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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, 1997

[ ] 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, 1998 as reported on the Nasdaq National Market, was approximately
$58,670,158. 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 12,629,469 shares of the Registrant's Common Stock, $0.001 par
value, outstanding as of February 28, 1998.

                     DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held May 21, 1998, 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," "ANITICPATE," "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 AND (iii) EXPANDED MARKETING EFFORTS, 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."

      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' ("TSP") 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 our TSP market. The Company has two business units: the Network Systems
business unit and the Network Management business unit. The business units
are the result of the evolution of the Company from a single product line to
multiple product lines. 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"), and Protocol
Analysis Access System ("PAAS"). The Network Management business unit focuses
on Operations Systems ("OS") software products including .Provisioner, Test
OS, Graphical Test Assistant ("GTA"), Sectionalizer, Fault Management System
("FMS"), Traffic Data Collection and Engineering System ("TDC&E"), and OS
design services.

         ADA's network systems products are deployed by a number of TSPs,
including the five regional bell operating companies ("RBOCs"), several long
distance or "interexchange carriers" ("IXCs"), including MCI, Worldcomm and
IXC Communications, several competitive local exchange carriers ("CLECs") and
competitive access providers ("CAPs"), including Brooks Fiber and
Consolidated Communications, international carrier Chunghwa Telecom of
Taiwan, and several independent telephone companies ("ITOCs"). Some of the
Company's customers for its network management OS products and services
include MCI, Worldcomm, British Columbia Telecom ("BC TEL"), Fujitsu
Australia, OPTUS, GTE, Sprint/Centel Telephone, Metropolitan Fiber Systems
("MFS"), Teleport Communications Group ("TCG"), MGC Communications ("MGC"),
TDS Telecom ("TDS"), IntelCom Group ("ICG"), several enterprise networks and
several other TSPs.

RECENT DEVELOPMENTS

         In September 1997, the Company entered in to a Joint Development
Agreement ("JDA") with Northern Telecom, Inc. ("Nortel") to develop unique
Synchronous Optical Network ("SONET") products for the telecommunications
industry. Nortel and the Company will each contribute technology and
development resources to projects conducted under the JDA. The companies will
equally share development costs, estimated to be several million dollars per
quarter. Development of the first product under the JDA has commenced with
initial availability expected in the first half of 1999. The JDA also
contemplates additional projects as agreed to in the future by Nortel and
ADA. However, there can be no assurance that the Company will be able to
develop the initial product or any future products on a timely basis or that
its development efforts will result in commercially successful products.
Operating expenses for the year ended December 31, 1997 include a $2.2
million offset to research and development

                                      -2-

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costs representing Nortel's proportionate share of development costs that
were incurred through December 31, 1997 in connection with the initial
project being conducted under the JDA.

         In June 1997, the Company acquired from Northern Telecom an
exclusive worldwide license to Northern Telecom's DSS II OS software product,
subject to certain residual rights retained by Northern Telecom. The Company
markets and supports the DSS II product under the new name, .Provisioner. The
product is an OS software application for provisioning and configuration
management for transport networks comprised of multiplexers, digital
cross-connect systems ("DCSs") and other transport elements. The Company
acquired the license and related assets for $3.1 million in cash. As part of
the transaction, the Company also issued Nortel a warrant to purchase 150,000
shares of the Company's common stock at an exercise price of $12 per share.
The warrant has a 3 year term. In June 1997, the Company recorded a $1.6
million charge for purchased research and development associated with the
license and asset acquisition. The acquisition of .Provisioner was part of
the Company's strategic plan to build upon its portfolio of network
management OS products essential to the operation of TSP networks.

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 telphone companies and long distance providers.
TSPs, which include the RBOCs, IXCs, CLECs, CAPs, ITOCs, Internet servive
providers ("ISPs"), 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,
telephone companies 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 long distance telephone company market, and the emergence of CAPs
and CLECs who offer local telephone service in competition with the RBOCs or
ITOCs. 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 telephone companies 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 both CLECs and from the local service competitive
initiatives of the long distance telephone companies and will potentially
face competition 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.

         Prior to the 1984 divestiture, AT&T was responsible for end-to-end
telecommunication service. When problems occurred with a telephone
connection, customers called AT&T to diagnose and fix the problem. Today,
however, a long distance data or voice circuit often involves three or more
telephone companies: the local telephone companies

                                      -3-

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on each end and the long distance telephone company 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 a degradation in service is noted, the telecommunications
manager of the firm contacts the telephone company that manages the network -
typically the long distance carrier. Initially, the long distance telephone
company 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.

         Long distance telephone companies 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 long distance telephone
company 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.

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, 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 telephone network in the era of increased 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.

                                      -4-

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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 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 their 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 nonintrusively, either in a standalone 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 standalone 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 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, CAPs, and
other TSPs.

                                      -5-
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         3. DEVELOPING AND ENHANCING PRODUCTS 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 PAAS system
currently provides 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 its applications have historically
been addressed by companies such as AT&T and BellCore. 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 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,
often using custom software development provided by the Company's design
services group.

         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 entered into the JDA with Nortel to develop new products focused on
SONET optical transmission standards. The Company does not expect to complete
the first phase of development under the JDA until 1999. 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

         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. 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's evolutionary platform can be reconfigured as an in-line T3AS system
without obsolescence of original modules to add new capabilities and

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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. The Company believes T3AS is the only 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
DSO, 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 digital cross-connect systems 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's 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 a long distance telephone company, 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 expands the Company's
product line by providing 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.

         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.

         REMOTE MODULE

         ADA's Remote Module is an intelligent DS1 NIU that nonintrusively
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 servicelevel 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 standalone mode, or in
conjunction with DTAUs and RTUs provided by other suppliers.

         NETWORK MANAGEMENT SOFTWARE

         TEST OS

         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

                                      -7-

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varying access levels for tests at DS0, DS1 and DS3 rates. Graphical Test
Assistant ("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.

         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 Modules, T3AS and CTS by utilizing the
equipment to rapidly identify and isolate network troubles and take a
proactive perspective in networks management. Sectionalizer is the driving
force behind ADA's Network Boundary Sectionalization application.
Sectionalizer executes on T3AS, CTS, and Remote Module platforms.

         .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 turn-key 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.

         FAULT MANAGEMENT SYSTEM

         Fault Management System ("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.

         TRAFFIC DATA COLLECTION AND ENGINEERING

         Traffic Data Collection and Engineering ("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.

CUSTOMERS

         The Company sells its network perfomance management products and
services to the TSP market and several enterprise networks. Historically, the
Company's network test and performance monitoring products have been sold to
the RBOCs. The RBOCs accounted for approximately 99%, 73% and 31% of the
Company's total revenue in years 1995, 1996 and 1997, 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 and Worldcomm. 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, Worldcomm, BC TEL, Fujitsu Australia, OPTUS, GTE,
Sprint/Centel Telephone, MFS, TCG, MGC, TDS, ICG and other TSPs and
enterprise networks. The Company has provided software design services to
Northern Telecom's Network Management Services Division, Telus, BC Tel and
Bell Canada. The Company has increased its sales and marketing efforts aimed
at CLECs, CAPs, IXCs, 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, BellSouth,
Ameritech and Southwestern Bell. MCI has also entered into license agreements
with the Company. Other TSPs purchase the Company's systems products and
license OS products under standard purchase orders. Since the MCI, BellSouth,
Ameritech and Southwestern Bell 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 purchase orders. Most of the Company's customers are
significantly

                                      -8-

<PAGE>

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 has historically
accounted for substantially all of the Company's revenue in any given fiscal
period. In 1997, Northern Telecom, MCI and Bell South accounted for 20%, 18%,
and 17% of the Compay's revenue, respectively. In 1996, US WEST, NYNEX, and
Northern Telecom accounted for 31%, 23%, and 15% of the Company's revenue,
respectively.

         Prior to selling products to RBOCs and certain IXCs and ITOCs, a
vendor must often first undergo a product qualification process for its
product with these carriers. The Company typically spends from six to 18
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
the Company's products will be approved by new customers, 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.

         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

                                      -9-

<PAGE>

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 it's 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 ("PM") and the ability to convey PM
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
technolgy 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 from Booch. 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 products have year 2000 compliance support activities
scheduled in 1998. There can be no assurance that the Company will be
successful in implementing its year 2000 modifications in a timely manner.

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. Therefore, the Company intends to continue to make significant
investments in research and product development.

         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, PAAS, distributed
system and the low-speed subsystem. 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 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 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 and other
markets, to address new industry transmission standards and changing customer
needs and to achieve broad market acceptance for its products.

         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 network
circuit test and performance monitoring products. 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 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.

         In 1995, 1996, and 1997, the Company spent $5.8 million, $7.4
million and $9.2 million, respectively, on research and development efforts.

MANUFACTURING AND SUPPLIERS

                                     -10-
<PAGE>

         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. All final assembly and tests
are completed by the Company at its production facility. The Company utilizes
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.

         In January 1997, the Company achieved ISO 9001 certification for its
headquarters facility in San Diego, California. The Company was formerly
registered to the internationally recognized ISO 9001 standards by BellCore,
its registrar. 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 subassemblies. 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 to 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.

         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. At December 31, 1997, the Company
had open noncancelable purchase commitments of approximately $2.5 million
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

                                     -11-

<PAGE>

incorporate such components in its products could have a material adverse
effect on the Company's business, operating results and financial condition.

