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                    U.S. SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
 
                            ------------------------
 
                                  FORM 10-KSB
 
(MARK ONE)
[X]   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
 
[ ]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
     OF 1934 FOR THE TRANSITION PERIOD FROM             TO
 
                          NATIONAL DATACOMPUTER, INC.
                 (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
 
<TABLE>
<S>                                                       <C>
                        DELAWARE                                            04-2942832
              (STATE OR OTHER JURISDICTION                                (IRS EMPLOYER
            OF INCORPORATION OR ORGANIZATION)                          IDENTIFICATION NO.)
 
900 MIDDLESEX TURNPIKE, BLDG. 5, BILLERICA, MASSACHUSETTS                     01821
        (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                            (ZIP CODE)
</TABLE>
 
                                 (978) 663-7677
                (ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
      SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT: NONE
 
      SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:
 
                     COMMON STOCK, $.08 PAR VALUE PER SHARE
                                (TITLE OF CLASS)
 
     Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
 
     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
 
     The registrant had revenues of approximately $5,255,000 in the calendar
year ended December 31, 1998. The aggregate market value of the voting stock
held by non-affiliates of the registrant on March 10, 1999 was approximately
$1,378,124. As of March 10, 1999, 2,276,850 shares of Common Stock, $.08 par
value per share, of the registrant were outstanding.
 
     Transitional Small Business Disclosure Format:  Yes [ ]  No [X]
 
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                                     PART I
 
     This annual report on Form 10-KSB contains forward-looking statements as
defined in the Private Securities Litigation Reform Act of 1995. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes", "anticipates", "plans", "expects", and similar
expressions are intended to identify forward-looking statements. The important
factors discussed in Item 1 "Description of Business" and Item 6 "Management's
Discussion and Analysis of Financial Condition and Results of Operations" among
others, could cause actual future results to differ materially from those
indicated by forward-looking statements made herein and presented elsewhere by
management from time to time.
 
ITEM 1.  DESCRIPTION OF BUSINESS.
 
GENERAL
 
     The mission of National Datacomputer, Inc. (the "Company"), a Delaware
corporation organized in 1987 is to provide solutions to workplace problems
through the use of mobile information systems. The Company designs,
manufactures, sells and services computerized systems used to automate the
collection, processing and communication of information related to product
sales, distribution, and inventory control. The Company's products and services
include data communication networks, application-specific software, hand-held
computers and related peripherals, and associated training and support services.
The Company's products facilitate rapid and accurate data collection, data
processing and two-way communication of information with a customer's host
information system.
 
     The Company invests in technologies that support its systems solution
approach, such as application software and network communication systems. The
Company believes that its future success depends on superior marketing, service
and solutions. The Company's goal is to be the leading supplier in selected
market sectors. The key elements of the Company's strategy include: (i)
performing effective market research to assess and identify market sectors that
represent viable business opportunities; (ii) providing system communications to
a customer's host information system in addition to data collection software and
hardware; (iii) updating hardware and software solutions to remain current with
customers' needs as well as existing technology; and (iv) maintaining superior
software to run on the Company's hardware and network communications in selected
market segments.
 
INDUSTRY BACKGROUND
 
     In the 1970s, the application of microprocessor-powered equipment began to
find applications where portable, battery-powered units were required. These
units found their largest applications in the retail industry for entering
re-order information into the distribution systems to supply retail stores. A
number of other data collection applications also began to appear in the
inventory service industry.
 
     The state of the art in microprocessors at the time was units with small
memories and programs written in proprietary or machine languages contained in
firmware. The applications were, by necessity, simple compared to other
applications of computers in business and industry. As the need for more
flexible and sophisticated programs grew, the use of units requiring firmware
became less and less desirable. This situation existed until the mid-1980s when
personal computers blossomed and the computer industry shifted to low-powered
CMOS electronics (generally categorized as semiconductors requiring small power
drain). At that point, the opportunity to create software systems with the level
of flexibility and sophistication available in other parts of the software
industry presented itself and the hand-held personal computer was introduced.
 
     Management believes that the future of hand-held computers is governed by
the software or solutions industry, and the opportunity to design computers for
"people who don't work at a desk" has opened up large new markets. The
application of this software technology to industries involving distribution of
products on routes is a good example of this opportunity as the distribution
process can be highly automated capturing every transaction as well as supplying
additional information for management controls not previously possible.
 
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PRODUCTS
 
     The Company designs, manufactures, markets and services rugged, hand-held
computers, data collection devices and associated peripherals. The Company
believes that its customers require products that allow flexible tailored
software solutions in a cost-effective and timely manner.
 
HARDWARE
 
     The Company's hand-held computers ("Datacomputers") include a
microprocessor, keyboard, LCD displays and full alphabetic and numeric character
sets. Application programs for the Datacomputer can be written on conventional
desk-top computers with commonly-used programming languages and then executed on
the Datacomputer. Application programs and data in Datacomputers are stored in
random access memory ("RAM") and can be readily changed by communicating
revisions or new programs to the Datacomputer through its industry standard
serial port. Datacomputers can receive data through bar-code readers, cables
from other computers (including other Datacomputers) and over telephone lines
through a modem. The Company's Datacomputer product line includes various models
of the Datacomputer, bar-code readers, printers, communication devices, carrying
cases, cables and add-on memory boards.
 
DATACOMPUTER MODEL DC4
 
     The Datacomputer Model DC4 (the "DC4") is a hand-held computer that was
introduced in late 1997 and which is designed for use by the Route Service
market. The DC4 is an advanced version of the DC 3X described below in that it
employs a faster processor and a faster internal modem. The DC4 also
incorporates several significant features not available in the DC 3X, such as a
touch-screen, a signature capture capability and two slots for PC-cards. The
enhanced processing power and ruggedness of the DC4 is drawing interest from
markets other than the Company's traditional markets. The DC4 is intended to
complement rather than replace the DC 3X, which will continue to be sold to its
present markets. The Company estimates that approximately 26% of its 1998 total
revenue was attributable to sales of the DC4.
 
DATACOMPUTER MODEL 3X
 
     The Datacomputer Model 3X (the "DC 3X") is a hand-held computer designed
for use by people whose jobs involve entry and access to a computer as they
stand or move about. The DC 3X contains an industry standard bar-code port that
allows quick and convenient scanning of bar-codes for accurate inventory
management and supports fixed beam pencil wands, CCD and laser light beam
readers for a multitude of scanning applications. The Company estimates that
approximately 21% of its 1998 total revenue was attributable to the sale of the
DC 3X.
 
     The DC 3X is designed to be highly reliable, tolerant to human error and
easy to use. The DC 3X is shock resistant, water tight and operates over a wide
temperature range. In addition, the DC 3X's full-sized, numeric key pad is
designed for fast and accurate data entry, even while a user is wearing gloves.
The Company also offers optional accessories, such as an internal modem that
allows communications over telephone lines.
 
     The Company offers the DC 3X in two different sales packages. The Pre-Sales
System (the "PSS") includes a DC 3X, software and various peripherals for sale
to customers who sell their products on routes and who book the sales orders
through a dedicated sales force. The Driver-Sales System (the "DSS") is a
packaged system that includes a DC 3X, one of several portable or truck-mounted
printers, peripherals and software. The DSS is used by customers who sell their
products through delivery drivers. The Company believes that the application
software included in the PSS and DSS packages described above permits a high
degree of customization for a variety of customer applications.
 
     The PSS is typically purchased by distributors who sell products prior to
actual shipment. Due to the fact that the salesman is not required to create and
print out a delivery slip for any customer, there is no need for a printer. The
PSS allows the salesman to access all of the distributor's information on the
customer's account as well as to input the customer's next delivery order. The
DSS, on the other hand, is typically purchased by
 
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distributors who do not sell products prior to actual shipment. Accordingly, a
salesperson arriving at a stop performs an inventory check, determines how much
inventory should be delivered and prints out the delivery slip for the customer.
 
     The DC 3X has many industrial applications, where portability, access
speed, ruggedness and small size are essential. Examples of two applications for
the DC 3X are set forth below:
 
     DELIVERY ROUTES.  At the end of each day, a driver parks his truck and goes
into the office where he connects his DC 3X to a host computer. The host
computer extracts and processes the information entered into the DC 3X by the
driver during his route. After processing the data, the host computer downloads
the delivery schedule and inventory for the driver's next day, including account
information about each customer. During the day, at each route stop, the driver
takes the customer's inventory, calculates what new stock needs to be added and
prints out a delivery slip for each customer. At the end of the day, a complete
report of the driver's deliveries can be printed. According to many of the
Company's customers, the implementation of the DC 3X has significantly improved
driver efficiency.
 
     INSPECTION SYSTEMS.  Using a DC 3X, a railroad inspector checks the
condition of railroad cars in the railroad yard. The DC 3X prompts the inspector
by requesting that he respond to a number of pre-determined questions. By
selecting specific answers to each question, the inspector reports a detailed
condition of each railroad car. After completing his inspection, the DC 3X is
connected to the railroad's repair center where the list of repairs and parts is
reviewed and processed by repairmen. The implementation of the DC 3X has
improved the effectiveness and efficiency of railroad car inspection and repair
by reducing human error and accelerating data collection and analysis. DC 3Xs
are presently in use at the BNSF, Union Pacific and Illinois Central Railroads.
 
DATACOMPUTER MODEL 2X
 
     The Datacomputer Model 2X (the "DC 2X") is an advanced version of the DC
2.5 described below. The DC 2X provides all the features of the DC 2.5, but, is
also faster, has more memory and provides for a PC card slot option.
 
     The Company estimates that approximately 4% of its 1998 total revenue was
attributable to the sale of the DC 2X.
 
DATACOMPUTER MODEL 2.5
 
     The Datacomputer Model 2.5 (the "DC .5") is a hand-held computer designed
primarily for use by inventory auditors who enter voluminous numeric data,
mostly by touch keying. The Company offers utility software that includes a
modem, printer, bar code wand and scanner interfaces, screen and keyboard
routines, calculator functions and database functions. Due to the wide range of
optional features, the user is able to control the creation, updating and cost
of the DC 2.5's software.
 
     The DC 2.5 is marketed primarily to inventory service companies. An
inventory service company is an organization that contracts with businesses who
maintain large inventories, such as department or retail stores. The Company
estimates that approximately 7% of its 1998 total revenue was attributable to
the sale of the DC 2.5.
 
