering the Company's investment in HVVR
through royalty payments and the associated risks of that delay, the Company
decided to write its investment down to $100,000.

         Other assets also includes long-term receivables from an affiliate and
a customer for a five-year software license.

NOTE E - BORROWING ARRANGEMENTS

         At December 31, 1998 the Company had a demand bank line of credit with
maximum borrowings of $10,500,000 secured by all assets of the Company. The loan
agreement provided for interest at the bank's prime rate plus .25%. The
agreement contained certain covenants including, but not limited to,
restrictions related to net worth and certain financial ratios. At December 31,
1998 the remaining balance available under the credit facility was approximately
$1,187,000.

         In April 1999 the Company reached agreement with the bank on new terms 
extending the Company's line of credit until January 4, 2000. The initial line 
of $10,300,000 has been reduced to a new line of $8,700,000 through the 
application of tax refunds received by the Company in 1999 and will be further 
reduced by certain other proceeds received by the Company including additional 
tax refunds and equity investments. Under the agreement, the Company has also 
agreed to undertake certain actions to reduce the line of credit with the bank 
during 1999. The line of credit expires on January 4, 2000. Management believes 
the amounts available under the line and other financing arrangements will meet 
its operating cash needs through 1999.

         Long-term debt in the amount of $710,000 at December 31, 1998 and 1997
is payable to an officer and stockholder of the Company. The debt is unsecured,
bears interest at prime plus 1%, and is subordinated to the demand line of
credit. Interest expense related to the obligation amounted to $67,450, $66,100
and $84,000 for 1998, 1997 and 1996, respectively.

NOTE F - RELATED PARTY TRANSACTIONS

         The Company leases plant and office facilities from an affiliated
entity as a tenant-at-will, under a triple-net operating lease agreement. Rent
expense under this lease for 1998, 1997 and 1996 amounted to $200,400, $195,600
and $187,200, respectively.

         The president of one of the Company's major customers is a member of
the board of directors of the Company (see Note M).




                                       33


<PAGE>   34
NOTE G - COMMITMENTS

         The Company leases certain property and equipment under noncancellable
leases which expire at various dates through 2002. Future minimum lease payments
are $443,000, $68,000, $19,000, and $15,000 for the years 1998 through 2002,
respectively.

         Amounts charged to operations for operating leases were $275,000,
$286,000 and $203,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.

NOTE H - STOCK OPTION PLAN

         The Company's 1994 Stock Incentive Plan, as amended, provides for the
granting of options to purchase up to 2,500,000 shares of common stock. Option
activity during 1998, 1997 and 1996 is summarized as follows:

<TABLE>
<CAPTION>
                                                                       WEIGHTED -
                                                                       AVERAGE
                                                      NUMBER OF      OPTION PRICE
                                                       SHARES          PER SHARE
                                                     ----------      ------------  
         <S>                                         <C>                <C>
 
         Balance - December 31, 1995 ..............   1,507,400         $ 1.35
         Granted ..................................     382,000          10.01
         Exercised ................................     (65,000)          1.02
         Canceled .................................    (160,900)          3.32
                                                     ----------         ------  
         Balance - December 31, 1996 ..............   1,663,500           3.41
         Granted ..................................     814,500           6.36
         Exercised ................................    (447,675)          1.46
         Canceled .................................    (201,425)         10.50
                                                     ----------         ------  
         Balance - December 31, 1997 ..............   1,828,900           6.47
         Granted ..................................   1,038,150           2.23
         Exercised ................................    (174,800)           .79
         Canceled .................................  (1,219,850)          4.51
                                                     ----------         ------  
         Balance - December 31, 1998 ..............   1,472,400         $ 1.64
                                                     ==========         ======
</TABLE>

         Options granted generally vest over a period not to exceed four years
Options for 569,950 shares are exercisable at December 31, 1998 at exercise
prices ranging from $.10 to $11.38 and a weighted-average price of approximately
$.83 per share, with a weighted-average remaining contractual life of
approximately two years. At December 31, 1998, options to purchase 220,125
shares were available for grant under the plan.