MARKETING, SALES AND CUSTOMER SUPPORT

         The Company markets its products to the RBOCs, their local telephone
company affiliates, ITOCs, CAPs and IXCs through an experienced direct sales
force that works closely with senior management as well as the network
management departments of these customers as part of the sales effort. As of
February 28, 1998, the Company's sales organization consisted of 14
professionals, including 13 regional sales managers and one vice president.
Each of the regional sales managers operates 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, 1997, the Company had a firm backlog of
approximately $2,672,000, all of which is expected to be filled during fiscal
1998. At December 31, 1996, backlog was approximately $1,885,000. The Company
does not believe the year-to-year increase in backlog is meaningful. The
Company has been operating in a book and ship mode for network systems
products, a trend the Company anticipates will continue. 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. 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 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 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

                                     -12-

<PAGE>

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.

       The Company believes there are an increasing number of current
competitors in the network management OS market that provide network
management and 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, such as Lucent, Northern Telecom, Fujitsu, and Ericcson, that offer
software applications to manage their own and other suppliers' equipment,
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 eleven U.S. patents granted (each
of which has a minimum of twelve years remaining) and three U.S. patent
applications allowed. One of the granted patents relates to the Company's
Remote Module product. Additionally, the Company has six pending U.S. patent
applications and four international (Patent Cooperation Treaty and European
Patent Office) 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

                                     -13-

<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, 1998, ADA had approximately 272 full-time
employees, including 149 in engineering, 68 in sales, marketing and customer
support, 24 in operations and 31 in finance, and network and general
administration. 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. Certain of the
Company's executive officers have entered into severance arrangements with
the Company. No other member of the Company's senior management is subject to
an employment arrangement with the Company. The Company's employees are not
represented by any collective bargaining agreements, and the Company has
never experienced a work stoppage. The Company believes that its employee
relations are good.

RISKS AND UNCERTAINTIES

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. 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.

         The Company believes there are an increasing number of current
competitors in the network management OS market that provide network
management and 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, Northern
Telecom, 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.

                                     -14-

<PAGE>

      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 in 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.

CONCENTRATION OF MAJOR CUSTOMERS; TELEPHONE COMPANY QUALIFICATION
REQUIREMENTS. The market for the Company's products and services currently
consists of the five RBOCs, IXCs, LECs, CLECs, CAPs, ISPs, enterprise
networks and other TSPs. Historically, the Company's marketing efforts
focused primarily on the RBOCs, which accounted for approximately 99%, 73%
and 31% of the Company's total revenue in 1995, 1996, and 1997, respectively.
However, the Company's strategy has been to focus its efforts on diversifying
its customer base. RBOCs, IXCs and enterprise customers accounted for 31%,
27% and 20% of the Company's total revenue 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 Northern Telecom 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, CAPs 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 have entered into purchase contracts with the
Company. MCI 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 contracts may be
terminated at either the customer's or the Company's convenience of the RBOC
or MCI, 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,
Worldcomm 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.

      HIGH 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 74%
and 50% of the Company's total revenues in 1996 and 1997, respectively.
Revenue from network management OS products and services, including software
design services, .Provisioner, Test OS, TDC&E and FMS generated 26% and 50%
of the Company's total revenue in 1996 and 1997, respectively. However, there
can be no assurance that the Company's future revenues will not be heavily
dependent on sales from 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, PAAS, T3AS and OS
products. Failure by the 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,
the Company obtained additional office space and hired additional personnel
in both Terre Haute, Indiana and British Columbia, Canada to support the
business operations of the new products, services and technologies acquired.
The Company continues to face significant management challenges related to
the integration of the business operations of the new organizations'
personnel, products, services and technologies acquired. In 1996, the Company
formed two business units: the Network Systems business unit and the Network
Management business unit. The business units are a result of the evolution of
the Company from a single product line to multiple product lines. The Network
Management business unit focuses on OS software products including
 .Provisioner, Test OS, GTA. Sectionalizer, FMS, TDC&E, and OS design
services. The Network Systems business unit is built around the

                                     -15-

<PAGE>

Company's test and performance management products, including T3AS, CTS,
Remote Module and PAAS products. There can be no assurance that the Company
will be successful in managing its new business unit structure. In June 1997,
the Company acquired a license from Nortel to its DSS II software product and
technology. The Company markets and supports the DSS II product and
technology under the new name .Provisioner. The Company is integrating the
licensed technology into new product development. The acquisition of the
software license has generated a shift in the Company's Canadian subsidiary's
operations from a software design services business to a product business and
the transition will likely place a significant strain on the Company's
management, information systems and operations and there can be no assurance
that such a transition can be successfully managed. In addition, in November
1997, the Company opened an office in Richardson, Texas to expand new product
development efforts. 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.

      CUSTOMER MERGERS. Of the nine major TSPs currently involved in or that
have recently completed merger transactions, seven are customers of the
Company. Several of the mergers involve companies that purchase network
systems and software products and services from the Company's competitors.
Consequently, the completion of certain of 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
could 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

                                     -16-

<PAGE>

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.

      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 test and 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 and
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,
operations 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,
operations 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 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, operations 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.

                                     -17-

<PAGE>

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 subassemblies. 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. 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 installed computer systems and software
products are coded to accept only two digit entries in the date code field.
As the year 2000 approaches, these code fields will need to accept four digit
entries to distinguish years beginning with "19" from those beginning with
"20" dates. As a result, in less than two years, computer systems and/or
software products used by many companies may need to be upgraded to comply
with such year 2000 requirements. The Company is assessing its products, as
well as its internal management information systems in order to identify and
modify those products and systems that are not year 2000 compliant. Based
upon a preliminary assessment, the Company expects such modifications will be
made on a timely basis and does not believe that the cost of such
modifications will have a material effect on the Company's operating results
or financial condition. There can be no assurance, however, that the
Company's preliminary assessment is accurate. If the Company encounters any
unanticipated delays in or costs associated with the implementation of such
changes, in particular with respect to the Company's products, the Company's
business, operating results and financial condition could be materially
adversely affected.

      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 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.

                                     -18-

<PAGE>

      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 eleven U.S. patents granted and three U.S. patent
applications allowed. One of the granted patents relates to the Company's
Remote Module product. Additionally, the Company has six pending U.S. patent
applications and four international (Patent Cooperation Treaty and European
Patent Office) 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.

      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

                                     -19-

<PAGE>

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 1998. 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 1998, December 1999 and January 2005, respectively. The
Terre Haute lease includes an option to extend the lease term one year from
the September 1998 expiration date. The Company believes that its existing
facilities will be adequate to meets its needs through 1998.

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>

                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

                1996                       High                 Low
                ----                       ----                 ---
            First Quarter                 $17.00             $ 9.50
            Second Quarter                 19.00               9.75
            Third Quarter                  11.75               6.25
            Fourth Quarter                  8.75               4.75

</TABLE>

There were 237 shareholders of record as of February 28, 1998.

         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.

                                     -20-

<PAGE>

         Use of Proceeds

The following information is being provided in accordance with Rule 463
promulgated under the Securities Act of 1933, as amended (the "Securities Act"),
and Item 701 of Regulation S-K under the Securities Act.

The Company registered 2,590,000 shares of Common Stock (the "Shares") on
registration statement No. 33-75258 which was declared effective on March 29,
1994 (the "Offering"). The co-managing underwriters of the Offering were
Alex. Brown & Sons Incorporated and Hambrecht & Quist Incorporated. The
Company sold 2,590,000 Shares with an aggregate offering price of $31,080,000
(or $12.00 per share). The net offering proceeds to the Company after
deducting estimated total expenses were $28,334,000. From the effective date
of the Offering to December 31, 1997, the Company has used all of the net
proceeds for working capital, as was originally anticipated in the Offering.

ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>

(Dollars in thousands)                                  1993              1994             1995              1996             1997
                                                        ----              ----             ----              ----             ----
<S>                                                  <C>               <C>              <C>               <C>              <C>
Revenue                                              $14,259           $35,597          $20,470           $24,422          $34,050

Gross Profit                                           7,125            20,791           11,753            11,813           15,116

Operating Expenses:

Research and  development                              3,902             5,335            5,807             7,356            9,164

In process research and development related
to acquisition                                             -                 -                -             3,286            1,578

Sales and marketing                                    2,406             3,363            4,234             6,312            7,995

General and administrative                             1,354             2,337            2,985             3,576            5,252
                                                     -------           -------          -------           -------          -------

    Total operating expenses                           7,662            11,035           13,026            20,530           23,989


Net income (loss)                                       (619)           10,620              759            (7,120)          (4,283)
                                                     -------           -------          -------           -------          -------

Net income (loss) per share, basic (1)               $  (.75)          $  1.01          $   .06           $  (.59)         $  (.34)
                                                     -------           -------          -------           -------          -------

Net income (loss) per share, diluted (1)
                                                     $  (.07)(2)       $   .88          $   .06           $  (.59)         $  (.34)
                                                     -------           -------          -------           -------          -------

Weighted average number of shares,
basic (1)                                                820            10,542           11,806            12,084           12,460

Weighted average number of shares,
diluted (1)                                            8,693(2)         12,091           12,848            12,084           12,460


Working Capital                                      $ 2,251           $26,081          $36,728           $31,229          $26,788

Total assets                                           6,878            48,919           49,936            45,972           46,283

Long-term debt                                           117                82               49                33               15

</TABLE>

(1) See Note 2 of Notes to Consolidated Financial Statements for an
    explanation of the determination of the number of 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".

(2) Weighted average shares outstanding includes 55,105,577 shares of preferred
    stock which converted into 7,872,199 shares of common stock in connection
    with the Company's initial public offering in March 1994 after giving
    effect to the 1-for-7 reverse stock split, immediately prior to the
    closing of the initial public offering.

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

Recent Developments

In September 1997, the Company entered into a JDA with Nortel to develop
unique SONET network products for the telecommunications industry. Nortel and
ADA will each contribute technology and development resources to projects
conducted under the JDA. The companies will equally share development costs,
estimated to be several million dollars per quarter. Development of the first
product under the JDA has commenced with initial availability expected in the
first half of 1999. The agreement also contemplates additional projects as
agreed to in the future by Nortel and ADA. Operating expenses for the year
ended December 31, 1997 include a $2.2 million offset to research and
development costs representing Nortel's proportionate share of development
costs that have been incurred through December 31, 1997 in connection with
the initial project being conducted under the JDA.