ICAL MODEL 100R
 
     The ICAL Model 100R (the "ICAL 100R") is designed and used for inventory
taking for financial and control purposes. The ICAL 100R allows a user to divide
a store's inventory into a maximum of 128 separate departments and keep a
running total in each department. The ICAL 100R is a recent version of a
hand-held product sold by the Company to the inventory audit market for the last
18 years. The Company estimates that approximately 6% of its 1998 total revenue
was attributable to the sale of the ICAL 100R.
 
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<PAGE>   5
 
     The primary customers for the ICAL 100R are inventory service companies,
which perform inventory taking for retailers and other institutions on a
contract basis, and retailers, primarily convenience store chains or others
selling large quantities of relatively low priced items.
 
     Revenues generated by the ICAL 100R are almost exclusively from current
customers of the Company who wish to continue to use their installed base of
ICAL devices. The Company intends to continue to support the ICAL product line
to protect its customers' investments.
 
MARKETS
 
     The Company currently focuses on the route accounting system market for
hand-held computers and believes it is well positioned in this industry to
become a leading provider. Route accounting involves concurrent order taking,
product delivery and inventory tracking. Salespeople enter customer orders in
hand-held computers and use the Company's portable printers to generate invoices
that are left with the customers' orders at their locations. At the end of a
route delivery day, information stored in hand-held computers is transferred to
the host information system and instructional and control information for the
next day's delivery routes is transferred back to the hand-held computer.
 
MARKETING AND DISTRIBUTION
 
     The Company has separate marketing efforts for its Datacomputer products
and its ICAL 100R. Management believes that the Datacomputer products have a
wide variety of applications that have not yet been fully exploited by the
Company or potential users of the Datacomputer.
 
     Recognizing the need to focus the Company's limited resources, the Company
has applied its business strategy for Datacomputers to a limited number of
selected markets. The Company is currently focused in market sectors where
businesses distribute their products on routes. The Company believes that the
route sales and service market is attractive because (i) customer acceptance of
hand-held computers has been established in several sectors; (ii) customers have
realized a substantial return on their investment in hand-held computers; and
(iii) the Company enjoys a competitive advantage in this market due to its
software and related services. To date, the Company believes it has gained the
leading positions in the office coffee service market sector, and has penetrated
the beer distribution, bakery, snacks and dairy market sectors.
 
     The ICAL 100R is sold principally to repeat customers who already have a
sizable investment in their use of and applications for ICAL products. The
Company devotes relatively few resources to generate additional sales of ICAL
units above those demanded by past customers.
 
     The Company primarily sells and distributes its systems and products
through a direct sales force that concentrates on systems sales.
 
DIRECT SALES FORCE
 
     The Company believes that the optimum method for the marketing and sale of
its products is gained through direct sales. Therefore, direct selling is the
Company's primary strategy in the route sales and service market. The Company
believes that the key elements to successful direct selling include: (i)
maintaining a well-qualified direct sales staff that is experienced in marketing
and selling solutions to medium and large accounts; (ii) performing
well-executed software solutions; (iii) offering excellent service; and (iv)
maintaining good customer references.
 
SERVICE AND SUPPORT
 
     The Company believes that superior service is a vital part of its
competitive strategy and therefore emphasizes the quality of both hardware and
software service. The Customer Service department manages all installations,
preparations, and follow-up support with each customer.
 
     The Company typically offers industry-standard 90 day warranties and offers
several flexible service arrangements and maintenance contracts to meet customer
needs. In addition to technical support of installed
 
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<PAGE>   6
 
systems, the Company provides pre-installation site surveys, installation
services, user training, technical training, application software support and
host information system interface assistance.
 
SOURCES OF SUPPLY
 
     The Company believes there is more than one supplier for all of its raw
materials and maintains inventories and close working relationships with its
suppliers to ensure timely and reliable delivery. Although the Company has not
experienced major interruptions in production due to a shortage of raw
materials, prolonged supply shortages would materially and adversely affect the
Company's manufacturing operations, business and financial performance.
 
COMPETITION
 
     The market for the Company's products is highly competitive and rapidly
changing. The Company's competitors include Norand, Symbol Technologies, Telxon
and related third-parties, all of which have greater financial, marketing and
technical resources than the Company. In addition, larger corporations could
enter into the route sales and service segment of the hand-held computer market.
The Company competes on the basis of product features, software, quality,
service and price.
 
EMPLOYEES
 
     As of December 31, 1998, the Company had 37 full-time employees. Of these
employees, 6 were engaged in sales and marketing, 10 in service and customer
support, 6 in hardware and software development, 9 in manufacturing and 6 in
administration and finance. The Company's employees are not represented by a
labor union. Management believes that the Company's relationship with its
employees is good.
 
ITEM 2.  DESCRIPTION OF PROPERTY.
 
     The Company maintains its principal offices and manufacturing operations in
a leased 19,000 square foot facility in Billerica, Massachusetts. The Company's
lease expires on September 30, 2000. The annual base rent for the Company's
leased facilities is approximately $123,300. The lease further provides that the
Company will pay to its landlord as additional rent its pro rata share of
certain operational and maintenance costs at the facility during the term of the
lease. The Company believes that its facilities are adequate for its current
needs and that additional space, if required, would be available at competitive
rates.
 
ITEM 3.  LEGAL PROCEEDINGS.
 
     The Company is not presently involved in any pending litigation other than
routine litigation that is incidental to the business of the Company.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
 
     None
 
                                    PART II
 
ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     From March 7, 1997, until October 15, 1998, the Company's Common Stock
traded on the NASDAQ Small Cap Market Quotation System ("NASDAQ") under the
symbol "IDCP". Since October 16, 1998, the Company's Common Stock has been
trading on the OTC Bulletin Board ("OTC"). On March 10, 1999, the last bid price
for the Common Stock as reported by OTC was $0.63 per share.
 
     For the periods indicated below, the table sets forth the range of high and
low bid prices for the Common Stock as reported by NASDAQ or OTC. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission,
and may not represent actual transactions.
 
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<TABLE>
<CAPTION>
                                                              HIGH      LOW
                                                              -----    -----
<S>                                                           <C>      <C>
1997
First Fiscal Quarter........................................  $6.88    $3.88
Second Fiscal Quarter.......................................   3.75     2.00
Third Fiscal Quarter........................................   1.88     1.00
Fourth Fiscal Quarter.......................................   1.00      .38
 
1998
First Fiscal Quarter........................................  $1.81    $ .50
Second Fiscal Quarter.......................................   1.47      .63
Third Fiscal Quarter........................................   1.13      .50
Fourth Fiscal Quarter.......................................   1.13      .44
</TABLE>
 
     As of March 10, 1999, there were approximately 2,375 stockholders of record
of the Company's Common Stock.
 
DIVIDENDS
 
     Since inception, the Company has not paid any dividends on its Common Stock
and management does not anticipate the payment of any dividends to its
stockholders in the foreseeable future. The Company currently intends to
reinvest earnings, if any, in the development and expansion of its business. The
declaration of dividends in the future will be at the election of the Board of
Directors and will depend upon the earnings, capital requirements and financial
position of the Company, general economic conditions and other pertinent
factors. The Company's outstanding Preferred Stock also requires that holders of
Preferred Stock be entitled to receive dividends prior to the payment of
dividends on the Company's Common Stock.
 
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.
 
     The following discussion and analysis should be read in conjunction with
the financial statements and notes thereto appearing elsewhere herein.
 
RESULTS OF OPERATIONS
 
  Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
 
     Revenues decreased approximately 10% to approximately $5,255,000 in 1998
from approximately $5,813,000 in 1997. The decrease in revenues was primarily
attributable to a decrease in sales of units of the Company's Datacomputers
which decreased 24% to $3,507,532 in 1998 from $4,644,903 during 1997.
 
     Service and other revenues increased to approximately $1,747,000 in 1998
from approximately $1,168,000 in 1997, an increase of approximately 50%. The
increase was a direct result of improved maintenance and pricing policies
instituted, combined with an increase in customer requested software
enhancements.
 
     Cost of sales and services decreased approximately 15% to $2,781,000 in
1998 from approximately $3,265,000 in 1997. As a percentage of sales, cost of
sales and services decreased to approximately 53% in 1998 from approximately 56%
in 1997. This decrease is primarily due to the institution of the Company's
quality control programs, which improved the quality of the Company's products
and led to fewer field support demands and, thereby, lower field support costs.
 
     Research and development expenses decreased to approximately $992,000 in
1998 from approximately $1,276,000 in 1997, a decrease of approximately 22%. The
decrease resulted primarily from a reduction in the Company's product
development staff due to the completion of the Datacomputer model DC4 which was
introduced in the later part of 1997. Although no assurance can be given, the
Company expects to maintain research and development spending necessary to
enhance current products and to develop future products.
 
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<PAGE>   8
 
     Selling, general and administrative expenses decreased to approximately
$1,773,000 in 1998 from approximately $2,373,000 in 1997, a decrease of
approximately 25%. The decrease resulted primarily from the Company's ongoing
programs of streamlining its operations and organizational structure.
 
     The Company's operating loss was approximately $292,000 in 1998 as compared
to a loss from operations of approximately $1,101,000 in 1997. The decreased
loss was primarily attributable to the decrease in the expenses discussed above.
 
     Interest expense was approximately $40,000 in 1998 as compared to
approximately $125,000 in 1997. This decrease resulted primarily from the
amortization of approximately $81,000 of interest expense related to the
discount on the convertible debt obtained in 1997.
 
     On February 20, 1998, the Company announced the signing of a letter of
intent ("LOI"), subject to a definitive agreement, to merge with Infos
International, Inc. ("Infos"). The LOI has expired and the Company has entered
into discussion with Infos with an objective to either continue pursuing the
merger and/or to agree on access and exclusive territories for each company to
sell the other company's products.
 
     In 1998 the Company paid approximately $99,000 for costs related with the
proposed merger. These costs were expensed and recorded as other expenses.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     During fiscal 1998, net cash used for operating activities decreased to
$11,854, as compared to net cash used for operating activities of $1,786,353 in
fiscal 1997. During fiscal 1998 and fiscal 1997, net cash used for investing
activities was $76,108 and $143,774, respectively. In fiscal 1998, net cash
provided by financing activities was $370,405 consisting primarily of the
issuance of preferred stock lowered by principal payment of a convertible note.
In fiscal 1997, net cash provided by financing activities was $1,416,573,
consisting primarily of the issuance of preferred stock and a convertible note.
In fiscal 1998, the Company incurred interest of $413,625 on its Series B, C, D
and F Convertible Preferred Stock as compared to $404,750 with respect to the
Series B, C and D Convertible Preferred Stock in fiscal 1997. In fiscal 1998,
the Company also issued Common Stock valued at $516,375 in satisfaction of
interest due on Series B, C, D and F Convertible Preferred Stock, as compared to
$386,000 with respect to the Series B, C and D in fiscal 1997.
 
