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                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                           --------------------------

                                    FORM 10-K

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

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

 [  ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES  
         EXCHANGE ACT OF 1934

                        COMMISSION FILE NUMBER 000-23698

                          APPLIED DIGITAL ACCESS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                               DELAWARE 68-0132939
        (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
                         INCORPORATION OR ORGANIZATION)

                 9855 SCRANTON ROAD, SAN DIEGO, CALIFORNIA 92121
               (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, ZIP CODE)

                                 (619) 623-2200
              (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
                                (TITLE OF CLASS)

                           --------------------------

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No__

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

The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on February
28, 1999 as reported on the Nasdaq National Market, was approximately
$18,132,185. For the purposes of this calculation, shares owned by officers,
directors and 5% shareholders known to the registrant have been deemed to be
owned by affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. There were 12,918,599 shares of the
Registrant's Common Stock, $0.001 par value, outstanding as of February 28,
1999.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held May 12, 1999, referred to herein as the "Proxy
Statement", are incorporated by reference as provided in Part III.


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PART I

ITEM 1.  BUSINESS 

         THE STATEMENTS CONTAINED IN THIS FORM 10-K THAT ARE NOT PURELY 
HISTORICAL ARE FORWARD LOOKING STATEMENTS. STATEMENTS WHICH USE THE WORDS 
"OBJECTIVE," "SEEK," "INTEND," "WILL," "ANTICIPATE," "CAN," "CONTINUE," AND 
"EXPECT," ARE FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS, 
INCLUDING STATEMENTS REGARDING THE COMPANY'S (I) PLANS FOR DEVELOPMENT OR 
ACQUISITION OF NEW PRODUCTS OR ENHANCEMENT OF EXISTING PRODUCTS, (II) 
STRATEGY, (III) EXPANDED MARKETING EFFORTS, (IV) EXPECTED LEVELS OF 
EXPENDITURES, (V) GOAL OF MAXIMIZING THE VALUE OF TECHNOLOGY AND (VI) THE 
COMPANY'S TIMING OF YEAR 2000 COMPLIANCE, ARE BASED ON INFORMATION AVAILABLE 
TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO 
UPDATE ANY SUCH FORWARD-LOOKING STATEMENT. IT IS IMPORTANT TO NOTE THAT THE 
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD 
LOOKING STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO 
DIFFER MATERIALLY ARE THE FACTORS SET FORTH BELOW UNDER THE HEADING "RISKS 
AND UNCERTAINTIES."

         Applied Digital Access, Inc. ("ADA" or the "Company"), was incorporated
in California in August 1987, and reincorporated in Delaware in December 1997
through its merger into a newly formed Delaware corporation. Unless otherwise
indicated, as used in this report, the "Company" and "ADA" refer to Applied
Digital Access, Inc., a Delaware corporation, and it predecessor entity. The
Company's principal executive offices are located at 9855 Scranton Road, San
Diego, California, 92121.

         ADA is a leading provider of network performance management products
that include systems, software, and services used to manage the quality,
performance, availability and reliability of telecommunications service
providers' ("TSPs") networks. ADA's products are designed to enable TSPs to
improve their quality of service, to increase productivity, to lower operating
expenses and to effectively deploy new services. ADA has positioned its business
to assist TSPs in addressing the rapidly increasing demand for new services,
higher bandwidth and access to the Internet. ADA's systems and software provide
network management functions such as circuit provisioning, network configuration
management, network performance management, circuit testing, and traffic
management of the public switched network. ADA has addressed the industry demand
for network management products with a three-faceted approach: (1) network
systems that provide testing and performance monitoring functions as well as
selected transport functions; (2) network management software that enables TSPs
to manage their network operations; and (3) services that are customized to meet
the evolving needs of the TSP market. The Company has formed two business units
around the company's product lines: the Network Systems business unit and the
Network Management business unit.

         The Network Systems business unit is built around the Company's test
and performance management products and services, including its T3AS Test and
Performance Monitoring System ("T3AS"), Centralized Test System ("CTS"), Remote
Module, a DS1 network interface unit ("NIU"), Sectionalizer, Network Embedded
Protocol Access system ("NEPA"), and Protocol Analysis Access System ("PAAS").

         The Network Management business unit focuses on the Company's
Operations Systems ("OS") software products, including .Provisioner, Traffic
Data Collection and Engineering System ("TDC&E"), Test OS, Fault Management
System ("FMS"), Graphical Test Assistant ("GTA"), and OS design services. The
formation of the Network Management business unit resulted from strategic
acquisitions made in 1996 and 1997. The Company's 1996 acquisition of certain
assets from Applied Computing Devices, Inc. ("ACD") resulted in the addition of
the Company's TDC&E and FMS product lines. The Company's 1996 acquisition of
certain assets from MPR Teltech, Ltd. and the subsequent 1997 acquisition of a
software license from Northern Telecom, Ltd. resulted in the addition of the
Company's .Provisioner product line.

         The Company's products are deployed by over 50 TSPs including the five
regional bell operating companies ("RBOCs"), long-distance or interexchange
carriers ("IXCs"), competitive local exchange carriers ("CLECs"), independent
local exchange carriers ("ILECs"), emerging carriers and cable companies.

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RECENT DEVELOPMENTS

         On March 3, 1999, the Company announced the termination of its joint 
development agreement ("JDA") with Nortel. The Company and Nortel entered 
into the agreement in September 1997 to develop SONET network element 
products for the telecommunications industry. The intellectual property 
rights associated with the jointly developed technology will become the 
property of the Company. Under the JDA, the Company and Nortel each 
contributed technology and development resources to the project conducted 
under the JDA and shared the development costs. The Company's development 
costs associated with the JDA have been expensed as incurred. Nortel is 
obligated to continue funding its share of the development costs associated 
with the JDA project through June 2, 1999. The Company expects to 
substantially reduce expenses associated with the development conducted under 
the JDA and will explore alternatives for maximizing the value of the jointly 
developed technology. There can be no assurance that the Company will be 
successful in its efforts to maximize the value of the technology developed 
under the JDA or that the jointly developed technology will provide future 
value to the Company. Under terms of the JDA, if the jointly developed 
technology is successfully implemented into a marketable product, Nortel 
retains the right to receive limited future royalties in order to recoup its 
share of development costs incurred under the JDA.

          On March 31, 1999 the Company announced a reduction in its workforce
 of approximately 65 people, or 22% of its total workforce. Of the reduction 
in workforce, 23 were temporary positions. The Company determined the 
reduction was necessary in order to align its current operations with the 
Company's objectives of focusing on market opportunities in its core 
business, reducing expenses including expenses related to its recently 
terminated JDA with Nortel and improving operating results. The majority of 
the reduction in workforce were engineers focused on development conducted 
under JDA. As a result of the reduction in workforce, the Company will close 
its office in Richardson, Texas. The Company will incur a significant 
one-time charge in the first quarter ending March 31, 1999, related to the 
reduction in workforce. The Company's restructuring plan includes the 
identification of the affected personnel, facility closures, asset write 
downs, and lease terminations. The Company has not completed its analysis of 
the total dollar amount associated with the restructuring charge, but will 
complete this process prior to issuing its first quarter operating results.

BACKGROUND

         The Telecommunications Deregulation Act of 1996 (the "1996
Telecommunications Act") has greatly increased the competitive nature of the
telecommunications industry and has changed traditional supplier-customer
relationships among local telephone companies and long distance providers. TSPs,
which include the RBOCs, IXCs, CLECs, ILECs, Internet service providers
("ISPs"), cable companies, and emerging carriers are entering the territories
and businesses of each other, fiercely competing to supply business customers
with highly profitable telecommunications networks and services. The competitive
climate has created significant challenges for TSPs as they strive to meet
objectives of increasing revenue and market share, while retaining current
customers and lowering operating costs.

         The volume of digital information transmitted through the 
telecommunication system has grown rapidly in recent years. This growth has 
been driven primarily by the proliferation of personal computers and 
workstations, the prevalence of networking and use of the Internet, the 
adoption of client/server computing, the increase in cellular telephone and 
facsimile use, and the deployment of new digital information applications 
including multimedia, video conferencing, and image-processing. As a result, 
TSPs have been required to rapidly deploy new high-speed data and voice 
circuits operating at a 1.54 megabit-per-second rate, called DS1, or T1, and 
at a 45 megabit-per-second rate, called DS3 or T3. The DS3 transmission rate 
is the highest electrical telecommunication circuit transmission rate 
currently available in North America.

         The present structure of the telecommunications industry in the 
United States is largely a result of the court-mandated divestiture of AT&T 
in 1984. The AT&T divestiture resulted in the creation of the RBOCs, the 
competitive IXC market, and the emergence of CLECs and emering carriers who 
offer local telephone service in competition with the RBOCs and ILECs. 
Regulation through competition is the philosophy that resulted in the breakup 
of AT&T, and the Company believes it continues to be the philosophy of the 
Federal Communications Commission ("FCC"). The passage of the 1996 
Telecommunications Act allows each of these TSPs to enter the territories and 
businesses of the others and has resulted in an unprecedented number of 
mergers and acquisitions among TSPs. While the Company believes that the new 
law will bring new opportunities for network equipment suppliers, it is too 
early to assess the long-term impact of this new law on the 
telecommunications industry and ADA's business. RBOCs have faced increased 
competition from CLECs and emerging carriers and from the local service 
competitive initiatives of the IXCs and from non-traditional providers of 
telephone service such as cable television companies. The Company believes 
that many of the new competitive entrants will continue to focus their 
efforts on corporate and government communications networks, which are among 
the most profitable market segments. Customers in these segments require 
highly reliable data and voice communications circuits to enable them to 
conduct their day-to-day business without interruption. These new competitors 
are often able to offer higher-quality and lower-cost service than local 
telephone companies, and as a result, have gained significant market share in 
these segments. This increased competition has brought pressure on RBOCs to 
protect their existing revenue bases by improving the quality of their 
service and to reduce their costs. At the same time, the RBOCs continue to 
re-engineer and downsize their organizations. The large reductions in staff 
have often resulted in the loss of highly experienced and technical people, 
leaving less experienced staff to operate and maintain the networks.

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         Long distance data or voice circuit often involves three or more 
telephone companies: the local telephone companies on each end and the IXC 
providing the connection between the two local companies. Responsibility for 
service in long distance high-speed data and voice networks is transferred 
from one carrier to another at their network boundaries.

         The Company believes that the segmentation of the telecommunications 
network has made it more difficult for telephone companies to identify and 
respond to problems in their networks. For example, many stock brokerage 
firms communicate real-time stock quotes and buy and sell orders to and from 
their brokers over high-speed data communications lines. Such firms monitor 
their own circuits and can detect when data communications service begins to 
degrade. When degradation in service is noted, the telecommunications manager 
of the firm contacts the telephone company that manages the network - 
typically the IXC. Initially, the IXC does not know where the problem is 
located and must initiate three trouble reports, one in each local telephone 
company and one in its own company. Each telephone company then dispatches 
multiple repair crews with portable test equipment to attempt to locate the 
problem. Typically, repair crews are dispatched to a number of locations, 
including the network boundary between the long distance and the local 
telephone company, the telephone building nearest the user, and to outside 
facilities such as the cables and equipment beneath streets and on poles 
between the central offices and the end-user customer. This system of 
maintenance results in a number of inefficiencies. For example, the Company 
believes telephone company repair crews often incur needless expense only to 
report "no trouble found." Despite their best efforts, repair crews often 
inadvertently interrupt or damage circuits that are working and may make 
unnecessary repairs.

         IXCs measure quality of service provided by the local telephone 
companies in two principal ways: failure rate (customer-reported troubles per 
100 circuits per month), and mean-time-to-restore (the time needed to respond 
to and resolve a customer's complaint). These measures frequently influence 
IXCs and end-user customer decisions about which local telephone company to 
use. To date, local telephone companies' level of services measured by these 
standards has often placed them at a competitive disadvantage. In order to 
reduce failure rates and improve restoration times, the Company believes 
telephone companies are motivated to change the traditional methods of 
handling service problems as described above. They are looking for solutions 
that do not require dispatching repair crews with portable test equipment 
when problems occur and, instead, allow them to monitor circuits remotely 
from a central management site. They are also seeking effective methods of 
remotely testing and monitoring DS3 and DS1 circuits at the network boundary. 
Finally, telephone companies are looking to improve their quality of service 
by moving from reactive maintenance to preventive maintenance through 
performance monitoring. These network quality and performance requirements 
have created a need for a cost-effective solution to network performance 
management.

THE APPLIED DIGITAL ACCESS SOLUTION

         ADA focuses on providing network performance management solutions to 
TSPs. These solutions are comprised of products that address traffic, fault, 
performance, configuration, provisioning and test management. The Company has 
focused its research and development activities on creating products that 
provide answers, instead of data, to TSPs, and on making network management 
easier.

         ADA's test and monitoring systems, intelligent NIUs, and OS software,
in stand-alone applications, and in integrated solutions, help TSPs improve
performance to their business customers. The Company's products help TSPs
provide better service to their business customers by providing new services
faster, restoring service faster when circuits fail, optimizing performance on
in-service circuits, and maximizing the performance of the public switched
telephone network. When competing for profitable business customers, the
integration of network management functions are valuable assets to TSPs. Without
efficient integrated network management systems, TSPs are hard pressed to
increase market share.

         The Company provides TSPs with network performance management products
to provision new circuits, test circuits, monitor telephone network building
blocks such as digital switches, digital cross-connect systems and SONET
transmission systems, monitor transmission performance on high-speed digital
circuits, and manage transmission facilities to optimize the performance of the
telecommunications network in the era of increased

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demand from Internet usage. The Company believes its network systems products 
enable TSPs to greatly improve their reliability of service, reduce circuit 
repair time, reduce network management expense, and proactively maintain 
network quality.

STRATEGY

         The Company seeks to maintain a leadership position as a supplier of
network performance management solutions for high-speed TSPs and to become a
leading provider of OS solutions for network management of telecommunications
networks:

         1.  DEVELOPING AND ENHANCING PRODUCTS FOR NETWORK BOUNDARY 
             APPLICATIONS.

         The initial application for the Company's network systems products 
has been at the network boundary between the IXC and the local TSP. 
Installation of the T3AS system at these boundaries allows the local TSP to 
quickly determine if a reported trouble is within its network. It also allows 
the local TSP to continuously monitor its circuits and react to degradation 
of the signal before service is affected. With the Company's Remote Module, a 
DS1 NIU, the boundary between the local telephone company and the end-user 
can now be monitored non-intrusively, either in a stand-alone application or 
continuously monitored as part of an integrated system using the Company's 
test and monitoring systems or test and monitoring capabilities in systems 
from other suppliers. While the Remote Module provides valuable information 
about circuit performance when used in a stand-alone mode, it provides better 
information when used in conjunction with a test and monitoring system 
elsewhere in the network. The Company believes the Remote Module provides the 
most valuable information when used in conjunction with the Company's 
Sectionalizer Software and test and monitoring systems also made by the 
Company. The combination of the products' capabilities enables TSPs to 
improve their ability to address the increasingly competitive business 
environment.

         2. FOCUSING SALES AND MARKETING EFFORTS ON A BROADER RANGE OF TSPS.

         ADA's initial sales have been to the RBOCs and their affiliates, all of
whom have a compelling need to improve the quality and reduce the cost of their
services. Competitive pressures are forcing telephone companies to move toward a
centralized network management infrastructure that uses integrated test and
performance monitoring systems. The Company has broadened its target market with
applications that are appropriate for IXCs, CLECs, emerging carriers, enterprise
networks and other TSPs.

         3. DEVELOPING AND ENHANCING PRODUCTS AND SERVICES TO ADDRESS DATA
PROTOCOLS.

         The Company believes that there are additional applications for ADA's
product lines that extend its utility to new service offerings by its customers
that address data protocols, including frame relay, asynchronous transfer mode
("ATM") and Internet protocols. The Company's NEPA and PAAS systems currently
provide customers with testing and monitoring capabilities for broadband
networks. The Company has additional protocol monitoring and analysis products
under development.

         4. DEVELOPING AND ENHANCING PRODUCTS AND SERVICES TO ADDRESS OS.

         The Company is extending its current product line and market to 
address selected applications within the OS function. OS are computer 
software-based systems that provide operations support for telecommunications 
functions. The OS market is very large and companies such as Lucent 
Technologies, Inc. ("Lucent") and BellCore (recently renamed Telcordia 
Technologies) have historically addressed its applications. Some of the older 
products from these suppliers, called "legacy systems," are limited in their 
ability to provide TSPs with the real-time information that is needed to 
manage complex high-speed telecommunications networks. The market for 
intelligent network management systems has become fragmented, and the Company 
perceives a need for solutions that address the OS applications of 
provisioning, configuration management, testing, surveillance, performance 
monitoring and traffic management, among others. The Company further believes 
that additional value can be provided to its TSP customers through 
integration of multiple OS applications, and through integration of the 
Company's OS applications with existing legacy systems.

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         5. DEVELOPING PRODUCTS TO ADDRESS NEW TRANSMISSION STANDARDS.

         The Company intends to extend its current products and develop new 
products to accommodate new telecommunication transmission standards. The 
Company anticipates that the SONET and SDH optical transmission standards 
will become the industry transmission standards for the North American and 
international networks, respectively. The Company's current network circuit 
test and performance monitoring systems do not address either the SONET or 
SDH transmission standards. The Company intends to extend its current 
products and develop new products to accommodate such new transmission 
standards and other advances in technology, as they evolve. See "Risks and 
Uncertainties--Rapid Technological Change and Dependence on New Products."

         6.  EXPANDING TO OTHER APPLICATIONS.

         The Company believes that there are additional applications for ADA's
product lines that extend its utility to network boundaries between TSPs and
other users, such as corporate customers, cellular telephone companies, and
cable television companies.

PRODUCTS

         NETWORK SYSTEMS TEST AND PERFORMANCE MANAGEMENT PRODUCTS

         CENTRALIZED TEST SYSTEM (CTS)

         CTS is a sophisticated digital test system device for voice frequency
("VF"), digital data service ("DDS"), high-capacity digital service ("HCDS"),
DS3, and packet based services, such as frame relay and ATM. CTS functions as a
remote test unit ("RTU") and a test system controller for circuits transported
through digital cross-connect systems (DCS). CTS accesses DS0, DS1 and DS3
circuits carried through synchronous or asynchronous interfaces on DCS. CTS is
designed for applications with both centralized and distributed architectures.
Its modular design, scalability, test suite and integrated testing and fault
isolation functions provide an economic and flexible solution for DCS or non-DCS
based test and performance monitoring. CTS' evolutionary platform can be
reconfigured as an in-line T3AS system without obsolescence of original modules
to add new capabilities and full-time performance monitoring and non-intrusive
testing. CTS is installed where test access is highly critical and efficient use
of network resources is important.

         T3AS TEST AND PERFORMANCE MONITORING SYSTEM (T3AS)

         T3AS consists of digital test access units ("DTAU") that can be 
co-located or placed at network boundaries between TSPs. The performance 
monitoring capabilities of T3AS provide visibility to the services carried by 
the network. T3AS is physically located at network boundaries between TSPs to 
quickly isolate, identify and report the location of circuit troubles in 
these networks. T3AS is an integrated test and performance monitoring device 
that interfaces to the network at both the DS1 and DS3 transport rates while 
providing visibility down to DS0, and subrate DS0, circuits. T3AS' technology 
and flexible architecture enable T3AS to function either as a DTAU or RTU. 
The T3AS system interfaces with the TSPs' network management OS using 
industry-standard interfaces and protocols. T3AS can also function as a CTS 
to interface with DCSs in the telephone network to provide additional test 
capability when circuit access is provided through such systems. The T3AS 
system supports up to 48 DS3 circuits, or 1,120 DS1 circuits when accessing 
the network at the DS1 rate of transmission. T3AS' distributed architecture 
allows individual high-speed or low-speed subsystems to be installed at 
locations remote from the T3AS base system. T3AS' distributed architecture 
supports applications where the number of DS3 or DS1 circuits at a particular 
remote location does not warrant the cost of a full T3AS system, such as at 
network boundaries with fewer than six DS3 circuits or 140 DS1 circuits 
between a local telephone company and an IXC, and at network boundaries 
between the local telephone company and the end-user. Users can easily 
upgrade their existing T3AS systems by adding distributed system hardware 
modules and software. The low-speed subsystem provides test and performance 
monitoring capabilities similar to the high-speed subsystem, but for DS1 
circuits. This subsystem is intended for network boundaries where circuits 
cross at the DS1 rate. The low-speed subsystem units are interchangeable with 
the high-speed subsystem units in the T3AS racks. Each low-speed subsystem 
has a capacity of 140 DS1 circuits and can be deployed in a distributed 
system to share administration and test resources with the other subsystems 
of the T3AS base system.

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         REMOTE MODULE

         ADA's Remote Module is an intelligent DS1 NIU that non-intrusively
monitors the performance of T1 circuits. Installed at network boundaries between
the local TSP and the end-user, the Remote Module enables the TSP to determine
whether circuit troubles originated in the TSP's network or in the end-user's
network. When installed at the local TSP's network boundary at the end-user
customer premises, and in tandem with a T3AS system at the network boundary
between the long distance telephone company and the local service provider, the
Remote Module provides a unique end-to-end view of the DS1 circuit. This view of
service level performance is critical to improve service quality and reliability
and to reduce costs. Telephone network management centers can view a DS1 circuit
within their network and beyond the boundaries of their network, and can quickly
identify and isolate failures from the performance monitoring information
available. The Remote Module can provide similar, although less extensive
functionality, in a stand-alone mode, or in conjunction with DTAUs and RTUs
provided by other suppliers.

         SECTIONALIZER

         Sectionalizer is expert system software that non-intrusively identifies
the location of DS1 circuit troubles and provides answers in seconds rather than
hours. Sectionalizer correlates and processes extended superframe performance
monitoring data and presents that information pictorially to technicians
enabling them to isolate problems in real time to determine whether they are on
the customer's premises or other portions of the network. Hard to isolate
sporadic troubles are identified through the software's correlation of
historical circuit events. Sectionalizer complements the deployment of Remote
Module, T3AS and CTS by utilizing the equipment to rapidly identify and isolate
network troubles and take a proactive perspective in network management.
Sectionalizer is the driving force behind ADA's Network Boundary
Sectionalization application. Sectionalizer executes on T3AS, CTS, and Remote
Module platforms.