In June 1997, the Company acquired an exclusive worldwide license to Northern
Telecom's DSS II OS software product, subject to certain residual rights
retained by Northern Telecom. The Company acquired the license and certain
assets related to the DSS II product for a net amount of $3.1 million in
cash, $2.2 million of which was paid in 1997 and $0.9 million of which was
paid in January 1998. In June 1997, the Company recorded a charge of
approximately $1.6 million for purchased research and development associated
with the acquisition of the license and assets. As part of the transaction,
the Company also issued Northern Telecom a warrant to purchase 150,000 shares
of the Company's common stock at an exercise price of $12 per share. The
warrant has a three year term. Northern Telecom retained the right to and
will continue to support its current DSS II customer base outside of North
America as part of its integrated network management portfolio for broadband
network solutions. The Company obtained exclusive worldwide rights to market
and sell the DSS II product under the new name, .Provisioner, and acquired
all of Northern Telecom's North American DSS II customer relationships. The
acquisition of .Provisioner was part of the Company's strategic plan to build
upon its portfolio of network management OS software products essential to
the operation of TSP networks. The first part of the plan involved the
acquisition by the Company of its Vancouver-based development team known as
British Columbia Group ("BCG") from MPR Teltech, Ltd., a subsidiary of BC
Telecom, Inc., in July 1996. BCG has been responsible for design,
development, and maintenance of DSS II and its predecessor DSS since 1986,
most recently under contract to Northern Telecom's Network Services
Management Division.

In June 1997, the Company signed a three year supply contract with MCI for
the Company's systems and services products. This contract is a standard
supply contract which specifies the terms and conditions under which MCI will
order and the Company will supply products and services. The contract is not
a commitment contract and does not guarantee any purchases of products and
services or any level of purchases. Although MCI has purchased certain
products of the Company under the terms of this contract, the Company is
uncertain whether this contract will result in any future orders for the
Company's products, or if it does, whether the orders will result in
significant revenue.

                                     -21-

<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, 1997, 1996 and 1995.

<TABLE>
<CAPTION>

                                                         Years Ended December 31,
                                                 -------------------------------------
                                                 1997              1996           1995
                                                 ----              ----           ----
<S>                                              <C>               <C>            <C>
Revenue                                          100%              100%           100%
Cost of revenue                                   44%               52%            43%
                                                  ---               ---            ---
Gross profit                                      56%               48%            57%

Operating Expenses:
Research and development                          27%               30%            28%

Purchased in-process research and
 development related to acquisitions               5%               13%             -
Sales and marketing                               23%               26%            21%
General and administrative                        15%                5%            14%
                                                  ---               ---            ---
Total operating expenses                          70%               84%            63%
                                                  ---               ---            ---
Operating income (loss)                          (15)%             (36)%           (6)%
Other income (expense), net                        3%                7%            10%
                                                  ---               ---            ---
Income (loss) before income taxes                (12)%             (29)%            4%
Provision for income taxes                        (1)%               -              -
                                                  ---               ---            ---
Net income (loss)                                (13)%             (29)%            4%
                                                  ---               ---            ---
                                                  ---               ---            ---

</TABLE>

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 and Worldcomm 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. 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. The license of .Provisioner
was acquired from Northern Telecom in June 1997. The acquisition of the
software license from Northern Telecom has generated a shift in the Company's
BCG 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. The Company also intends to integrate the
licensed technology into new product development. Although the Company has
continued to market and develop the software design services business, future
revenue levels for software design services are expected to be significantly
lower than in the past due to the shift in BCG's operations. Although the
Company believes it will be successful in transitioning the majority of its
OS operations from a software design services business to a product business,
there can be no assurance the Company will be able to maintain historical OS
revenue levels in the future. As a result, the Company may experience
quarterly revenue fluctuations in the future that could have a material
adverse effect on the Company's business, operating results and financial
condition. In 1997, Northern Telecom, MCI and Bell South accounted for 20%,
18%, and 17% of the Company's revenue, respectively. In 1996, US WEST, NYNEX,
and Northern Telecom 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 55% 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 pressures which have contributed to
significantly lower overall gross profits on these products. Additionally,
gross profit for the year 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 BCG's operations from design services to
product development. During 1997, the Company transitioned the majority of
BCG's operations from OS software design services to OS product development
as a result of the acquisition of the license to the DSS II product from
Northern Telecom. 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.

                                     -22-

<PAGE>

         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 BCG's 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 BCG's operations to
a product oriented business. 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.

         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 14 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 is due to increased personnel
costs in the network management business unit supporting the shift from a
design services business to a product based business, a full year of expenses
for the personnel acquired in 1996 and increased commission expenses as a
result of increased sales. The Company expects that sales and marketing
expenses will continue to increase in absolute dollars as the Company
continues to hire additional sales, marketing and technical support personnel
to support planned product introductions in both the Network Systems and
Network Management business units.

         General and administrative expenses totaled $5,260,000 in 1997, a
47% increase from $3,576,000 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 Northern Telecom 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. The
Company expects that general and administrative expenses will increase in
absolute dollars as the Company invests in the expansion of its internal
networking capabilities to integrate the Company's geographically distributed
organization.

         Interest income totaled $904,000 in 1997, a 46% decrease from
$1,673,000 in 1995. 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 carryforwards are significantly limited as a result of ownership
changes associated with equity financings in January 1989 and March 1991. See
Note 11 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. See Note 11 of Notes to Consolidated
Financial Statements.

         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 Northern
Telecom, 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.

1996 COMPARED WITH 1995

         Revenue totaled $24,422,000 in 1996, a 19% increase from $20,470,000
in 1995. The increase is primarily the result of revenue generated from
network management OS software design services and products acquired through
acquisitions during 1996. Revenue from the Company's T3AS products and
services totaled $18,144,000 in 1996, an 11% decrease from $20,470,000 in
1995. The decrease was the result of lower T3AS sales compared to

                                     -23-

<PAGE>

last year due to continued capital constraints at several of the Company's
customers, the highly competitive market for the Company's CTS and NIU
products, and the impact of regulatory actions on the Company's customers.
Revenue from OS services and products totaled $6,278,000 in 1996. The Company
did not have any OS product revenue in 1995. In 1996, US WEST, NYNEX, and
Northern Telecom accounted for 31%, 23%, and 15% of the Company's revenue,
respectively. In 1995, U S WEST, Ameritech, NYNEX and Bell South accounted
for 45%, 19%, 18% and 13% of the Company's revenue, respectively.

         Gross profit totaled $11,813,000 in 1996, a slight increase from
$11,753,000 in 1995. Gross profit as a percent of revenue was 48% in 1996
compared to 57% in 1995. The decrease in gross profit as a percent of revenue
resulted primarily from a product mix weighted toward lower margin T3AS
products and services and lower-margin revenue from OS software design
services. The majority of the Company's Canadian subsidiary's operations
supported OS software design services. Since the cost of design services
revenue includes both direct and indirect costs of supplying the services,
the majority of the Canadian subsidiary's operating costs are included in
cost of revenue.

         Research and development expenses totaled $7,356,000 in 1996, a 27%
increase from $5,807,000 in 1995. The increase was primarily due to the
addition of research and development personnel as a result of the ACD asset
acquisition, increases in depreciation expense, and increases in
non-recurring engineering (NRE) expenses due to timing of planned development
projects during 1996 compared to 1995. Research and development personnel
expenses increased 26% compared to 1995, mostly related to the ACD asset
acquisition.

         In 1996, the Company recorded one-time charges for purchased
research and development costs related to the ACD asset acquisition and the
SSN asset acquisition of $1,186,000 and $2,100,000, respectively.

         Sales and marketing expenses totaled $6,312,000 in 1996, a 49%
increase from $4,234,000 in 1995. The majority of the increase resulted from
the addition of technical customer support personnel, the addition of
customer support and marketing personnel related to the ACD asset
acquisition, and increased promotional expenses.

         General and administrative expenses totaled $3,576,000 in 1996, a
20% increase from $2,985,000 in 1995. The majority of the increase is the net
result of increased expenses for the amortization of goodwill and intangibles
related to the SSN asset acquisition and increased personnel expenses related
to acquisitions in 1996 offset by a decrease in legal expenses compared
to 1995 as a result of greater legal expense in 1995 related to the
settlement of a shareholder suit.

         Interest income totaled $1,673,000 in 1996, a 17% decrease from
$2,023,000 in 1995. The decrease is the result of a decrease in cash
investments during 1996 compared to 1995.

         In 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%. The Company did not provide for U.S. income taxes
in 1996 or 1995 due to net losses for income tax purposes. At December 31,
1996, the Company had federal income

                                     -24-

<PAGE>

tax-loss carry-forwards of approximately $12,987,000 and California state
income tax-loss carry-forwards of approximately $5,835,000.

         As a result of the factors discussed above, the Company incurred a
net loss of $7,120,000, or $.59 per basic and diluted share in 1996 compared
to net income of $759,000, or $.06 per basic and diluted share in 1995.
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 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 committment of resources by prospective customers. Accordingly, the
Company is dependent on its customers' decisions as to the 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 $13,179,000 at December 31, 1997 and
$21,461,000 at December 31, 1996. The 1997 decrease in cash and investments
compared to 1996 is primarily due to cash payments for the acquisition of the
DSS II license from Northern Telecom, purchases of property and equipment and
1997 operating losses.