     In March 1998, the Company designated and sold 500 shares of Series E
Convertible Preferred Stock with a warrant to purchase up to 700,000 shares of
common stock at an exercise price of $.75 per share, for net proceeds of
$487,880. The warrant expires in March 2000. The proceeds of this financing were
allocated to the preferred shares and warrant based on management's estimate of
their fair values. This resulted in $214,000 being ascribed to the warrant which
was recorded as additional paid-in-capital and $273,880 being recorded as
preferred stock. Series E Convertible Preferred Stock has voting rights,
dividend preference, liquidation preference, mandatory conversion, and Company
redemption terms similar to the Company's existing Series B, Series C and Series
D Convertible Preferred Stock, and also has anti-dilution protection. The
Subscription Agreement for Series E Convertible Preferred Stock provides for a
right of first refusal on future issuances of stock by the Company. Series E
Convertible Preferred Stock is convertible into shares of common stock at a
conversion price of $.75.
 
     The Company, in conjunction with the issuance of Series E Convertible
Preferred Stock, canceled its previously issued warrants to purchase 700,000
shares of common stock for $4.00 per share. Additionally, the Company changed
the conversion price on Series B and Series C Convertible Preferred Stock to
$2.74 and offered anti-dilution protection with respect to these shares. In
addition, the holders of the Series E Convertible Preferred Stock agreed to
place into escrow 2,100 shares of the Series B Convertible Preferred Stock that
they also owned. The Company may at its option and at any time through January
31, 2000 redeem the escrowed shares of Series B Convertible Preferred Stock at a
price of $1,250 per share.
 
     Also in March 1998, the Company refinanced the $250,000 convertible debt by
making a principal payment of $75,000 and issuing a convertible note payable for
$175,000. The note bears interest at a rate of 6% per annum, matures in March
1999, and is convertible into shares of the Company's common stock at a
conversion price equal to the average closing bid price for the Company's common
stock for the five days

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ending March 6, 1998. On September 24, 1998, the debt holders agreed to convert
the note payable into 175 shares of Series F Convertible Preferred Stock.
 
     Series F Convertible Preferred Stock has voting rights, dividend
preference, liquidation preference, anti-dilution protection and Company
redemption terms similar to the Company's existing Series B, C, D and E
Convertible Preferred Stock. The Subscription Agreement for Series F Convertible
Preferred Stock provides for registration rights for the shares of Common Stock
which the Series F Convertible Preferred Stock may be converted into. Series F
Convertible Preferred Stock is convertible into shares of common stock at a
conversion price of $1.00 at any time after one year from the date of issuance,
until 18 months after issuance, and will be subject to adjustments thereafter in
certain circumstances.
 
     At December 31, 1998, the Company had cash of $491,174 and a current ratio
of 2.5:1. The Company anticipates that available cash, together with cash flow
from anticipated operations, will be sufficient to meet its working capital
needs for the remainder of fiscal 1999. However, unanticipated adverse results
of operations could impact anticipated cash flows and, as a result, there can be
no assurance that the Company will not be required to raise additional capital
or that the Company will be able to raise additional capital on favorable terms,
if at all.
 
IMPACT OF THE YEAR 2000 ISSUE.
 
     The Company is assessing the nature, extent and cost of remediation of any
Year 2000 ("Y2K") readiness issues confronting the Company and its suppliers,
customers and other critical third parties. The project encompasses reviewing
the Company's products and internal systems, both information technology ("IT")
and non-information technology ("non-IT") as well as the Year 2000 readiness of
companies with which the Company has a material relationship, including
customers, suppliers, creditors, financial organizations, and utility providers.
This assessment has begun and the Company has identified certain requisite
corrective actions.
 
     PRODUCTS.  The Company is in the process of completing Y2K readiness
testing utilizing testing guidelines prepared by the British Standards Institute
identified as PD2000-1 in 1998. Corrective actions for software included in the
Company's products have included formulating software patches that provide
proper system operation or a combination of software patches and upgrades that
provide proper system operation and the reporting of the year 2000. These
patches and upgrades will be provided to customers for a determined fee. The
Company anticipates all testing and corrective actions related to Year 2000
issues in its products will be completed by December 1999. However,
notwithstanding such efforts, any failure of the Company's products to perform,
including system malfunctions due to the onset of the Year 2000, could result in
claims against the Company, which could have a material adverse effect on the
Company's business, results of operations or financial condition.
 
     INFORMATION TECHNOLOGY.  The Company is in the process of reviewing its
internal software applications to determine whether all network systems and
server architecture are Y2K-ready. The Company utilizes standard, vendor
supplied software for its electronic mail, corporate communications, engineering
design, manufacturing and accounting, materials purchasing/planning, desktop and
database systems. The Company has contacted these vendors to obtain assurances
that these IT systems are or will be Y2K compliant. Some software at the
individual user level remains to be tested and the Company anticipates this
testing will be completed in calendar 1999. To the extent that some older
versions of these software systems may not be Y2K compliant and are currently
being utilized by employees, the Company intends to upgrade such systems to
achieve Y2K readiness. The failure of any such IT system to be Y2K compliant
could have a material adverse effect on the Company and no assurance can be
provided that all such programs will be implemented on a timely basis.
 
     NON-INFORMATION TECHNOLOGY.  The Company is aware of potential non-IT
system (building security, telecommunications, utility and water systems, etc.)
risks associated with the Y2K issue and is currently evaluating its potential
exposure at its facility. The Company anticipates that any necessary renovation
of its non-IT systems as well as the validation of any repairs will be
substantially completed by December 1999. Formal queries to landlords, water,
utility and telecommunications providers for the Company's location, and
                                        8
<PAGE>   10
 
other third parties with whom the Company has material relationships will be
sent to these suppliers by June 1999 to assess the systems' Y2K readiness.
 
     SUPPLIERS.  The Company is in the process of inquiring from its significant
suppliers the status of their Y2K readiness through completion of a Year 2000
Readiness Supplier Questionnaire that has been developed by a consortium of
semiconductor manufacturers. All such requests have been sent as of March 23,
1999 and the Company is hoping to receive responses by the end of April 1999
indicating that the respective third party is or will be Y2K ready by December
31, 1999. However, the Company has no means of assuring that third parties will
achieve Y2K readiness. Furthermore, there can be no assurance that IT, non-IT
and other suppliers who have provided Y2K readiness documentation will be Y2K
compliant or that such documentation accurately and fully reflects the Y2K
readiness of their systems. The Company's assessments of the effects of Y2K on
the Company are based, in part, upon information received from third parties and
the Company's reliance on that information. The failure of any such supplier's
systems to be Y2K compliant may have a material adverse effect on the Company's
business, results of operations or financial condition.
 
     YEAR 2000 COSTS AND EXPENSES.  The Company has used both internal and
external resources to address Y2K readiness and to program, test and implement
software for Y2K modifications. The Company specifically tracks the costs
associated with product software testing and patch development costs (consulting
and internal payroll costs), network server upgrades, internal payroll costs
related to the contacting of third parties to determine Y2K status, and postage
and related costs associated with providing patches and upgrades to customers
for software utilized in the Company's products. The Company has not separately
tracked the costs of utilizing its internal information systems personnel in
addressing its Y2K readiness, with these costs principally relating to payroll
and related benefits. Total costs for Y2K readiness are currently estimated to
be approximately $50,000 of which approximately $24,000 have been incurred
throughout all phases of the Y2K project. Costs incurred to date and anticipated
future costs have been, and will be funded through operations. As the Company
continues to complete its Y2K readiness plan, actual costs may exceed the
current estimate.
 
     CONTINGENCY PLANS.  The Company's contingency plan with respect to the Y2K
issue is currently being developed and will be completed by December 1999. The
Company is currently in the process of reviewing the status of all third party
suppliers. Replacement suppliers will be identified for critical suppliers who
the Company believes will not be Y2K ready. The Company is considering
contingency plans on a global basis relative to systematic failure of
electricity or telecommunications beyond the control of the Company. There can
be no assurance that any contingency plan measures will mitigate the impact of
Y2K problems.
 
     If unforeseen Y2K readiness efforts are required or if the cost of any
updating, modification or replacement of the Company's systems or products
exceeds the Company's estimates, the Y2K issue could result in material costs
and have a material adverse effect on the business, results of operations or
financial condition of the Company. There can be no assurance that the Company
will be successful in addressing Y2K problems as they relate to its products and
internal systems.
 
     In addition, there can be no assurance that the systems of third parties
with which the Company interacts will not suffer from Y2K problems. Furthermore,
Y2K problems that have been or may in the future be identified with respect to
the IT and non-IT systems of third parties having widespread national and
international interactions with persons and entities generally (for example,
certain systems of governmental agencies, utilities and information and
financial networks) could have a major impact on the Company's financial
condition or results of operations. The most reasonably likely worst case Y2K
scenario, in the event that the Company does not identify or fails to fix
material non-ready IT systems or non-IT systems operated by the Company or third
parties with which it has a material relationship, are not limited to, increased
operating costs, disruption in product shipments, loss of customer orders, and
claims of mismanagement, misrepresentation or breach of contract, any of which
could have a material adverse effect on the Company.
 
NEW ACCOUNTING PRONOUNCEMENTS
 
     In June 1998, the Financial Accounting Standard Board issued Statement of
Accounting Standard No. 130 "Reporting Comprehensive Income" ("SFAS 130") and
Statement of Financial Accounting Standards No. 131 "Disclosure about Segments
of an Enterprise and Related Information ("SFAS 131").
                                        9
<PAGE>   11
 
SFAS 130 establishes standards for reporting comprehensive income and its
components in the consolidated financial statements. SFAS 131 establishes
standards for reporting information on operating segments in interim and annual
financial statements. SFAS 130 and SFAS 131 were adopted in 1998, required
disclosure only and had no impact on the Company's financial position and
results of operations.
 