         NETWORK EMBEDDED PROTOCOL ACCESS (NEPA)

         NEPA is a system that provides TSPs with the ability to remotely and
non-intrusively access, analyze and monitor Frame Relay, IP, and ATM networks.
NEPA probes the network and the embedded protocols within it, providing
real-time analysis of both the physical and logical network layers, including
fault isolation and notification, circuit turn-up, and systems testing. NEPA is
an SNMP standards based system that provides on-demand, non-intrusive remote
protocol analysis and testing of data communciations networks, circuits, and
devices. NEPA's intuitive user interface utilizes web browser technology to
provide remote access and analysis of network protocols via the Internet. The
systems architecture facilitates multiple remote monitoring, analysis and access
sessions supporting concurrent users and simultaneous testing sessions. The NEPA
system collects data out in the network and transports the information to a UNIX
or NT server. NEPA software applications interactively utilize the server's
collected data to allow support personnel network analysis from anywhere in the
network via the Internet. These access locations may be at the network backbone,
or at switching devices, routers, and other network access devices.

         PROTOCOL ANALYSIS ACCESS SYSTEM

         The T3AS platform can be configured to provide access to broadband
circuits that are provisioned for advanced data services such as frame relay,
SMDS or ATM. Surveillance and testing capabilities in broadband networks may not
be as automated as they are in traditional telephone networks. Diagnosing
troubles within the network often requires coordination among multiple
organizations and dispatches to customer sites. PAAS provides circuit testing
and connects circuits to a protocol analyzer for more detailed troubleshooting.
T3AS PAAS provides a cost-effective method to access circuits from a centralized
network management center.

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         NETWORK MANAGEMENT OS SOFTWARE PRODUCTS

         .PROVISIONER

         Provisioner is an OS software application that provides service
initiation and service management capability for transport networks comprised of
multiplexers, DCSs, and other transport elements. .Provisioner enables TSPs to
activate new circuits and services, and to manage transport networks from a
single user interface concentrating on end-to-end services rather than on
individual network elements. .Provisioner is a turnkey solution for multi-vendor
operations. The modular architecture and object-oriented software support
current and future applications, including management of frame relay and ATM
networks.

         TRAFFIC DATA COLLECTION AND ENGINEERING ("TDC&E")

         TDC&E is a traffic management OS that provides the capability to 
collect traffic data from a variety of existing network elements, 
predominantly central office switches, in addition to emerging network 
elements such as ATM and frame relay switches. TDC&E supports all major 
traffic engineering functions and provides an accurate, quantifiable 
reporting mechanism for marketing and quality assurance functions.

         FAULT MANAGEMENT SYSTEM ("FMS")

         FMS is an alarm and network surveillance OS that is used in 
combination with other OS software installed in TSP networks. This 
application is designed to receive and analyze alarm messages, fault 
messages, and information from managed network elements. Key features of this 
system include real-time event and alarm acquisition, event processing and 
correlation, and historical fault analysis and reporting. In addition, 
automated reactions and responses can be programmed based upon selected event 
occurrences. FMS provides operational system features to manage the state of 
a multi-network-element, multi-vendor hybrid network.

         TEST OS & Graphical Test Assistant ("GTA")

         Test OS is a browser-based test management operating system that 
provides fast test access through point-and-click graphical user interfaces 
("GUI") that replace cumbersome test commands and hide distinctions in test 
equipment and software to simplify ease of use. Test OS is a highly scalable, 
flexible application that supports multiple users at varying access levels 
for tests at DS0, DS1 and DS3 rates. GTA is a Test OS application that 
functions as a graphical test front-end system to T3AS and CTS for DS0, DS1 
and DS3 testing. GTA provides simple point-and-click access to all T3AS and 
CTS testing functionality on a Windows NT or Windows 95 platform. While 
primarily designed for TSPs without a test management OS, GTA also 
complements existing test OSs by augmenting functionality.

CUSTOMERS

         The Company sells its network performance management products and 
services to the TSP market and several enterprise networks. Historically, the 
majority of the Company's network test and performance monitoring products 
have been sold to the RBOCs. The RBOCs accounted for approximately 73%, 31% 
and 47% of the Company's total revenue in years 1996, 1997 and 1998, 
respectively. In 1997, the Company expanded its customer base for its network 
test and performance monitoring products to include the long distance, or 
IXC, market with sales of these products to MCI WorldCom. In 1996 and 1997, 
the Company acquired and developed several network management OS software 
products. The acquisitions added over 30 new customers to the Company's 
customer base. Customers for the Company's network management OS software 
products and services include MCI WorldCom, British Columbia Telecom, GTE, 
WinStar Communications, IntelCom Group and other TSPs and enterprise 
networks. The Company has provided software design services to Nortel Network 
Management Services Division, Telus, BC Tel and Bell Canada. The Company has 
increased its sales and marketing efforts aimed at CLECs, IXCs, emerging 
carriers and enterprise networks. There can be no assurance that these 
efforts will be successful. See "Risks and Uncertainties--Competition."

         The Company currently has purchase contracts with MCI WorldCom,
Ameritech, BellAtlantic, BellSouth and Southwestern Bell. MCI WorldCom has also
entered into license agreements with the Company. Other TSPs purchase the
Company's network systems products and network management OS products under
standard purchase orders and software license agreements. Since the MCI
WorldCom, BellSouth, Ameritech and Southwestern Bell

                                       8
<PAGE>

contracts may be terminated at either the customers' or the Company's 
convenience, the Company believes that these purchase and license contracts 
are not materially different than purchasing or licensing under standard 
purchase orders. Most of the Company's customers are significantly larger 
than the Company and may be able to exert a high degree of influence over the 
Company. In addition, a small number of customers have historically accounted 
for substantially all of the Company's revenue in any given fiscal period. In 
1998, BellSouth, MCI WorldCom and Bell Atlantic accounted for 26%, 23%, and 
12% of the Company's total revenue, respectively. In 1997, Nortel, MCI 
WorldCom and BellSouth accounted for 20%, 28%, and 17% of the Company's total 
revenue, respectively.

         Prior to selling products to RBOCs and certain IXCs and ILECs, a vendor
must often first undergo a product qualification process for its product with
these carriers. The Company typically spends from six to eighteen months or more
discussing its products with a potential customer prior to the customer agreeing
to put the product through its qualification process. Although the qualification
process for a new product varies somewhat among these prospective customers, the
Company's experience is that the process often takes a year or more and
generally consists of the following phases:

         -   LABORATORY EVALUATIOn. The product's function and performance are
             tested against all relevant industry standards, including BellCore
             standards. This process can take from two weeks to three months or
             more depending on a variety of factors.
 
         -   FIELD TRIAl. A number of telephone lines are equipped with the
             product for simulated operation in a field trial lasting from three
             weeks to three months or more. These field trials are used to
             evaluate performance, to assess the ease of installation and to
             establish troubleshooting procedures. The evaluating carriers grant
             conditional product approval upon successful completion of a field
             trial, enabling field personnel to order limited quantities of the
             product under one-time approvals.

        -    FIRST OFFICE APPLICATIOn. In a first office application, live
             circuits are placed on the system under evaluation. The system is
             then used on live circuits for periods ranging from one to six
             months or more to verify functionality and operation.

         -   PRODUCT SELECTION AND DEPLOYMENt. Prior to product selection and
             deployment which may take from one to four months or more, the
             evaluating carrier develops and implements a variety of methods and
             procedures that cover ordering, stocking, installation, 
             maintenance, returns and all other activities associated with the
             use of the product.

         The loss of one or more of the Company's major customers, the reduction
of orders or a delay in deployment of the Company's products could materially
and adversely affect the Company's business, operating results and financial
condition. Further, any failure on the part of any of the Company's customers to
maintain their approval of the Company's products, failure of any of the
Company's customers to deploy the Company's products or any attempt by any of
the Company's customers to seek out alternative suppliers could have a material
adverse effect on the Company's business, operating results and financial
condition. In addition, there can be no assurance that new customers will
approve the Company's products, or that such approval will not be significantly
delayed. Furthermore, work force reductions and staff reassignments by the
Company's customers have in the past delayed or indefinitely postponed the
product approval process and the Company expects such reductions and
reassignments to continue in the future. There can be no assurance that the
impact of such reductions and reassignments will not have a material adverse
effect on the Company's business, operating results and financial condition.

TECHNOLOGY

         The T3AS system consists of a real-time operating system and an
extensive suite of proprietary applications software that is executed on
proprietary distributed processing hardware. The operating system implements the
distributed processing functionality of T3AS by linking, in a maximum capacity
system, more than 350 dedicated microprocessors in a real-time computing
environment. The T3AS software architecture is designed to enable new system
features and capabilities to be installed easily through field software
upgrades. Up to 145 simultaneous users can be supported by the T3AS system. All
performance monitoring parameters and telephone circuit tests have been verified
for compliance with BellCore-published technical requirements by BellCore, and
also independently verified by the Company's telephone company customers.

                                       9
<PAGE>

         The Company's software and hardware architecture facilitates important
system capabilities such as fault tolerance and hitless access. Fault tolerance
provides a one-to-one redundant circuit path that provides backup for each DS3
and DS1 circuit. DS3 and DS1 circuits may be transferred from the online main
path to the redundant standby path without disruption of the embedded data
streams. Transfers are accomplished automatically if a hardware or software
malfunction is detected in the T3AS system. Transfers can also be accomplished
manually when telephone company personnel initiate maintenance actions. "Hitless
access" is an industry term used to describe a method of obtaining access to a
low-speed circuit embedded in a high-speed circuit without affecting any other
circuit embedded in the high-speed circuit. In the T3AS system, the Company's
proprietary technology provides access to the DS3 circuit, any embedded DS1
circuit, DS0 circuit, or other subrate circuit, without affecting any other
circuit within the DS3 circuit.

         The CTS contains many of the core technology building blocks present in
the T3AS. The T3AS is optimized for large cross sections of circuits and is
positioned in series with the network DS3 and DS1, or T1 traffic. CTS, by
contrast, contains DS3/T1/DS0 test resources that are shared among a cross
section of circuits that are passing through DCSs. CTS interfaces to DCS systems
to provide test capability. CTS provides firewall technology by taking in
commands from a tester in a centralized maintenance center and translating these
commands into a sequence of instructions that are sent to the DCS to configure
the circuit access appropriately. In this fashion, the risk of improper circuit
manipulation is minimized since the CTS system isolates the test technician from
the details of the access and automatically configures the DCS appropriately.

         Both the in-line T3AS and the CTS systems are modularly expandable and
support distributed configurations. Subsystems can be optionally co-located in a
common rack or the individual subsystems can be located in remote locations many
miles away and connected to the base system via a packetized T1 link that is
used for transport of control information and DS0 circuits under test. This
technology provides for a virtual single network element configuration with a
single interface to the OS while at the same time allowing the flexibility to
locate modular subsystems in smaller remote locations. In addition, this
technology provides a significant cost benefit since the cost of the common
equipment located in the base location is shared among all remote subsystems.
The subsystems can then be configured in a low cost streamlined fashion since
they can rely on the shared base system to provide a significant amount of
functionality.

         The Company has evolved its performance management technology,
originally focusing on the physical layer, and moving to higher levels
addressing logical layers and higher protocol layers. This technology provides
for end-to-end circuit performance management in a diverse network containing
multiple hierarchical transport protocols.

         The Company's Remote Module introduces new technology that serves to
extend the performance management capabilities of the T3AS to the customer
premises boundary for use in NIU products. This capability facilitates
sectionalization of network faults on T1 circuits. This technology provides
support for T1 performance monitoring and the ability to convey performance
monitoring information into the network from the customer premises in a fashion
that is completely transparent to the customer's data. This new technology has
been offered up for standardization and the Company is working closely with the
ANSI, T1R1 and T1M1 standards bodies on incorporating this technology into the
new T1 standards. However, there can be no assurances that this new technology
will be adopted by the ANSI, T1R1 and T1M1 standards bodies as an industry
standard.

         The Company's OS software products include systems that perform digital
cross-connect and add-drop multiplexer service activation, circuit provisioning,
node surveillance and switched fault management, and traffic data collection and
reporting. The products provide capabilities as stand-alone products or can be
integrated into a total solution offering with other ADA products or a TSP's
legacy or standards based service management framework. The software products
are designed using the latest object-oriented methodologies. The development
life cycle process is well documented and has been registered as ISO 9001
compliant. The enhanced products are written to support the latest in Relational
database, ODBC, JDBC, Corba compliant and client server technologies. GUI
versions of the TDC&E and .Provisioner products support JAVA web browser
enabling technology and all current versions of these products are either year
2000 compliant or have year 2000 support activities scheduled to complete in
1999. There can be no assurance that the Company will be successful in
implementing its year 2000 modifications in a cost-effective and timely manner.

                                      10
<PAGE>

RESEARCH AND PRODUCT DEVELOPMENT

         The Company believes its future success will depend in part on its
ability, on a cost-effective and timely basis, to continue to enhance its
products, to develop and introduce new products for the telecommunications
network performance management market, to address new industry standards and
changing customer needs and to achieve broad market acceptance for its products.

         Product line extensions require the Company to work closely with its 
current and potential customers. Using feedback received from such customers, 
the Company identifies and then develops new products and enhancements to its 
existing products that the Company believes will increase their usefulness or 
extend their application. Examples of product extensions of the Company's 
T3AS test and performance monitoring system include CTS, NEPA and PAAS. In 
addition, the Company continually seeks to reduce the manufacturing costs of 
its products by taking advantage of advances in hardware technology. Finally, 
new technologies, such as SONET, frame relay, and ATM are the focus of 
significant research and product development activity at ADA. The Company 
anticipates that the SONET and SDH optical transmission standards will become 
the industry standards over the coming years for the North American and 
international networks, respectively. The Company's current network circuit 
test and performance monitoring systems do not address either the SONET or 
SDH transmission standards.

         The market for the Company's products is characterized by rapid
technological advances, evolving industry transmission standards, changing
regulatory environments, price-competitive bidding, changes in customer
requirements and frequent new product introductions and enhancements. The
introduction of telecommunications network performance management products
involving superior technologies or the evolution of alternative technologies or
new industry transmission standards could render the Company's existing
products, as well as products currently under development, obsolete and
unmarketable. 

         In 1996, 1997, and 1998, the Company spent $7.4 million, $9.2 million
and $14.3 million, respectively, on research and development efforts. In 1997
and 1998, the Company's research and development operating expenses included
$2.2 million and $3.9 million offsets, respectively, representing Nortel's
proportionate share of development costs incurred for the initial project
conducted under the JDA. As a result of Nortel's termination of the JDA, the
Company expects to significantly reduce research and development expenses
previously associated with the JDA. Nortel is obligated to continue funding its
share of development costs associated with the JDA through June 2, 1999. The
Company cannot currently determine the impact the JDA termination will have on
the company's operating results.

MANUFACTURING AND SUPPLIERS

         The Company's manufacturing operations focus on network systems 
products and consist primarily of material planning and procurement, final 
assembly, module testing, burn-in, final system testing and quality control. 
The Company procures all components from outside manufacturers and believes 
it has good relationships with its suppliers. The majority of final assembly 
and tests are completed by the Company at its production facility. The 
Company utilizes

                                      11

<PAGE>

contract manufacturing (both consignment and turnkey operations) for the 
assembly of certain sub-assemblies, including printed circuit board modules. 
The Company also purchases sub-assemblies that have been modified to the 
Company's specifications from original equipment manufacturers.

         The Company is registered under the ISO 9001 standard for its 
headquarters facility in San Diego, California. ISO 9001 Quality Standards 
were developed by the International Organization for Standardization. It is a 
quality system standard for ensuring a total quality management system in 
engineering and manufacturing. The scope of the Company's registration is for 
the design and manufacture of telecommunications network performance 
management products, including associated software that help TSPs manage 
their networks.

         All products are rigorously tested prior to shipment to customers. All
printed circuit board modules are tested individually and as part of a system.
The Company's quality control program is modeled to support the BellCore
standards. To date, the Company has not experienced significant field failures.

         In the event there are material deficiencies or defects in the design
or manufacture of the Company's systems or if the Company's systems become
incompatible with existing third-party network equipment, the affected products
could be subject to a recall. The Company has experienced two significant
product recalls in its history. There can be no assurance that the Company will
not experience product recalls in the future. The cost of any subsequent product
recall could have a material adverse effect on the Company's business, operating
results and financial condition. In addition, the Company could materially
suffer from the potential negative publicity associated with a recall.

         Generally, the Company uses industry standard components for its
products. Some components, however, including VLSI ASICs, are custom made to the
Company's specifications. Certain components used in the Company's T3AS, CTS,
PAAS and Remote Module products, including its VLSI ASICs, are currently
available from only one source and other components are available from only a
limited number of sources. The Company has few supply agreements and generally
makes its purchases with purchase orders. Further, certain components require an
order lead time of up to one year. Other components that currently are readily
available may become difficult to obtain in the future. Failure of the Company
to order sufficient quantities of these components in advance could prevent the
Company from increasing production of products in response to customer orders in
excess of amounts projected by the Company. In the past, the Company has
experienced delays in the receipt of certain of its key components, which have
resulted in delays in product deliveries. There can be no assurance that delays
in key component and product deliveries will not occur in the future. The
inability to obtain sufficient key components as required or to develop
alternative sources if and as required in the future could result in delays or
reduction in product shipments, which in turn could have a material adverse
effect on the Company's customer relationships and operating results.

         Additionally, the Company uses third-party subcontractors for the
manufacture of its sub-assemblies. This reliance on third-party subcontractors
involves several risks, including the potential absence of adequate capacity,
the unavailability or interruption of access to certain process technologies and
reduced control over product quality, delivery schedules, manufacturing yields
and costs. Shortages of raw materials or production capacity constraints at the
Company's subcontractors could negatively affect the Company's ability to meet
its production obligations and result in increased prices for affected parts. To
procure adequate supplies of certain components, the Company must make advance
commitments to purchase relatively large quantities of such components in a
number of circumstances. The Company believes, however, that by relying on a
limited number of suppliers, it is in a better position to control quality,
reduce manufacturing costs and improve product standardization.

         At December 31, 1998, the Company had open noncancelable purchase
commitments of approximately $3,003,000 covering several different components. A
large portion of the Company's purchase commitments consist of custom parts,
some of which are sole source such as VLSI ASICs, for which there is no
alternative use or application. The inability of the Company to incorporate such
components in its products could have a material adverse effect on the Company's
business, operating results and financial condition.

                                       12

<PAGE>

MARKETING, SALES AND CUSTOMER SUPPORT

         The Company markets its products to TSPs through an experienced 
direct sales force and strategic partnerships with third parties. Each of the 
Company's sales managers operate from a site located near his or her 
strategic responsibility.

         The Company also provides engineering and installation services ("E&I")
for customers. These services are performed at the customer site and involve
assisting the customers with the installation of the Company's products into the
customer's network structure. These services are performed by customer support
field applications and field support engineers.

         All service, repair and technical support of the Company's products are
performed in-house. The Company also provides comprehensive on-site field
support to its customers. The Company offers technical support to its customers
on a 24-hours-a-day, 7-days-a-week basis. The Company's standard hardware and
software warranties are two years and one year, respectively.

BACKLOG

         At December 31, 1998, the Company had a firm backlog of approximately
$5,178,000, all of which is expected to be filled during fiscal 1999. At
December 31, 1997, backlog was approximately $2,672,000. The majority of backlog
represents orders for the Company's network management OS products. Orders for
network management OS products generally have longer lead times than network
systems products but are generally delivered within six months of the order
placement. The Company has been operating in a book and ship mode for network
systems products, a trend the Company anticipates will continue. There can be no
assurance that the current level of backlog will continue. In addition, since
orders constituting the Company's current backlog are subject to changes in
delivery schedules, the backlog is not necessarily an indication of future
revenue. In certain cases, ADA may permit orders to be canceled without penalty
where management believes it may be in the best interests of ADA to do so. To
date, cancellation of orders has not been material.

COMPETITION

         Competition in the Company's markets is intense and is characterized by
rapidly changing technologies, conformance with evolving industry standards,
frequent new product introductions and enhancements, rapid change in customer
requirements, and price-competitive bidding. To maintain and improve its
competitive position, the Company must continue to develop and introduce, in a
timely and cost-effective manner, new products and features that keep pace with
increasing customer requirements. The Company expects competition in its markets
to increase from existing competitors and from other companies which may enter
the Company's current or future markets.

         The Company believes the principal competitive factors affecting the
market for its network systems test and performance monitoring products are:
product features, price, conformance with BellCore and other industry
transmission standards and specifications, performance and reliability,
technical support, and the maintenance of close working relationships with
customers. The Company's network systems products, especially CTS and Remote
Module, are currently focused in highly competitive market niches. The
environment for CTS and Remote Module is fiercely competitive with respect to
price, product features, established customer-supplier relationships and
conformance with industry standards. The Company believes the current
competitors that provide partial solutions to either performance monitoring or
testing of the DS3, and the DS1 and DS0 circuits that make up the DS3 circuit,
include Hekimian Laboratories, Inc. ("Hekimian"), Telecommunications Techniques
Corporation ("TTC"), Anritsu Wiltron Corporation ("Wiltron") and some of the
manufacturers of large transmission equipment and digital cross-connect test and
performance monitoring equipment such as Lucent Technologies, Inc. ("Lucent"),
Alcatel Data Networks ("Alcatel"), Ericsson Communications Inc. ("Ericsson"),
ADC Telecommunications, and Tellabs, Inc. The Company's Remote Module product
addresses the DS1 NIU market in which current competitors include Westell Inc.,
Teltrend Inc., and Troncom, Inc. Many of these competitors have significantly
greater technical, financial, manufacturing, and marketing resources than the
Company. In addition, in 1997, ANSI adopted certain of the Company's technology
as an industry standard. As a result, the Company is obligated to grant licenses
of this technology to third parties, including competitors, on fair and
equitable terms and may also face competition from the licensees of its own
technology.