         Net working capital totaled $26,788,000 at December 31, 1997 and
$31,229,000 at December 31, 1996. The 1997 decrease in working capital
compared to 1996 was primarily the result of a decrease in cash and
investments and increased accounts payable associated with inventory
purchases for fourth quarter revenue shipments, partially offset by an
increase in accounts receivable.

         The Company's 1997 operating activities used $3,528,000 in cash
primarily the 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. In 1996, the Company's operating activities used $2,265,000
in cash primarily as a result of net operating losses.

         In 1997, the purchase cost of the DSS II license acquisition totaled
$3,383,000, of which all but $867,000 had been paid in cash by year end. The
tangible assets acquired as part of the DSS II license acquisition consisted
mostly of computer and lab equipment. Cash used for capital expenditures
totaled approximately $2,432,000 in 1997 and $1,709,000 in 1996. Most of the
capital additions were for the purchase of computers, lab equipment and
software tool kits to support the Company's expanded research and product
development efforts, improvements to the Company's internal network
infrastructure to support the Company's multiple locations and the BCG
operations move to a new facility in February 1997. The Company did not
acquire any capital equipment through capital lease arrangements in 1997 or
1996. The Company expects that the level of capital expenditures will
increase in 1998 as a result of planned facility moves in Richardson, Texas
and planned research and development projects.

         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.
Significant additional capital resources, however, may be required to fund
acquisitions of complementary businesses, products or technologies.
Alternatively, the Company may need to issue additional shares of its capital
stock or incur indebtedness in connection with any such acquisitions. At
present, the Company does not have any agreements or commitments with respect
to any such acquisition and there can be no assurance that the Company will
be able to obtain such agreements or commitments on reasonable terms, or at
all.

                                     -25-

<PAGE>

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

Impact of New Accounting Pronouncements

        In June 1997, the Financial Accounting Standards Board issued SFAS
No. 130, COMPREHENSIVE INCOME, and SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF
AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. Comprehensive income is defined
as the change in equity in a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. SFAS
No. 131 requires publicly-held companies to report financial and other
information about key revenue-producing segments of the entity for which such
information is available and is utilized by the chief operating decision
maker. Specific information to be reported for individual segments includes
profit or loss, certain revenue and expense items and total assets. The
impact of adopting SFAS No. 130 and SFAS No. 131, both effective for the
Company in 1998, has not yet been determined.

        In October 1997, the American Institute of Certified Public
Accountants issued State of Position 97-2 ("SOP 97-2"), SOFTWARE REVENUE
RECOGNITION. This statement establishes requirements for revenue recognition
for software companies for fiscal years beginning after December 15, 1997.
The Company is currently evaluating the impact of SOP 97-2 and has not
determined the result, if any, on the Company's financial position, results
of operations or cash flows.

        The Company has adopted the provisions of SFAS No. 128, EARNINGS PER
SHARE, effective December 31, 1997. SFAS No. 128 requires the presentation of
basic and diluted earnings per share. Basic EPS is computed by dividing
income available to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted EPS is computed giving
effect to all dilutive potential common shares that were outstanding during
the period. Dilutive potential common shares consist of the incremental
common shares issuable upon the conversion of convertible preferred stock
(using the "if converted") method) and exercise of stock options and warrants
for all periods. All prior period earnings per share amounts have been
restated to comply with SFAS No. 128.

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-24 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.

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-24 of this Annual Report on Form 10-K:

         Report of Independent Accountants

         Consolidated Balance Sheets at December 31, 1996 and December 31,
         1997

         Consolidated Statements of Operations for the years ended
         December 31, 1995, 1996 and 1997

         Consolidated Statements of Shareholders' Equity for the years ended
         December 31, 1995, 1996 and 1997

                                     -26-

<PAGE>

         Consolidated Statements of Cash Flows for the years ended
         December 31, 1995, 1996 and 1997

         Notes to Consolidated Financial Statements

                  2.   FINANCIAL STATEMENT SCHEDULES

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

         Report of Independent Accountants
         Schedule II  -  Valuation and Qualifying Accounts

         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

                  The Company filed a report on Form 8-K on December 23, 1997
in connection with its reincorporation in Delaware.

     (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

        2.2(7)   Asset Purchase Agreement between Applied Digital Access, Inc. and MPR                  --
                 Teltech, 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

</TABLE>

                                     -27-

<PAGE>

<TABLE>
<CAPTION>

EXHIBIT                                                                                               PAGE
NUMBER                                                                                               NUMBER
------                                                                                               ------
<S>              <C>                                                                                 <C>
                 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.                                    --

      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


</TABLE>

                                     -28-

<PAGE>

<TABLE>
<CAPTION>

EXHIBIT                                                                                               PAGE
NUMBER                                                                                               NUMBER
------                                                                                               ------
<S>              <C>                                                                                 <C>
                 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 Telcom, 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 Telcom, 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)][VERIFY CT
                 DONE-NOT NOTED ON 10Q].

      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).

      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

</TABLE>
                                     -29-

<PAGE>

<TABLE>
<CAPTION>

EXHIBIT                                                                                               PAGE
NUMBER                                                                                               NUMBER
------                                                                                               ------
<S>              <C>                                                                                 <C>
    +10.37(15)   Amended and Restated 1996 Non-qualified Stock Option Plan Form of Stock
                 Option Agreement.

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

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

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

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

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

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

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

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

        +10.46   Management Team Incentive Compensation Plan, as amended.

         23.1    Consent of Independent Accountants.

         24.1    Power of Attorney (See page 32).

         27.1    Financial Data Schedule.


         +        Management contract or compensatory plan.
         (1)      Incorporated by reference to the Company's Registration Statement on Form S-1 (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).

</TABLE>

                                     -30-

<PAGE>

<TABLE>
<CAPTION>

EXHIBIT                                                                                               PAGE
NUMBER                                                                                               NUMBER
------                                                                                               ------
<S>               <C>                                                                                <C>
         (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).

</TABLE>


                                     -31-
<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 30, 1998             By:      /s/ Peter P. Savage
                                      ------------------------
                                           Peter P. Savage
                                           President and Chief Executive Officer


                                POWER OF ATTORNEY

         Know all men by these presents, that each person whose signature
appears below constitutes and appoints Peter P. Savage or James L. Keefe, his
or her attorney-in-fact, with power of substitution in any and all
capacities, to sign any amendments to this Annual Report on Form 10-K, and to
file the same with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that the attorney-in-fact or his or her substitute or
substitutes may do or cause to be done by virtue hereof.

         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>
/s/ Peter P. Savage               President, Chief Executive             March 30, 1998
--------------------------        Officer and Director
  (Peter P. Savage)               (Principal Executive
                                  Officer)


/s/ James L. Keefe                Vice President, Finance and            March 30, 1998
--------------------------        Administration, Secretary,
  (James L. Keefe)                Chief Financial Officer
                                  (Principal Financial and
                                  Accounting Officer)


/s/ Kenneth E. Olson              Director                               March 30, 1998
--------------------------
  (Kenneth E. Olson)


/s/ Christopher B. Paisley        Director                               March 30, 1998
--------------------------
  (Christopher B. Paisley)


/s/ Edward F. Tuck                Director                               March 30, 1998
--------------------------
  (Edward F. Tuck)

</TABLE>

                                     -32-

<PAGE>





                   APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY
                                   ----------

               REPORT ON AUDITED CONSOLIDATED FINANCIAL STATEMENTS
              FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
                                   ----------





<PAGE>
                       APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                       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, 1996 and 1997...............    F-3

     Consolidated Statements of Operations for the Years Ended
     December 31, 1995, 1996 and 1997...........................................    F-4

     Consolidated Statements of Shareholders' Equity for the Years Ended
     December 31, 1995, 1996 and 1997...........................................    F-5

     Consolidated Statements of Cash Flows for the Years Ended
     December 31, 1995, 1996 and 1997...........................................    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, 1995, 1996 and 1997...............................  F-24
</TABLE>

                                       F-1
<PAGE>


                       REPORT OF INDEPENDENT ACCOUNTANTS




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


We have audited the accompanying consolidated balance sheets of Applied Digital
Access, Inc. and subsidiary as of December 31, 1996 and 1997 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Applied
Digital Access, Inc. and subsidiary as of December 31, 1996 and 1997 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.






San Diego, California
January 23, 1998

                                       F-2
<PAGE>

                   APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

                                 ----------
<TABLE>
<CAPTION>
                                                                                       DECEMBER 31,
                                                                                       ------------
                                                                                    1996           1997
                                                                                    ----           ----
                                      ASSETS                                       (DOLLARS IN THOUSANDS)
<S>                                                                               <C>            <C>
Current assets:
      Cash and cash equivalents...................................................$  1,504        $  4,400
      Investments - available for sale............................................  19,957           8,779
      Accounts receivable, less allowance for doubtful
           accounts of $50 .......................................................   6,798          12,981
      Inventory, net..............................................................   7,363           5,859
      Deferred income taxes.......................................................     130             130
      Prepaid expenses and other current assets...................................   1,089           3,775
                                                                                  --------        --------
                 Total current assets.............................................  36,841          35,924

Property and equipment, net.......................................................   4,936           6,165
Intangible assets, net............................................................   2,823           2,822
Deferred income taxes.............................................................   1,372           1,372
                                                                                  --------        --------
                 Total assets.....................................................$ 45,972        $ 46,283
                                                                                  --------        --------
                                                                                  --------        --------

                     LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
      Accounts payable............................................................$  2,120        $  3,478
      Accrued expenses ...........................................................   1,491           2,846
      Accrued warranty............................................................   1,398           1,323
      Current portion of obligations under capital leases.........................      16              18
      Deferred revenue............................................................     587           1,471
                                                                                  --------        --------
                 Total current liabilities........................................   5,612           9,136

Obligations under capital leases, net of current portion..........................      33              15
                                                                                  --------        --------
                 Total liabilities................................................   5,645           9,151
                                                                                  --------        --------

Commitments and contingency

Shareholders' equity:
      Preferred stock, no par value, 7,500,000 shares authorized,
           no shares issued.......................................................      -              -
      Common stock, $0.001 par value, 30,000,000 shares authorized,
           12,255,334 and 12,605,082 shares issued and outstanding at
           December 31, 1996 and 1997, respectively...............................  50,631          51,610
      Additional paid-in capital..................................................   2,492           2,492
      Unrealized gain on investments .............................................      25              84
      Deferred compensation.......................................................     (50)             -
      Accumulated deficit......................................................... (12,771)        (17,054)
                                                                                  --------        --------
                 Total shareholders' equity.......................................  40,327          37,132
                                                                                  --------        --------
                 Total liabilities and shareholders' equity.......................$ 45,972        $ 46,283
                                                                                  --------        --------
                                                                                  --------        --------
</TABLE>
                The accompanying notes are an integral part of the
                               financial statements.