         During the third quarter of 1998 the Board of Directors approved a
voluntary common stock option repricing program. On August 25, 1998 the Company
extended an offer to option holders to reprice their options. All employees,
officers and directors were given the option to reprice to $2.50, the fair
market value on August 24, 1998.

         The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," and applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its plans.
There was no compensation expense recognized in 1998, 1997 or 1996. If the
Company had elected to recognize compensation cost for the plans based on the
fair value at the grant date for awards under the plans, consistent with the
method prescribed by SFAS No. 123, pro forma net income (loss) would have been
($11,003,981) in 1998, $3,539,297 in 1997 and $4,874,280 in 1996. Proforma net
income (loss) per diluted share would have been ($.98) in 1998, $.30 in 1997,
and $.41 in 1996.

         The fair value of the Company's stock options used to compute pro forma
net income and net income per diluted share disclosures is the estimated present
value at grant date using the Black-Scholes option-pricing model with the
following weighted average assumptions for 1996 through 1998: dividend yield of
0%; expected volatility of 80%; a risk free interest rate ranging from 4.22% to
6.33%, and an expected holding period of six years.




                                       34


<PAGE>   35
    All options outstanding at December 31, 1998 are categorized by the ranges
shown in the table below:

<TABLE>
<CAPTION>
                                                WEIGHTED                   
                                                AVERAGE                    
                           WEIGHTED            REMAINING        
                       AVERAGE EXERCISE       CONTRACTUAL         NUMBER OF  
    RANGE                  PRICE                 LIFE              SHARES 
 -----------           ----------------       -----------         ---------
<S>                         <C>                   <C>              <C>    

  $      .10               $ .10                 1.0               420,400
  1.25- 2.56                2.16                 3.0               998,900
  3.50-11.38                4.35                 1.1                53,100
                                                                 ---------
                                                                 1,472,400
                                                                 ========= 
</TABLE>

         All options exercisable at December 31, 1998 are categorized by the
ranges shown in the table below:

<TABLE>
<CAPTION>
                                                WEIGHTED                   
                                                AVERAGE                    
                           WEIGHTED            REMAINING        
                       AVERAGE EXERCISE       CONTRACTUAL         NUMBER OF  
    RANGE                  PRICE                 LIFE              SHARES  
 -----------           ----------------       -----------         ---------
<S>                         <C>                   <C>              <C>    

 $       .10                $.10                  1.0              420,400
  1.25- 2.56                2.19                  3.0              323,234
  3.50-11.38                4.26                  1.1               50,770
                                                                  --------
                                                                   794,404
                                                                  ========
</TABLE>


NOTE I-  INCOME TAXES

         At December 31, 1998 and December 31, 1997, the Company has net
deferred tax assets as follows:

<TABLE>
<CAPTION>
                                                         DECEMBER 31,
                                                  -------------------------
                                                     1998            1997
                                                  -----------    ----------
         <S>                                      <C>            <C>       

         Accounts receivable reserve ...........  $    66,000    $        0
         Inventory costs .......................      186,000        22,000
         Reserve on other assets ...............      102,000             0
         Write down of investment ..............      712,000             0
         Deferred revenue ......................      257,000       269,000
         Accrued expenses ......................        2,000        10,000
         General business tax credits ..........      508,000       360,000
         Domestic operating loss carryover .....    2,098,000     1,861,000
         Foreign operating loss carryover ......    1,238,000       572,000
                                                  -----------    ----------
              Total deferred tax assets ........    5,169,000     3,094,000
         Valuation allowance ...................   (2,975,000)     (900,000)
                                                  -----------    ----------
         Net deferred tax assets ...............    2,194,000     2,194,000
         Less current tax asset ................            0       350,000
                                                  -----------    ----------
         Noncurrent tax asset ..................  $ 2,194,000    $1,844,000
                                                  ===========    ==========

</TABLE>

         The domestic operating loss carryovers, amounting to approximately
$5,777,000 expire at various dates through 2018 and the foreign operating loss
carryovers amounting to approximately $4,554,000 can be carried forward
indefinitely. The Company is subject to Internal Revenue Code provisions which
limit the domestic net operating loss carryovers available annually. The general
business tax credits expire at various dates through 2018.