                                       13

<PAGE>

         The Company believes there are an increasing number of current
competitors in the network management OS market that provide network management
OS applications for circuit and services provisioning and services management,
testing and test management, fault and alarm management and surveillance,
network and circuit performance monitoring and traffic data collection and
management telecommunications functions. The OS market is characterized by a
wide range of companies that have varying degrees of market influence. The
nature of the network management and OS market is such that improved
technologies and tool sets have made the barriers to entry in this market
relatively small resulting in fierce competition. The principal competitive
factors affecting the Company's network management and OS products include
product quality, performance, price, customer support, corporate reputation, and
product features such as scalability, interoperability, functionality and ease
of use. The Company's existing and potential competitors offer a variety of
solutions to address network management needs. Competitors include suppliers of
standard off-the-shelf products, custom software developers, large
telecommunications equipment vendors that offer software applications to manage
their own and other suppliers' equipment, such as Lucent, Nortel, Fujitsu, and
Ericcson, hardware and software vendors, including IBM, Sun Microsystems and
Hewlett Packard, and providers of specific network management and OS
applications such as BellCore, Objective Systems Integrators ("OSI"), TCSI
Corporation ("TCSI"), Architel and others. Additionally, many of the Company's
existing and potential customers continuously evaluate whether they should
develop their own network management and OS applications or license them from
outside vendors. The Company expects competition in the OS market to increase
significantly in the future.

         Additionally, several of the Company's competitors have
long-established relationships with the Company's current and prospective
customers which may adversely affect the Company's ability to successfully
compete for business with these customers. In addition, product price reductions
resulting from market share penetration initiatives or competitive pricing
pressures could have a material and adverse effect on the Company's business,
operating results, and financial condition. There can be no assurance that the
Company will have the financial resources, technical expertise or manufacturing,
marketing, distribution and support capabilities to compete successfully in the
future.

PROPRIETARY RIGHTS

         ADA relies on a combination of technical leadership, trade secret, 
patent, copyright and trademark protection and non-disclosure agreements to 
protect its proprietary rights. Although the Company has pursued and intends 
to continue to pursue patent protection of inventions that it considers 
important and for which such protection is available, the Company believes 
its success will be largely dependent on its reputation for technology, 
product innovation, affordability, marketing ability and response to 
customers needs. Currently, the Company has fifteen U.S. patents granted 
(each of which has a minimum of eleven years remaining). Additionally, the 
Company has three pending U.S. patent applications on file covering various 
circuit and system aspects of its products. There can be no assurance that 
the Company will be granted additional patents or that, if any patents are 
granted, they will provide the Company's products with significant protection 
or will not be challenged.

         The Company believes that the rapid rate of technological change and
the relatively long development cycle for integrated circuits are also
significant factors in the protection of the Company's proprietary position. The
Company's proprietary VLSI ASICs incorporate unique system architectures and
circuit approaches that have been developed through a broad, in-depth
understanding of the telephone network. Availability of these proprietary
devices, knowledge and experience of the Company's personnel, new product
development, market recognition and product support are key factors in the
protection of the Company's proprietary position. As part of its confidentiality
procedures, the Company generally enters into non-disclosure agreements with its
employees, consultants and suppliers, and limits access to and distribution of
its proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's technology without
authorization. Accordingly, there can be no assurance that the Company will be
successful in protecting its proprietary technology or that ADA's proprietary
rights will preclude competitors from developing products or technology
equivalent or superior to that of the Company.

         The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. There can be no assurance that third parties will not assert
infringement claims against the Company in the future or that any such
assertions will not result in costly litigation or

                                      14

<PAGE>

require the Company to obtain a license to intellectual property rights of 
such parties. There can be no assurance that any such licenses would be 
available on terms acceptable to the Company, if at all. Further, litigation, 
regardless of outcome, could result in substantial cost to and diversion of 
efforts by the Company. Any infringement claims or litigation against the 
Company could materially and adversely affect the Company's business, results 
of operations and financial condition. Moreover, the laws of some foreign 
countries do not protect the Company's proprietary rights in the products to 
the same extent as do the laws of the United States.

EMPLOYEES

         As of February 28, 1999, ADA had approximately 261 employees, 
including 150 in engineering, 60 in sales, marketing and customer support, 21 
in operations and 30 in administration and finance. The Company also employs 
a number of temporary and contract employees. As of February 28, 1999, the 
Company employed approximately 31 temporary and contract employees mostly in 
research and development. The success of the Company is dependent, in part, 
on its ability to attract and retain highly qualified personnel. Competition 
for such personnel is intense and the inability to attract and retain 
additional key employees or the loss of one or more current key employees 
could adversely affect the Company. There can be no assurance that the 
Company will be successful in hiring or retaining requisite personnel.

INDUSTRY SEGMENT AND GEOGRAPHICAL INFORMATION

         The Company operates in one industry segment through two business 
units focused on the Company's network systems and network management product 
lines, respectively. Information with respect to the Company's operations in 
its business units and geographical areas for the 1996, 1997 and 1998 fiscal 
years is set forth in Note 6 on pages F-15 through F-19 of the Company's 
Financial Statements and is incorporated herein by reference.

 RISKS AND UNCERTAINTIES

         CUSTOMER MERGERS. Many of the major TSPs currently involved in or that
have recently completed merger transactions are customers of the Company.
Several of these mergers involved companies that purchase network systems and
software products and services from the Company's competitors. Consequently,
these mergers may result in the loss of business and customers for the Company.
Additionally, the impact of capital spending constraints during the merger
transitions and thereafter has had and could continue to have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, future merger transactions involving or contemplated by the Company's
current or prospective customers may cause increased concentration among some of
the Company's major customers or delays or decreases in their capital spending
decisions, any of which could have a material adverse effect on the Company's
business, operating results and financial condition.

         FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; HISTORY OF LOSSES. The
Company has experienced significant fluctuations in bookings, revenue and
operating results from quarter to quarter due to a combination of factors and
expects such fluctuations to continue in future periods. Factors that may cause
the Company's results of operations to vary significantly from quarter to
quarter include but are not limited to the size and timing of customer orders
and subsequent shipment of systems products and implementation of OS software
products to major customers, timing and market acceptance of product
introductions or enhancements by the Company or its competitors, customer order
deferrals in anticipation of new products, technological changes in the
telecommunications industry, competitive pricing pressures, changes in the
Company's operating expenses, personnel changes, management of a changing
business, changes in the mix of products sold and licensed, disruption in
sources of supply, changes in pricing policies by the Company's suppliers,
regulatory changes, capital spending, delays of payments by customers and
general economic conditions. The Company believes that in late 1997 it began
experiencing seasonality in its product shipments and OS software licensing.
Generally, TSPs place more orders for products and licenses in the second and
fourth quarters, with the orders significantly down in the first quarter and
relatively flat in the third quarter of each year. The Company expects that
revenue may begin to reflect these seasonal order cycles more closely, which
could result in quarterly fluctuations. There can be no assurance that the TSPs
will not defer or delay orders contrary to the historical seasonal pattern or
that they will not change their ordering patterns. Because of the relatively
fixed nature of most of the Company's costs, including personnel and facilities
costs, any unanticipated shortfall in revenue in any fiscal quarter would have a
proportionately greater impact on the Company's operating income in that quarter
and may result in fluctuations in the price of the Company's Common Stock.

         As the impact of the Company's Network Management business unit on 
the Company's revenue increases, the Company may be faced with greater 
fluctuations in operating income. The licensing and implementation of the 
Company's OS products generally involves a significant capital expenditure 
and a commitment of resources by prospective customers. Accordingly, the 
Company is dependent on its customers' decisions as to the timing and level 
of commitment and expenditures. In addition, the Company typically realizes a 
significant portion of license revenues in the last weeks or even days of a 
quarter. As a result, the magnitude of quarterly fluctuations in the Network 
Management business unit may not become evident until late in, or after the 
close of, a particular quarter. In addition, the Company does not recognize 
service revenues until the services are rendered. The time required to 
implement the Company's OS products can vary significantly with the needs of 
its customers and is generally a process that extends for several months. 
Because of their complexity, larger implementations may take multiple 
quarters to complete. Additionally, quarter-to-quarter product mix 
variations, customer orders tending to be placed late in the quarter, and 
competitive pressures on pricing could have a materially adverse effect on 
the Company's operating results in any one quarter. The Company's expenses 
are based in part on the Company's expectations as to future revenues and to 
a large extent are fixed in the short term. If revenues do not meet 
expectations, the Company's business, operations and financial condition are 
likely to be materially adversely affected. The Company has experienced 
losses in the past and there can be no assurance that the Company will not 
experience losses in the future.

                                       15

<PAGE>

         COMPETITION. Competition in the Company's markets is intense and is
characterized by rapidly changing technologies, conformance with evolving
industry standards, frequent new product introductions and enhancements, rapid
changes in customer requirements, and price-competitive bidding. To maintain and
improve its competitive position, the Company must continue to develop and
introduce, in a timely and cost-effective manner, new products and features that
keep pace with increasing customer requirements. The Company expects competition
in its markets to increase from existing competitors and from other companies
which may enter the Company's current or future markets. The Company believes
the principal competitive factors affecting the market for its network systems
test and performance monitoring products are product features, price,
conformance with BellCore and other industry transmission standards and
specifications, performance and reliability, technical support, and the
maintenance of close working relationships with customers. The Company's network
systems products, especially CTS and Remote Module, are currently focused in
highly competitive market niches. The environment for CTS and Remote Module is
fiercely competitive with respect to price, product features, established
customer-supplier relationships and conformance with industry standards. The
Company believes the current competitors that provide partial solutions to
either performance monitoring or testing of the DS3, and the DS1 and DS0
circuits that make up the DS3 circuit, include Hekimian, TTC, Wiltron and some
of the manufacturers of large transmission equipment and digital cross-connect
test and performance monitoring equipment such as Lucent, Alcatel, Ericsson, ADC
Telecommunications, and Tellabs, Inc. The Company's Remote Module product
addresses the DS1 NIU market in which current competitors include Westell Inc.,
Teltrend Inc., and Troncom, Inc. In addition, in 1997, ANSI adopted certain of
the Company's Remote Module signaling technology as an industry standard. As a
result, the Company is obligated to grant licenses of this technology to third
parties, including competitors, on fair and equitable terms which has resulted
in competition from the licensees of its own technology. Many of these
competitors have significantly greater technical, financial, manufacturing, and
marketing resources than the Company.

         The Company believes there are an increasing number of current
competitors in the network management OS market that provide network management
OS applications for circuit and services provisioning and services management,
testing and test management, fault and alarm management and surveillance,
network and circuit performance monitoring and traffic management
telecommunications functions. The OS market is characterized by a wide range of
companies that have varying degrees of market influence. The nature of the
network management OS market is such that improved technologies and tool sets
have made the barriers to entry in this market relatively small resulting in
fierce competition. The principal competitive factors affecting the Company's
network management OS products include product quality, performance, price,
customer support, corporate reputation, and product features such as
scalability, interoperability, functionality and ease of use. The Company's
existing and potential competitors offer a variety of solutions to address
network management needs. Competitors include suppliers of standard
off-the-shelf products, custom software developers, large telecommunications
equipment vendors that offer software applications to manage their own and other
suppliers' equipment, such as Lucent, Nortel, Fujitsu, and Ericsson, hardware
and software vendors, including IBM, Sun Microsystems and Hewlett Packard, and
providers of specific network management and OS applications, such as BellCore,
OSI, TCSI, Architel and others. Additionally, many of the Company's existing and
potential customers continuously evaluate whether they should develop their own
network management and OS applications or license them from outside vendors. The
Company expects competition in the OS market to increase significantly in the
future. Additionally, several of the Company's competitors have long-established
relationships with the Company's current and prospective customers which may
adversely affect the Company's ability to successfully compete for business with
these customers. In addition, product price reductions resulting from market
share penetration initiatives or competitive pricing pressures could have a
material and adverse effect on the Company's business, operating results, and
financial condition. There can be no assurance that the Company will have the
financial resources, technical expertise or manufacturing, marketing,
distribution and support capabilities to compete successfully in the future.

                                       16

<PAGE>



         CONCENTRATION OF MAJOR CUSTOMERS; TELEPHONE COMPANY QUALIFICATION
REQUIREMENTS. The market for the Company's products and services currently
consists of the five RBOCs, IXCs, ILECs, CLECs, emerging carriers, ISPs,
enterprise networks and other TSPs. Historically, the Company's marketing
efforts focused primarily on the RBOCs, which accounted for approximately 73%,
31% and 47% of the Company's total revenue in 1996, 1997, and 1998,
respectively. However, the Company's strategy has been to focus its efforts on
diversifying its customer base. RBOCs, and IXCs customers accounted for 47%, and
23% of the Company's total revenue in 1998 and 31% and 27% in 1997,
respectively. The increased customer base is primarily a function of the
Company's acquisitions in 1996 of Applied Computing Devices, Inc. ("ACD") and
the Special Services Network ("SSN") division of MPR Teltech Inc. and the
acquisition of the DSS II license from Nortel in 1997. As a result of these
acquisitions, the Company added OS related products and services that the
Company has been able to market to a wider group of customers. In addition, the
Company added a number of TSPs that were new customers to the Company. To date,
the OS customers tend to be long distance telephone companies, CLECs, emerging
carriers and enterprise vendors who have not invested in legacy systems from
BellCore. While the Company believes its customer base diversification is
beneficial to the Company, there can be no assurances that the Company will be
able to continue expanding the distribution of its OS and system products and
services to additional prospective customers. In addition, the Company's
customers are significantly larger than the Company and may be able to exert a
high degree of influence over the Company. The loss of one or more of the
Company's major customers, the reduction of orders, a delay in deployment of the
Company's products or the cancellation, modification or non-renewal of license
or maintenance agreements could materially and adversely affect the Company's
business, operating results and financial condition. BellSouth, Ameritech,
Southwestern Bell and MCI WorldCom have entered into purchase contracts with the
Company. MCI WorldCom has also entered into license agreements with the Company.
Other TSPs purchase the Company's network system products and license OS
products under standard purchase orders. Since the RBOC and MCI WorldCom
contracts may be terminated at either the customer's or the Company's
convenience, the Company believes that the purchase contracts and license
agreements are not materially different than purchasing or licensing under
purchase orders. Prior to selling products to RBOCs and certain other TSPs, a
vendor must often first undergo a product qualification process with the TSP for
its products. Although the qualification process for a new product varies
somewhat among these prospective customers, the Company's experience is that the
process often takes a year or more. Currently, the five RBOCs, MCI WorldCom and
several other customers have qualified the Company's products, when required.
Any failure on the part of any of the Company's customers to maintain their
qualification of the Company's products, failure of any of the TSPs to deploy
the Company's products, or any attempt by any of the TSPs to seek out
alternative suppliers could have a material adverse effect on the Company's
business, operating results and financial condition. There can be no assurance
that the Company's products will be qualified by new customers, or that such
qualification will not be significantly delayed. Furthermore, work force
reductions and staff reassignments by some of the Company's customers have in
the past delayed the product qualification process, and the Company expects such
reductions and reassignments to continue in the future. There can be no
assurance that such reductions and reassignments will not have a material
adverse effect on the Company's business, operating results and financial
condition.

         DEPENDENCE ON TWO PRODUCT LINES. Historically, the majority of the
Company's revenue has been derived from the sale of its network systems products
and services. However, as a result of acquisitions completed in 1996 and 1997,
the Company added additional product lines and derived revenue from a product
mix of both network systems products and services and network management OS
software products and services. Revenue from network systems products and
services, including CTS, T3AS and Remote Module, generated 50% and 56% of the
Company's total revenues in 1997 and 1998, respectively. Revenue from network
management OS products and services, including software design services,
 .Provisioner, Test OS, TDC&E and FMS, generated 50% and 44% of the Company's
total revenue in 1997 and 1998, respectively. However, there can be no assurance
that the Company's future revenues will not be heavily dependent on sales from
only one of its primary product lines. The Company is investing in the expansion
of these two product lines through the enhancement, development and marketing of
its NIU, CTS, NEPA, T3AS, Test OS, .Provisioner, TDC&E and FMS products. Failure
by the

                                       17

<PAGE>

Company to enhance either its existing products and services or to develop 
new product lines and new markets could materially and adversely affect the 
Company's business, operating results and financial condition. There is no 
assurance that the Company will be able to develop and market new products 
and technology or otherwise diversify its source of revenue.

         MANAGEMENT OF CHANGING BUSINESS. As a result of acquisitions in 1996
and 1997, the Company formed two business units around the Company's product
lines: the Network Systems business unit and the Network Management business
unit. The Network Systems business unit is built around the Company's test and
performance management products, including T3AS, CTS, Remote Module,
Sectionalizer, NEPA and PAAS products. The Network Management business unit
focuses on OS software products including .Provisioner, TDC&E, Test OS, GTA,
FMS, and OS design services. These business units operate in four separate
geographic locations. The Company continues to face significant management
challenges related to the integration of the business operations of these
business units. The acquisitions and resultant growth in the Company's
infrastructure have placed, and are expected to continue to place, a significant
strain on the Company's management, information systems and operations. The
strain experienced to date has chiefly been in management of a geographically
distributed organization, and in hiring sufficient numbers of qualified
personnel to support the expansion of the business. The Company may also make
future acquisitions where it believes it can acquire new products or otherwise
rapidly enter new or emerging markets. Mergers and acquisitions of high
technology companies are inherently risky and can place significant strains on
the Company's management, information systems and operations. The Company is not
able to forecast additional strains that may be placed on the Company's
management, information systems and operations as a result of recent or future
acquisitions or in the future. The Company's potential inability to manage its
changing business effectively could have a material adverse effect on the
Company's business, operating results, and financial condition. Additionally, as
a result of the termination of the JDA, the Company expects to discontinue
operations conducted at its Richardson, Texas facility. There can be no
assurance that the Company will not incur significant expenses related to the
closure of the Texas facility that could have a material impact on the Company's
business, operating results and financial condition.

         RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW PRODUCTS. The market
for the Company's products is characterized by rapid technological advances,
evolving industry transmission standards, changing regulatory environments,
price-competitive bidding, changes in customer requirements, and frequent new
product introductions and enhancements. The introduction of telecommunications
network performance management products involving superior technologies or the
evolution of alternative technologies or new industry transmission standards
could render the Company's existing products, as well as products currently
under development, obsolete and unmarketable. The Company believes its future
success will depend in part upon its ability, on a cost-effective and timely
basis, to continue to enhance its products, to develop and introduce new
products for the telecommunications network performance management market, to
address new industry standards and changing customer needs and to achieve broad
market acceptance for its products. In particular, the Company anticipates that
the SONET and SDH optical transmission standards will become the industry
transmission standards over the coming years for the North American and
international networks, respectively. The Company's current network circuit test
and performance monitoring systems do not address either the SONET or SDH
transmission standards. The Company intends to extend its current products and
develop new products to accommodate such new transmission standards and other
advances in technology, as they evolve. The widespread adoption of SONET and/or
SDH as industry transmission standards before the Company is able to
successfully develop products which address such transmission standards could in
the future adversely affect the sale and deployment of the Company's products.

         The Company's OS products are designed to operate on a variety of
hardware and software platforms and with a variety of databases employed by its
customers in their networks. The Company must continually modify and enhance its
OS products to keep pace with changes in hardware and software platforms and
database technology. As a result, uncertainties related to the timing and nature
of new product announcements, introductions or modifications by systems vendors,
particularly, Sun Microsystems and Hewlett Packard, and by vendors of relational
database software, particularly, Oracle Corporation, could materially adversely
impact the Company's business, operating results and financial condition. In
addition, the failure of the Company's OS products to operate across the various
existing and evolving versions of hardware and software platforms and database
environments employed by customers would have a material adverse effect on the
Company's business, operating results and financial condition.

         The introduction or announcement of products by the Company or one or
more of its competitors embodying new technologies, or changes in industry
standards or customer requirements, could render the

                                       18

<PAGE>

Company's existing products and solutions obsolete and unmarketable. The 
introduction of new or enhanced versions of its products requires the Company 
to manage the transition from older products in order to minimize disruption 
in customer ordering. There can be no assurance that the introduction or 
announcement of new product offerings by the Company or its competitors will 
not cause customers to defer licensing or purchasing of existing Company 
products or engaging the Company's services. Any deferral of revenues could 
have a material adverse effect on the Company's business, operating results 
and financial condition.

         Any failure by the Company to anticipate or respond on a cost-effective
and timely basis to technological developments, changes in industry transmission
standards or customer requirements, or any significant delays in product
development or introduction could have a material adverse effect on the
Company's business. There can be no assurance that the Company will be able to
successfully develop new products to meet customer requirements, to address new
industry transmission standards and technological changes or to respond to new
product announcements by others, or that such products will achieve market
acceptance.

         DEPENDENCE ON SUPPLIERS AND SUBCONTRACTORS. Certain components used in
the Company's T3AS, CTS, PAAS and Remote Module products, including its VLSI
ASICs, are available from a single source and other components are available
from only a limited number of sources. The Company has few supply agreements and
generally makes its purchases with purchase orders. Further, certain components
require an order lead time of up to one year. Other components that currently
are readily available may become difficult to obtain in the future. Failure of
the Company to order sufficient quantities of these components in advance could
prevent the Company from increasing production in response to customer orders in
excess of amounts projected by the Company. In the past, the Company has
experienced delays in the receipt of certain of its key components, which have
resulted in delays in product deliveries. There can be no assurance that delays
in key component and part deliveries will not occur in the future.

         The inability to obtain sufficient key components as required or to
develop alternative sources if and as required in the future could result in
delays or reductions in product shipments, which in turn could have a material
adverse effect on the Company's customer relationships and operating results.
Additionally, the Company uses third-party subcontractors for the manufacture of
its sub-assemblies. This reliance on third-party subcontractors involves several
risks, including the potential absence of adequate capacity, the unavailability
of or interruption in access to certain process technologies, and reduced
control over product quality, delivery schedules, manufacturing yields and
costs. Shortages of raw materials or production capacity constraints at the
Company's subcontractors could negatively affect the Company's ability to meet
its production obligations and could result in increased prices for affected
parts.

         HIGH INVENTORY LEVELS AND NEED TO MAKE ADVANCE PURCHASE COMMITMENTS. To
respond to anticipated customer demand, the Company maintains high inventory
levels. Maintaining high inventory levels substantially increases the risk that
the Company's profitability and results of operations may from time to time be
materially and adversely affected by inventory obsolescence. To procure adequate
supplies of certain products or components, the Company must make advance
commitments to purchase relatively large quantities of such products or
components in a number of circumstances. A large portion of the Company's
purchase commitments consists of custom parts, some of which are sole-source
such as VLSI ASICs, for which there is no alternative use or application. In the
first quarter of 1998, the Company recorded a charge for inventory obsolescence
totaling $378,000. The inability of the Company to sell such products or
incorporate such components in its other products could have a material adverse
effect on the Company's business, operating results and financial condition.

         YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be unable to
appropriately interpret or recognize dates beyond the calendar year 1999. The
Year 2000 computer issue could result in system failures or miscalculations
causing disruptions in business operations worldwide (including, without
limitation, disruptions in order processing, invoicing, manufacturing and
similar functions).

         The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.

                                      19
<PAGE>

         The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.

         ADA has conducted a comprehensive evaluation of its non-IT systems 
and equipment (e.g., facilities, and test equipment containing 
microprocessors or other similar circuitry, etc.). Based on this evaluation, 
ADA does not expect Year 2000 issues to have a material adverse effect on the 
Company's non-IT systems and equipment. However, Year 2000 compliance for 
some of the Company's non-IT systems and equipment is dependent upon upgrades 
to be provided by third party vendors. The Company expects all upgrades 
required from third party vendors to complete Year 2000 compliance for non-IT 
systems and equipment to be completed by September 30, 1999. There can be no 
assurance that third party vendor upgrades to non-IT systems and equipment 
will be Year 2000 complaint or that the upgrades will be completed prior to 
the end of 1999 which could negatively impact the functionality of non-IT 
systems and equipment that could have a material adverse effect on the 
Company's revenue, operating results and financial condition.

         In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.

         The Company believes that the majority of its current products are 
Year 2000 compliant. The remaining Company products are expected to be Year 
2000 compliant by June 30, 1999. The Company had originally expected this 
process to be completed by December 31, 1998. The Company does not expect 
additional efforts required to complete Year 2000 compliance for these 
products will be material. Internal validation testing is being conducted as 
products are being upgraded. An independent third party also performed 
validation testing on one of the Company's test and performance management 
products. However, since all customer situations cannot be anticipated, 
particularly those involving third party products, the Company may see an 
increase in warranty and other claims as a result of the Year 2000 
transition. In addition, litigation regarding Year 2000 compliance issues is 
expected to escalate. For these reasons, the impact of customer claims could 
have a material adverse impact on the Company's operating results or 
financial condition.

         Year 2000 compliance is an issue for virtually all businesses, whose 
computer systems and applications may require significant hardware and 
software upgrades or modifications. TSPs have devoted a substantial portion 
of their information systems' spending to fund such upgrades and 
modifications and divert spending away from network performance management 
products. Such changes in customers' spending patterns have had and could 
continue to have a material adverse impact on the Company's sales, operating 
results or financial condition.

         The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.

         PRODUCT RECALL AND DEFECTS. Producers of telecommunications network
performance management products such as those being marketed by the Company, are
often required to meet rigorous standards imposed by BellCore, the research and
development entity created following the divestiture of AT&T to provide ongoing
engineering support to the RBOCs. In addition, the Company must meet specialized
standards imposed by many of its customers. The Company's products are also
required to interface in a complex and changing environment with
telecommunication network equipment made by numerous other suppliers. Since many
of these suppliers are competitors of the Company, there can be no assurance
that they will cooperate with the Company. In the event there are material
deficiencies or defects in the design or manufacture of the Company's systems,
or if the Company's systems become incompatible with existing third-party
network equipment, the affected products could be subject to a recall. The
Company has experienced two significant product recalls in its history and there
can be no assurance that the Company will not experience any product recalls in
the future. The cost of any subsequent product recall and associated negative
publicity could have a material adverse effect on the Company's business,
operating results and

                                       20

<PAGE>

financial condition. In addition, the Company's development and enhancement 
of its complex OS products entails substantial risks of product defects. 
There can be no assurance that software errors will not be found in existing 
or new products or releases after commencement of commercial licensing, which 
may result in delay or loss of revenue, loss of market share, failure to 
achieve market acceptance, or may otherwise adversely impact the Company's 
business, operating results and financial condition.

         GOVERNMENT REGULATION. The majority of the Company's customers operate
within the telecommunications industry which is subject to regulation in the
United States and other countries. Most of the Company's customers must receive
regulatory approvals in conducting their businesses. Although the
telecommunications industry has recently experienced government deregulation,
there is no assurance this trend will continue. Moreover, the federal and state
courts and the FCC continue to interpret and clarify the provisions of the 1996
Telecommunications Act. In fact, recent regulatory rulings have affected the
ability of the Company's customers to enter new markets and deliver new services
which could impact their ability to make significant capital expenditures. The
effect of judicial or regulatory rulings by federal and state agencies on the
Company's customers may adversely impact the Company's business, operating
results and financial condition.

         POTENTIAL COMPETITION FROM RBOCS. The 1996 Telecommunications Act has
generally eliminated the restrictions which had previously prohibited the RBOCs
from manufacturing telecommunications equipment (subject to first satisfying
certain conditions designed to facilitate local exchange competition and receipt
of prior approval by the FCC). These restrictions had been imposed under the
Modification of Final Judgment, which governed the structure of the 1984
divestiture by AT&T of its local operating telephone company subsidiaries. The
passage of the 1996 Telecommunications Act may have an adverse effect on the
Company because the RBOCs, which are presently the Company's principal
customers, may now become manufacturers of some or all of the products currently
manufactured and sold by the Company and, consequently, may no longer purchase
telecommunications equipment produced by the Company at the levels historically
experienced.

         PROPRIETARY TECHNOLOGY. The Company relies on a combination of 
technical leadership, patent, trade secret, copyright and trademark 
protection and non-disclosure agreements to protect its proprietary rights. 
Although the Company has pursued and intends to continue to pursue patent 
protection of inventions that it considers important and for which such 
protection is available, the Company believes its success will be largely 
dependent on its reputation for technology, product innovation, 
affordability, marketing ability and response to customers needs. Currently, 
the Company has fifteen U.S. patents granted. Additionally, the Company has 
three pending U.S. patent applications on file covering various circuit and 
system aspects of its products. There can be no assurance that the Company 
will be granted additional patents or that, if any patents are granted, they 
will provide the Company's products with significant protection or will not 
be challenged. Additionally, should a third party challenge any of the 
Company's current or future patents, there can be no assurance that the 
Company will be successful in defending its patents or that any litigation, 
regardless of outcome, will not result in substantial cost to and diversion 
of efforts by the Company. As part of its confidentiality procedures, the 
Company generally enters into non-disclosure agreements with its employees, 
consultants and suppliers, and limits access to and distribution of its 
proprietary information. Despite these precautions, it may be possible for a 
third party to copy or otherwise obtain and use the Company's technology 
without authorization. Accordingly, there can be no assurance that the 
Company will be successful in protecting its proprietary technology or that 
ADA's proprietary rights will preclude competitors from developing products 
or technology equivalent or superior to that of the Company.

         The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. The Company is currently not party to any litigation regarding any
patents or other intellectual property rights. However, there can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that any such assertions will not result in costly
litigation or require the Company to obtain a license to intellectual property
rights of such parties. There can be no assurance that any such licenses would
be available on terms acceptable to the Company, if at all. Further, litigation,
regardless of outcome, could result in substantial cost to and diversion of
efforts by the Company. Any infringement claims or litigation by or against the
Company could materially and adversely affect the Company's business, operating
results and financial condition. Moreover, the laws of some foreign countries do
not protect the Company's proprietary rights in the products to the same extent
as do the laws of the United States.

                                       21

<PAGE>

         The Company relies on certain software that it licenses from third
parties, including software that is integrated with internally developed
software and used in the Company's products to perform key functions. There can
be no assurance that these third party software licenses will continue to be
available to the Company on commercially reasonable terms or that such licenses
will not be terminated. Although the Company believes that alternative software
is available from other third party suppliers, the loss of or inability of the
third parties to enhance their products in a timely and cost-effective manner
could result in delays or reductions in product shipments by the Company until
equivalent software could be developed internally or identified, licensed, and
integrated, which could have a material adverse effect on the Company's
business, operating results and financial condition.

         DEPENDENCE ON KEY PERSONNEL. The success of the Company is dependent,
in part, on its ability to attract and retain highly qualified personnel.
Competition for such personnel is intense and the inability to attract and
retain additional key employees or the loss of one or more current key employees
could adversely affect the Company. There can be no assurance that the Company
will be successful in hiring or retaining requisite personnel.

         VOLATILITY OF STOCK PRICE. The Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by public
market analysts and investors could have an immediate and significant adverse
effect on the trading price of the Company's Common Stock. Fluctuation in the
Company's stock price may also have an effect on customer decisions to purchase
the Company's products which could have a material adverse effect on the
Company's business, operating results and financial condition.

ITEM 2.  PROPERTIES

         The Company currently maintains its headquarters in a leased facility
in San Diego, California, which contains all development, engineering, assembly,
marketing and administrative functions, in 62,368 square feet of space in one
building. The lease expires in 2003. The Company has sub-leased a portion of the
San Diego facility through 2000. The Company also leases additional office
facilities in Terre Haute, Indiana, Burnaby, British Columbia and Richardson,
Texas, all of which house product development and customer support operations.
The Company leases 12,600, 25,604 and 14,750 square feet of space in Terre
Haute, Burnaby and Richardson, respectively. The Terre Haute, Burnaby and
Richardson leases expire in September 1999, December 1999 and January 2005,
respectively. The Company believes that its existing facilities will be adequate
to meets its needs through 1999.

ITEM 3.  LEGAL PROCEEDINGS

         From time to time, ADA may be involved in litigation relating to claims
arising out of its operations in the normal course of business. As of the date
of this Annual Report, the Company is not a party to any legal proceedings.

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

         None.


PART II

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

STOCK MARKET INFORMATION

         Applied Digital Access' Common Stock is listed on the Nasdaq National
Market and is traded on the over the counter market under the symbol "ADAX". The
following table sets forth the high and low sales prices the Company's Common
Stock for the periods indicated.

<TABLE>
<CAPTION>
                                1998                     HIGH        LOW
                                ----                     ----        ---
                           <S>                       <C>          <C>
                           First Quarter             $   10.75    $    6.06

                                       22

<PAGE>

                           Second Quarter                 8.75         4.31
                           Third Quarter                  5.94         2.38
                           Fourth Quarter                 3.69         2.00
</TABLE>

<TABLE>
<CAPTION>
                                1997                     HIGH         LOW
                                ----                     ----         ---
                           <S>                       <C>          <C>
                           First Quarter             $    8.50    $    4.88
                           Second Quarter                 9.38         3.63
                           Third Quarter                 10.00         6.50
                           Fourth Quarter                11.88         5.00
</TABLE>

There were 321 shareholders of record as of February 28, 1999.

DIVIDEND POLICY

         Applied Digital Access has not declared or paid any cash dividends on
its Common Stock to date. The Company currently intends to retain all earnings,
if any, to fund the development and growth of its business and therefore does
not anticipate paying any cash dividends within the foreseeable future.

ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                 1994              1995            1996             1997             1998
                                                 ----              ----            ----             ----             ----
<S>                                        <C>                <C>               <C>             <C>              <C>
(Dollars in thousands, except 
per share data)
Revenue                                    $    35,597        $    20,470       $   24,422      $   34,050       $   29,217
Gross profit                                    20,791             11,753           11,813          18,934           15,630
Operating expenses:

    Research and  development                    5,335              5,807            7,356           9,164           14,313
    In process research and development
       related to acquisitions

                                                     -                  -            3,286           1,578                -
    Sales and marketing                          3,363              4,234            6,312           7,995            9,801
    General and administrative                   2,337              2,985            3,576           5,252            5,079
                                             ---------          ---------         --------         -------          -------
         Total operating expenses               11,035             13,026           20,530          23,989           29,193
                                             ---------          ---------         --------          ------           ------
Net income (loss)                         $     10,620        $       759       $   (7,120)     $   (4,283)      $  (13,124)
                                             ---------          ---------         --------         -------          -------
                                             ---------          ---------         --------         -------          -------
Net income (loss) per share,               $      1.01        $       .06       $     (.59)     $     (.34)      $    (1.03)
                                             ---------          ---------         --------         -------          -------
                                             ---------          ---------         --------         -------          -------
       basic (1)

Net income (loss) per share,               $       .88        $       .06       $     (.59)     $     (.34)      $    (1.03)
                                             ---------          ---------         --------         -------          -------
                                             ---------          ---------         --------         -------          -------
       diluted (1)
Weighted average number of shares,              10,542              11,806          12,084          12,460           12,711
       basic (1)
Weighted average number of shares,              12,091             12,848           12,084          12,460           12,711
       diluted (1)
Working capital                             $   26,081        $    36,728       $   31,229      $   26,788       $   16,756
Total assets                                    48,919             49,936           45,972          46,283           34,272
Long-term debt                                      82                 49               33              15                -
</TABLE>

(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
    of the determination of the number of

                                       23

<PAGE>

    shares used in computing net income per share. Amounts have been restated 
    for the adoption of Statement of Financial Accounting Standard No. 128 
    "Earnings Per Share".

                                       24

<PAGE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS
         
RECENT DEVELOPMENTS

         On March 3, 1999, the Company announced the termination of its joint 
development agreement ("JDA") with Nortel. The Company and Nortel entered 
into the JDA in September 1997 to develop SONET network element products for 
the telecommunications industry. The intellectual property rights associated 
with the jointly developed technology will become the property of the 
Company. Under the JDA, the Company and Nortel each contributed technology 
and development resources to the project and shared the development costs. 
The Company's development costs associated with the JDA have been expensed as 
incurred. Nortel is obligated to continue funding its share of the 
development costs associated with the JDA project through June 2, 1999. The 
Company expects to substantially reduce expenses associated with the 
development conducted under the JDA and will explore alternatives for 
maximizing the value of the jointly developed technology. There can be no 
assurance that the Company will be successful in it efforts to maximize the 
value of the technology developed under the JDA or that the jointly developed 
technology will provide future value to the Company. Under terms of the JDA, 
if the jointly developed technology is successfully implemented into a 
marketable product, Nortel retains the right to receive limited future 
royalties in order to recoup its share of development costs incurred under 
the JDA.

          On March 31, 1999 the Company announced a reduction in its workforce
of approximately 65 people, or 22% of its total workforce. Of the reduction in
workforce, 23 were temporary positions. The Company determined the reduction 
was necessary in order to align its current operations with the Company's 
objectives of focusing on market opportunities in its core business, reducing 
expenses including expenses related to its recently terminated JDA with 
Nortel and improving operating results. The majority of the reduction in 
workforce were engineers focused on development conducted under JDA. As a 
result of the reduction in workforce, the Company will close its office in 
Richardson, Texas. The Company will incur a significant one-time charge in 
the first quarter ending March 31, 1999, related to the reduction in 
workforce. The Company's restructuring plan includes the identification of 
the affected personnel, facility closures, asset write downs, and lease 
terminations. The Company has not completed its analysis of the total dollar 
amount associated with the restructuring charge, but will complete this 
process prior to issuing its first quarter operating results.


                                       25

<PAGE>

RESULTS OF OPERATIONS

         The following table sets forth certain statements of operations data as
a percent of revenue, for the years ended December 31, 1996, 1997 and 1998.

<TABLE>
<CAPTION>
                                                                                  YEARS ENDED DECEMBER 31,
                                                                              ---------------------------------
                                                                              1996          1997           1998
                                                                              ----          ----           ----
                   <S>                                                       <C>           <C>            <C>
                   Revenue                                                    100%          100%           100%
                   Cost of revenue                                             52%           44%            47%
                                                                             -----         -----          -----
                   Gross profit                                                48%           56%            53%
                                                                             -----         -----          -----

                   Operating expenses:

                        Research and Development                               30%           27%            49%
                        Purchased in-process research and development
                          related to acquisitions                              13%            5%              -
                        Sales and marketing                                    26%           23%            34%
                        General and administrative                             15%           15%            17%
                                                                             -----        ------          -----
                            Total operating expenses                           84%           70%           100%
                                                                             -----         -----         ------
                   Operating loss                                            (36)%         (14)%          (47)%
                   Other income, net                                            7%            3%             2%
                                                                              ----         -----           ----
                   Loss before income taxes                                  (29)%         (11)%          (45)%
                   Provision for income taxes                                 (1)%          (1)%           (1)%
                                                                            ------         ------         ------
                   Net loss                                                  (30)%         (12)%          (46)%
                                                                            ------         ------         ------
                                                                            ------         ------         ------
</TABLE>

         1998 COMPARED WITH 1997

         Revenue totaled $29,217,000 in 1998, a 14% decrease from $34,050,000 
in 1997. The decrease is primarily the result of decreased revenue from the 
sale of network management OS products and to a lesser extent decreased 
revenue from the sale of network systems products. The Company believes the 
majority of the revenue decreases resulted from decreased capital spending by 
TSPs for network performance management products. Revenue generated from the 
sale of the Company's network management OS services and products totaled 
$12,762,000 in 1998, a 25% decrease from $16,989,000 in 1997. The decrease 
was the net result of decreased OS design services revenue partially offset 
by increased sales of the Company's .Provisioner and TDC&E OS software 
products. The decreased revenue from OS design services and increased sales 
of the Company's .Provisioner product partially resulted from the Company's 
acquisition of an exclusive license to Northern Telecom Ltd.'s ("Northern 
Telecom") DSS II software product in June 1997. Prior to the acquisition, the 
Company provided OS design services to Northern Telecom that supported the 
DSS II product. As a result of the acquisition, the Company's OS design 
services business supporting DSS II shifted to a product-based business. The 
Company now markets and supports the DSS II product and technology under the 
new name .Provisioner. Unlike revenue from OS software design services which 
is recognized as the service is performed, revenue from OS software product 
sales requires the satisfaction of specific delivery and acceptance criteria 
prior to revenue recognition. The timing of product acceptance can have a 
material impact on revenue recognition in a particular quarter or year. As a 
result, there can be significant quarterly or yearly variations in revenue 
from OS product sales. Revenue generated from the sale of the Company's 
network systems products and services totaled $16,455,000 in 1998, a 4% 
decrease from $17,061,000 in 1997. The decrease was the net result of 
decreased sales of CTS products offset by increased sales of the Company's 
T3AS and Remote Module products. In 1998, BellSouth, MCI WorldCom and Bell 
Atlantic accounted for 26%, 23%, and 12% of the Company's total revenue, 
respectively. In 1997, MCI WorldCom, Northern Telecom and BellSouth accounted 
for 28%, 20%, and 17% of the Company's total revenue, respectively.

         The Company believes decreased capital spending by its customers in
1998 resulted from several factors, including, but not limited to, large-scale
merger activity, capital budget constraints, Y2K concerns, and customer
inventory reductions and tightening of inventory control. There can be no
assurance that the Company's future revenue will not be negatively impacted by
these factors which could have a material adverse effect on the company's
operating results.

                                       26

<PAGE>

         Gross profit totaled $15,630,000 in 1998, a 17% decrease from
$18,934,000 in 1997. Gross profit as a percent of revenue was 53% in 1998
compared to 56% in 1997. The decrease in gross profit and gross profit as a
percent of revenue was the result of decreased sales of the Company's OS
software products, increased sales of the Company's lower-margin Remote Module
NIU, and the impact of a $378,000 one-time inventory obsolescence charge. The
Company's OS software products typically have significantly higher gross margins
than network systems products. The highly competitive Remote Module NIU market
is subject to severe pricing pressures which have contributed to significantly
lower overall gross profits on these products. Additionally, the Company's
relatively fixed manufacturing overhead costs allocated over lower revenue
levels in 1998 resulted in lower overall gross profit levels. The net decrease
in gross profit as a percent of revenue resulted from the factors discussed
above substantially offset by the shift in the Company's OS software design
services business to an OS software product-based business. As a result of the
 .Provisioner (formerly DSS II) license acquisition in 1997, a majority of
engineering design labor previously associated with OS design services revenue
shifted from the cost of revenue line to research and development operating
expenses supporting OS software product development. There can be no assurance
that the Company will be able to maintain the current gross profit margins or
gross profit as a percent of revenue levels. Factors which may materially and
adversely affect the Company's gross profit in the future include its level of
revenue, competitive pricing pressures in the telecommunication network
management market, new product introductions by the Company or its competitors,
potential inventory obsolescence and scrap, possible recalls, production or
quality problems, timing of development expenditures, changes in material costs,
disruptions in sources of supply, regulatory changes, seasonal patterns of
bookings, capital spending, and changes in general economic conditions.

         Research and development expenses totaled $14,313,000 in 1998, a 56% 
increase from $9,164,000 in 1997. The increase was primarily due to increased 
personnel and non-recurring engineering costs associated with the Nortel JDA 
and a shift in engineering labor from cost of revenue to research and 
development operating expenses as a result of the .Provisioner license 
acquisition in June 1997 discussed above in the gross profit analysis. 
Research and development personnel expenses increased 19% compared to 1997, 
mostly related to increased personnel to support the JDA. In 1998 and 1997, 
the Company's net research and development expenses included $3,926,000 and 
$2,190,000 offsets, respectively, representing Nortel's proportionate share 
of development costs incurred for the initial project conducted under the 
JDA. As a result of Nortel's termination of the JDA, the Company expects to 
significantly reduce research and development expenses previously associated 
with the JDA. Nortel is obligated to continue funding its share of 
development costs associated with the JDA through June 2, 1999. The Company 
cannot currently determine the impact the JDA termination will have on the 
Company's operating results. The Company believes that its future success 
depends on its ability to maintain its technological leadership through 
enhancement of its existing products and development of innovative new 
products and services that meet customer needs. Therefore, the Company 
intends to continue to make significant investments in research and product 
development in association with planned development projects. The competition 
for highly qualified engineering personnel is intense. There can be no 
assurance that the Company will be successful in attracting and retaining key 
personnel required to develop new products which could have a material 
adverse effect on the Company's future operating results.

          Sales and marketing expenses totaled $9,801,000 in 1998, a 23%
increase from $7,995,000 in 1997. The majority of the increase is the result of
increased staff and travel costs in sales to support increased sales efforts and
new customer accounts and increased personnel costs in technical support and
marketing to support the shift of a majority of the Company's OS design services
business to an OS software product-based business. The Company expects to
continue to increase the level of sales, marketing and technical support
personnel in order to support increased focus on existing and new markets and
planned product introductions.

         General and administrative expenses totaled $5,129,000 in 1998, a 2% 
decrease from $5,252,000 in 1997. The majority decrease is primarily due to 
lower consulting and recruiting costs significantly offset by increased legal 
expenses and increased expenses for the amortization of goodwill and 
intangible assets associated with the Nortel license acquisition. The Company 
expects that general and administrative expenses may increase in 1999 as a 
result of expected administrative costs related to the termination of the JDA 
with Nortel and potential increased expenses related to the Company's focus 
on Year 2000 issues.

         Interest income totaled $675,000 in 1998, a 25% decrease from $904,000
in 1997. The decrease is the result of a decrease in cash investments during
1998 compared to 1997.