                                       F-3
<PAGE>


                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                         CONSOLIDATED STATEMENTS OF OPERATIONS

                                      ----------

<TABLE>
<CAPTION>
                                                                                                YEARS ENDED DECEMBER 31,
                                                                                                ------------------------
                                                                                             1995         1996         1997
                                                                                             ----         ----         ----
                                                                                                 (DOLLARS IN THOUSANDS,
                                                                                                 EXCEPT PER SHARE DATA)
<S>                                                                                        <C>           <C>          <C>
Revenue          ......................................................................... $20,470        $24,422     $34,050
Cost of revenue  .........................................................................   8,717         12,609      15,116
                                                                                           -------        -------     -------
     Gross profit.........................................................................  11,753         11,813      18,934
                                                                                           -------        -------     -------
Operating expenses:
     Research and development.............................................................   5,807          7,356       9,164
     In-process research and development related
         to acquisitions..................................................................      -           3,286       1,578
     Sales and marketing..................................................................   4,234          6,312       7,995
     General and administrative...........................................................   2,976          3,529       5,252
                                                                                           -------        -------     -------
                 Total operating expenses.................................................  13,017         20,483      23,989
                                                                                           -------        -------     -------
                 Operating loss...........................................................  (1,264)        (8,670)     (5,055)
                                                                                           -------        -------     -------
Interest income  .........................................................................   2,023          1,673         904
                                                                                           -------        -------     -------
                 Income (loss) before income taxes........................................     759         (6,997)     (4,151)
                                                                                           -------        -------     -------
Provision for income taxes................................................................      -             123         132
                                                                                           -------        -------     -------
                 Net income (loss)........................................................ $   759        $(7,120)    $(4,283)
                                                                                           -------        -------     -------
                                                                                           -------        -------     -------
                 Net income (loss) per share, basic and diluted ..........................   $.06          $(.59)      $(.34)
                                                                                             ----           -----      ------
                                                                                             ----           -----      ------
                 Shares used in per share computations ...................................  12,848         12,084      12,460
                                                                                            ------         ------      ------
                                                                                            ------         ------      ------
</TABLE>
                The accompanying notes are an integral part of the
                               financial statements.

                                       F-4
<PAGE>

                       APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                    CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

                                   ----------

<TABLE>
<CAPTION>
                                                                      UNREALIZED
                                                         ADDITIONAL      GAIN
                                              COMMON      PAID-IN     (LOSS) ON         DEFERRED    ACCUMULATED
                                              STOCK       CAPITAL     INVESTMENTS     COMPENSATION    DEFICIT        TOTAL
                                              -----       -------     -----------     ------------    -------        -----
                                                                         (DOLLARS IN THOUSANDS)
<S>                                           <C>        <C>          <C>             <C>            <C>             <C>
Balance, January 1, 1995......................$48,281     $2,492       $(436)          $(153)        $ (6,410)        $43,774

Exercise of stock options and warrants
for 261,662 shares of common stock............     76        -           -               -                -                76

Issuance of 62,493 shares of common
stock under stock purchase plan...............    643        -           -               -                -               643

Unrealized gain on investments................    -          -           583             -                -               583

Amortization of deferred compensation
related to stock options......................    -          -           -                52              -                52

Net income ...................................    -          -           -               -                759             759
                                              -------     ------      ------           -----         --------         -------
Balance, December 31, 1995.................... 49,000      2,492         147            (101)          (5,651)         45,887

Exercise of stock options for 149,261
shares of common stock........................    115        -           -               -                -               115

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

Unrealized loss on investments................    -          -          (122)            -                -              (122)

Amortization of deferred compensation
related to stock options......................    -          -           -                51              -                51

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

Net loss .....................................    -          -           -               -             (7,120)         (7,120)
                                              -------     ------      ------           -----         --------         -------

Balance, December 31, 1996.................... 50,631      2,492          25             (50)         (12,771)         40,327

Exercise of stock options for 221,235
shares of common stock........................    381        -           -               -                -               381

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

Unrealized gain on investments................    -          -            59             -                -                59

Amortization of deferred compensation
related to stock options......................    -          -           -                50              -                50

Net loss .....................................    -          -           -               -             (4,283)         (4,283)
                                              -------     ------      ------           -----         --------         -------
Balance, December 31, 1997....................$51,610     $2,492      $   84           $ -           $(17,054)        $37,132
                                              -------     ------      ------           -----         --------         -------
                                              -------     ------      ------           -----         --------         -------
</TABLE>

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

                                       F-5

<PAGE>

                        APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                           CONSOLIDATED STATEMENTS OF CASH FLOWS

                                        ----------
<TABLE>
<CAPTION>
                                                                                                  YEARS ENDED DECEMBER 31,
                                                                                                  ------------------------
                                                                                             1995           1996         1997
                                                                                             ----           ----         ----
                                                                                                   (DOLLARS IN THOUSANDS)
<S>                                                                                        <C>              <C>          <C>
Cash flows from operating activities:
    Net income (loss)...................................................................   $    759         $(7,120)     $(4,283)
    Adjustments to reconcile net income (loss) to net cash used
        by operating activities:
           In-process research and development related to acquisitions..................        -             3,286        1,578
           Depreciation and amortization................................................        904           1,819        3,089
           Amortization of discount or premium on investments...........................        119              95         (119)
           Amortization of deferred compensation........................................         52              51           50
           Change in accounts receivable and inventory reserves.........................        103             (68)         101
           Changes in operating assets and liabilities:
               Accounts receivable......................................................     (2,792)         (1,440)      (6,183)
               Inventory................................................................     (2,232)           (723)       1,403
               Prepaid expenses and other current assets................................       (327)            207       (2,686)
               Accounts payable.........................................................       (440)            300        1,358
               Accrued expenses.........................................................       (515)            648        1,355
               Accrued warranty ........................................................        (15)             93          (75)
               Deferred revenue.........................................................        -               587          884
                                                                                             ------          ------       ------
                  Net cash used by operating activities.................................     (4,384)         (2,265)      (3,528)
                                                                                             ------          ------       ------
Cash flows from investing activities:
    Purchases of investments............................................................    (33,863)        (20,923)     (18,517)
    Maturities of investments...........................................................     38,595          30,923       29,792
    Purchases of property and equipment.................................................     (1,948)         (1,709)      (2,432)
    Purchase costs related to asset acquisitions........................................        -            (6,356)      (3,382)
    Purchase of license agreement.......................................................        -              (350)          -
                                                                                             ------          ------       ------
                  Net cash provided by investing activities.............................      2,784           1,585        5,461
                                                                                             ------          ------       ------
Cash flows from financing activities:
    Principal payments on obligations under capital leases..............................       (126)            (32)         (16)
    Proceeds from exercise of stock options and warrants................................         76             115          381
    Proceeds from issuance of common stock, net of  costs...............................        643             428          598
                                                                                             ------          ------       ------
                  Net cash provided by financing activities.............................        593             511          963
                                                                                             ------          ------       ------
                  Net increase (decrease) in cash and cash equivalents..................     (1,007)           (169)       2,896

Cash and cash equivalents at beginning of year..........................................      2,680           1,673        1,504
                                                                                             ------          ------       ------
           Cash and cash equivalents at end of year.....................................     $1,673          $1,504       $4,400
                                                                                             ------          ------       ------
                                                                                             ------          ------       ------
</TABLE>

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

                                       F-6

<PAGE>


                     APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                     ----------


 1.     NATURE OF OPERATIONS:

        Applied Digital Access, Inc. and subsidiary (the "Company") designs,
        engineers and manufactures network test and performance monitoring
        systems, software and services for the management and test of
        telecommunication circuits. Current sales are concentrated with
        telecommunication service providers or affiliated companies in the
        United States and Canada.

        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.


 2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

        PRINCIPLES OF CONSOLIDATION

        The consolidated financial statements include the accounts of the
        Company and its wholly-owned subsidiaries. All significant intercompany
        transactions and balances have been eliminated.

        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.

        INVENTORY

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

        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.

                                       F-7
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

 2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

        INVESTMENTS

        The Company determines the appropriate classification of its debt
        securities at the time of purchase and re-evaluates such designations at
        each balance sheet date. Investments are classified as "available for
        sale" and are carried at their fair value. 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.

        PROPERTY AND EQUIPMENT

        Property and equipment is stated at cost and depreciated over the
        estimated useful lives of the assets (3 to 7 years) using the
        straight-line method. Leased property meeting certain criteria is
        capitalized and the present value of the related lease payments is
        recorded as an obligation. Amortization of capitalized leased assets is
        computed on the straight-line method over the shorter of the lease term
        or the assets' estimated useful lives.

        Maintenance and repairs are charged to expense as incurred. Upon the
        retirement or other disposition, the property and related accumulated
        depreciation or amortization are removed from the accounts and any
        resulting profit or loss is reflected in income.