     In February 1998, the Financial Accounting Standards Board issued
Statements of Accounting Standards No. 132 "Employers Disclosures about Pensions
and Other Post-retirement Benefits" ("SFAS 132"). SFAS 132 revises standards for
disclosures of employers' pension and other post retirements benefit plans. SFAS
132 does not change the measurement or recognition of those plans. SFAS 132 was
adopted in 1998 and had no impact on the Company's financial position and
results of operations.
 
     In June 1998, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). SFAS 133 is effective for all fiscal quarters and for
all fiscal years beginning after June 15, 1999. SFAS 133 will not have any
impact on the Company's financial position and results of operations.
 
ITEM 7.  FINANCIAL STATEMENTS
 
     See Item 13 below and the Index therein for a listing of the financial
statements and supplementary data filed as part of this report.
 
ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE.
 
     Not applicable.
 
                                    PART III
 
ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS; COMPLIANCE WITH
        SECTION 16(A) OF THE EXCHANGE ACT.
 
     Each Director of the Company is elected for a period of one year and holds
office until his successor is elected and qualified. Vacancies may be filled by
a majority vote of Directors then remaining in office. Officers are elected by
and serve at the discretion of the Board of Directors. The following table sets
forth the year each Director was elected a Director and the age, positions and
offices currently held by each Director. For information about ownership of the
Company's voting securities by each Director, see "Security Ownership of Certain
Beneficial Owners and Management."
 
<TABLE>
<CAPTION>
                                                  YEAR
                                              FIRST BECAME
NAME                                   AGE      DIRECTOR                      POSITION
----                                   ---    ------------                    --------
<S>                                    <C>    <C>             <C>
Dr. Malcolm M. Bibby.................  58         1996        Chairman of the Board, President, and CEO
William R. Smart.....................  78         1989        Director
John P. Ward.........................  71         1967        Director
</TABLE>
 
BUSINESS EXPERIENCE AND BACKGROUNDS OF THE DIRECTORS
 
     The background of each of the Company's current Directors is as follows:
 
     DR. MALCOLM M. BIBBY has served as a Director of the Corporation since
January 1996 and was elected Chairman of the Board in July 1996. Dr. Bibby has
also served as President and Chief Executive Officer of the Company since April
1996. He was President of LXE Inc. ("LXE"), a diversified wireless data
communications products company, from 1983 to December 1994. During this period
LXE's annual revenues grew from approximately $600,000 to approximately
$63,000,000. Prior to LXE , Dr. Bibby was an Executive Assistant to the
President at Ciba Vision Care , a Vice President of Product Development at
Wesley-Jessen, Inc. and a Project Manager/Group Leader for hardware and software
development at Monsanto Co. Dr. Bibby holds a
 
                                       10
<PAGE>   12
 
Bachelor of Science degree and a Ph.D. both in Electrical Engineering from the
University of Liverpool and an Master of Business Administration from the
University of Chicago.
 
     WILLIAM R. SMART has served as a Director of the Company since December
1989. He spent 32 years with the General Electric Company where his
responsibilities included distribution and marketing management and general
management as a Division Vice President. He spent nine years with Honeywell,
Inc. where he served as Vice President in charge of European operations and
Senior Vice President of Honeywell Information Systems, responsible for
international operations as well as for the corporate staff. Mr. Smart currently
serves as a Senior Vice President of the Cambridge Strategic Management Group, a
privately-held management consultant company. Mr. Smart holds a Bachelor of
Science degree in Electrical Engineering from Princeton University. Mr. Smart is
also the non-executive Chairman of 1st Carolina Corporation (the "Corporation").
The Corporation filed a Chapter 7 bankruptcy petition in the United States
Bankruptcy Court for the District of South Carolina on August 16, 1994 (Case
Number 94-73884).
 
     JOHN P. WARD has served as a Director of the Company since its founding in
1967. Since February 1996, Mr. Ward has served as the Chief Executive Officer of
Midas Vision Systems, Inc., a privately held company specializing in machine
vision systems for automatic optical inspections. From 1990 to 1996 Mr. Ward was
the Chief Executive Officer and Director of Vanzetti Vision Systems, Inc., a
privately-held company specializing in infrared systems. Mr. Ward was Vice
President of Engineering, co-founder and Clerk of the Company from its founding
until December 1986. From 1953 to 1968 Mr. Ward was a Design Section Manager at
the Raytheon Company. Mr. Ward holds a Bachelor of Science degree in Electrical
Engineering from the Massachusetts Institute of Technology and a Master of
Science degree in Electrical Engineering from Northeastern University.
 
EXECUTIVE OFFICERS
 
     The executive officers of the Company, their ages and positions held in the
Company are as follows:
 
<TABLE>
<CAPTION>
NAME                                   AGE                       POSITION
----                                   ---                       --------
<S>                                    <C>    <C>
Dr. Malcolm M. Bibby.................  58     President, Chairman of the Board and CEO
Gerald S. Eilberg....................  65     Vice President of Finance and Administration,
                                              Chief Financial Officer
Joseph C. Pinto......................  52     Vice President of Operations
Patrick T. Kearney(1)................  50     Vice President of Sales
</TABLE>
 
---------------
(1) Mr. Kearney will commence his employment with the Company on April 1, 1999.
 
BUSINESS EXPERIENCE AND BACKGROUNDS OF THE EXECUTIVE OFFICERS
 
     The following is a brief summary of the background of each executive
officer of the Company other than Dr. Malcolm M. Bibby, whose background is
summarized above.
 
     GERALD S. EILBERG joined the Company in September 1988 as Vice President of
Finance and Administration and Chief Financial Officer. From October 1986 to
August 1988, Mr. Eilberg served as a financial consultant to small private and
public companies. From September 1982 to September 1986, he was President of
Direct Marketing Inc. Previous positions included Division and Corporate
Controller positions with large public companies. Mr. Eilberg is a graduate of
the Boston University School of Management and the Columbia University Graduate
School of Business.
 
     JOSEPH C. PINTO joined the Company in March 1984 as Materials Manager,
advanced into the position of Manufacturing Manager in September 1986 and was
appointed Vice President of Manufacturing in January 1988. Prior to joining the
Company, Mr. Pinto had been Production Control Manager at BLH Electronics, a
manufacturer of process control systems, since January, 1979. Mr. Pinto holds a
Bachelor of Science degree in Industrial Technology from Northeastern University
and a Master of Science degree in Systems Management from Western New England
College.
 
                                       11
<PAGE>   13
 
     PATRICK T. KEARNEY will join the Company in April 1999 as Vice President of
Sales. He has extensive experience as a sales manager in the computer, software
solutions and hand-held computer markets, servicing VARs, distributors and
end-users. Most recently, Mr. Kearney was Director of Worldwide Sales at Optical
Access International, a developer and manufacturer of network storage systems.
From 1993 to 1996, Mr. Kearney was President of Ancilla Associates, a consulting
firm serving the computer market, specializing in sales, marketing and channel
development. Previous work experience includes being Vice President and General
Manager of U.S. Sales and Operations for Eden Group Limited, Eastern Regional
Manager of Poquet Computer Corporation, National Sales Manager and National
Marketing Manager of BASF Corporation. Mr. Kearney holds a Bachelor of Science
degree in Marketing from Providence College.
 
     None of the Company's executive officers or Directors are related to any
other executive officer or Director.
 
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
     Section 16(a) ("Section 16(a)") of the Securities Exchange Act of 1934, as
amended, requires executive officers, Directors, and persons who beneficially
own more than ten percent (10%) of the Company's Common Stock to file initial
reports of ownership on Form 3 and reports of changes in ownership on Form 4
with the Securities and Exchange Commission (the "SEC") and any national
securities exchange on which the Company's securities are registered. Executive
officers, Directors and greater than ten percent (10%) beneficial owners are
required by SEC regulations to furnish the Company with copies of all Section
16(a) forms they file.
 
     Based solely on a review of copies of such forms furnished to the Company
and written representations from executive officers and Directors, the Company
believes that all Section 16(a) filings applicable to its executive officers,
Directors and ten percent (10%) beneficial owners were complied with during the
fiscal year ended December 31, 1998.
 
ITEM 10.  EXECUTIVE COMPENSATION.
 
EXECUTIVE OFFICERS' COMPENSATION
 
     The following table sets forth the compensation paid during the fiscal
years ended December 31, 1998, December 31, 1997, and December 29,1996 ("Fiscal
1998, 1997 and 1996", respectively) to Dr. Malcolm M. Bibby, the Company's
President along with the other current executive officers of the Company, who
earned total compensation in excess of $100,000 during Fiscal 1998.
 
                           SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                                                         (e)
                                                                                ---------------------
                                                         ANNUAL COMPENSATION          LONG TERM
                                                         -------------------     COMPENSATION AWARDS
                      (a)                        (b)        (c)        (d)      ---------------------
                      ---                        ----    ---------    ------    SECURITIES UNDERLYING
          NAME AND PRINCIPAL POSITION            YEAR     SALARY      BONUS        OPTIONS/SAR(#)
          ---------------------------            ----    ---------    ------    ---------------------
<S>                                              <C>     <C>          <C>       <C>
Dr. Malcolm M. Bibby(1)(2)(3)..................  1998    $150,461       $0             294,000
  President, CEO and Chairman of the Board       1997     127,818       $0                   0
                                                 1996      72,051       $0             118,750

Gerald S. Eilberg(4)...........................  1998    $110,413       $0                   0
  Vice President of Finance and Administration   1997     102,106       $0                   0
  and CFO                                        1996     102,106       $0               5,000

Larry F. Yeager(4).............................  1998    $ 61,537       $0                   0
  Former Vice President of                       1997     100,522       $0                   0
  Research and Development                       1996     100,522       $0               5,000
</TABLE>
 
---------------
(1) On January 1, 1998, Non-Qualified Stock Options to purchase 294,000 shares
    of Common Stock at an exercise price of $0.73 were granted to Dr. Bibby. The
    294,000 shares vest fully on December 31, 2000, but contain the following
    acceleration clauses: (a) 150,000 will vest upon a change in control of the
 
                                       12
<PAGE>   14
 
    Company, (b) 12,000 will vest for each fiscal quarter, from January 1, 1998
    through December 31, 2000, in which the Company realizes positive net income
    before taxes; (c) 50,000 will vest if the Company realizes net income before
    taxes of $200,000 in any four consecutive quarters between January 1, 1998
    and December 31, 2000; (d) 10,000 will vest for each $50,000 of net income
    before taxes in excess of $200,000 that the Company realizes in any four
    consecutive quarters between January 1, 1998 and December 31, 2000.
 