                                       27

<PAGE>

         In 1998 and 1997, the Company provided for income taxes related to the
operations of the Company's Canadian subsidiary, based on an effective Canadian
tax rate of 46%. At December 31, 1998, the Company had federal income tax-loss
carry-forwards of approximately $27,642,000 and California state income tax-loss
carry-forwards of approximately $5,458,000. The Company's use of approximately
$1,166,000 of its federal tax-loss carry-forwards, and $408,000 of its federal
and $105,000 of its California tax credit carry-forwards are significantly
limited as a result of ownership changes associated with equity financing in
January 1989 and March 1991. See Note 9 of Notes to Consolidated Financial
Statements. Management is not able to estimate levels of tax deductions which
will be generated as a result of these transactions in future periods.

         As a result of the factors discussed above, the Company incurred a net
loss of $13,124,000, or $1.03 per basic and diluted share in 1998 compared to
net loss of $4,283,000, or $.34 per basic and diluted share in 1997. Excluding
$1,578,000 in one-time charges for purchased research and development costs
associated with the license acquisition from Nortel, the Company would have
recorded a net loss of $2,705,000, or $.22 per basic and diluted share in 1997.

         1997 COMPARED WITH 1996

         Revenue totaled $34,050,000 in 1997, a 39% increase from $24,422,000 in
1996. The increase is primarily the result of revenue generated from network
management OS software design services and products acquired through
acquisitions during 1997 and 1996. Revenue from the Company's network systems
products and services totaled $17,061,000 in 1997, a 6% decrease from
$18,144,000 in 1996. The decrease was the net result of decreased sales of the
Company's T3AS system offset by sales of the Company's CTS products to MCI
WorldCom and increased sales of the Company's Remote Module to BellSouth.
Revenue from network management OS services and products totaled $16,989,000 in
1997, a 171% increase from $6,278,000 in 1996. The majority of the increase was
the result of increased sales of software design services to Northern Telecom
and sales of the Company's .Provisioner software product to BC Tel and MCI
WorldCom. Since the Company acquired its software design services business in
July 1996, the increased revenue in 1997 was mostly the result of a full year of
software design services revenue. In June 1997, the Company acquired an
exclusive license from Nortel to its DSS II software product. The acquisition
generated a shift in the Company's Canadian operations from a software design
services business to a product business. The Company markets and supports the
DSS II product and technology under the new name .Provisioner. In 1997, MCI
WorldCom, Nortel and BellSouth accounted for 28%, 20%, and 17% of the Company's
revenue, respectively. In 1996, US WEST, NYNEX, and Nortel accounted for 31%,
23%, and 15% of the Company's revenue, respectively.

         Gross profit totaled $18,934,000 in 1997, a 60% increase from
$11,813,000 in 1996. Gross profit as a percent of revenue was 56% in 1997
compared to 48% in 1996. The increases in gross profit and gross profit as a
percent of revenue resulted primarily from increased sales of higher margin
network management OS software products partially offset by decreased sales of
network systems products as well as a change in product mix for network systems
products from T3AS systems to a product mix weighted toward the Company's CTS
and Remote Module NIU products which carry lower product margins compared to the
Company's T3AS system. The highly competitive CTS and NIU markets are subject to
severe pricing pressures which have contributed to significantly lower overall
gross profits on these products. Additionally, gross profit for 1997 increased
due to the shift of a majority of engineering labor previously associated with
design services revenue from the cost of revenue line to research and
development operating expenses as a result of the transition of most of the
Company's Canadian operations from design services to product development
resulting from the license acquisition.

          Research and development expenses totaled $9,164,000 in 1997, a 25%
increase from $7,356,000 in 1996. The increase was primarily due to a shift of a
majority of engineering labor previously associated with design services revenue
from the cost of revenue line to research and development operating expenses as
a result of the transition of most of the Company's Canadian operations from
design services to product development as discussed above in the gross profit
analysis, and the addition of research and development personnel as part of the
JDA with Nortel. Research and development personnel expenses increased 57%
compared to 1996, mostly related to the shift in the Company's Canadian
operations from OS design services to a product based business.

                                       28
<PAGE>

         In 1997, the Company recorded a one-time charge for purchased research
and development costs related to the acquisition of the DSS II software license
and related assets of $1,578,000. In 1996, the Company acquired certain assets
of both ACD in Terre Haute, Indiana and the SSN division of MPR Teltech, in
Vancouver, British Columbia. See Note 8 of Notes to Consolidated Financial
Statements for additional information. In conjunction with the ACD and SSN
acquisitions, the Company recorded one-time charges for purchased research and
development costs of $1,186,000 and $2,100,000, respectively.

         Sales and marketing expenses totaled $7,995,000 in 1997, a 27% increase
from $6,312,000 in 1996. The increase was the result of increased personnel
costs in the network management business unit to support the shift from a design
services business to a product based business, increased personnel expenses in
1997 as a result of the acquisitions made in 1996, and increased commission
expenses.

         General and administrative expenses totaled $5,252,000 in 1997, a 49%
increase from $3,529,000 in 1996. The majority of the increase was attributable
to the amortization of goodwill and intangible assets associated with the SSN
acquisition in the third quarter of 1996 and the license acquisition from Nortel
in June 1997, as well as increased personnel and infrastructure expenses
required to support the expanded operations of the Company as a result of the
1996 and 1997 acquisitions.

         Interest income totaled $904,000 in 1997, a 46% decrease from
$1,673,000 in 1996. The decrease is the result of a decrease in cash investments
during 1997 compared to 1996.

         In 1997 and 1996, the Company provided for income taxes related to the
operations of the Company's Canadian subsidiary, based on an effective Canadian
tax rate of 46%. At December 31, 1997, the Company had federal income tax-loss
carry-forwards of approximately $15,644,000 and California state income tax-loss
carry-forwards of approximately $7,561,000. The Company's use of approximately
$1,166,000 of its federal tax-loss carry-forwards, and $408,000 of its federal
and $105,000 of its California tax credit carry-forwards are significantly
limited as a result of ownership changes associated with equity financing in
January 1989 and March 1991.

         As a result of the factors discussed above, the Company incurred a net
loss of $4,283,000, or $.34 per basic and diluted share in 1997 compared to net
loss of $7,120,000, or $.59 per basic and diluted share in 1996. Excluding
$1,578,000 in one-time charges for purchased research and development costs
associated with the license acquisition from Nortel, the Company would have
recorded a net loss of $2,705,000, or $.22 per basic and diluted share in 1997.
Excluding $3,286,000 in one-time charges for purchased research and development
costs associated with the ACD and SSN asset acquisitions, the Company would have
recorded a net loss of $3,834,000, or $.32 per basic and diluted share in 1996.

QUARTERLY RESULTS

         The Company has experienced significant fluctuations in bookings,
revenue and operating results from quarter to quarter due to a combination of
factors and expects such fluctuations to continue in future periods. Factors
that may cause the Company's results of operations to vary significantly from
quarter to quarter include but are not limited to the size and timing of
customer orders and subsequent shipment of systems products and implementation
of OS software products to major customers, timing and market acceptance of
product introductions or enhancements by the Company or its competitors,
customer order deferrals in anticipation of new products, technological changes
in the telecommunications industry, competitive pricing pressures, changes in
the Company's operating expenses, personnel changes, management of a changing
business, changes in the mix of products sold and licensed, disruption in
sources of supply, changes in pricing policies by the Company's suppliers,
regulatory changes, capital spending, delays of payments by customers and
general economic conditions. The Company believes its product shipments and OS
software licensing are subject to seasonality trends. Generally, TSPs place more
orders for products and licenses in the second and fourth quarters with the
orders significantly down in the first quarter and relatively flat in the third
quarter of each year. The Company expects that revenue may begin to reflect
these seasonal order cycles more closely, which could result in quarterly
fluctuations. There can be no assurance that the TSPs will not defer or delay
orders contrary to the historical seasonal pattern or that they will not change
their ordering patterns. Because of the relatively fixed nature of most of the
Company's costs, including personnel and facilities costs, any unanticipated
shortfall in revenue in any fiscal quarter would have a proportionately greater

                                       29

<PAGE>

impact on the Company's operating income in that quarter and may result in 
fluctuations in the price of the Company's Common Stock.

         As the impact of the Company's Network Management business unit on the
Company's revenue increases, the Company may be faced with greater fluctuations
in operating income. The licensing and implementation of the Company's OS
products generally involves a significant capital expenditure and a commitment
of resources by prospective customers. Accordingly, the Company is dependent on
its customers' decisions as to the timing and level of commitment and
expenditures. In addition, the Company typically realizes a significant portion
of license revenues in the last weeks or even days of a quarter. As a result,
the magnitude of quarterly fluctuations in the Network Management business unit
may not become evident until late in, or after the close of, a particular
quarter. In addition, the Company does not recognize service revenues until the
services are rendered. The time required to implement the Company's OS products
can vary significantly with the needs of its customers and is generally a
process that extends for several months. Because of their complexity, larger
implementations may take multiple quarters to complete. Additionally,
quarter-to-quarter product mix variations, customer orders tending to be placed
late in the quarter, and competitive pressures on pricing could have a
materially adverse effect on the Company's operating results in any one quarter.
The Company's expenses are based in part on the Company's expectations as to
future revenues and to a large extent are fixed in the short term. If revenues
do not meet expectations, the Company's business, operations and financial
condition are likely to be materially adversely affected.

LIQUIDITY AND CAPITAL RESOURCES

         Cash and investments totaled $12,513,000 at December 31, 1998 and
$13,179,000 at December 31, 1997. The decrease in cash and investments is
primarily due to the net loss incurred substantially offset by cash collections
from accounts receivable and payments received from Nortel under the JDA.

         Net working capital totaled $16,756,000 at December 31, 1998 and
$26,788,000 at December 31, 1997. The decrease in working capital was primarily
the result of a decrease in accounts receivable and other current assets. The
decrease in other current assets is primarily related to payments received from
Nortel for their proportionate share of the development costs incurred under the
JDA

         The Company's 1998 operating activities used $91,000 in cash primarily
as a result of the net loss incurred which was offset by decreases in accounts
payable and other current assets and an increase in deferred revenue. In 1997,
the Company's operating activities used $3,528,000 in cash primarily as a result
of increased accounts receivable resulting from a majority of the Company's
fourth quarter sales occurring late in the quarter and increased operating
expenses related to internal funding of the JDA with Nortel, partially offset by
increased accounts payable and decreased inventory levels.

         Cash used for capital expenditures totaled approximately $1,806,000 in
1998 and $2,432,000 in 1997. Most of the capital additions were for the purchase
of software development tool kits, computer workstations and lab equipment
associated with the Company's expanded research and development efforts
associated with the JDA and tenant improvements for the Company's Richardson,
Texas office. The Company acquired capital equipment through capital lease
arrangements totaling $43,000 and $0 in 1998 and 1997, respectively. In 1997,
the purchase cost of the DSS II license acquisition from Nortel totaled
$3,382,000, of which $2,515,000 was paid in 1997 and $867,000 in 1998. The
tangible assets acquired as part of the DSS II license acquisition consisted
mostly of computer and lab equipment. The Company expects that 1999 capital
expenditures will decrease slightly from 1998 levels. Most of the planned
expenditures are for network computer servers and software development tool kits
related to planned research and development efforts and upgrades to the
Company's network infrastructure.

         Assuming no material changes in the Company's current operating plans,
the Company believes that cash generated from operations, and the total of its
cash and investments, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months. However, there can
be no assurance that the Company will not need to seek additional capital
resources to meet working capital and capital expenditure requirements.
Additionally, significant additional capital resources may be required to fund
acquisitions of complementary businesses, products or technologies that are
focused on the Company's core business. The Company may need to issue additional
shares of its capital stock or incur indebtedness in connection with any such
acquisitions or future operations. At present, the Company does not have any
agreements or commitments with

                                       30

<PAGE>

respect to any such acquisitions.

         The Company believes the impact of inflation on its business activities
has not been significant to date.

         YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Without modification, these systems and software will be unable to
appropriately interpret or recognize dates beyond the calendar year 1999. The
Year 2000 computer issue could result in system failures or miscalculations
causing disruptions in business operations worldwide (including, without
limitation, disruptions in order processing, invoicing, manufacturing and
similar functions).

         The risk to ADA exists in four areas: systems used by the Company to
run its business, systems used by the Company's suppliers, potential warranty or
other claims from Company customers, and the potential reduced spending by TSPs
on network performance management products as a result of significant
information systems spending on Year 2000 remediation.

         The Company is continuing to conduct an assessment and analysis of its
internal information technology ("IT") systems to determine the potential costs
and scope of any Year 2000 issues. Based on a preliminary assessment, ADA has
determined that certain of its IT systems need to be upgraded or replaced to
address Year 2000 issues. The Company believes that all necessary upgrades or
replacements of its IT systems will be completed by June 30, 1999. Validation
testing will be conducted as IT systems are upgraded and replaced. All IT
systems that have been purchased in 1999 or 1998 are Year 2000 compliant. The
upgrades are generally covered by service contracts previously entered into by
the Company in the ordinary course of business and the cost of the upgrades and
remediation is not expected to be material to the Company's operating results.
If implementation of upgrades or replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.

         ADA has conducted a comprehensive evaluation of its non-IT systems 
and equipment (e.g., facilities, and test equipment containing 
microprocessors or other similar circuitry, etc.). Based on this evaluation, 
ADA does not expect Year 2000 issues to have a material adverse effect on the 
Company's non-IT systems and equipment. However, Year 2000 compliance for 
some of the Company's non-IT systems and equipment is dependent upon upgrades 
to be provided by third party vendors. The Company expects all upgrades 
required from third party vendors to complete Year 2000 compliance for non-IT 
systems and equipment to be completed by September 30, 1999. There can be no 
assurance that third party vendor upgrades to non-IT systems and equipment 
will be Year 2000 complaint or that the upgrades will be completed prior to 
the end of 1999 which could negatively impact the functionality of non-IT 
systems and equipment that could have a material adverse effect on the 
Company's revenue, operating results and financial condition.

         In addition, the Company has made inquiries of its third party
suppliers to determine if they have any Year 2000 issues that will materially
and adversely impact the Company. To date, the Company has not been made aware
of any material Year 2000 issues which would adversely affect ADA.

         The Company believes that the majority of its current products are 
Year 2000 compliant. The remaining Company products are expected to be Year 
2000 compliant by June 30, 1999. The Company had originally expected this 
process to be completed by December 31, 1998. The Company does not expect 
additional efforts required to complete Year 2000 compliance for these 
products will be material. Internal validation testing is being conducted as 
products are being upgraded. An independent third party also performed 
validation testing on one of the Company's test and performance management 
products. However, since all customer situations cannot be anticipated, 
particularly those involving third party products, the Company may see an 
increase in warranty and other claims as a result of the Year 2000 
transition. In addition, litigation regarding Year 2000 compliance issues is 
expected to escalate. For these reasons, the impact of customer claims could 
have a material adverse impact on the Company's operating results or 
financial condition.

         Year 2000 compliance is an issue for virtually all businesses, whose 
computer systems and applications may require significant hardware and 
software upgrades or modifications. TSPs have devoted a substantial portion 
of their information systems' spending to fund such upgrades and 
modifications and divert spending away from network performance management 
products. Such changes in customers' spending patterns have had and could 
continue to have a material adverse impact on the Company's sales, operating 
results or financial condition.

         The Company intends to continue the review, remediation and testing of
its Year 2000 status and, to the extent necessary, it will develop Year 2000
contingency plans for critical business purposes. In addition, there can be no
assurance that Year 2000 issues will not have a material adverse effect on the
Company if ADA and/or those with whom it conducts business are unsuccessful in
identifying or implementing timely solutions to any Year 2000 problems.

IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS

         In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS
No. 133 establishes accounting and reporting standards for derivative and
hedging activities. In accordance with SFAS No. 133 all derivatives must be
recognized as assets or liabilities and measured at fair value. This Statement
will be effective for the Company's fiscal year 2000. The Company has not yet
determined the impact of the adoption of this new accounting pronouncement on
its consolidated financial position or results of operations.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 

         Not Required.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The Financial Statements are set forth on pages F-1 through F-28 of
this Annual Report.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND  
         FINANCIAL DISCLOSURE

         Not applicable.


PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Identification of Directors. The information under the caption
"Director Nominees," appearing in the Proxy Statement, is incorporated herein by
reference.

         Identification of Executive Officers. The information under the caption
"Executive Officers," appearing in the Proxy Statement, is incorporated herein
by reference.

         Section 16(a) Beneficial Ownership Reporting Compliance. The
information under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance," appearing in the Proxy Statement, is incorporated herein by
reference.

ITEM 11.  EXECUTIVE COMPENSATION

         The information under the caption "Executive Compensation and Other
Matters," appearing in the Proxy Statement, is incorporated herein by reference.

                                       31

<PAGE>

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information under the heading "Security Ownership of Certain
Beneficial Owners and Management," appearing in the Proxy Statement, is
incorporated herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information under the heading "Certain Transactions," appearing in
the Proxy Statement, is incorporated herein by reference.

PART IV

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

         (a)      1.  Financial Statements 

         The following financial statements of the Company are included on pages
F-1 through F-28 of this Annual Report on Form 10-K:

      Report of Independent Accountants

      Consolidated Balance Sheets at December 31, 1997 and December 31, 1998

      Consolidated Statements of Operations and Comprehensive loss for the years
      ended December 31, 1996, 1997 and 1998

      Consolidated Statements of Shareholders' Equity for the years ended 
      December 31, 1996, 1997 and 1998

      Consolidated Statements of Cash Flows for the years ended 
      December 31, 1996, 1997 and 1998

      Notes to Consolidated Financial Statements

                  2.  Financial Statement Schedules

      The following financial statement schedules are included in Item 14 (d):

      Schedule II  - Valuation and Qualifying Accounts for the years ended 
      December 31, 1996, 1997 and 1998

         All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore have
been omitted.

         (b)      Reports on Form 8-K

         None.

(c)      Exhibits

<TABLE>
<CAPTION>
       EXHIBIT                                                                                     PAGE
       NUMBER                                                                                     NUMBER
       ---------------                                                                         --------------
       <S>             <C>                                                                     <C>
               2.1(5)  Asset Purchase Agreement between Applied Digital Access,
                       Inc. and Applied Computing Devices, Inc. dated February
                       29, 1996
</TABLE>

                                       32

<PAGE>

<TABLE>
<CAPTION>
       EXHIBIT                                                                                     PAGE
       NUMBER                                                                                     NUMBER
       ---------------                                                                         --------------
       <S>             <C>                                                                     <C>
               2.2(7)  Asset Purchase Agreement between Applied Digital Access,
                       Inc. and MPRTeltech, Ltd. dated July 16, 1996

              2.3(11)  Asset Purchase Agreement between the Company and
                       Northern Telecom Limited dated June 27, 1997 (the "Asset
                       Purchase Agreement") (with certain confidential portions
                       omitted).

              3.3(13)  Certificate of Incorporation of the Company

              3.4(14)  Certificate of Agreement of Merger of the Company
                       and its California predecessor.

             +3.5(15)  Bylaws of the Company.

             10.1(1)   Registration Rights Agreement by and between
                       the Company and certain shareholders of the
                       Company, dated May 22, 1992 as amended pursuant
                       to the Amendment to Registration Rights Agreement
                       dated April 9, 1993.

              10.2(1)  Lease for the Company's facilities at 9855 Scranton
                       Road, dated June 15, 1993

              10.3(1)  Agreement dated July 1, 1991 by and between the
                       Company and BellSouth Services Incorporated, as
                       amended (with certain confidential portions
                       omitted).

              10.4(1)  Software License Agreement dated January 16, 1992
                       by and between the Company and GCOM (with certain
                       confidential portions omitted).

              10.5(1)  Master Agreement for Operations Systems
                       Modifications for the Integration of Network
                       Elements, dated June 17, 1991 by and between the
                       Company and BellCore, as amended.

              10.6(1)  Addendum #1 to Master Agreement for Operations
                       Systems Modifications for the Integration of
                       Network Elements, dated June 17, 1991 by and
                       between the Company and BellCore dated July 10,
                       1991.

              10.7(1)  Addendum #2 to Master Agreement for Operations
                       Systems Modifications for the Integration of
                       Network Elements, dated June 17, 1991 by and
                       between the Company and BellCore dated November
                       19, 1993.

              10.8(1)  Addendum #3 to Master Agreement for Operations
                       Systems Modification for the Integration of
                       Network Elements dated June 17, 1991 by and
                       between the Company and BellCore dated December
                       27, 1993.

             +10.9(1)  Severance Agreement dated November 27, 1990 by and
                       between the Company and Peter P. Savage.

            +10.10(1)  Severance Agreement dated June 20, 1988 by and between
                       the Company and Paul R. Hartmann.

            +10.11(1)  1994 Stock Option/Stock Issuance Plan Form of Stock
                       Option Agreement.

            +10.12(1)  1994 Stock Option/Stock Issuance Plan Form of Stock
                       Issuance Agreement.

            +10.13(1)  1994 Employee Stock Purchase Plan Form of Stock Purchase
                       Agreement.

            +10.14(1)  Form of Employee Proprietary Information Agreement.
</TABLE>
                                       33

<PAGE>

<TABLE>
<CAPTION>
       EXHIBIT                                                                                     PAGE
       NUMBER                                                                                     NUMBER
       ---------------                                                                         --------------
       <S>             <C>                                                                     <C>
             10.15(1)  Binary Software License Agreement dated March 7,
                       1989 between the Company and Software Components
                       Group, Inc., as amended.

             10.16(2)  Reinstatement Agreement dated September 22, 1994
                       between the Company and BellSouth
                       Telecommunications Incorporated (with certain
                       confidential portions omitted) (Exhibit 10.2).

             10.17(2)  Purchase Agreement for Telecommunications Products and
                       Related Services between Ameritech Services, Inc. (with
                       certain confidential portions omitted) (Exhibit 10.3).

             10.18(3)  First Amendment to Office Lease dated September 23, 1994
                       between the Company and Sorrento Tech Associates.

             10.19(4)  Purchase Agreement for Telecommunications Products and
                       Related Services between Southwestern Bell Telephone
                       Company and the Company, dated September 8, 1995 (with
                       certain confidential portions omitted)

            +10.20(6)  Applied Digital Access, Inc. 1994 Stock Option/Stock
                       Issuance Plan, as amended

             10.21(8)  Master Agreement between Northern Telecom, Ltd. and
                       Applied Digital Access, Inc. dated July 16, 1996.