        INTANGIBLE ASSETS

        The Company amortizes costs in excess of fair value of net assets of
        businesses acquired using the straight-line method over 3 to 5 years.
        Recoverability is reviewed annually or sooner if events or changes in
        circumstances indicate that the carrying value may exceed fair value.

        REVENUE RECOGNITION

        Revenue is generally recognized at the time of shipment or delivery,
        based on specified shipping terms, or when services have been performed.
        When customer acceptance criteria are specified in the customer order,
        revenue recognition is deferred until the acceptance criteria are met.

                                       F-8
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

 2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

        INCOME TAXES

        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. Income
        tax expense is the tax payable for the period and the change during the
        period in deferred tax assets and liabilities.

        ADVERTISING COSTS

        Advertising costs are expensed as incurred.  Total advertising expense
        was approximately  $141,000,  $217,000 and $250,000 for the years
        ended December 31, 1995, 1996 and 1997, respectively.

        STOCK-BASED COMPENSATION

        Statement of Financial Accounting Standards ("SFAS") No. 123, ACCOUNTING
        FOR STOCK-BASED COMPENSATION, encourages, but does not require,
        companies to record compensation cost for stock-based employee
        compensation plans at fair value. The Company has chosen to continue to
        account for stock-based compensation using the intrinsic value method
        prescribed in Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
        STOCK ISSUED TO EMPLOYEES, and related interpretations. Accordingly,
        options granted at below fair market value result in deferred
        compensation to the extent of the difference between the fair market
        value at the date of grant and the exercise price. The deferred
        compensation is charged to earnings ratably over the vesting period.
        During the three year period ended December 31, 1997, no options were
        granted at below fair market value.

        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.

                                       F-9
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

 2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

        NEW ACCOUNTING PRONOUNCEMENTS

        In June 1997, the Financial Accounting Standards Board issued SFAS No.
        130, COMPREHENSIVE INCOME, and SFAS No. 131, DISCLOSURE ABOUT SEGMENTS
        OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 130 establishes
        standards for reporting and display of comprehensive income and its
        components in a full set of general purpose financial statements.
        Comprehensive income is defined as the change in equity in a business
        enterprise during a period from transactions and other events and
        circumstances from nonowner sources. SFAS No. 131 requires publicly-held
        companies to report financial and other information about key
        revenue-producing segments of the entity for which such information is
        available and is utilized by the chief operating decision maker.
        Specific information to be reported for individual segments includes
        profit or loss, certain revenue and expense items and total assets. The
        impact of adopting SFAS No. 130 and SFAS No. 131, both effective for the
        Company in 1998, has not yet been determined.

        In October 1997, the American Institute of Certified Public Accountants
        issued State of Position 97-2 ("SOP 97-2"), SOFTWARE REVENUE
        RECOGNITION. This statement establishes requirements for revenue
        recognition for software companies for fiscal years beginning after
        December 15, 1997. The Company is currently evaluating the impact of SOP
        97-2 and has not determined the result, if any, on the Company's
        financial position, results of operations or cash flows.

        The Company has adopted the provisions of SFAS No. 128, EARNINGS PER
        SHARE, effective December 31, 1997. SFAS No. 128 requires the
        presentation of basic and diluted earnings per share. Basic EPS is
        computed by dividing income available to common stockholders by the
        weighted average number of common shares outstanding for the period.
        Diluted EPS is computed giving effect to all dilutive potential common
        shares that were outstanding during the period. Dilutive potential
        common shares consist of the incremental common shares issuable upon the
        conversion of convertible preferred stock (using the "if converted")
        method) and exercise of stock options and warrants for all periods. All
        prior period earnings per share amounts have been restated to comply
        with SFAS No. 128.

        RECLASSIFICATIONS

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

                                       F-10
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

 3.     STATEMENTS OF CASH FLOWS:

        Non-cash investing and financing activities for the years ended December
31, 1995, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
                                                                       1995        1996         1997
                                                                       ----        ----         ----
                                                                          (DOLLARS IN THOUSANDS)
        <S>                                                           <C>          <C>          <C>
        Issuance of stock in connection with acquisition              $  -         $1,088       $  -
</TABLE>

        Cash payments for interest and income taxes for the years ended December
        31, 1995, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
                                                                       1995        1996         1997
                                                                       ----        ----         ----
                                                                          (DOLLARS IN THOUSANDS)
        <S>                                                           <C>          <C>          <C>

        Interest                                                      $ 13          $ 7         $  4
        Income taxes                                                   506            -          229
</TABLE>

 4.     INVESTMENTS:

        Marketable  securities at December 31, 1996 and 1997 consist of
        obligations of the U.S. Government and its agencies and are summarized
        as follows:
<TABLE>
<CAPTION>
                                                                       1996        1997
                                                                       ----        ----
                                                                    (DOLLARS IN THOUSANDS)
        <S>                                                         <C>          <C>
        Cost                                                        $19,936      $8,767
        Gross unrealized gains                                           57          31
        Gross unrealized losses                                         (36)        (19)
                                                                    -------      ------
             Estimated fair value                                   $19,957      $8,779
                                                                    -------      ------
                                                                    -------      ------
</TABLE>

 5.     INVENTORY:

        Inventory at December 31, 1996 and 1997 consists of the following:
<TABLE>
<CAPTION>
                                                                       1996        1997
                                                                       ----        ----
                                                                    (DOLLARS IN THOUSANDS)
        <S>                                                         <C>          <C>
        Raw materials                                               $4,211       $3,419
        Work-in-process                                              2,558        2,223
        Finished goods                                               1,063          787
                                                                    ------       ------
                                                                     7,832        6,429
        Less inventory reserve                                        (469)        (570)
                                                                    ------       ------
                                                                    $7,363       $5,859
                                                                    ------       ------
                                                                    ------       ------
</TABLE>
                                       F-11
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

 6.     PROPERTY AND EQUIPMENT:

        Property and equipment at December 31, 1996 and 1997 consists of the
        following:

<TABLE>
<CAPTION>
                                                                1996                  1997
                                                                ----                  ----
                                                                 (DOLLARS IN THOUSANDS)
                <S>                                              <C>                 <C>
                Computers                                      $  4,254              $ 5,655
                Machinery, furniture and equipment                3,614                4,782
                Purchased computer software                         894                1,371
                Leasehold improvements                              766                  911
                                                               --------              -------
                                                                  9,528               12,719
                Less accumulated depreciation and amortization   (4,592)              (6,554)
                                                               --------              -------
                                                               $  4,936              $ 6,165
                                                               --------              -------
                                                               --------              -------
</TABLE>

        Property and equipment acquired under capital leases totaled
        approximately $216,000 at December 31, 1996 and 1997. Accumulated
        amortization related to assets under capital leases totaled
        approximately $106,000 and $140,000 as of December 31, 1996 and 1997
        respectively.

 7.     INTANGIBLE ASSETS:

        Intangible assets at December 31,1996 and 1997 consist of the following:

<TABLE>
<CAPTION>
                                                                1996                1997
                                                                ----                ----
                                                                 (DOLLARS IN THOUSANDS)
                <S>                                            <C>                 <C>


                Goodwill and know-how                          $2,588              $ 3,619
                Purchased technology, customer contracts          337                  337
                License agreement                                 350                  350
                                                               ------              -------
                                                                3,275                4,306
                Less accumulated amortization                    (452)              (1,484)
                                                               ------              -------
                                                               $2,823               $2,822
                                                               ------              -------
                                                               ------              -------
</TABLE>

                                       F-12
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

 8.     ACCRUED EXPENSES:

        Accrued expenses at December 31, 1996 and 1997 consist of the following:

<TABLE>
<CAPTION>
                                                          1996                1997
                                                          ----                ----
                                                           (DOLLARS IN THOUSANDS)
                <S>                                      <C>                  <C>
                Accrued payroll and related costs        $  443               $  902
                Income taxes                                444                  388
                Accrued vacation                            431                  583
                Other                                       173                  973
                                                         ------               ------
                                                         $1,491               $2,846
                                                         ------               ------
                                                         ------               ------
</TABLE>

 9.     COMMITMENTS AND CONTINGENCY:

        LEASES

        The Company leases office space and equipment under operating leases.
        Certain of these leases include renewal or purchase options. Rent
        expense related to these leases was approximately $386,000, $613,000 and
        $673,000 for the years ended December 31, 1995, 1996 and 1997,
        respectively.

        The Company also leases certain property and equipment under capital
        leases.

        Minimum commitments under these leases are as follows:

<TABLE>
<CAPTION>
                                                             OPERATING        CAPITAL
           YEAR ENDING DECEMBER 31,                            LEASES          LEASE
           ------------------------                          ---------        -------
                                                              (DOLLARS IN THOUSANDS)
           <S>                                               <C>              <C>
               1998                                           $1,006          $ 20
               1999                                            1,297            16
               2000                                              980            -
               2001                                            1,004            -
               2002                                            1,034            -
               Thereafter                                      1,127            -
                                                              ------          ----
                  Total minimum lease payments                $6,448            36
                                                              ------
                                                              ------
                  Less amounts representing interest                            (3)
                                                                              ----
                  Obligations under capital leases                              33
                    Less current portion                                       (18)
                                                                              ----
                                                                              $ 15
                                                                              ----
                                                                              ----
</TABLE>

                                       F-13
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

 9.     COMMITMENTS AND CONTINGENCY:

        PURCHASE COMMITMENTS

        At December 31, 1996 and 1997, the Company has open purchase commitments
        of approximately $3,731,000 and $4,413,000 respectively, which include
        approximately $2,264,000 and $1,938,000 of cancelable purchase
        commitments.