(2) On February 28, 1996, May 31, 1996, and November 30, 1996, Incentive Stock
    Options to purchase 5,250, 48,000, 65,500 shares of Common Stock,
    respectively, at an exercise price of $6.00 were granted to Dr. Bibby. Such
    options were subsequently repriced on August 14, 1997 at an exercise price
    of $1.47 per share. The options granted to Dr. Bibby have the following
    vesting periods: (i) 6,000 options were fully vested upon grant (ii) 16,250
    vested fully in 1996 (iii) 23,000 vested fully in 1997 (iv) 750 vested fully
    in 1998 and (v) the remaining 72,750 vest fully in ten years, but contain
    the following acceleration clauses: (a) 2,750 will vest 50% if net income
    before taxes for the five year period ended December 31, 1999 exceeds
    $1,000,000 and 100% if net income for the five year period exceeds
    $2,000,000; and (b) up to 45,000 options will vest if sales during any four
    consecutive quarters exceed $8,500,00 and the following amounts of net
    income before taxes are exceeded:
 
<TABLE>
<CAPTION>
  NET INCOME BEFORE TAXES            OPTIONS THAT VEST
<S>                             <C>
         $1,000,000                        5,000
          1,250,000                        10,000
          1,500,000                        15,000
          1,750,000                        20,000
          2,000,000                        27,500
          2,250,000                        35,000
          2,500,000                        45,000
</TABLE>
 
(3) Dr. Bibby commenced employment with the Company in April 1996.
 
(4) On August 1, 1996, Incentive Stock Options to purchase 5,000 shares of
    Common Stock at an exercise price of $5.00 were granted to each of Messrs.
    Eilberg and Yeager. Such options were subsequently repriced on August 14,
    1997 at an exercise price of $1.47 per share. The options granted to Messrs.
    Eilberg and Yeager vest 25% in each of 1998, 1999, 2000 and 2001.
 
                     OPTION/SAR GRANTS IN FISCAL YEAR 1998
                              (INDIVIDUAL GRANTS)
 
<TABLE>
<CAPTION>
                                       NUMBER OF      PERCENT OF TOTAL
                                      SECURITIES       OPTIONS /SAR'S
                                      UNDERLYING         GRANTED TO       EXERCISE OR
                                     OPTIONS/SAR'S      EMPLOYEES IN      BASE PRICE      EXPIRATION
NAME                                    GRANTED         FISCAL YEAR         ($/SH)           DATE
(A)                                       (B)               (C)               (D)             (E)
----                                 -------------    ----------------    -----------    -------------
<S>                                  <C>              <C>                 <C>            <C>
Malcolm M. Bibby(1)................     294,000              83%             $0.73       December 2007
</TABLE>
 
---------------
(1) On January 1, 1998, Non-Qualified Stock Options to purchase 294,000 shares
    of Common Stock at an exercise price of $0.73 were granted to Dr. Bibby. The
    294,000 shares vest fully on December 31, 2000, but contain the following
    acceleration clauses: (a) 150,000 will vest upon a change in control of the
    Company, (b) 12,000 will vest for each fiscal quarter, from January 1, 1998
    through December 31, 2000, in which the Company realizes positive net income
    before taxes; (c) 50,000 will vest if the Company realizes net income before
    taxes of $200,000 in any four consecutive quarters between January 1, 1998
    and December 31, 2000; (d) 10,000 will vest for each $50,000 of net income
    before taxes in excess of $200,000 that the Company realizes in any four
    consecutive quarters between January 1, 1998 and December 31, 2000.
 
                                       13
<PAGE>   15
 
                AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1998
                            AND FY-END OPTION VALUES
 
<TABLE>
<CAPTION>
                                                                         NUMBER OF
                                                                         SECURITIES
                                                                         UNDERLYING        VALUE OF
                                                                        UNEXERCISED       UNEXERCISED
                                                                          OPTIONS/       IN-THE-MONEY
                                                                            SARS            OPTIONS
                                                                         AT FY-END         AT FY-END
                                        SHARES ACQUIRED     VALUE       EXERCISABLE/     EXERCISABLE/
                                          ON EXERCISE      REALIZED    UNEXERCISABLE     UNEXERCISABLE
NAME                                          (#)            ($)            (#)             ($)(1)
(A)                                           (B)            (C)            (D)               (E)
----                                    ---------------    --------    --------------    -------------
<S>                                     <C>                <C>         <C>               <C>
Malcolm M. Bibby
  President, CEO......................         0              $0       58,000/354,750         $0
Gerald S. Eilberg
  Vice President Finance & Admin and
  CFO.................................         0              $0        1,265/16,809          $0
Larry F. Yeager
  Vice President of Research &
  Development.........................         0              $0            15/0              $0
</TABLE>
 
---------------
(1) In-the-Money options, are those options for which the fair market value of
    the underlying shares of Common Stock is greater than the exercise price of
    the option. As of December 31, 1998, Dr. Bibby had exercisable options to
    purchase 46,000 and 12,000 shares of Common Stock at share exercise prices
    of $1.47 and $0.73 respectively. Messrs. Eilberg and Yeager had exercisable
    options to purchase 1,265, and 1,265 shares of Common Stock, respectively,
    at share exercise prices of $1.47. See "Security Ownership of Certain
    Beneficial Owners and Management". The fair market value of the Company's
    Common Stock underlying the options as of December 31, 1998 was $0.81 (OTC
    closing bid price on December 30, 1998).
 
COMPENSATION OF DIRECTORS
 
     During Fiscal 1998, the Company's Directors received an aggregate cash
compensation of $2,000 for their services as Directors. Messrs. Ward and Smart
received $1,000 respectively.
 
EMPLOYMENT AGREEMENT
 
     On January 1, 1998, the Company entered into an employment agreement with
Dr. Bibby for a period of three years through December 31, 2000. The agreement
is automatically renewed for successive periods of one year, unless written
notice of non-renewal is given by the Company to Dr. Bibby not less than six
months before termination of the agreement. During this period Dr. Bibby will
serve as President and Chief Executive Officer of the Company for a Base Salary
of $150,000 per annum through December 31, 1998. For future years, any increases
in Base Salary will be established by the Board of Directors. Dr. Bibby will be
entitled to receive stock option grants and bonus arrangements as determined by
the Board of Directors from time to time. The Company may terminate this
agreement, if, at any time during the duration of the agreement, the Company has
incurred losses (exclusive of extraordinary items of income and loss) of
$1,000,000 or more in any four consecutive quarters. At such time, the Company
is obligated to pay Dr. Bibby 50% of his then current annual Base Salary, plus
benefits for six months. If the agreement is not renewed by the Company,
including upon change of control, then Dr. Bibby is entitled to receive
severance benefits which will be determined based upon an amount equal to (X)(i)
1/12th of 100% of Dr. Bibby's then current annual Base Salary, plus (ii) 1/12th
of 100% of Dr. Bibby's bonus arrangement earned for the Company's most recent
fiscal year, multiplied by (Y) the greater of the remaining calendar months
under the agreement or eighteen months.
 
                                       14
<PAGE>   16
 
ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
     The following table sets forth, as of March 31, 1999, certain information
concerning stock ownership of the Company by (i) each person who is known by the
Company to own beneficially 5% or more of the Company's voting securities, (ii)
each of the Company's Directors and officers, and (iii) all Directors and
officers as a group. Except as otherwise indicated, the stockholders listed in
the table have sole voting and investment powers with respect to the shares
indicated. For purposes of this table, the Common Stock and the Series B
Convertible Preferred Stock, Series C Convertible Preferred Stock, Series D
Convertible Preferred Stock, Series E Convertible Preferred Stock and Series F
Convertible Preferred Stock, (collectively, the "Preferred Stock") are treated
as one class. As of March 31, 1999, the Company had 2,276,850 shares of Common
Stock outstanding and approximately 2,375 stockholders of record. In addition,
the Company had 6,125 shares of Preferred Stock outstanding. Each share of
Preferred Stock, which has a face value of $1,000, is convertible into Common
Stock at a conversion price of $2.74 per share for the Series B, C and D, $0.75
per share for Series E and $1.00 for Series F. Based upon the conversion prices,
the Preferred Stock would be convertible into a total of 2,830,718 shares of
Common Stock. Each holder of Preferred Stock is entitled to the number of votes
equal to the number of shares of Common Stock into which such Preferred Stock is
convertible. The Company has no other voting securities.
 
<TABLE>
<CAPTION>
                                                            NUMBER OF SHARES
NAME AND ADDRESS OF BENEFICIAL OWNER(1)                    BENEFICIALLY OWNED    PERCENTAGE OF CLASS(2)
---------------------------------------                    ------------------    ----------------------
<S>                                                        <C>                   <C>
Dr. Malcolm M. Bibby (3).................................        85,550                   1.7%
William R. Smart.........................................         2,500                     *
John P. Ward (4).........................................        28,868                     *
Gerald S. Eilberg (5)....................................         9,282                     *
Larry F. Yeager (6)......................................        13,430                     *
All Directors and Officers as a Group (6
  persons)(3)(4)(5)(6)(7)................................       147,521                   2.9%
</TABLE>
 
---------------
  * Less than 1%.
 
(1) The address for all of the named entities is c/o National Datacomputer,
    Inc., 900 Middlesex Turnpike, Bldg. 5, Billerica, Massachusetts 01821.
 
(2) Pursuant to the rules of the Securities and Exchange Commission, shares of
    Common Stock that an individual or group has a right to acquire within 60
    days pursuant to the exercise of options or warrants are deemed to be
    outstanding for the purpose of computing the percentage ownership of such
    individual or group, but are not deemed to be outstanding for the purpose of
    computing the percentage ownership of any other person shown in the table.
    This table reflects the ownership of all shares of Common Stock and the
    Preferred Stock voting as a single class.
 
(3) Includes an aggregate of 58,000 shares of Common Stock underlying vested
    options to purchase Common Stock.
 
(4) Includes 10,137 shares held by Mr. Ward's wife for which Mr. Ward disclaims
    beneficial ownership.
 
(5) Includes 15 shares of Common Stock underlying vested options to purchase
    Common Stock.
 
(6) Includes 15 shares of Common Stock underlying vested options to purchase
    Common Stock.
 
(7) Includes an aggregate of 58,170 shares of Common Stock underlying vested
    options to purchase Common Stock held by four of the Company's officers.
 