             10.22(8)  Stock Purchase Agreement between Applied Digital Access,
                       Inc. and MPR Teltech, Ltd. dated July 16, 1996.

             10.23(8)  License Agreement between Northern Telecom, Ltd. and
                       Applied Digital Access, Inc. dated July 16, 1996

             10.24(8)  Second Amendment to Lease between Sorrento Tech
                       Associates and Applied Digital Access, Inc. dated August
                       8, 1996.

             10.25(8)  Lease Agreement between Rose Hulman Institute of
                       Technology, through its authorized leasing agent, Ragle
                       and Company, and Applied Digital Access, Inc. dated
                       September 15, 1996.

             10.26(9)  Sublease agreement between the Company and ENOVA
                       Corporation dated December 9, 1996

             10.27(9)  First Amendment to Sublease between the Company
                       and ENOVA Corporation dated January 24, 1997.

             10.28(9)  Office Lease Agreement between 2725321 Canada Inc. and
                       Applied Digital Access - Canada, Inc. dated January 1,
                       1997.

            10.29(10)  License Agreement between Northern Telecom, Ltd. and the
                       Company dated as of January 24, 1997 (with certain
                       confidential portions omitted).

            10.30(11)  License Agreement between Northern Telecom, Ltd. and the
                       Company dated as of June 27, 1997 (with certain
                       confidential portions omitted).

            10.31(11)  Applied Digital Access, Inc. 1997 Registration Rights
                       Agreement between the Company and Northern Telecom, Ltd.
                       dated as of June 27, 1997.

            10.32(11)  Stock and Warrant Purchase Agreement between the Company
                       and Northern Telecom, Ltd. dated as of June 27, 1997.

            10.33(11)  Master Purchase Agreement between MCI Telecommunications
                       Corporation and the Company dated June 16, 1997 (with
                       certain confidential portions omitted).
</TABLE>
                                       34

<PAGE>

<TABLE>
<CAPTION>
       EXHIBIT                                                                                     PAGE
       NUMBER                                                                                     NUMBER
       ---------------                                                                         --------------
       <S>             <C>                                                                     <C>
            10.34(11)  Master Agreement between Northern Telecom, Ltd. and the
                       Company dated as of June 26, 1997 (with certain
                       confidential portions omitted).

            10.35(12)  Joint Development Agreement between Northern Telecom,
                       Inc. and the Company dated September 30, 1997 (with
                       certain confidential portions omitted).

           +10.36(15)  Applied Digital Access, Inc. Amended and Restated 1996
                       Non-qualified Stock Option Plan

           +10.37(15)  Amended and Restated 1996 Non-qualified Stock Option
                       Plan Form of Stock Option Agreement.

           +10.38(16)  Severance Agreement dated March 24, 1995 by and between
                       the Company and Donald J. O'Connor.

           +10.39(16)  Severance Agreement dated March 12, 1997 by and between
                       the Company and Steven F.X. Murphy.

            10.40(16)  Lease Agreement between Campbell Creek, Ltd. and the
                       Company dated as of October 1, 1997.

            10.41(16)  First Amendment to Lease Agreement between Campbell
                       Creek, Ltd. and the Company dated as of January 22,
                       1998.

            10.42(16)  Second Amendment to Sublease between the Company and
                       ENOVA Corporation dated December 31, 1997.

           +10.43(16)  Form of Indemnification Agreements between the Company
                       and each of its directors.

           +10.44(16)  Form of Indemnification Agreements between the Company
                       and each of its officers.

           +10.45(16)  Applied Digital Access, Inc. 1994 Employee Stock
                       Purchase Plan, as amended.

           +10.46(16)  Management Team Incentive Compensation Plan, as amended.

            10.47(16)  Agreement between Telesector Resources Group, Inc.
                       ("Bell Atlantic") and Applied Digital Access, Inc.
                       executed July 15, 1998 (with certain confidential
                       portions omitted). (Exhibit 10.1)

               +10.48  Form of Executive Officer Retention Agreement between
                       Applied Digital Access and the following Executive
                       Officers: Donald L. Strohmeyer, Paul R. Hartmann, James
                       L. Keefe, Wayne M. Lettiere, Donald J. O'Connor, and 
                       Kevin T. Pope.

               +10.49  President and Chief Executive Officer Retention
                       Agreement between Applied Digital Access and Peter P.
                       Savage dated November 3, 1998.

               +10.50  Confidential Separation Agreement between Stephen F.X.
                       Murphy and Applied Digital Access, Inc. dated January
                       25, 1999.

                 23.1  Consent of Independent Accountants.

                 27.1  Financial Data Schedule.

                    +  Management contract or compensatory plan.
</TABLE>

                 (1)   Incorporated by reference to the Company's Registration
                       Statement on Form S-1 

                                       35

<PAGE>

                       (No. 33-75258), as amended.
                 (2)   Incorporated by reference to the Company's Quarterly
                       Report on Form 10-Q for the quarter ended September 30,
                       1994 (File No.0-23698).
                 (3)   Incorporated by reference to the Company's Annual Report
                       on Form 10-K for the fiscal year ended December 31, 1995
                       (File No. 0-23698).
                 (4)   Incorporated by reference to the Company's Quarterly
                       Report on Form 10-Q for the quarter ended September 30,
                       1995 (File No.0-23698).
                 (5)   Incorporated by reference to the Company's Current
                       Report on Form 8-K dated March 15, 1996 (File No.
                       0-23698).
                 (6)   Incorporated by reference to the Company's Registration
                       Statement on Form S-8 (No. 333-08297), as amended
                 (7)   Incorporated by reference to the Company's Current
                       Report on Form 8-K dated July 31, 1996 (File No.
                       0-23698).
                 (8)   Incorporated by reference to the Company's Quarterly
                       Report on Form 10-Q for the quarter ended September 30,
                       1995 (File No. 0-23698).
                 (9)   Incorporated by reference to the Company's Annual Report
                       on Form 10-K for the year ended December 31, 1996 (File
                       No. 0-23698).
                 (10)  Incorporated by reference to the Company's Quarterly
                       Report on Form 10-Q for the quarter ended March 31, 1997
                       (File No. 0-23698).
                 (11)  Incorporated by reference to the Company's Quarterly
                       Report on Form 10-Q for the quarter ended June 30, 1997
                       (File No. 0-23698).
                 (12)  Incorporated by reference to the Company's Quarterly
                       Report on Form 10-Q for the quarter ended September 30,
                       1997 (File No. 0-23698).
                 (13)  Incorporated by reference to the Company's Current
                       Report on Form 8-K dated December 23, 1997 (File No.
                       0-23698).
                 (14)  Incorporated by reference to the Company's Current
                       Report on Form 8-K/A dated January 12, 1998 (File No.
                       0-23698).
                 (15)  Incorporated by reference to the Company's Registration
                       Statement on Form S-8 (File No. 333- 48105).
                 (16)  Incorporated by reference to the Company's Annual Report
                       on Form 10-K for the fiscal year ended December 31, 1997
                       (File No. 0-23698).
                 (17)  Incorporated by reference to the Company's Quarterly
                       Report on Form 10-Q for the quarter ended June 30, 1998
                       (File No. 0-23698).

                                       36

<PAGE>

                                   SIGNATURES

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

                                    APPLIED DIGITAL ACCESS, INC.

Date:  March 31, 1999                By:  /s/ Donald L. Strohmeyer
                                        ---------------------------
                                          Donald L. Strohmeyer
                                          President and Chief Executive Officer

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

<TABLE>
<CAPTION>
                SIGNATURE                           TITLE                        DATE
                ---------                           -----                        ----
<S>                                      <C>                                <C>
By:   /s/  Donald L. Strohmeyer          President, Chief Executive         March 31, 1999
   ---------------------------------     Officer and Director 
         (Donald L. Strohmeyer)          (Principal Executive Officer) 

By:   /s/  James L. Keefe                Vice President, Finance            March 31, 1999
   ---------------------------------     and Administration, Chief    
         (James L. Keefe)                Financial Officer, Secretary 
                                         (Principal Accounting Officer)
                                         

By:   /s/  Gary D. Cuccio                Director                           March 31, 1999
   ---------------------------------
         (Gary D. Cuccio)

By:   /s/  John F. Malone                Director                           March 31, 1999
   ---------------------------------
         (John F. Malone)

By:   /s/  Kenneth E. Olson              Director                           March 31, 1999
   ---------------------------------
         (Kenneth E. Olson)

By:   /s/  Christopher B. Paisley        Director                           March 31, 1999
   ---------------------------------
        (Christopher B. Paisley)

By:   /s/  Peter P. Savage               Director                           March 31, 1999
   ---------------------------------
              (Peter P. Savage)
</TABLE>

                                       37
<PAGE>

APPLIED DIGITAL ACCESS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>

                                                                            Page
<S>                                                                        <C>
1.   CONSOLIDATED FINANCIAL STATEMENTS:

     Report of Independent Accountants                                       F-2

     Consolidated Balance Sheets as of December 31, 1997 and 1998            F-3

     Consolidated Statements of Operations and Comprehensive Loss
     for the Years Ended December 31, 1996, 1997 and 1998                    F-4

     Consolidated Statements of Shareholders' Equity for the Years Ended
     December 31, 1996, 1997 and 1998                                        F-5

     Consolidated Statements of Cash Flows for the Years Ended
     December 31, 1996, 1997 and 1998                                        F-6

     Notes to Consolidated Financial Statements                              F-7


2.   FINANCIAL STATEMENT SCHEDULE:

     Schedule II - Valuation and Qualifying Accounts for the
     Years Ended December 31, 1996, 1997 and 1998                           F-28


</TABLE>



                                     F-1
<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders of
  Applied Digital Access, Inc.


In our opinion, the consolidated financial statements listed in the index 
appearing under Item 14(a)(1) on page 32 present fairly, in all material 
respects, the financial position of Applied Digital Access, Inc. and its 
subsidiary at December 31, 1997 and 1998, and the results of their operations 
and their cash flows for each of the three years in the period ended December 
31, 1998, in conformity with generally accepted accounting principles. In 
addition, in our opinion, the financial statement schedule listed in the 
index appearing under Item 14(a)(2) on page 32 presents fairly, in all 
material respects, the information set forth therein when read in conjunction 
with the related consolidated financial statements. These financial 
statements and financial statement schedule are the responsibility of the 
Company's management; our responsibility is to express an opinion on these 
financial statements and financial statement schedule based on our audits. 
We conducted our audits of these statements in accordance with generally 
accepted auditing standards which 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, 
assessing the accounting principles used and significant estimates made by 
management, and evaluating the overall financial statement presentation. We 
believe that our audits provide a reasonable basis for the opinion expressed 
above.


PricewaterhouseCoopers LLP
January 28, 1999, except as to Note 10
       which is as of March 31, 1999




                                     F-2
<PAGE>

APPLIED DIGITAL ACCESS, INC.

<TABLE>
<CAPTION>

CONSOLIDATED BALANCE SHEETS
-----------------------------------------------------------------------------------------------------------------
                                                                                               DECEMBER 31,
                                                                                             1997         1998
                                                                                           (DOLLARS IN THOUSANDS,
                                                                                           except per share data)
<S>                                                                                       <C>          <C>
ASSETS
Current assets:
  Cash and cash equivalents                                                               $   4,400    $  12,513
  Investments                                                                                 8,779            -
  Trade accounts receivable, net                                                             12,981        6,111
  Inventory, net                                                                              5,859        5,679
  Deferred income taxes                                                                         130          130
  Prepaid expenses and other current assets                                                   3,775        1,700
                                                                                          ---------    ---------

      Total current assets                                                                   35,924       26,133

Property and equipment, net                                                                   6,165        5,466
Intangible assets, net                                                                        2,822        1,247
Deferred income taxes                                                                         1,372        1,426
                                                                                          ---------    ---------

      Total assets                                                                        $  46,283    $  34,272
                                                                                          ---------    ---------
                                                                                          ---------    ---------

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                                                        $   3,478    $   2,922
  Accrued expenses                                                                            2,846        2,333
  Accrued warranty expense                                                                    1,323        1,264
  Current portion of capital lease obligations                                                   18           41
  Deferred revenue                                                                            1,471        2,817
                                                                                          ---------    ---------

      Total current liabilities                                                               9,136        9,377

Capital lease obligations, net of current portion                                                15            -
                                                                                          ---------    ---------

      Total liabilities                                                                       9,151        9,377
                                                                                          ---------    ---------

Commitments and contingencies (Note 4)

Shareholders' equity:
  Preferred stock, no par value; 7,500,000 shares authorized;
    no shares issued                                                                              -            -
  Common stock, $.001 par value; 30,000,000 shares authorized;
    12,605,082 and 12,909,315 shares issued and outstanding at
    December 31, 1997 and 1998, respectively                                                     13           13
  Additional paid-in capital                                                                 54,089       54,897
  Accumulated other comprehensive income                                                         84          163
  Accumulated deficit                                                                       (17,054)     (30,178)
                                                                                          ---------    ---------

      Total shareholders' equity                                                             37,132       24,895
                                                                                          ---------    ---------
                                                                                          ---------    ---------

      Total liabilities and shareholders' equity                                          $  46,283    $  34,272
                                                                                          ---------    ---------
                                                                                          ---------    ---------
</TABLE>

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

                                     F-3
<PAGE>

APPLIED DIGITAL ACCESS, INC.

<TABLE>
<CAPTION>

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
------------------------------------------------------------------------------------------------------------------
                                                                                 YEARS ENDED DECEMBER 31,
                                                                          1996             1997            1998
                                                                                  (DOLLARS IN THOUSANDS,
                                                                                  EXCEPT PER SHARE DATA)
<S>                                                                  <C>              <C>             <C>
Revenue                                                              $     24,422     $     34,050    $     29,217
Cost of revenue                                                            12,609           15,116          13,587
                                                                     ------------     ------------    ------------

  Gross profit                                                             11,813           18,934          15,630
                                                                     ------------     ------------    ------------

Operating expenses:
  Research and development                                                  7,356            9,164          14,313
  In-process research and development related
    to acquisitions                                                         3,286            1,578               -
  Sales and marketing                                                       6,312            7,995           9,801
  General and administrative                                                3,529            5,252           5,129
                                                                     ------------     ------------    ------------

      Total operating expenses                                             20,483           23,989          29,243
                                                                     ------------     ------------    ------------

      Operating loss                                                       (8,670)          (5,055)        (13,613)

Interest income                                                             1,673              904             675
                                                                     ------------     ------------    ------------

      Loss before income taxes                                             (6,997)          (4,151)        (12,938)
                                                                     ------------     ------------    ------------

Provision for income taxes                                                    123              132             186
                                                                     ------------     ------------    ------------

      Net loss                                                             (7,120)          (4,283)        (13,124)

Other comprehensive income (loss)
  Foreign currency translation adjustments                                     (1)              68              91
  Unrealized gains (losses) on securities                                    (121)              (9)            (12)
                                                                     ------------     ------------    ------------

  Other comprehensive income (loss)                                          (122)              59              79
                                                                     ------------     ------------    ------------

Comprehensive loss                                                   $     (7,242)    $     (4,224)   $    (13,045)
                                                                     ------------     ------------    ------------
                                                                     ------------     ------------    ------------

      Net loss per share, basic and diluted                          $       (.59)    $       (.34)   $      (1.03)
                                                                     ------------     ------------    ------------
                                                                     ------------     ------------    ------------

      Shares used in per share computations                            12,084,242       12,459,511      12,711,203
                                                                     ------------     ------------    ------------
                                                                     ------------     ------------    ------------
</TABLE>

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

                                     F-4
<PAGE>

APPLIED DIGITAL ACCESS, INC.

<TABLE>
<CAPTION>

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
---------------------------------------------------------------------------------------------------------------------------------
                                                           
                                                                                        ACCUMULATED                
                                       COMMON STOCK        ADDITIONAL                      OTHER                   
                                  ----------------------    PAID-IN      DEFERRED      COMPREHENSIVE     ACCUMULATED 
                                   SHARES       AMOUNT      CAPITAL    COMPENSATION    INCOME (LOSS)       DEFICIT      TOTAL
                                                                           (DOLLARS IN THOUSANDS)
<S>                               <C>         <C>         <C>          <C>             <C>              <C>           <C>
Balance, December 31, 1995        11,899,216  $       12  $   51,480   $     (101)     $       147      $    (5,651)  $   45,887
                                  ----------  ----------  ----------   ----------      -----------      -----------   ----------  
Net loss                                   -           -           -            -                -           (7,120)      (7,120)
Foreign currency
  translation adjustment                   -           -           -            -               (1)               -           (1)
Unrealized loss on
  investments                              -           -           -            -             (121)               -         (121)

Amortization of deferred
compensation for stock options             -           -           -           51                -                -           51

Issuance of common stock upon
exercise of stock options            149,261           -         115            -                -                -          115

Issuance of common stock
under stock purchase plan             56,857           -         428            -                -                -          428

Issuance of common stock in
connection with acquisition          150,000           -       1,088            -                -                -        1,088
                                  ----------  ----------  ----------   ----------      -----------      -----------   ----------  

Balance, December 31, 1996        12,255,334          12      53,111          (50)              25          (12,771)      40,327

Net loss                                   -           -           -            -                -           (4,283)      (4,283)
Foreign currency
  translation adjustment                   -           -           -            -               68                -           68
Unrealized loss on
  investments                              -           -           -            -               (9)               -           (9)

Amortization of deferred
compensation for stock options             -           -           -           50                -                -           50

Issuance of common stock upon
exercise of stock options            221,235           1         380            -                -                -          381

Issuance of common stock
under stock purchase plan            128,513           -         598            -                -                -          598
                                  ----------  ----------  ----------   ----------      -----------      -----------   ----------  

Balance, December 31, 1997        12,605,082          13      54,089            -               84          (17,054)      37,132

Net loss                                   -           -           -            -                -          (13,124)     (13,124)
Foreign currency
  translation adjustment                   -           -           -            -               91                -           91
Unrealized loss on
  investments                              -           -           -            -              (12)               -          (12)

Issuance of common stock upon
exercise of stock options             91,649           -         192            -                -                -          192

Issuance of common stock
under stock purchase plan            212,584           -         616            -                -                -          616
                                  ----------  ----------  ----------   ----------      -----------      -----------   ----------  

Balance, December 31, 1998        12,909,315  $       13  $   54,897   $       -       $       163      $   (30,178)   $  24,895
                                  ----------  ----------  ----------   ----------      -----------      -----------   ----------  
                                  ----------  ----------  ----------   ----------      -----------      -----------   ----------  
</TABLE>

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

                                     F-5
<PAGE>

APPLIED DIGITAL ACCESS, INC.

<TABLE>
<CAPTION>

CONSOLIDATED STATEMENTS OF CASH FLOWS
----------------------------------------------------------------------------------------------------------------
                                                                                   YEARS ENDED DECEMBER 31,
                                                                                 1996         1997       1998
                                                                                    (DOLLARS IN THOUSANDS)
<S>                                                                           <C>         <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss                                                                    $   (7,120) $   (4,283) $  (13,124)
  Adjustments to reconcile net loss to net cash used
    by operating activities:
      Depreciation and amortization                                                1,819       3,089       3,703
      Amortization of discount (accretion of premium) on investments                  95        (119)         41
      Amortization of deferred compensation                                           51          50           -
      Acquired in-process research and development                                 3,286       1,578           -
      Change in inventory reserves                                                   (68)        101         104
      Changes in operating assets and liabilities:
         Trade accounts receivable                                                (1,440)     (6,183)      6,870
         Inventory                                                                  (723)      1,403          76
         Deferred taxes                                                                -           -         (54)
         Prepaid expenses and other current assets                                   207      (2,686)      2,075
         Accounts payable                                                            300       1,358        (556)
         Accrued expenses                                                            648       1,355        (513)
         Accrued warranty expense                                                     93         (75)        (59)
         Deferred revenue                                                            587         884       1,346
                                                                              ----------  ----------  ----------

           Net cash used by operating activities                                  (2,265)     (3,528)        (91)
                                                                              ----------  ----------  ----------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of investments                                                       (20,923)    (18,517)    (10,903)
  Maturities of investments                                                       30,923      29,792      19,640
  Purchases of property and equipment                                             (1,709)     (2,432)     (1,806)
  Purchase costs related to asset acquisitions                                    (6,356)     (3,382)          -
  Reimbursement of costs related to acquisition                                        -           -         500
  Purchase of license agreement                                                     (350)          -           -
                                                                              ----------  ----------  ----------

           Net cash provided by investing activities                               1,585       5,461       7,431
                                                                              ----------  ----------  ----------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Principal payments on capital lease obligations                                    (32)        (16)        (35)
  Proceeds from exercise of stock options and warrants                               115         381         192
  Proceeds from issuance of common stock                                             428         598         616
                                                                              ----------  ----------  ----------

           Net cash provided by financing activities                                 511         963         773
                                                                              ----------  ----------  ----------

           Net increase (decrease) in cash and cash equivalents                     (169)      2,896       8,113

Cash and cash equivalents at beginning of year                                     1,673       1,504       4,400
                                                                              ----------  ----------  ----------

      Cash and cash equivalents at end of year                                $    1,504  $    4,400  $   12,513
                                                                              ----------  ----------  ----------
                                                                              ----------  ----------  ----------

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid during the year for interest                                      $        7  $        4  $        2
  Cash paid during the year for income taxes                                           -         229         104

Noncash investing and financing activities:
  Issuance of common stock in connection with acquisition                          1,088           -           -
  Assets acquired under capital lease                                                  -           -          43
</TABLE>

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

                                     F-6
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

 1.    NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

       NATURE OF OPERATIONS
       Applied Digital Access, Inc. (the "Company") designs, engineers and
       manufactures network test and performance monitoring systems and software
       and provides services for the management and testing of
       telecommunications circuits. The Company has two core business segments:
       Network Systems and Network Management. The Network Systems business unit
       provides test and performance management products and services whereas
       the Network Management business unit focuses on the design and
       manufacture of operations systems software.

       PRINCIPLES OF CONSOLIDATION
       The consolidated financial statements include the accounts of the Company
       and its wholly-owned subsidiary, Applied Digital Access Canada ("ADA
       Canada"). All significant intercompany transactions and balances have
       been eliminated in consolidation.