                                       35


<PAGE>   36
         The United States, foreign, and state components of the tax provision
(benefit) are as follows:

<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                   ----------------------------------------
                                                      1998           1997          1996
                                                   -----------    ----------    -----------
<S>                                                <C>            <C>           <C>        

Current:                                                                         
     Federal, net of business tax credits of
       $197,000 and $50,000 in 1997 and 1996,       
       respectively ............................   $(2,150,020)   $1,580,000    $ 1,513,533
     State .....................................         5,000       440,000        348,000
                                                   -----------    ----------    -----------
                                                   $(2,145,020)    2,020,000      1,861,533
                                                   -----------    ----------    -----------
Deferred:
     Federal ...................................             0       180,000     (1,222,553)
     Foreign ...................................             0       164,000       (198,000)
                                                   -----------    ----------    -----------
                                                             0       344,000     (1,420,553)
                                                   -----------    ----------    -----------
Provision (benefit) for income taxes ...........   $(2,145,020)   $2,364,000    $   440,980
                                                   ===========    ==========    ===========
</TABLE>

         The following table reconciles the provision for taxes with the
expected income tax obligation obtained by applying the United States federal
statutory rate to pretax income.


<TABLE>
<CAPTION>
                                                        1998          1997         1996
                                                        ----          ----         ----
<S>                                                 <C>            <C>          <C>         

Income (loss) before income taxes ................  $(13,035,512)  $6,255,753   $ 5,502,531 
                                                    ------------   ----------   -----------
Expected tax (benefit) at statutory
   rate of 34% ...................................  $ (4,432,000)  $2,127,000   $ 1,871,000  
Adjustments due to:                                                                          
     Difference between foreign rate and U.S.
        statutory rate ...........................       196,000       40,000       165,000  
     State taxes, net of federal benefit .........         5,000      291,000       230,000  
     Increase (decrease) in valuation reserve ....     2,075,000        5,000    (1,513,000) 
     Adjustment of prior years' deferred tax                                           
       assets related to foreign entities ........                                 (295,000)   
     Tax credits .................................      (130,000)     (50,000)               
     Other .......................................        10,980       31,000        32,980  
                                                    ------------   ----------   -----------
Provision (benefit) for income taxes                $ (2,145,020)  $2,364,000   $   440,980
                                                    ============   ==========   ===========
</TABLE>

NOTE J - LEGAL PROCEEDINGS

         On April 28, 1998, the Superior Court, Cheshire County, New Hampshire,
rendered its decision in the suit brought by Raul Kacirek (Dkt. No. 94-E-0102)
seeking specific performance to have the Company issue up to 300,000 shares of
its common stock. The Court found in favor of the Company on all claims in this
action. The Company does not believe that its involvement in, the judicial
decisions rendered or the final resolution of this legal proceeding, has had a
material effect upon the Company's business, operating results or financial
condition.

         One of the Company's suppliers of disk drives, Micropolis (USA) Inc.,
filed for a plan of reorganization under Chapter 11 of the Bankruptcy Code. If
the Bankruptcy Court does not approve the Plan, then the likelihood is that the
case would be converted to one under Chapter 7 of the Bankruptcy Code.

         The Company believes that the disk drives supplied by Micropolis,
together with its inability to support the disk drives supplied, caused the
Company material and adverse damages in 1998. These damages include, but are not
limited to, lost sales, deferred sales, substantial field and factory expenses,
loss of reputation, and inventory writeoffs.

         The Company has filed various proof of claims against Micropolis (USA)
Inc. in the United States Bankruptcy Court in the Central District of California
and against its parent, Micropolis (S) Limited, in the court in Singapore. The
Company can not estimate what its continuing involvement in, any judicial
decision rendered or the resolution of this set of claims will have upon the
Company's business, operating results or financial condition.