     All of the Preferred Stock is registered in the name of RBB Bank AG ("RBB
Bank"). RBB Bank is not included in the table above because the Company has been
informed that RBB Bank holds such Preferred Stock solely in the capacity of
custodian for the benefit of numerous other investors. The Company has been
informed that none of such investors, either individually or in the aggregate
with affiliated entities, beneficially owns more than five percent (5%) of the
Company's issued and outstanding capital stock.
 
                                       15
<PAGE>   17
 
ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
     None
 
ITEM 13.  EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
 
     (a)(1) Financial Statements.  The financial statements required to be filed
by Item 7 herewith are as follows:
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Report of Independent Accountants...........................  F-1
Balance Sheet as of December 31, 1998 and December 31,
  1997......................................................  F-2
Statement of Operations for the years ended December 31,
  1998 and December 31, 1997................................  F-3
Statement of Stockholders' Equity for the years ended
  December 31, 1998 and
  December 31, 1997.........................................  F-4
Statement of Cash Flows for the years ended December 31,
  1998 and December 31, 1997................................  F-5
Notes to Financial Statements...............................  F-6
</TABLE>
 
     (a)(2) Exhibits.
 
     (i) The following exhibits are filed herewith:
 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                            DESCRIPTION
-------                          -----------
<S>      <C>
3a*      Certificate of Incorporation, as amended.(3c)
3b*      Certificate of Amendment of Certificate of Incorporation to
         increase the number of authorized shares.(3a)
3c*      Certificate of Amendment of Certificate of Incorporation to
         effect a 1:4 reverse split of Common Stock.(3b)
3d**     Statement of Designation of Series B Convertible Preferred
         Stock.(4a)
3e**     Statement of increase of shares designated as Series B
         Convertible Preferred Stock.(4b)
3f(+)    Statement of Designation of Series C Convertible Preferred
         Stock.(99a)
3g(+)    Statement of Designation of Series D Convertible Preferred
         Stock.(99b)
3h(++)   Statement of Designation of Series E Convertible Preferred
         Stock.(4(a))
3i       Statement of Designation of Series F Convertible Preferred
         Stock.
3j@      By-Laws.(3.02)
4a       Instruments defining the rights of security holders (see
         Exhibits 3a through 3j).
4b*      Specimen Certificate of Common Stock, $.08 par value per
         share.(4)
10a%     1994 Stock Option Plan.
10b#%    1995 Stock Option Plan.(10)
10c%     1997 Stock Option Plan.
10d%     1998 Stock Option Plan.
10e(++)  Form of Regulation S Offshore Subscription Agreement.(4(b))
10f      Employment Agreement of Dr. Bibby.
27       Financial Data Schedule.
</TABLE>
 
---------------
 
<TABLE>
<S>  <C>
*    Previously filed with the Commission as Exhibits to, and
     incorporated herein by reference from, the Company's Annual
     Report on Form 10-K for the fiscal year ended December 29,
     1996.
**   Previously filed with the Commission as Exhibits to, and
     incorporated herein by reference from, the Company's Current
     Report on Form 8-K filed September 16, 1996.
(+)  Previously filed with the Commission as Exhibits to, and
     incorporated herein by reference from, the Company's Current
     Report on Form 8-K filed March 3, 1997.
</TABLE>
 
                                       16
<PAGE>   18
<TABLE>
<S>  <C>
(++) Previously filed with the Commission as Exhibits to, and
     incorporated herein by reference from, the Company's Current
     Report on Form 8-K filed March 6, 1998.
@    Previously filed with the Commission as Exhibits to, and
     incorporated herein by reference from, the Company's
     Registration Statement on Form S-1 filed April 17, 1987.
#    Previously filed with the Commission as Exhibits to, and
     incorporated herein by reference from, the Company's Annual
     Report on Form 10-K for the fiscal year ended December 31,
     1995.
%    Management contract or compensatory plan, contract or
     arrangement.
</TABLE>
 
     Where a document is incorporated by reference from a previous filing, the
Exhibit number of the document in that previous filing is indicated in
parentheses after the description of such document.
 
     (b) Reports on Form 8-K.
 
     During the quarter for which this report is filed, the Company filed (i) a
Form 8-K dated October 22, 1998 to report the notice received from NASDAQ that
the Company was delisted from the SmallCap Market (ii) a Form 8-K dated November
25, 1998 to report the issuance of shares of Common Stock pursuant to Regulation
S, and (iii) a Form 8-K dated December 16, 1998 to report the issuance of shares
of Common Stock pursuant to Regulation S.
 
                                       17
<PAGE>   19
 
                                   SIGNATURES
 
     In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
 
                                          NATIONAL DATACOMPUTER, INC.
 
                                          By:     /s/ MALCOLM M. BIBBY
                                            ------------------------------------
                                                      Malcolm M. Bibby
                                                         President
 
Date: March 30, 1999
 
     In accordance with the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
NAME                                                               CAPACITY                      DATE
----                                                               --------                      ----
<C>                                                    <S>                                  <C>
 
               /s/ MALCOLM M. BIBBY                    Chairman of the Board, President
---------------------------------------------------      and Chief Executive Officer
                 Malcolm M. Bibby                        (principal executive officer)      March 30, 1999
 
               /s/ WILLIAM R. SMART                    Director
---------------------------------------------------
                 William R. Smart                                                           March 30, 1999
 
                 /s/ JOHN P. WARD                      Director
---------------------------------------------------
                   John P. Ward                                                             March 30, 1999
 
               /s/ GERALD S. EILBERG                   Chief Financial Officer
---------------------------------------------------      (principal financial and
                 Gerald S. Eilberg                       accounting officer)                March 30, 1999
</TABLE>
 
                                       18
<PAGE>   20
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Stockholders
of National Datacomputer, Inc.
 
In our opinion, the accompanying balance sheet and the related statements of
operations, of stockholders' equity and of cash flows present fairly, in all
material respects, the financial position of National Datacomputer, Inc. at
December 31, 1998 and 1997, and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles. 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 of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
 
PricewaterhouseCoopers LLP
 
Boston, Massachusetts
March 12, 1999
 
                                       F-1
<PAGE>   21
 
                          NATIONAL DATACOMPUTER, INC.
 
                                 BALANCE SHEET
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,    DECEMBER 31,
                                                                  1998            1997
                                                              ------------    ------------
<S>                                                           <C>             <C>
                                          ASSETS
Current Assets:
 
  Cash and cash equivalents.................................  $    491,174    $    208,731
  Accounts receivable, net of allowance for doubtful
     accounts of $146,600 and $108,602 at December 31, 1998
     and December 31, 1997, respectively....................     1,048,315       1,545,319
  Inventories...............................................     1,516,306       1,298,979
  Other current assets......................................        31,493          59,800
                                                              ------------    ------------
     Total current assets...................................     3,087,288       3,112,829
Fixed assets, net...........................................       205,508         259,512
                                                              ------------    ------------
                                                              $  3,292,796    $  3,372,341
                                                              ============    ============
                           LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
 
  Convertible debt to related party.........................  $         --    $     75,000
  Current obligations under capital lease...................        44,198          41,810
  Accounts payable..........................................       356,866         349,807
  Accrued payroll and related taxes.........................        78,224         127,675
  Accrued expenses -- other.................................       218,264         264,024
  Accrued interest on preferred stock.......................         6,125         102,750
  Deferred revenues, current portion........................       552,334         470,125
  Deferred compensation.....................................            --          45,214
                                                              ------------    ------------
     Total current liabilities..............................     1,256,011       1,476,405
Convertible debt to related party...........................            --         158,730
Obligations under capital lease.............................        25,754          70,617
Deferred revenues...........................................         6,143          38,143
                                                              ------------    ------------
                                                                 1,287,908       1,743,895
                                                              ------------    ------------
Stockholders' equity
 
  Preferred stock, Series A convertible, $0.001 par value;
     20 shares authorized; 0 shares issued and outstanding
     at December 31, 1998 and December 31, 1997.............            --              --
  Preferred stock, Series B convertible $0.001 par value;
     4,200 shares authorized, issued and outstanding
     (liquidating preference of $4,200,000).................     3,685,206       3,685,206
  Preferred stock, Series C convertible $0.001 par value;
     900 shares authorized, issued and outstanding
     (liquidating preference of $900,000)...................       834,370         808,412
  Preferred stock, Series D convertible $0.001 par value;
     350 shares authorized, issued and outstanding
     (liquidating preference $350,000)......................       324,639         303,995
  Preferred stock, Series E convertible $0.001 par value;
     500 shares authorized; 500 and 0 shares issued and
     outstanding at December 31, 1998 and December 31, 1997,
     respectively (liquidating preference of $500,000)......       273,880              --
  Preferred stock, Series F convertible $0.001 par value;
     175 shares authorized; 175 and 0 shares issued and
     outstanding at December 31, 1998 and December 31, 1997,
     respectively (liquidating preference of $175,000)......       118,750              --
  Common stock, $0.08 par value; 5,000,000 shares
     authorized; 2,276,850 and 1,628,332 shares issued and
     outstanding at December 31, 1998 and December 31, 1997,
     respectively...........................................       182,148         130,267
  Capital in excess of par value............................    10,998,903      10,310,761
  Accumulated deficit.......................................   (14,000,566)    (13,165,753)
  Unamortized stock compensation............................       (61,173)        (93,173)
  Notes receivable -- employees.............................      (351,269)       (351,269)
                                                              ------------    ------------
     Total stockholders' equity.............................     2,004,888       1,628,446
                                                              ------------    ------------
                                                              $  3,292,796    $  3,372,341
                                                              ============    ============
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       F-2
<PAGE>   22
 
                          NATIONAL DATACOMPUTER, INC.
 