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

       SEGMENT REPORTING
       The Company adopted Statement of Financial Accounting Standards ("SFAS")
       No. 131 DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
       INFORMATION during the year ended December 31, 1998. This Statement
       establishes standards for reporting information about operating segments
       in annual financial statements and requires selected information about
       operating segments in interim financial reports issued to shareholders.
       Under SFAS 131, operating segments are to be determined consistent with
       the way that management organizes and evaluates financial information
       internally for making operating decisions and assessing performance.
       Disclosures required under this Statement include information about
       products and services, geographic areas and major customers. The
       presentation of segment information in prior periods has been
       reclassified to conform to the current year presentation.

       REVENUE RECOGNITION
       The Company's revenues are primarily derived from hardware product sales,
       software product sales and perpetual license fees. In addition, the
       Company also derives revenues from installation and implementation
       services, maintenance agreement sales and software royalties.


                                     F-7
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       Revenue from sales of hardware and software products is generally
       recognized upon shipment. For shipments of products involving significant
       acceptance requirements, revenue is recognized when the Company has met
       substantially all its performance requirements and acceptance criteria
       have been met.

       Revenue from perpetual license arrangements is recognized upon delivery
       of the related software and customer acceptance when the Company has no
       significant continuing obligations and collection is probable.

       Revenue from installation and implementation services is recognized as
       the services are performed while revenue from maintenance contracts is
       recognized ratably over the related contract terms.

       Royalty revenue is generally recognized as earned in accordance with the
       terms of respective license agreements. For certain of the Company's
       license agreements, royalty revenue is recognized when reasonable
       estimates of such amounts can be made.

       Amounts received on uncompleted contracts in excess of incurred costs are
       classified depending upon the nature of the contract as either deferred
       revenue or payments in excess of billings on contracts.

       CASH AND CASH EQUIVALENTS
       Cash and cash equivalents consist of cash and short-term investments with
       original maturities of 90 days or less when purchased. At December 31,
       1998, cash in excess of daily requirements was invested in marketable
       securities consisting of obligations of the U.S. Government and
       commercial paper with original maturities of less than 90 days.

       INVESTMENTS
       The Company determines the appropriate classification of its debt
       securities at the time of purchase and assesses such designations at each
       balance sheet date. Realized gains and losses are determined using the
       specific identification method and are included in other income. Gross
       unrealized holding gains or losses are excluded from earnings and
       reported, net of the related tax effect, as a separate component of
       shareholders' equity. The amortized cost of debt securities is adjusted
       for the amortization of premiums and accretion of discounts to maturity.
       Such amortization is included in interest income. Fair value is 
       determined based on quoted market prices.

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


                                     F-8
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       PROPERTY AND EQUIPMENT
       Property and equipment are stated at cost. Significant renewals and
       improvements are capitalized while maintenance and repairs are expensed
       as incurred. Depreciation is computed over estimated useful lives using
       the straight-line method.

       Useful lives for property and equipment are as follows:

          Computer equipment                             3 - 6 years
          Machinery and equipment                        3 - 6 years
          Office furniture and equipment                 3 - 7 years
          Purchased computer software                    3 - 6 years

       Leasehold improvements are amortized using the straight-line method over
       the shorter of the lease term or the estimated useful lives of such
       improvements.

       Upon retirement or other disposition, the cost and related accumulated
       depreciation or amortization are removed from the accounts and any
       resulting gain or loss is reflected in income.

       INTANGIBLE ASSETS
       Intangible assets consist of goodwill, purchased technology, customer
       contracts and license agreement fees. Goodwill represents the excess of
       the purchase price over net assets of businesses acquired. Purchased
       technology, customer contracts and license agreement fees are stated at
       cost. Intangible assets are amortized on a straight-line basis over
       periods of three to five years.

       The carrying value of intangible assets is periodically reviewed by the
       Company and impairment recognized if events indicate that the expected
       future cash flows from such intangibles are less than their carrying
       value. The Company did not recognize any impairment on its intangible
       assets during the years ended December 31, 1996, 1997, and 1998.

       During the year ended December 31, 1998, the Company received amounts
       determined to be contingent consideration related to an acquisition in
       the prior period. Accordingly, goodwill related to the acquisition was
       decreased by the amount of $500 representing contingent consideration
       received.

       ADVERTISING
       Advertising costs are expensed as incurred.  Advertising expense was
       approximately $217, $250 and $302 for the years ended December 31, 1996,
       1997 and 1998, respectively.


                                     F-9
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       STOCK-BASED COMPENSATION
       The Company measures compensation cost for its stock-based employee and
       non-employee director compensation plans using the intrinsic value
       method. Pro forma disclosures of net loss and net loss per common share
       are provided as if the fair value method had been applied in measuring
       compensation expense.

       FOREIGN CURRENCY TRANSLATION
       The local currency is the functional currency for ADA Canada. Assets and
       liabilities are translated at the exchange rate on the balance sheet date
       while revenues and expenses are translated at average rates of exchange
       prevailing during the year. Adjustments resulting from translating ADA
       Canada's financial statements into U.S. dollars are reported as a
       separate component of shareholders' equity and classified as other
       comprehensive income (loss). For the years ended December 31, 1996, 
       1997 and 1998, the effect of exchange rate changes on cash has not been 
       significant.

       CONCENTRATIONS
       The market for the Company's products is characterized by rapid
       technological advances, evolving industry transmission standards, changes
       in customer requirements and frequent new product introductions and
       enhancements. The introduction of telephone network test and performance
       monitoring products involving superior technologies or the evolution of
       alternative technologies or new industry transmission standards could
       render the Company's existing products, as well as products currently
       under development, obsolete and unmarketable.

       The Company operates in an environment significantly affected by recent
       merger and acquisition activity among its customers. Such activity may
       substantially reduce the number of customers for the Company's products
       and may have a material and adverse effect upon the Company's results of
       operations and financial position.

       A significant portion of the Company's revenues and trade receivables are
       concentrated with a limited number of telecommunications service
       providers or affiliated companies in the United States and Canada.

       The Company's customers consist primarily of Regional Bell Operating
       Companies, long distance carriers, local exchange carriers and
       independent telephone companies. Sales are typically made on credit with
       varying terms depending upon the customer and nature of the product. The
       Company does not hold collateral to secure payment as the Company
       considers its customers to be large companies with substantial financial
       resources. Although the Company deems its reserve for uncollectible
       receivables to be adequate, a default on payment of a significant
       customer receivable could materially and adversely affect the Company's
       operating results and financial position.

       From time to time, the Company may have cash in excess of federally
       insured limits held at certain banks. The Company has not experienced any
       losses on its cash or cash equivalents to date.


                                    F-10
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       All the Company's investments at December 31, 1997 consisted of
       obligations of the U.S. Government and its agencies.

       The Company currently buys certain key components of its products from a
       limited number of suppliers. Although there are a limited number of
       suppliers of the components, management believes that other suppliers
       could provide similar key components on comparable terms. A change in
       suppliers, however, could cause a delay in manufacturing and a possible
       loss of sales, which would adversely affect operating results.

       INCOME TAXES
       The Company's current income tax expense is the amount of income taxes
       expected to be payable for the current year. Deferred income taxes are
       recognized for the tax consequences in future years for differences
       between the tax basis of assets and liabilities ("temporary differences")
       and their financial reporting amounts at each year end based on enacted
       tax laws and statutory rates applicable to the periods in which the
       temporary differences are expected to affect taxable income. Valuation
       allowances are established when necessary to reduce deferred tax assets
       to the amount expected to be realized.

       EARNINGS (LOSS) PER SHARE
       Basic earnings (loss) per common share is computed by dividing net income
       (loss) by the weighted average number of common shares outstanding during
       the period. Diluted earnings (loss) per common share is computed by
       dividing net income (loss) by the weighted average number of common
       shares and potential common shares outstanding during the period using
       the treasury stock method. For the years ended December 31, 1996, 1997,
       and 1998, the weighted average number of common shares outstanding for
       both basic and diluted earnings (loss) per common share is comparable as
       the inclusion of potential common shares for diluted earnings (loss) per
       share would have been antidilutive due to the Company's losses from
       continuing operations. There are no reconciling items in calculating the
       numerator and denominator for basic and diluted earnings (loss) per share
       for any periods presented.

       COMPREHENSIVE INCOME
       The Company adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME during
       the year ended December 31, 1998. This Statement requires the Company to
       report all changes in equity from non-owner sources, including unrealized
       gains and losses on certain investments in debt and equity securities and
       foreign currency translation adjustments, as components of other
       comprehensive income. Such amounts are presented as a separate component
       of equity entitled "Accumulated Other Comprehensive Income" in the
       statement of financial position. The individual components of other
       comprehensive income are also reported with net income (loss) as
       "Comprehensive Income" in the results of operations. The income tax
       expense (benefit) related to items of other comprehensive income is not
       significant for the years ended December 31, 1996, 1997, and 1998.
       Financial statements for earlier periods have been reclassified for
       comparative purposes.


                                    F-11
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       NEW ACCOUNTING PRONOUNCEMENTS
       In June 1998, the Financial Accounting Standards Board ("FASB") issued
       SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
       ACTIVITIES. This Statement establishes accounting and reporting standards
       for derivatives and hedging activities. In accordance with this
       Statement, all derivatives must be recognized as assets or liabilities
       and measured at fair value. This Statement will be effective for the
       Company's fiscal year 2000. The Company has not yet determined the impact
       of the adoption of this new accounting pronouncement on its consolidated
       financial position or results of operations.

       RECLASSIFICATIONS
       Certain reclassifications have been made to the prior year financial
       statements to conform to the current year presentation.


 2.    INVESTMENTS

       At December 31, 1997, all marketable debt securities consisted of
       obligations of the U.S. Government and its agencies and were classified
       as available-for-sale. The estimated fair value of such investments
       approximated its amortized cost and, therefore, there were no significant
       unrealized gains or losses.


 3.    COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

<TABLE>
<CAPTION>
                                                                                     DECEMBER 31
                                                                              ---------------------------
                                                                                 1997           1998
             <S>                                                              <C>            <C>
             Inventories:
                 Raw materials                                                $     3,419    $      3,266
                 Work-in-process                                                    2,223           2,389
                 Finished goods                                                       787             698
                                                                              -----------    ------------

                                                                                    6,429           6,353
                 Less reserves                                                       (570)           (674)
                                                                              -----------    ------------

                                                                              $     5,859    $      5,679
                                                                              -----------    ------------
                                                                              -----------    ------------

             Property and equipment:
                 Computer equipment                                           $     5,655    $      6,031
                 Machinery and equipment                                            2,967           4,062
                 Office furniture and equipment                                     1,815           1,166
                 Purchased computer software                                        1,371           2,136
                 Leasehold improvements                                               911           1,129
                                                                              -----------    ------------

                                                                                   12,719          14,524
                 Less accumulated depreciation and amortization                    (6,554)         (9,058)
                                                                              -----------    ------------

                                                                              $     6,165    $      5,466
                                                                              -----------    ------------
                                                                              -----------    ------------
</TABLE>

                                    F-12
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       Depreciation expense was $1,368, $1,904 and $2,629 for the years ended
       December 31, 1996, 1997 and 1998, respectively. Of these amounts, $140,
       $194 and $412 related to amortization of purchased software costs for the
       years ended December 31, 1996, 1997 and 1998, respectively.

<TABLE>
<CAPTION>
                                                                                     DECEMBER 31
                                                                              ---------------------------
                                                                                 1997           1998
             <S>                                                              <C>            <C>
             Intangible Assets:                                                               
                 Goodwill                                                     $     3,619    $      3,119
                 Technology and customer contracts                                    337             337
                 Licenses                                                             350             350
                                                                              -----------    ------------

                                                                                    4,306           3,806
                 Less accumulated amortization                                     (1,484)         (2,559)
                                                                              -----------    ------------

                                                                              $     2,822    $      1,247
                                                                              -----------    ------------
                                                                              -----------    ------------

             Accrued expenses:
                 Accrued payroll and related costs                            $       902    $        287
                 Accrued vacation                                                     583             773
                 Accrued income taxes                                                 388             425
                 Accrued contract costs                                                -              448
                 Payments in excess of billings on contracts                           -              250
                 Acquisition costs payable                                            867               -
                 Other accrued liabilities                                            106             150
                                                                              -----------    ------------

                                                                              $     2,846    $      2,333
                                                                              -----------    ------------
                                                                              -----------    ------------
</TABLE>


 4.    COMMITMENTS AND CONTINGENCIES

       PURCHASE COMMITMENTS
       The Company had unconditional purchase obligations under contracts for
       inventory purchases. The portion of such obligations not completed at
       year end represent unrecorded commitments of approximately $2,500 and
       $3,003 at December 31, 1997 and 1998, respectively.

       LEASES
       The Company leases certain facilities and equipment under both operating
       and capital leases.


                                    F-13
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       Commitments for minimum lease payments under non-cancelable leases with 
       the initial or remaining terms greater than twelve months as of 
       December 31, 1998 are as follows:

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

                1999                                                    $    43            $    1,203
                2000                                                          -                   897
                2001                                                          -                   789
                2002                                                          -                 1,047
                2003                                                          -                   859
                Thereafter                                                                        269
                                                                        ---------------    ----------------
                                                                             43            $    5,064
                                                                                           ----------------
                Less amounts representing interest                           (2)           ----------------
                                                                        ---------------

                Present value of net minimum lease
                   payments                                             $    41
                                                                        ---------------
                                                                        ---------------
</TABLE>

       Property and equipment includes the following amounts for capitalized
       leases:

<TABLE>
<CAPTION>
                                                                                     DECEMBER 31
                                                                              ---------------------------
                                                                                 1997           1998
             <S>                                                              <C>            <C>
             Machinery and equipment                                          $      -       $     43
             Office furniture and equipment                                         67             67
             Leasehold improvements                                                149            149
                                                                              -----------    ------------

                                                                                   216            259
             Less accumulated amortization                                        (140)          (182)
                                                                              -----------    ------------

                                                                              $     76       $     77
                                                                              -----------    ------------
                                                                              -----------    ------------
</TABLE>

       Capital lease agreements of certain equipment contain bargain purchase
       options whereby the Company has the option to purchase the equipment for
       a nominal amount at the end of the lease term.

       Certain of the Company's operating leases contain purchase options and
       renewal options. Rent expense incurred under such leases was
       approximately $613, $673 and $1,259 for the years ended December 31,
       1996, 1997 and 1998, respectively.

       LITIGATION
       Various claims arising in the ordinary course of business, seeking
       monetary damages and other relief, are pending. The amount of the
       liability, if any, from such claims cannot be determined with certainty.


                                    F-14
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

 5.    COMMON STOCK WARRANTS

       In conjunction with an acquisition in June 1997, the Company issued three
       year warrants to purchase 150,000 shares of common stock at $12 per
       share.


 6.    SEGMENT REPORTING

       In accordance with SFAS No. 131, information regarding the Company's
       business segments is reported for financial statement purposes
       consistently with the manner in which these segments are evaluated for
       internal reporting and management's assessment of performance. The
       Company evaluates the performance of its segment and allocates resources
       to them based on segment earnings before allocation of corporate costs.

       The Company is organized primarily on the basis of products which are
       broken down into Network Systems and Network Management. Network Systems
       products include T3AS products and services, including CTS and PAAS, as
       well as the Remote Module product. Network Management products focus on
       Operating System ("OS") software products which include .Provisioner,
       TDC&E, FMS and OS design services.

       The table below presents information about revenues, operating income
       (loss) and total assets for reportable segments for the years ended
       December 31:

<TABLE>
<CAPTION>
                                                                                  OPERATING
                                                                                    INCOME              TOTAL
                                                              REVENUES              (LOSS)             ASSETS
       <S>                                                 <C>                  <C>                <C>
       1996:                                                                                        
          Network Systems                                  $   18,144           $     (782)        $    14,565
          Network Management                                    6,278               (2,603)              4,533
                                                           ----------------     ---------------    ----------------

              Total for reportable segments                    24,422               (3,385)            19,098

          Reconciling items                                         -               (5,285)            26,874
                                                           ----------------     ---------------    ----------------

          Consolidated totals                              $   24,422           $   (8,670)        $   45,972
                                                           ----------------     ---------------    ----------------
                                                           ----------------     ---------------    ----------------

       1997:
          Network Systems                                  $   17,061           $   (3,209)        $   18,573
          Network Management                                   16,989                4,961              6,432
                                                           ----------------     ---------------    ----------------

              Total for reportable segments                    34,050                1,752             25,005

          Reconciling items                                         -               (6,807)            21,278
                                                           ----------------     ---------------    ----------------

          Consolidated totals                              $   34,050           $   (5,055)        $   46,283
                                                           ----------------     ---------------    ----------------
                                                           ----------------     ---------------    ----------------
</TABLE>

                                    F-15
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                  OPERATING
                                                                                    INCOME              TOTAL
                                                              REVENUES              (LOSS)             ASSETS
       <S>                                                 <C>                  <C>                <C>

       1998:
          Network Systems                                  $    16,455          $    (7,186)       $     13,312
          Network Management                                    12,762                1,556               3,944
                                                           ----------------     ---------------    ----------------

              Total for reportable segments                     29,217               (5,630)             17,256

          Reconciling items                                          -               (7,983)             17,016
                                                           ----------------     ---------------    ----------------

          Consolidated totals                              $    29,217          $   (13,613)       $     34,272
                                                           ----------------     ---------------    ----------------
                                                           ----------------     ---------------    ----------------
</TABLE>

       The table below presents the reconciliation of operating income (loss)
       for reportable segments to consolidated loss before income taxes for the
       years ended December 31:

<TABLE>
<CAPTION>
                                                                1996                 1997               1998
       <S>                                                 <C>                  <C>                <C>
       Operating income (loss) for reportable
          segments                                         $    (3,385)         $     1,752        $     (5,630)
       Other segment expenses                                   (5,285)              (6,807)             (7,983)
       Other unallocated income                                  1,673                  904                 675
                                                           ----------------     ---------------    ----------------

              Consolidated loss before
                   income taxes                            $    (6,997)         $    (4,151)       $    (12,938)
                                                           ----------------     ---------------    ----------------
                                                           ----------------     ---------------    ----------------
</TABLE>

       Operating income (loss) for reportable segments includes segment revenues
       with deductions made for related selling costs and certain expenses
       controllable by segment managers. Other segment expenses consist of
       corporate selling, general and administrative expenses allocated to each
       segment based on segment revenues. Other unallocated income consists
       of interest income on investments held at the corporate level.


                                    F-16
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       The table below presents the reconciliation of total assets for
       reportable segments to consolidated total assets at December 31:

<TABLE>
<CAPTION>
                                                              1996                1997               1998
             <S>                                         <C>                 <C>                <C>
             Total assets for reportable                                                         
                segments                                 $     19,098        $     25,005       $     17,256
             Other segment assets                               3,525               6,492              2,925
             Other unallocated assets:
                Cash                                            1,504               4,400             12,513
                Investments                                    19,956               8,779                  -
                Other                                           1,889               1,607              1,578
                                                         ----------------    ----------------   ----------------

                 Consolidated total assets               $     45,972        $     46,283       $     34,272
                                                         ----------------    ----------------   ----------------
                                                         ----------------    ----------------   ----------------
</TABLE>

       Total assets for reportable segments includes amounts attributable to
       trade accounts receivable, inventory and property and equipment. Other
       segment assets consist primarily of intangible assets obtained in
       conjunction with certain acquisitions. Other unallocated assets consists
       principally of deferred taxes and prepaid expenses

       The table below presents information about other significant items
       included in segment operating income and segment assets as of and for the
       years ended December 31:

<TABLE>
<CAPTION>
                                                                               DEPRECIATION        EXPENDITURES
                                                                                    AND           FOR ADDITIONS
                                                                               AMORTIZATION       TO LONG-LIVED
                                                                                  EXPENSE             ASSETS
             <S>                                                              <C>                 <C>
             1996:
                Network Systems                                               $     1,024         $    1,239
                Network Management                                                    344                374
                Reconciling items                                                     451                 96
                                                                              ----------------    ---------------

                Consolidated totals                                           $     1,819         $    1,709
                                                                              ----------------    ---------------
                                                                              ----------------    ---------------

             1997:
                Network Systems                                               $     1,131         $    1,573
                Network Management                                                    773                694
                Reconciling items                                                   1,185                165
                                                                              ----------------    ---------------

                Consolidated totals                                           $     3,089         $    2,432
                                                                              ----------------    ---------------
                                                                              ----------------    ---------------
</TABLE>

                                    F-17
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                               DEPRECIATION        EXPENDITURES
                                                                                    AND           FOR ADDITIONS
                                                                               AMORTIZATION       TO LONG-LIVED
                                                                                  EXPENSE             ASSETS
             <S>                                                              <C>                 <C>
             1998:
                Network Systems                                               $     1,595         $    1,449
                Network Management                                                  1,033                284
                Reconciling items                                                   1,075                 73
                                                                              ----------------    ---------------

                Consolidated totals                                           $     3,703         $    1,806
                                                                              ----------------    ---------------
                                                                              ----------------    ---------------
</TABLE>

       Depreciation expense on segment property and equipment included as a
       component of total segment assets utilized by management in assessing
       segment operating performance is included in operating income for
       reportable segments. For each of the years ended December 31, 1996, 1997,
       and 1998, the reconciling item to arrive at consolidated depreciation and
       amortization expense consists of amortization expense related to
       intangible assets.

       The table below presents information about revenue and long-lived assets
       by geographic area as of and for the years ended December 31:

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

             Revenues:                                                                           
                United States                            $    20,071         $    24,189        $    25,571
                Canada                                         4,351               9,861              3,646
                                                         ----------------    ----------------   ----------------

                Consolidated totals                      $    24,422         $    34,050        $    29,217
                                                         ----------------    ----------------   ----------------
                                                         ----------------    ----------------   ----------------

             Long-lived assets:
                United States                            $     4,109         $     4,515        $     4,156
                Canada                                           827               1,650              1,310
                                                         ----------------    ----------------   ----------------

                Consolidated totals                      $     4,936         $     6,165        $     5,466
                                                         ----------------    ----------------   ----------------
                                                         ----------------    ----------------   ----------------
</TABLE>

                                    F-18
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       The table below presents information about segment revenues from major
       customers as a percentage of total revenues for the years ended 
       December 31:

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

             Network Systems:
                US WEST                                      31%                  4%                 3%
                Bell Atlantic (NYNEX)                        23%                  8%                12%
                BellSouth                                     7%                 17%                26%
                MCI WorldCom                                  -                  18%                 7%
             Network Management:
                Northern Telecom, Inc.                       15%                 20%                 -
                MCI WorldCom                                  -                  10%                16%
</TABLE>


 7.    EMPLOYEE BENEFIT PLANS

       EMPLOYEE SAVINGS AND RETIREMENT PLAN
       The Company has a 401(k) defined contribution plan that allows eligible
       employees who have been employed by the Company for a minimum of one
       month to contribute up to 15% of their salary, subject to annual limits.
       The Company may also elect to make discretionary contributions to the
       accounts of employees who have completed 1,000 hours of service during
       the plan year. Such discretionary employer contributions vest ratably
       over a four year period. The Company did not make any contributions
       related to this Plan for the years ended December 31, 1996, 1997, or
       1998.