                                       36


<PAGE>   37

NOTE K - SUPPLEMENTAL CASH FLOW INFORMATION

         Cash payments for interest for the years 1998, 1997 and 1996 were
$580,000, $486,000, and $133,000, respectively. For the same periods cash
payments for income taxes were $200,000, $718,000 and $1,831,000. In 1998 and
1997 the Company reduced federal taxes payable and increased additional paid-in
capital by $120,000, and $439,832, respectively for the tax benefits associated
with the exercise of stock options. In 1998, the Company contributed 24,007
shares of its common stock valued at $73,825 to its 401(k) plan.

NOTE L - ALLOWANCE FOR DOUBTFUL ACCOUNTS

         The Company established an allowance for doubtful accounts for the
first time in 1998 resulting in an allowance at December 31, 1998 of $583,623
which was charged to expense during the year.




                                       37


<PAGE>   38
NOTE M - BUSINESS SEGMENT INFORMATION

       The Company's operations are conducted in one business segment: the
design, manufacture and sale of high-performance scalable data storage.
Operations by geographic area are summarized as follows:

<TABLE>
<CAPTION>
                                                   UNITED                                    
                                                   STATES         EUROPE      ELIMINATIONS     CONSOLIDATED
                                                -----------     ----------    ------------     ------------
<S>                                             <C>             <C>           <C>              <C>
                      
1998:
     Domestic sales ..........................  $ 9,222,124     $2,704,186    $                 $11,926,310
     Export sales ............................    4,308,526        490,098                        4,798,624
     Export sales to affiliates ..............      909,402            706        (583,293)         326,815
        Transfers between geographic areas ...    2,141,156        603,834      (2,744,990)
                                                -----------     ----------    ------------      -----------
          Total revenue ......................   16,581,208      3,798,824      (3,328,283)      17,051,749
                                                ===========     ==========    ============      ===========
     Long-lived assets .......................   16,114,700        244,768     (10,702,727)       5,656,741

1997:
     Domestic sales ..........................   18,598,928      7,825,213                       26,424,141
     Export sales ............................    9,078,719                                       9,078,719
     Export sales to affiliates ..............    1,643,243                                       1,643,243
     Transfers between geographic areas ......    5,366,702        259,687      (5,626,389)
                                                -----------     ----------    ------------      -----------
          Total revenue ......................   34,687,592      8,084,900      (5,626,389)      37,146,103
                                                ===========     ==========    ============      ===========
     Long-lived assets .......................   14,606,309        372,132      (7,974,157)       7,004,284
                                                ===========     ==========    ============      ===========
1996:
     Domestic sales ..........................   14,636,000      6,251,000                       20,887,000
     Export sales ............................    8,103,000                                       8,103,000
     Export sales to affiliates ..............    2,021,429                                       2,021,429
     Transfers between geographic areas ......    4,245,000      1,296,000      (5,541,000)
                                                -----------     ----------    ------------      -----------
          Total revenue ......................   29,005,429      7,547,000      (5,541,000)      31,011,429
                                                ===========     ==========    ============      ===========
     Long-lived assets .......................    1,545,725        397,193       1,330,634        3,273,552
                                                ===========     ==========    ============      ===========

Export sales from the United States are summarized as follows:

<CAPTION>
                                                    1998           1997            1996
                                                 ----------    -----------     ----------- 
<S>                                              <C>           <C>             <C>         

Far East .....................................   $3,810,000    $ 8,631,000     $ 8,563,000 
Europe .......................................    1,059,000      1,855,000       1,036,000 
Other ........................................      349,000        236,000         522,000 
                                                 ----------    -----------     ----------- 
                                                 $5,218,000    $10,722,000     $10,121,000 
                                                 ==========    ===========     =========== 
</TABLE>

                                                  
       For the years ended December 31, 1998, December 31, 1997 and December 31,
1996 sales to one unaffiliated customer were in excess of 10% of revenues and
amounted to $3,430,000, $7,009,000 and $6,303,000, respectively (See Note F).







                                       38