                            STATEMENT OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                       YEAR ENDED
                                                              ----------------------------
                                                              DECEMBER 31,    DECEMBER 31,
                                                                  1998            1997
                                                              ------------    ------------
<S>                                                           <C>             <C>
Revenues
  Net product revenue.......................................  $ 3,507,532     $ 4,644,903
  Service and other revenue.................................    1,747,495       1,167,875
                                                              -----------     -----------
                                                                5,255,027       5,812,778
Cost of sales and services..................................    2,780,698       3,264,805
                                                              -----------     -----------
                                                                2,474,329       2,547,973
                                                              -----------     -----------
Operating expenses:
  Research and development..................................      992,495       1,275,916
  Selling, general and administrative.......................    1,773,414       2,373,285
                                                              -----------     -----------
                                                                2,765,909       3,649,201
                                                              -----------     -----------
Loss from operations........................................     (291,580)     (1,101,228)
Other income (expense):
  Interest income...........................................        9,534          13,258
  Interest expense..........................................      (40,128)       (124,596)
  Other expense.............................................      (99,014)             --
                                                              -----------     -----------
Net loss....................................................  $  (421,188)    $(1,212,566)
                                                              ===========     ===========
Calculation of net loss per common share and dilutive share
  equivalent:
  Net loss..................................................  $  (421,188)    $(1,212,566)
  Preferred stock preferences...............................     (767,977)       (667,412)
                                                              -----------     -----------
Net loss attributable to common shareholders................  $(1,189,165)    $(1,879,978)
                                                              ===========     ===========
Basic and diluted net loss per share........................  $     (0.66)    $     (1.40)
                                                              ===========     ===========
Weighted average shares.....................................    1,798,226       1,343,876
                                                              ===========     ===========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       F-3
<PAGE>   23
 
                          NATIONAL DATACOMPUTER, INC.
 
                       STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                             PREFERRED STOCK         PREFERRED STOCK         PREFERRED STOCK         PREFERRED STOCK
                                SERIES B                SERIES C                SERIES D                SERIES E
                          ---------------------   ---------------------   ---------------------   ---------------------
                                   NET ISSUANCE            NET ISSUANCE            NET ISSUANCE            NET ISSUANCE
                          SHARES      PRICE       SHARES      PRICE       SHARES      PRICE       SHARES      PRICE
                          ------   ------------   ------   ------------   ------   ------------   ------   ------------
<S>                       <C>      <C>            <C>      <C>            <C>      <C>            <C>      <C>
Balance at December 29,
 1996...................  4,200     $3,685,206      --             --       --             --       --             --
Net loss................
Issuance of preferred
 stock..................                           900       $867,183      350       $337,400
Interest on preferred
 stock (Note 9).........
Issuance of common stock
 in satisfaction of
 accrued interest.......
Amortization of stock
 compensation...........
Discounted conversion
 rate on Preferred
 Stock..................                                     (172,266)               (136,998)
Amortization of
 discounted conversion
 rate on Preferred
 Stock..................                                      146,308                 116,354
Issuance of common stock
 as payment of issuance
 cost on preferred stock
 and convertible debt...                                      (32,813)                (12,761)
Discount conversion rate
 on convertible debt....
                          -----     ----------     ---       --------      ---       --------      ---       --------
Balance at December 31,
 1997...................  4,200      3,685,206     900        808,412      350        303,995       --             --
Net loss................
Issuance of preferred
 stock..................                                                                           500        273,880
Interest on preferred
 stock (Note 9).........
Issuance of common stock
 in satisfaction of
 accrued interest.......
Amortization of stock
 compensation...........
Discounted conversion
 rate on Preferred
 Stock..................                                                                                      (75,000)
Amortization of
 discounted conversion
 rate on Preferred
 Stock..................                                       25,958                  20,644                  75,000
                          -----     ----------     ---       --------      ---       --------      ---       --------
Balance at December 31,
 1998...................  4,200     $3,685,206     900       $834,370      350       $324,639      500       $273,880
                          =====     ==========     ===       ========      ===       ========      ===       ========
 
<CAPTION>
                             PREFERRED STOCK                 COMMON STOCK
                                SERIES F          -----------------------------------
                          ---------------------                           CAPITAL IN      NOTES      UNAMORTIZED
                                   NET ISSUANCE                 PAR         EXCESS      RECEIVABLE      STOCK       ACCUMULATED
                          SHARES      PRICE        SHARES      VALUE     OF PAR VALUE   EMPLOYEES    COMPENSATION     DEFICIT
                          ------   ------------   ---------   --------   ------------   ----------   ------------   ------------
<S>                       <C>      <C>            <C>         <C>        <C>            <C>          <C>            <C>
Balance at December 29,
 1996...................    --             --     1,251,925   $100,154   $ 9,755,957    $(351,269)    $ (124,769)   $(11,548,437)
Net loss................                                                                                              (1,212,566)
Issuance of preferred
 stock..................
Interest on preferred
 stock (Note 9).........                                                                                                (404,750)
Issuance of common stock
 in satisfaction of
 accrued interest.......                            303,490     24,280       361,720
Amortization of stock
 compensation...........                                                                                  31,596
Discounted conversion
 rate on Preferred
 Stock..................                                                     309,264
Amortization of
 discounted conversion
 rate on Preferred
 Stock..................                                                    (262,662)
Issuance of common stock
 as payment of issuance
 cost on preferred stock
 and convertible debt...                             72,917      5,833        48,856
Discount conversion rate
 on convertible debt....                                                      97,626
                           ---       --------     ---------   --------   -----------    ---------     ----------    ------------
Balance at December 31,
 1997...................    --             --     1,628,332    130,267    10,310,761     (351,269)    $  (93,173)    (13,165,753)
Net loss................                                                                                                (421,188)
Issuance of preferred
 stock..................   175        175,000                                214,000
Interest on preferred
 stock (Note 9).........                                                                                                (413,625)
Issuance of common stock
 in satisfaction of
 accrued interest.......                            648,518     51,881       464,494
Amortization of stock
 compensation...........                                                                                  32,000
Discounted conversion
 rate on Preferred
 Stock..................              (75,000)                               150,000
Amortization of
 discounted conversion
 rate on Preferred
 Stock..................               18,750                               (140,352)
                           ---       --------     ---------   --------   -----------    ---------     ----------    ------------
Balance at December 31,
 1998...................   175       $118,750     2,276,850   $182,148   $10,998,903    $(351,269)    $  (61,173)   $(14,000,566)
                           ===       ========     =========   ========   ===========    =========     ==========    ============
 
<CAPTION>
 
                              TOTAL
                          STOCKHOLDERS'
                             EQUITY
                          -------------
<S>                       <C>
Balance at December 29,
 1996...................   $ 1,516,842
Net loss................    (1,212,566)
Issuance of preferred
 stock..................     1,204,583
Interest on preferred
 stock (Note 9).........      (404,750)
Issuance of common stock
 in satisfaction of
 accrued interest.......       386,000
Amortization of stock
 compensation...........        31,596
Discounted conversion
 rate on Preferred
 Stock..................
Amortization of
 discounted conversion
 rate on Preferred
 Stock..................
Issuance of common stock
 as payment of issuance
 cost on preferred stock
 and convertible debt...         9,115
Discount conversion rate
 on convertible debt....        97,626
                           -----------
Balance at December 31,
 1997...................     1,628,446
Net loss................      (421,188)
Issuance of preferred
 stock..................       662,880
Interest on preferred
 stock (Note 9).........      (413,625)
Issuance of common stock
 in satisfaction of
 accrued interest.......       516,375
Amortization of stock
 compensation...........        32,000
Discounted conversion
 rate on Preferred
 Stock..................
Amortization of
 discounted conversion
 rate on Preferred
 Stock..................
                           -----------
Balance at December 31,
 1998...................   $ 2,004,888
                           ===========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       F-4

<PAGE>   24
 
                          NATIONAL DATACOMPUTER, INC.
 
                            STATEMENT OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                       YEAR ENDED
                                                              ----------------------------
                                                              DECEMBER 31,    DECEMBER 31,
                                                                  1998            1997
                                                              ------------    ------------
<S>                                                           <C>             <C>
Cash flows from operating activities:
  Net loss..................................................   $(421,188)     $(1,212,566)
  Adjustments to reconcile net loss to net cash used for
     operating activities:
     Depreciation...........................................     130,112          132,977
     Amortization of stock compensation.....................      32,000           31,596
     Amortization of deferred debt issuance costs and debt
      discount..............................................      18,789           91,952
     Changes in assets and liabilities:
       Decrease (increase) in accounts receivable...........     497,004         (924,282)
       (Increase) decrease in inventories...................    (217,327)         180,174
       Decrease in other current assets.....................      25,788           92,460
       Increase in accounts payable.........................       7,059          224,353
       Decrease in accrued expenses and deferred
        compensation........................................    (134,300)        (157,517)
       Increase (decrease) in deferred revenues.............      50,209         (245,500)
                                                               ---------      -----------
          Net cash used for operating activities............     (11,854)      (1,786,353)
                                                               ---------      -----------
Cash flows from investing activities:
  Purchases of fixed assets.................................     (76,108)        (143,774)
                                                               ---------      -----------
          Net cash used for investing activities............     (76,108)        (143,774)
                                                               ---------      -----------
Cash flows from financing activities:
  Proceeds from issuance of preferred stock and warrants,
     net of issuance costs..................................     487,880        1,204,583
  Proceeds from issuance of convertible note to related
     party..................................................          --          250,000
  Principal payment on convertible debt.....................     (75,000)              --
  Principal payments on obligations under capital lease.....     (42,475)         (38,010)
                                                               ---------      -----------
          Net cash provided by financing activities.........     370,405        1,416,573
                                                               ---------      -----------
Net increase (decrease) in cash and cash equivalents........     282,443         (513,554)
Cash and cash equivalents at beginning of year..............     208,731          722,285
                                                               ---------      -----------
Cash and cash equivalents at end of year....................   $ 491,174      $   208,731
                                                               =========      ===========
Supplemental Cash Flow Information:
  Cash paid for interest....................................   $  13,964      $    18,894
  Noncash investing and financing activities:
     Conversion of promissory note into Series F Preferred
      Stock.................................................     175,000               --
     Accrued interest on preferred stock charged to
      accumulated deficit...................................     413,625          102,750
     Acquisition of property and equipment under capital
      lease.................................................          --           14,185
     Common stock issued in satisfaction of interest on
      preferred stock.......................................     516,375          386,000
     Common stock issued as payment of issuance cost for
      preferred stock ($45,574) and convertible debt........          --           54,689
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.

                                       F-5
<PAGE>   25
 
                          NATIONAL DATACOMPUTER, INC.
 
                         NOTES TO FINANCIAL STATEMENTS
 
1.  ORGANIZATION
 
     National Datacomputer, Inc. (the "Company") designs, develops,
manufactures, markets and services a line of hand-held battery powered
microprocessor-based data collection products and computers and associated
peripherals for use in mobile operations.
 
     On December 28, 1997, the Board of Directors of the Company voted to change
the end of the Company's fiscal year from the last Sunday in December to
December 31.
 