        LEGAL PROCEEDING

        In March 1995, a class action lawsuit was filed against the Company and
        two of its officers, one of whom is also a director of the Company, in
        the U.S. District Court for the Southern District of Southern
        California. The suit alleged violations of Section 10(b) and Rule 10b-5
        of the Securities Exchange Act of 1934, as amended (the "Act"), arising
        out of alleged misrepresentations and omissions made by the Company and
        the named officers. The suit also alleged violation of Section 20(a) of
        the Act arising out of alleged "control" of the Company by the officer
        defendants. The suit was brought on behalf of purchasers of the
        Company's securities during the period October 10, 1994 through March
        29, 1995, and sought unspecified damages. In December 1995, the Company
        entered into a settlement agreement pursuant to which all claims were
        dismissed with prejudice. The total settlement amount was approximately
        $1,500,000, of which the Company paid approximately $446,000 with the
        remaining amount paid by the Company's Directors' and Officers'
        liability insurance carriers. Obligations of the Company with respect to
        this matter were provided for in the financial statements during the
        year ended December 31, 1995 and paid during the year ended December 31,
        1996.


10.     SHAREHOLDERS' EQUITY:

        STOCK COMPENSATION PLANS

        The Company applies Accounting Principles Board Opinion No. 25,
        ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations in
        accounting for its stock-based compensation plans. Accordingly, no
        compensation cost has been recognized for its fixed stock option plans
        and its stock purchase plan. Had compensation costs for the Company's
        stock-based compensation plans been determined based on the fair value
        at the grant dates for awards in 1995, 1996 and 1997 under those plans
        consistent with the methods of SFAS No. 123, the Company's net income
        (loss) and earnings per share would have been reduced to the pro forma
        amounts indicated below:

                                       F-14
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

10.     SHAREHOLDERS' EQUITY, CONTINUED:

<TABLE>
<CAPTION>
                                                           1995        1996         1997
                                                           ----        ----         ----
                                                              (DOLLARS IN THOUSANDS)
                <S>                                       <C>        <C>          <C>
                Net income (loss):
                      As reported                         $ 759      $(7,120)     $(4,283)
                      Pro forma                            (195)      (8,352)      (6,830)

                Net income (loss) per common share:
                      As reported, basic                   $.06        $(.59)       $(.34)
                      As reported, diluted                  .06         (.59)        (.34)
                      Pro forma, basic and diluted         (.02)        (.69)        (.55)
</TABLE>

        FIXED STOCK OPTION PLANS

        In May 1996, the Company adopted the 1996 Non-Qualified Stock Option
        Plan (the "1996 Plan"). The 1996 Plan does not affect the 1994 Plan
        described below. Under the 1996 Plan, the Company is authorized to issue
        400,000 shares of common stock. The 1996 Plan is intended to promote the
        interests of the Company or its parents or subsidiary corporations.
        Under the 1996 Plan, eligible individuals may be granted options to
        purchase shares of the Company's common stock at not less than 85% of
        the fair market value of such shares on the date of grant. Such options
        shall be exercisable in one or more installments as specified in the
        Notice of Grant and have a maximum term of 10 years. Persons eligible to
        receive stock options under the 1996 Plan are key employees of the
        Company other than officers who are responsible for the growth and
        financial success of the Company and consultants and other independent
        contractors who provide valuable services to the Company.

        In February 1994, the Company adopted the 1994 Stock Option/Stock
        Issuance Plan (the "1994 Plan"). The 1994 Plan supersedes and
        consolidates 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. In May of 1996, the Board of Directors received shareholder
        approval to increase the authorized shares to 3,800,000 under the 1994
        Plan. The 1994 Plan is divided into three separate components: the
        Discretionary Option Grant Program (the "Discretionary Program"); the
        Automatic Option Grant Program (the "Automatic Program") and the Stock
        Issuance Program (the "Issuance Program"). Under the Discretionary
        Program, eligible individuals may be granted options to purchase shares
        of the Company's stock at not less than 85% of the fair market value of
        such shares on the date of grant. Under the Automatic Program,
        non-employee Directors will automatically be granted options to purchase
        common stock at 100% of the fair market value on the grant date. Under
        the Issuance

                                       F-15
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

10.     SHAREHOLDERS' EQUITY, CONTINUED:

        Program, eligible individuals may be allowed to purchase shares of the
        Company's common stock at discounts from the fair market value of such
        shares of up to 15%. Such shares may be issued as fully-vested shares or
        as shares to vest over time and have a maximum term of 10 years (5 years
        for options granted to a 10% shareholder). Persons eligible to receive
        stock issuances under the Issuance Program and/or option grants under
        the Discretionary Program are officers and other key employees of the
        Company and certain consultants or other independent contractors, as
        defined in the plan. The individuals eligible to receive option grants
        under the Automatic Program are individuals who are elected, re-elected
        or appointed as non-employee Board members.

        The fair value of each option grant is estimated on the date of grant
        using the Black-Scholes option-pricing model with the following
        weighted-average assumptions used for grants in 1996 and 1997: no
        dividend yield; expected volatility; risk-free interest rates on or
        about the date of grant represented by the interest rate on U.S.
        Treasury Bills with a term of maturity equal to the vesting period of
        the options, and expected lives of 5 years.

        The following table summarizes stock option transactions for each of the
three years in the period ended December 31, 1997:

<TABLE>
<CAPTION>
                                                        1994 AND 1996 PLANS                     OTHER
                                                     -------------------------           -------------------
                                                                      WEIGHTED                      WEIGHTED
                                                                       AVERAGE                       AVERAGE
                                                                      EXERCISE                      EXERCISE
                                                     SHARES             PRICE             SHARES      PRICE
                                                     ------             -----             ------      -----
              <S>                                   <C>            <C>                    <C>       <C>
              Outstanding at
                 January 1, 1995                    1,439,744          $4.22                27,587      $.14
                     Granted                          737,025         $12.30                   -          -
                     Exercised                       (205,068)          $.35               (10,500)     $.14
                     Canceled                        (300,392)        $18.30                   -          -
                                                    ---------                              -------
              Outstanding at
                 December 31, 1995                  1,671,309          $5.63                17,087      $.14
                     Granted                          874,887          $9.01                   -         -
                     Exercised                       (149,261)          $.77                   -         -
                     Canceled                        (598,732)        $18.30                   -         -
                                                    ---------                              -------
              Outstanding at
                 December 31, 1996                  1,798,203          $5.54                17,087      $.14
                     Granted                        1,404,976          $6.58                   -          -
                     Exercised                       (252,337)         $6.34                   -          -
                     Canceled                        (299,984)         $7.65                   -
                                                    ---------                              -------
               Outstanding at
                 December 31, 1997                  2,650,858          $6.20                17,087      $.14
                                                    ---------                              -------
                                                    ---------                              -------
</TABLE>
                                       F-16
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

10.     SHAREHOLDERS' EQUITY, CONTINUED:

        The range of exercise prices of stock options outstanding at December
        31, 1997 is as follows:

<TABLE>
<CAPTION>
                                          OPTIONS OUTSTANDING                                  OPTIONS EXERCISABLE
                          -----------------------------------------------------           --------------------------
                                             WEIGHTED                 WEIGHTED                              WEIGHTED
          RANGE OF                           AVERAGE                  AVERAGE                               AVERAGE
          EXERCISE          NUMBER           REMAINING                EXERCISE                NUMBER        EXERCISE
           PRICES         OUTSTANDING   CONTRACTUAL LIFE               PRICE               EXERCISABLE       PRICE
           ------         -----------   ----------------               -----               -----------      --------
        <S>               <C>           <C>                           <C>                  <C>              <C>
        $.14 - $1.05        544,785           4.60                    $  .30                544,785          $   .30
        $2.80 - $6.44       568,613           9.40                      6.06                 30,707             5.70
        $6.50 - $6.63       320,543           8.56                      6.51                 65,811             6.51
        $6.88               533,721           9.12                      6.88                143,244             6.88
        $7.00 - $16.13      700,283           8.26                      0.09                417,912            10.25
                          ---------           ----                    ------              ---------           ------
        $.14 - $16.13     2,667,945           7.97                    $ 6.16              1,202,459           $ 5.02
                          ---------           ----                    ------              ---------           ------
                          ---------           ----                    ------              ---------           ------
</TABLE>

        At December 31, 1996 and 1997,  1,191,381 and 339,959 shares,
        respectively, are available for granting of options under the 1994 and
        1996 Plans.

        STOCK PURCHASE PLAN

        The Amended 1994 Employee Stock Purchase Plan, originally adopted in
        February 1994 (the "Stock Purchase Plan"), authorizes the Company to
        issue up to 300,000 shares of common stock to participating employees.
        The Stock Purchase Plan is intended to provide qualifying employees with
        the opportunity to acquire an interest in the Company by accumulating
        amounts for the employees' account through payroll deductions and the
        periodic application of such amounts to the purchase of shares of the
        Company's common stock. Under the terms of the Stock Purchase Plan,
        qualified employees can choose each year to have up to 15% of their
        annual base earnings withheld to purchase the Company's common stock.
        The purchase price of the stock will be equal to 85% of the lower fair
        market value of the common stock on (i) the commencement date of the
        offering period or (ii) the purchase date. The Stock Purchase Plan
        terminates on December 31, 2003. Under the Stock Purchase Plan, the
        Company sold 56,857 and 97,413 shares to employees in 1996 and 1997,
        respectively. There are 31,102 shares of common stock available for
        purchase under the Stock Purchase Plan at December 31, 1997.