       PROFIT SHARING PLAN
       The Company has a profit sharing plan available to all employees which
       provides compensation to employees when the Company exceeds certain
       targeted performance objectives. Employees are eligible to participate in
       the first full quarter after their employment with the Company begins.
       The Compensation Committee of the Board of Directors determines the
       annual amount allocable to the Plan and such amount expensed was $418 for
       the year ended December 31, 1997. No amounts were expensed under the Plan
       for either of the years ended December 31, 1996 or 1998.

       STOCK OPTION PLANS
       Options to purchase common stock of the Company have been granted to
       employees and non-employee Directors under the 1994 Stock Option/Stock
       Issuance Plan, as amended (the "1994 Plan"), and to non-officer, 
       non-director employees and consultants under the 1996 Non-Qualified Stock
       Option Plan, as amended (the "1996 Plan"), which collectively comprise 
       the "Stock Option Plans." A description of each plan follows.

       -   The 1994 Plan superceded and consolidated the 1988 Stock Option Plan
           and Restricted Stock Purchase Plan (the "1988 Plan"). Outstanding
           stock options and unvested share issuances under the 1988 Plan were
           incorporated into and assumed in the 1994 Plan. 


                                    F-19
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

           The 1994 Plan authorizes up to 4,100,000 shares to be granted no 
           later than February 2004. The 1994 Plan provides for the grant of 
           both incentive and non-qualified stock options which are exercisable 
           for up to ten years from the grant date. The 1994 Plan has three 
           components as follows:

           -   The Discretionary Option Grant Program for selected employees and
               consultants has both incentive and non-qualified components.
               Non-qualified options granted under the Discretionary Option
               Grant Program may be purchased at not less than 85% of fair
               market value of the stock at the date of grant whereas incentive
               options may be purchased at fair market value. Such options
               generally vest over a period not exceeding five years.

           -   The Automatic Option Grant Program provides for non-qualified
               stock options to be granted to non-employee directors at fair
               market value. Options generally vest over a period not exceeding
               five years.

           -   The Stock Issuance Program provides for the issuance of shares of
               common stock which may be purchased by eligible employees and
               certain other qualified individuals at a price not less than 85%
               of fair market value. Such options may be immediately exercisable
               or may vest over a period not exceeding five years.

       -   The 1996 Plan authorizes up to 1,450,000 shares to be granted no 
    later than September 2008. Under terms of the 1996 Plan, the 
    Company may grant options to selected non-officer non-director 
    employees and consultants. The options are generally exercisable 
    at not less than 85% of fair market value. Options generally vest 
    over periods not exceeding five years and have a maximum term of 
    ten years.

       -   Additionally, a fully-exercisable non qualified option to purchase 
    17,087 shares of common stock at an exercise price of $0.14 was 
    outstanding at December 31, 1995, 1996, 1997, and 1998. This 
    option was not issued pursuant to any of the Company's stock 
    option plans. This option expires in May 2001.

       In September 1998, the Compensation Committee of the Company's Board 
       of Directors authorized a program to cancel and regrant option grants 
       made under the 1994 and 1996 Plans that were granted at exercise 
       prices exceeding the fair market value of common stock as of the 
       effective date of the program, October 23, 1998. The exercise price of 
       each regranted option was $2.75, based on the closing market price of 
       the Company's common stock on October 23, 1998. Each optionee holding 
       such an option had the opportunity to (i) elect to retain the old 
       option or (ii) accept a new option with an exercise price equal to the 
       fair market value of the Company's common stock on the effective date 
       and cancel the older, higher-priced option. Each regranted option 
       covered the same number of shares subject to the higher-priced option 
       at the time of cancellation and maintained the same vesting period as 
       the previously cancelled option. The regranted option is subject to 
       the condition that the options cannot be exercised, and employment is 
       not terminated, prior to April 23, 1999. Any employee voluntarily 
       leaving the Company during the suspended vesting period will lose the 
       affected options, including previously vested portions of those 
       options.

       In October 1998, the Compensation Committee of the Company's Board of 
       Directors authorized a program to cancel and regrant option grants 
       made under the 1994 Plan to officer employees of the Company that were 
       granted at exercise prices exceeding the fair market value of common 
       stock as of the effective date of the program, November 3, 1998. The 
       exercise price of each regranted option was $2.75, based on the 
       closing market price of the Company's common stock on November 3, 
       1998. Each optionee holding such an option had the opportunity to (i) 
       elect to retain the old option or (ii) accept new options with 
       exercise prices equal to the fair market value of the Company's common 
       stock on the effective date and cancel the older, higher-priced 
       option. Each regranted option covered one half the number of shares 
       subject to the higher-priced option at the time of cancellation. One 
       of the regranted options maintained the same vesting period as the 
       previously cancelled option. The other regranted option vests in equal 
       monthly installments over a 48 month period beginning on the effective 
       date of the program. The regranted options are subject to the 
       condition that the options cannot be exercised, and employment is not 
       terminated, prior to May 3, 1999. Any officer employee voluntarily 
       leaving the Company during the suspended vesting period will lose the 
       affected options, including previously vested portions of those 
       options.

                                    F-20
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       A summary of stock option transactions for the 1994 and 1996 Plans
       described above is as follows:

<TABLE>
<CAPTION>
                                                             1994 AND 1996 STOCK OPTION PLANS
                                            -------------------------------------------------------------------
                                                 OPTIONS OUTSTANDING                 OPTIONS EXERCISABLE
                                            -------------------------------     -------------------------------
                                                                WEIGHTED                            WEIGHTED
                                                                 AVERAGE                             AVERAGE
                                                NUMBER          EXERCISE            NUMBER          EXERCISE
                                              OF SHARES           PRICE           OF SHARES           PRICE
                                            ---------------    ------------     ---------------    ------------
       <S>                                  <C>                <C>              <C>                <C>
       Balance at December 31, 1995               1,671,309    $       5.63             787,291    $       2.17
            Options granted                         874,887            9.01
            Options exercised                      (149,261)            .77
            Options canceled                       (598,732)          18.30
                                            ---------------    ------------     ---------------    ------------

       Balance at December 31, 1996               1,798,203            5.54             813,939            2.49
            Options granted                       1,404,976            6.58
            Options exercised                      (252,337)           6.34
            Options canceled                       (299,984)           7.65
                                            ---------------    ------------     ---------------    ------------

       Balance at December 31, 1997               2,650,858            6.20           1,185,372            5.02
            Options granted                       2,990,941            3.49
            Options exercised                       (91,649)           5.23
            Options canceled                     (2,571,217)           7.32
                                            ---------------    ------------     ---------------    ------------

       December 31, 1998                          2,978,933    $       2.60             675,253    $       1.52
                                            ---------------    ------------     ---------------    ------------
                                            ---------------    ------------     ---------------    ------------
</TABLE>

       The following table summarizes information about all stock options
       outstanding at December 31, 1998:

<TABLE>
<CAPTION>
                                               ------------------------------     ------------------------------
                                                    OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                                               ------------------------------     ------------------------------
                                                 WEIGHTED
                                                  AVERAGE         WEIGHTED                            WEIGHTED
           RANGE OF                              REMAINING         AVERAGE                             AVERAGE
           EXERCISE             NUMBER          CONTRACTUAL       EXERCISE            NUMBER          EXERCISE
            PRICES            OF SHARES            LIFE             PRICE           OF SHARES           PRICE
       -----------------------------------     --------------    ------------     ---------------    -----------
       <S>                   <C>               <C>               <C>              <C>                <C>
        $0.14 to $2.69             496,526               3.77    $       0.36             475,713    $      0.27
             $2.75               2,295,415               8.71            2.75             142,525           2.75
        $3.00 to $16.13            204,079               9.00            6.34              57,015           8.81
                             -------------     --------------    ------------     ---------------    -----------

                                 2,996,020               7.91    $       2.60             675,253    $      1.52
                             -------------     --------------    ------------     ---------------    -----------
                             -------------     --------------    ------------     ---------------    -----------
</TABLE>

       EMPLOYEE STOCK PURCHASE PLANS
       The Company has three Employee Stock Purchase Plans which provide 
       eligible employees the opportunity to purchase the Company's common 
       stock through payroll deductions. The Company's employees in the 
       United States are eligible to participate in the 1994 Employee Stock 
       Purchase Plan, as amended and the 1998 Employee Stock Purchase Plan 
       whereas the Company's Canadian employees are eligible to participate 
       in a separate 1998 Employee Stock Purchase Plan. Each of the Plans has 
       substantially identical terms. Under the terms of the Plans, employees 
       qualify if they have 

                                    F-21
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       been employed at least 20 hours per week for more than five months. 
       After three months of service, qualifying employees are eligible to 
       participate in the Plans in the quarter following the period in which 
       the eligibility requirement is fulfilled. Employees may elect to have 
       up to 15% of their regular compensation withheld through regular 
       payroll deductions. At each quarter-end, amounts accumulated in the 
       participant's account are used to purchase shares of the Company's 
       common stock at the lower of 85% of the fair market value of the stock 
       at either the date of the participant's entry into the Plan or the 
       last day of the quarter. The initial option period for each of the 
       Plans is generally twelve to twenty-four months with subsequent option 
       periods covering one twelve month period. Each Plan terminates either 
       at the end of the respective option periods or when the maximum number 
       of shares available for issuance under the Plan have been issued. 
       Under these Plans, 56,857, 128,513, and 212,584 shares of common stock 
       were issued during the years ended December 31, 1996, 1997, and 1998, 
       respectively. At December 31, 1998, 218,443 shares of common stock 
       were available for future purchases. No shares remained available for 
       future purchases under the 1994 Employee Stock Purchase Plan, as 
       amended.

       ACCOUNTING FOR STOCK-BASED COMPENSATION
       The Company accounts for its stock-based compensation plans in accordance
       with Accounting Principles Board ("APB") Opinion No. 25 ACCOUNTING FOR
       STOCK ISSUED TO EMPLOYEES and related Interpretations. Under the
       provisions of APB 25, the Company measures compensation cost using the
       intrinsic value method rather than the fair value method prescribed by
       SFAS No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION. Accordingly, no
       compensation cost has been recognized in the Company's results of
       operations. The Company has adopted the disclosure-only provisions of
       SFAS No. 123 which require the presentation of pro forma information
       related to net income (loss) and net income (loss) per share as if the
       Company accounted for its stock-based compensation plans using the fair
       value method. Such pro forma information is as follows:

<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31,
                                                           -----------------------------------------------------
                                                                1996               1997              1998
             <S>                                           <C>                    <C>              <C>
             Net loss:
                  As reported                                  $(7,120)           $(4,283)         $(13,124)
                  Pro forma                                     (8,352)            (6,830)          (15,979)

             Net loss per common share:
                  As reported, basic and diluted                 $(.59)             $(.34)           $(1.03)
                  Pro forma, basic and diluted                   $(.69)             $(.55)           $(1.26)
</TABLE>

                                    F-22
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       The fair value of options granted under the Stock Option Plans and shares
       issued under the Employee Stock Purchase Plans reported below have been
       estimated at the date of grant using the Black-Scholes option-pricing
       model based on the following weighted-average assumptions:

<TABLE>
<CAPTION>
                                           STOCK OPTION PLANS                   EMPLOYEE STOCK PURCHASE PLANS
                                  --------------------------------------    ---------------------------------------
                                    1996           1997          1998          1996           1997         1998
       <S>                        <C>             <C>           <C>           <C>            <C>          <C>
       Risk-free interest rate      6.21%          6.17%         5.10%         6.21%          6.17%        4.69%
       Dividend yield                  0%             0%            0%            0%             0%           0%
       Expected volatility         65.09%         69.76%        74.17%        65.09%         69.76%       74.17%
       Expected life (in years)        5              5             5           .25            .25          .25
</TABLE>

       The estimated fair value of options granted under the Stock Option Plans
       at December 31, 1996, 1997 and 1998 was $4.22, $3.40, and $2.33 per
       share, respectively. The estimated fair value of shares issued under the
       Employee Stock Purchase Plans at December 31, 1996, 1997, and 1998 was
       $9.56, $6.58, and $1.05 per share, respectively.


 8.    ACQUISITIONS

       In February 1996, the Company acquired certain assets of Applied
       Computing Devices, Inc. ("ACD"), a company that developed and marketed
       operations systems software used primarily by independent telephone
       companies to manage certain functions in their networks. The customer set
       and products of ACD complement those of the Company and the Company
       intends to continue to market and enhance these products. The Company
       acquired the assets for $1,700 in cash and incurred approximately $200 in
       related costs. The assets were acquired at an auction held in Federal
       Bankruptcy Court, Southern District of Indiana. The transaction, which
       was accounted for as a purchase, included the acquisition of in-process
       research and development valued at approximately $1,200, property and
       equipment valued at approximately $377 and purchased technology valued at
       approximately $337. The Company recorded a one-time charge in the first
       quarter of 1996 for approximately $1,186 associated with purchased
       research and development costs.

       In July 1996, the Company acquired certain assets of MPR Teltech, a
       subsidiary of British Columbia Telecom, Inc. The assets acquired were
       part of MPR Teltech's operating unit commonly known as the Special
       Services Network division ("SSN"). The Company and its Canadian
       subsidiary, ADA Canada, acquired the assets for $4,200 in cash, 150,000
       shares of the Company's common stock and incurred approximately $200 in
       related costs. SSN was an operations systems software development group
       with expertise in the development of network management systems for
       public carriers. SSN developed operations systems software primarily for
       Northern Telecom ("Nortel"). SSN has become part of ADA Canada and will
       develop network performance management operations systems software
       products for the Company and its customers, including Nortel. The
       transaction, which was 


                                    F-23
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       accounted for as a purchase, included the acquisition of in-process 
       research and development valued at approximately $2,100, property and 
       equipment valued at approximately $900 and goodwill and know-how valued
       at approximately $2,588. The Company recorded a one-time charge in the 
       third quarter of 1996 for the $2,100 associated with purchased research
       and development costs.

       In June 1997, the Company acquired an exclusive worldwide license to
       Nortel's Digital Support System II-TM- ("DSSII") operations system
       software product, subject to certain residual rights retained by Nortel.
       The Company acquired the license and certain assets related to the DSSII
       product for a purchase price of $3,100. Of this amount, $3,100 was paid
       in cash. The Company recorded a charge of approximately $1,578 for 
       purchased research and development associated with the acquisition of 
       the license and the assets. As part of the transaction, the Company also
       issued Nortel three-year warrants to purchase 150,000 shares of the 
       Company common stock at an exercise price of $12 per share.

       The following condensed pro forma results of operations information has
       been presented to give effect to the acquisitions as if such transactions
       had occurred at the beginning of each of the periods presented. The
       historical results of operations have been adjusted to reflect additional
       depreciation and amortization expense based upon the value allocated to
       assets acquired in the purchases. The pro forma results of operations
       information is presented for information purposes only and is not
       necessarily indicative of the operating results that would have occurred
       had the acquisitions been consummated as of the beginning of the periods
       presented, nor is it necessarily indicative of future operating results.

<TABLE>
<CAPTION>
                    CONDENSED PRO FORMA RESULTS OF OPERATIONS
                                   (UNAUDITED)
                                                                                YEAR ENDED DECEMBER 31
                                                                              ---------------------------
                                                                                 1996           1997
             <S>                                                              <C>               <C>
             Revenue                                                             $29,660        $34,050
             Net loss                                                             (7,474)        (4,283)
             Net loss per share, basic and diluted                                  (.61)          (.34)
             Weighted average shares used in computation                          12,165         12,605
</TABLE>

                                    F-24
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

 9.    INCOME TAXES

       The provision for income taxes for the years ended December 31, 1996,
       1997 and 1998 consists of current taxes for foreign operations.

       Differences between the statutory rate and the effective tax rate for the
       year ended December 31, 1996, 1997 and 1998 are as follows:

<TABLE>
<CAPTION>
                                                                                   1996       1997        1998
                                                                                   ----       ----        ----
              <S>                                                                 <C>        <C>         <C>
              Taxes at federal statutory rate                                     (34.0%)    (34.0%)     (34.0%)
              Foreign income taxes                                                  1.8%       3.2%        1.4%
              Net operating loss carryforwards and research and
                   development tax credits (utilized) not utilized                 33.0%      33.0%       33.0%
              Other                                                                 1.0%       1.0%        1.0%
                                                                                    ---        ---         ---

              Provision for income taxes                                            1.8%       3.2%        1.4%
                                                                                    ---        ---         ---
                                                                                    ---        ---         ---
</TABLE>

       The components of the deferred tax assets at December 31, 1997 and 1998
       are as follows:

<TABLE>
<CAPTION>
                                                                                   YEAR ENDED DECEMBER 31
                                                                              ---------------------------------
                                                                                   1997              1998
             <S>                                                              <C>               <C>
             Allowances and reserves                                          $      780        $      818
             Vacation accrual                                                        178               250
             Capitalized research and development                                  2,577             2,982
             Net operating loss carryforwards                                      5,908            10,383
             Tax credits                                                           1,991             2,691
             Accelerated depreciation                                               (287)             (145)
             Other                                                                    10                10
                                                                              ---------------   ---------------

                      Total gross deferred tax asset                              11,157            16,989

             Less valuation allowance                                             (9,655)          (15,433)
                                                                              ---------------   ---------------

                                                                              $    1,502        $    1,556
                                                                              ---------------   ---------------
                                                                              ---------------   ---------------
</TABLE>

                                    F-25
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

       Realizability of the deferred tax asset is dependent on the Company
       generating sufficient taxable income or utilizing tax planning 
       strategies available to the Company prior to expiration of the net
       operating loss carryforwards. Although realization is not assured,
       management believes it is more likely than not that the net deferred tax
       asset will be realized. The amount of the deferred tax asset considered
       realizable, however, could be reduced in the near term if estimates of
       future taxable income during the carryforward period are reduced.

       At December 31, 1998, the Company has net operating loss carryforwards
       for federal income tax purposes of approximately $27,642, of which $5,458
       is attributable to disqualifying dispositions of stock options. The
       Company also has net operating loss carryforwards for California tax
       purposes of approximately $13,796 at December 31, 1998, of which $2,804
       is attributable to disqualifying dispositions of stock options. The
       amount attributable to the disposition of stock options will not impact
       the Company's effective tax rate in future periods as the impact will be
       reflected as a component of equity when recognized.

       The Company also has research and development tax credit carryforwards of
       approximately $2,162 for federal and $802 for California tax purposes at
       December 31, 1998. These carryforwards will begin expiring, if unused, in
       2003.

       The Internal Revenue Code imposes limits on the availability of net
       operating loss carryforwards and certain tax credits that arose prior to
       certain cumulative changes in a corporation's ownership resulting in a
       change of control of the Company. The Company's use of approximately
       $1,166 of its federal net operating loss carryforwards and $408 of its
       federal and $105 of its California tax credit carryforwards are
       significantly limited because the Company underwent "ownership-changes"
       in January 1989 and March 1991. In each year following the change, the
       Company will be able to offset taxable income by a limited amount of the
       pre-ownership change carryforwards. This limitation is determined by the
       value of the Company immediately prior to the ownership change multiplied
       by the long-term tax-exempt rate. Net operating losses and tax credits
       that are unavailable in any year as a consequence of this limitation may
       be carried forward for future use subject to certain restrictions.

                                    F-26
<PAGE>

APPLIED DIGITAL ACCESS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

10.    SUBSEQUENT EVENTS

       TERMINATION OF JOINT DEVELOPMENT AGREEMENT
       On March 3, 1999, the Company's Joint Development Agreement (the
       "Agreement") with Nortel was terminated. The Agreement, dated September
       29, 1997, was for the development of SONET network element products for 
       the telecommunications industry. Under the terms of the Agreement, the
       Company and Nortel each contributed technology and resources and shared
       development costs related to the project. Nortel is obligated to continue
       providing funding for the project for three months after the termination
       date. While the Company has retained the intellectual property rights
       associated with the jointly developed technology, Nortel has the right to
       receive royalties to recover its portion of development costs paid to the
       Company should the Company sell products utilizing the jointly developed
       technology. The amount potentially reimbursable to Nortel was $6,117 at
       December 31, 1998.

       On March 31, 1999 the Company announced a reduction in its workforce of
       approximately 65 people, or 22% of its total workforce. Of the reduction
       in workforce, 23 were temporary positions. The Company determined the 
       reduction was necessary in order to align its current operations with 
       the Company's objectives of focusing on market opportunities in its 
       core business, reducing expenses including expenses related to its 
       recently terminated JDA with Nortel and improving operating results. 
       The majority of the reduction in workforce were engineers focused on 
       development conducted under JDA. As a result of the reduction in 
       workforce, the Company will close its office in Richardson, Texas. 
       The Company will incur a significant one-time charge in the first 
       quarter ending March 31, 1999, related to the reduction in workforce. 
       The Company's restructuring plan includes the identification of 
       the affected personnel, facility closures, asset write downs, and lease 
       terminations. The Company has not completed its analysis of the total 
       dollar amount associated with the restructuring charge, but will complete
       this process prior to issuing its first quarter operating results.





                                    F-27
<PAGE>

APPLIED DIGITAL ACCESS, INC.

VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(DOLLARS IN THOUSANDS)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                    BALANCE AT    ADDITIONS
                                                                    BEGINNING     CHARGED TO                  BALANCE AT
             DESCRIPTION                                 YEAR        OF YEAR      EXPENSES      WRITEOFFS    END OF YEAR
<S>                                                      <C>        <C>           <C>            <C>          <C>
Allowance for doubtful accounts                          1996          $50           $ -           $  -           $50
                                                         1997           50             -              -            50
                                                         1998           50            50                          100

Inventory reserve                                        1996          537             -            (68)          469
                                                         1997          469           312           (211)          570
                                                         1998          570           757           (653)          674
</TABLE>



                                    F-28