        In order to disclose the pro forma net income and earnings per share as
        required by SFAS No. 123 (see Stock Compensation Plans above), the fair
        value of the employees' purchase rights is estimated using the
        Black-Scholes model with the following assumptions for 1996 and 1997: no
        dividend yield, expected volatility of 69.76%; risk-free interest rates
        on the date of grant represented by the interest rate on U.S. treasury
        bills with a term of maturity equal to the period from the subscription
        date to the purchase date. The weighted-average fair value of those
        purchase rights granted in 1996 and 1997 was $9.56 and $6.58,
        respectively.

                                       F-17
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

11.     INCOME TAXES:

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

        Differences between the statutory rate and the effective tax rate for
        the year ended December 31, 1995, 1996 and 1997 are as follows:

<TABLE>
<CAPTION>
                                                                         1995        1996          1997
                                                                         ----        ----          ----
                <S>                                                      <C>        <C>           <C>
                Taxes at federal statutory rate                          34.0%      (34.0%)       (34.0%)
                Foreign income taxes                                      -  %        1.8%          3.2%
                Net operating loss carryforwards and research and
                      development tax credits (utilized) not utilized   (33.0%)      33.0%         33.0%
                Change in valuation allowance                              - %        -  %          -  %
                Other                                                    (1.0%)       1.0%          1.0%
                                                                        -----       -----         -----
                      Provision for income taxes                          -  %        1.8%          3.2%
                                                                        -----       -----         -----
                                                                        -----       -----         -----
</TABLE>

        The components of the deferred tax assets at December 31, 1996 and 1997
        are as follows:
<TABLE>
<CAPTION>
                                                                             1996               1997
                                                                             ----               ----
                                                                            (DOLLARS IN THOUSANDS)
                <S>                                                       <C>                 <C>

                Allowances and reserves                                   $   773              $   780
                Vacation accrual                                              146                  178
                Capitalized research and development                        2,211                2,577
                Net operating loss carryforwards                            4,774                5,908
                Tax credits                                                 1,429                1,991
                Accelerated depreciation                                     (252)                (287)
                Other                                                          10                   10
                                                                          -------              -------
                      Total gross deferred tax asset                        9,091               11,157

                Less valuation allowance                                   (7,589)              (9,655)
                                                                          -------              -------
                      Net deferred tax asset                              $ 1,502              $ 1,502
                                                                          -------              -------
                                                                          -------              -------
</TABLE>

        The Company has recorded a net deferred tax asset of $1,502,000 as of
        December 31, 1997 and 1996. Realizability is dependent on generating
        sufficient taxable income 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.

                                       F-18
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

11.     INCOME TAXES, CONTINUED:

        At December 31, 1997, the Company has net operating loss carryforwards
        for federal income tax purposes of approximately $15,644,000, of which
        $5,378,000 is attributable to disqualifying dispositions of stock
        options. The Company also has net operating loss carryforwards for
        California tax purposes of approximately $7,561,000 at December 31,
        1997, of which $2,724,000 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 $1,620,000 for federal and $371,000 for California tax
        purposes at December 31, 1997. These carryforwards will begin expiring,
        if unused, in 2003.

        The Internal Revenue Code (the "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 $1,166,000 of its federal net operating loss
        carryforwards and $408,000 of its federal and $105,000 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.


12.     EMPLOYEE BENEFITS:

        The Company has a 401(k) defined contribution plan available to all
        employees who have been with the Company for more than one month.
        Employees may contribute up to 15% of their salary each year and the
        Company may elect to make a discretionary contribution to the plan once
        a year. All plan participants who are employed at the end of the plan
        year and have completed 1,000 hours of service in that plan year are
        eligible to receive a share of the employer contribution. Participant's
        rights to the employer contributions vest 25% per year of service with
        the participant being fully vested at the end of the fourth year of
        service. The Company did not make a discretionary contribution in 1995,
        1996 or 1997.

                                       F-19
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

12.     EMPLOYEE BENEFITS, CONTINUED:

        In 1995, the Company adopted a profit sharing plan available to all
        employees. The plan provides financial benefits to employees when the
        Company exceeds certain targeted objectives. The Compensation Committee
        of the Board of Directors annually determines the maximum amount that is
        allocated to the plan. Employees are eligible to participate in the plan
        at the start of the quarter following their employment at the Company.
        The Company allocated $-0-, $-0- and approximately $418,000 in 1995,
        1996 and 1997, respectively.


13.     CONCENTRATION OF CREDIT RISK:

        Financial instruments which potentially subject the Company to
        concentrations of credit risk consist principally of cash and cash
        equivalents, investments and trade receivables.

        The Company has approximately $4,908,000 of cash and cash equivalents in
        excess of FDIC insured limits at two financial institutions at December
        31, 1997. The Company has not experienced any losses on its cash and
        cash equivalents.

        All of the Company's investments, all of which mature in 1998, are in
        obligations of the U.S. Government and its agencies at December 31,
        1997.

        At December 31, 1996 and 1997, the Company's trade receivables are
        concentrated with "Regional Bell Operating Companies" and independent
        phone companies and suppliers or affiliated companies in the United
        States, all of which management believes are large companies with
        substantial financial resources. Sales are typically made on credit,
        with terms that vary depending upon the customer and the nature of the
        product. The Company does not hold collateral to secure payment.
        Although the Company maintains a reserve for uncollectible receivables
        that it believes to be adequate, a payment default on a significant sale
        or customer receivable could materially and adversely affect its
        operating results and financial condition.

        Sales to major customers for each year are as follows (% of revenue):

<TABLE>
<CAPTION>
                                               1995        1996       1997
                                               ----        ----       ----
                     <S>                       <C>         <C>        <C>
                     Nynex                     18%         23%          8%
                     Bell South                13%          7%         17%
                     US West                   45%         31%          4%
                     Ameritech                 19%          9%          3%
                     Nortel                     -          15%         20%
                     MCI                        -           -          18%
</TABLE>
                                       F-20
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

13.     CONCENTRATION OF CREDIT RISK, CONTINUED:

        Sales to an affiliate of a shareholder during the years ended December
        31, 1995, 1996 and 1997 were approximately $3,836,000, $2,263,000 and
        $922,000 respectively, of which approximately $140,000 and $342,800 are
        included in accounts receivable at December 31, 1996 and 1997,
        respectively.


14.     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 $1,700,000 in cash and incurred approximately
        $200,000 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 $1,200,000, property and equipment valued at approximately
        $377,000 and purchased technology valued at approximately $337,000. The
        Company recorded a one-time charge in the first quarter of 1996 for the
        $1,200,000 associated with purchased research and development costs.

        In July 1996, the Company acquired certain assets of MPR Teltech, a
        subsidiary of BC TELCOM, 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 $4,200,000 million in cash and 150,000 shares of
        the Company's common stock, and incurred approximately $200,000 in
        related costs. SSN was an operations systems software development group
        with expertise in 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 accounted for as a purchase, included the
        acquisition of in-process research and development valued at
        approximately $2,100,000, property and equipment valued at approximately
        $900,000 and goodwill and know-how valued at approximately $2,588,000.
        The Company recorded a one-time charge in the third quarter of 1996 for
        the $2,100,000 associated with purchased research and development costs.

                                       F-21
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

14.     ACQUISITIONS, CONTINUED:

        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 an amount of $3,100,000, $2,232,000 of which was paid in
        cash and the remainder of which is payable in cash and/or stock at the
        Company's option on January 15, 1998. The Company recorded a charge of
        approximately $1,578,000 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 a warrant to purchase
        150,000 shares of the Company common stock at an exercise price of $12
        per share. The warrant has a three year term.

        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.

                            CONDENSED PRO FORMA RESULTS OF OPERATIONS
                          (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
                                        (UNAUDITED)

<TABLE>
<CAPTION>
                                                               YEARS 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>

        Sales to Canadian customers, generated from both the Company's United
        States and Canadian operations in fiscal 1996 and 1997 were
        approximately $4,351,000 and $9,861,000, respectively. The identifiable
        assets of the Company's operations at December 31, 1996 and 1997 were
        approximately $970,000 and $1,997,000, respectively.

                                       F-22
Continued
<PAGE>

                      APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

                                    ----------

15.     EARNINGS PER SHARE ("EPS") DISCLOSURES:

        In accordance with the disclosure requirements of SFAS No. 128, a
        reconciliation of the numerator and denominator of basic and diluted EPS
        is provided as follows (dollars in thousands, except per share amounts).

<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31
                                                                ----------------------
                                                            1995        1996         1997
                                                            ----        ----         ----
               <S>                                        <C>          <C>          <C>
               Numerator - basic and diluted EPS:
                Net income (loss)                         $   759      $(7,120)     $(4,283)

               Denominator - basic and diluted EPS:
                Weighted average common stock
                   outstanding                             11,899       12,255       12,605
                                                          -------      -------      -------
               Basic and diluted earnings per share         $.06        $(.59)       $(.34)
                                                            ----        -----        ------
                                                            ----        -----        ------
</TABLE>
                                       F-23
<PAGE>

                                                                     SCHEDULE II

                  APPLIED DIGITAL ACCESS, INC. AND SUBSIDIARY

                       VALUATION AND QUALIFYING ACCOUNTS
              FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

                                   ----------

<TABLE>
<CAPTION>
                                                                 BALANCE AT
                                                                  BEGINNING                                             BALANCE AT
              DESCRIPTION                          YEAR            OF YEAR         ADDITIONS       DEDUCTIONS          END OF YEAR
              -----------                          ----            -------         ---------       ----------          -----------
<S>                                                <C>           <C>               <C>             <C>                 <C>
Allowance for doubtful accounts                    1995          $  50,000         $    -          $     -             $  50,000
                                                   1996             50,000              -                -                50,000
                                                   1997             50,000              -                -                50,000

Inventory reserve                                  1995            434,617          150,000          (47,055)            537,562
                                                   1996            537,562              -            (68,092)            469,470
                                                   1997            469,470          312,496         (211,966)            570,000
</TABLE>

                                       F-24