     In 1998 and 1997, the Company used cash for operations of $11,854 and
$1,786,353, respectively. The Company has financed its operations primarily
through the issuance of preferred stock and convertible debt totaling $675,000
in 1998 and $1,500,000 in 1997. If the Company is not successful in attaining
and sustaining cash from operations, it will need to reduce operating costs or
raise additional financing to maintain its operations.
 
2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Revenue Recognition
 
     The Company recognizes revenue for products upon shipment at the time of
delivery to the customer, provided that the Company has no remaining significant
service obligations that are essential to the functionality of the product
delivered, collectibility is considered probable, and the fees are fixed and
determinable.
 
     Revenue from installation and training is recognized upon the completion of
the project. Service revenue is recognized ratably over the contractual period.
 
  Concentration of Credit Risk
 
     The Company sells its products to customers in diverse industries
nationwide, particularly delivery based services such as bakeries and beer
distributors. The Company performs on-going credit evaluations of its customers,
provides credit on an unsecured basis, and maintains reserves for potential
credit losses. Such losses, in the aggregate, have not exceeded management's
expectations. Accounts receivable from three and two customers accounted for
approximately 48% of total accounts receivable at December 31, 1998 and December
31, 1997, respectively. Management does not believe that the Company is subject
to any unusual credit risk beyond the normal credit risk attendant to operating
its business.
 
  Inventories
 
     Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out (FIFO) method.
 
  Fixed Assets
 
     Fixed Assets are recorded at cost and depreciated over the estimated useful
lives of the assets, principally using accelerated methods. Leasehold
improvements are amortized over the shorter of the useful lives or the remaining
terms of the related leases. Maintenance and repair costs are expensed as
incurred.
 
  Loss Per Share
 
     Net loss per share is computed under SFAS No. 128, "Earnings Per Share."
Basic loss per share is computed by dividing loss, after deducting certain
amounts associated with the Company's preferred stock, by the weighted average
number of common shares outstanding for the period. Diluted earnings per share
is
 
                                       F-6
<PAGE>   26
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
computed using the weighted average number of common shares outstanding and
gives effect to all dilutive common share equivalents outstanding during the
period.
 
     Interest payable to preferred stockholders, the fair value of inducements
to convert preferred stock into common stock, and any discounts implicit in the
conversion terms upon issuance of preferred stock (Note 9) are added to the net
loss to determine the amount of net loss attributable to common stockholders.
 
     Common share equivalents consist of 4,174,336 and 2,625,444 shares of
common stock which may be issuable upon exercise of outstanding stock options
and warrants and the conversion of preferred stock and convertible debt at
December 31, 1998 and December 31, 1997, respectively. All common share
equivalents have been excluded from the calculation of weighted average shares
outstanding as their inclusion would be anti-dilutive.
 
  Stock Compensation
 
     The Company's employee stock option plans are accounted for in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," ("APB 25"). The Company adopted SFAS No. 123, "Accounting for Stock
Based Compensation," for disclosure only (Note 7).
 
  Research and Development and Computer Software Development Costs
 
     Research and development costs, other than software development costs, have
been charged to operations as incurred. SFAS No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased or Otherwise Marketed," requires the
capitalization of certain computer software development costs incurred after
technological feasibility is established. No software development costs have
been capitalized.
 
  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 amount of assets and liabilities and
disclosure of contingencies at the date of the financial statements, and the
reported results of operations during the reporting period. Actual results could
differ from these estimates.
 
  New Accounting Pronouncements
 
     In June 1998, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). SFAS 133 is effective for all fiscal quarters and for
all fiscal years beginning after June 15, 1999. SFAS 133 will not have any
impact on the Company's financial position and results of operations.
 
3.  INVENTORIES
 
     Inventories consist of the following:
 
<TABLE>
<CAPTION>
                                                             DECEMBER 31,    DECEMBER 31,
                                                                 1998            1997
                                                             ------------    ------------
<S>                                                          <C>             <C>
Raw materials..............................................   $  424,173      $  623,593
Work-in-process............................................      731,730         450,238
Finished goods.............................................      360,403         225,148
                                                              ----------      ----------
                                                              $1,516,306      $1,298,979
                                                              ==========      ==========
</TABLE>
 
                                       F-7
<PAGE>   27
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
4.  FIXED ASSETS
 
     Fixed assets consist of the following:
 
<TABLE>
<CAPTION>
                                                ESTIMATED
                                              USEFUL LIVES     DECEMBER 31,    DECEMBER 31,
                                               (IN YEARS)          1998            1997
                                              -------------    ------------    ------------
<S>                                           <C>              <C>             <C>
Production and engineering equipment........       3-5          $  864,921      $  809,363
Furniture, fixtures and office equipment....        5              738,177         717,629
Leasehold improvements......................  Life of lease         23,021          23,021
                                                                ----------      ----------
                                                                $1,626,119      $1,550,013
Less -- accumulated depreciation and
  amortization..............................                     1,420,611       1,290,501
                                                                ----------      ----------
                                                                $  205,508      $  259,512
                                                                ==========      ==========
</TABLE>
 
     At December 31, 1998, office and engineering equipment under capital lease
totaled $156,998. Related accumulated amortization of equipment under capital
lease totaled $109,059 at December 31, 1998. At December 31, 1997, office and
engineering equipment under capital lease totaled $156,998, with related
accumulated amortization of $77,100.
 
5.  CONVERTIBLE DEBT
 
     In March 1997, the Company issued an unsecured Convertible Promissory Note
for $250,000 to RBB Bank AG. The note bears interest at the rate of 6% per annum
and had an original maturity date of March 1998. In March 1998, $175,000 of this
note was refinanced and will mature in March 1999.
 
     The note is convertible at the option of the holder into shares of the
Company's common stock at a price of $2.74 per share. The discount of $97,626
implicit in the conversion terms at the date of issuance, based upon the market
price for the Company's common stock on that date, was recorded as a debt
discount and additional paid in capital. The debt discount is being amortized
over the term of the note as a charge to interest expense. Amortization of the
debt discount totaled $16,270 and $81,356 in 1998 and 1997, respectively.
 
     In March 1998, the Company refinanced the $250,000 convertible debt by
making a principal payment of $75,000 and issuing a convertible note payable for
$175,000. The note bears interest at a rate of 6% per annum, matures in March
1999, and is convertible into shares of the Company's common stock at a
conversion price of $1.34.
 
     In September 1998, the holders of the note payable converted the
outstanding debt of $175,000 into 175 shares, at a stated value of $1,000 per
share, of Series F Convertible Preferred Stock.
 
                                       F-8
<PAGE>   28
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
6.  INCOME TAXES
 
     Deferred tax assets are comprised of the following:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,    DECEMBER 31,
                                                                1998            1997
                                                            ------------    ------------
<S>                                                         <C>             <C>
Net operating loss carryforwards..........................  $ 4,253,449     $ 4,189,000
Business tax credit carryforwards.........................      291,611         297,000
Other.....................................................      189,240         127,000
                                                            -----------     -----------
Gross deferred tax asset..................................    4,734,300       4,613,000
Deferred tax asset valuation allowance....................   (4,734,300)     (4,613,000)
                                                            -----------     -----------
                                                            $        --     $        --
                                                            ===========     ===========
</TABLE>
 
     The Company's effective tax rate differs from the statutory U.S. federal
tax rate as follows:
 
<TABLE>
<CAPTION>
                                                                      YEAR ENDED
                                                             ----------------------------
                                                             DECEMBER 31,    DECEMBER 31,
                                                                 1998            1997
                                                             ------------    ------------
<S>                                                          <C>             <C>
Statutory federal rate.....................................     (34.0)%         (34.0)%
State taxes................................................      (5.0)%          (6.0)%
Non-deductible expenses....................................       6.0%            0.4%
Other......................................................       4.0%           (4.0)%
Valuation allowance on deferred tax assets.................      29.0%           43.6%
                                                                -----           -----
                                                                  0.0%            0.0%
                                                                =====           =====
</TABLE>
 
     The Company has generated losses from operations in each of the last two
years and has no taxable income available to offset the carryback of net
operating losses. In addition, although management's operating plans anticipate
taxable income in future periods, such plans make significant assumptions which
cannot be reasonably assured, including continued development and market
acceptance of new products and expansion of the Company's customer base. Based
on the weight of all available evidence, the Company has provided a full
valuation allowance for deferred tax assets since the realization of these
future benefits is not sufficiently assured. As the Company achieves
profitability, these deferred tax assets would be available to offset future
income tax liabilities and expense.
 
     At December 31, 1998, the Company has net operating loss and tax credit
carryforwards for federal tax purposes of $11,612,000 and $290,457,
respectively, which expire in various years through 2018 and 2010, respectively.
The Company has state net operating loss carryforwards for tax purposes of
$4,873,000, which expire in various years through 2003.
 
     Any significant change in ownership, as defined in the Internal Revenue
Code, may result in an annual limitation on the amount of the net operating loss
and credit carryforwards which could be utilized.
 
7.  STOCK OPTIONS
 
     In 1989, 1994 and 1995, the Board of Directors approved the 1989 Stock
Option Plan, the 1994 Stock Option Plan and the 1995 Stock Option Plan (the
"Plans") respectively. The Plans provide for the granting of incentive stock
options and non-qualified stock options to purchase up to 323,685 shares of
common stock of the Company to employees, officers, directors and consultants.
The exercise price for incentive stock options granted may not be less than 100%
of the fair market value per share of the common stock on the date granted (110%
for options granted to holders of more than 10% of the voting stock of the
Company). The exercise price per share for non-qualified options may not be less
than the lesser of 50% of the fair market value per
 
                                       F-9
<PAGE>   29
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
share of the common stock on the date of grant or the book value per share of
common stock as of the end of the fiscal year immediately preceding the date of
grant. The term of options granted under the Plans cannot exceed ten years (five
years for options granted to holders of more than 10% of the voting stock of the
Company). Outstanding options are written generally with five to ten-year
vesting periods, some with acceleration if certain profitability levels are
reached, and are fully exercisable by 2007.
 
     On August 19, 1997, the Board of Directors, adopted the 1997 Stock Option
Plan ("1997 Plan") which provided for issuance of both incentive stock options
and non-qualified options to employees. A maximum of 200,000 shares of Common
Stock was reserved for issuance in accordance with the terms of the 1997 Plan.
The 1997 Plan now only provides for the issuance of non-qualified options since
a stockholder meeting was not held.
 
     On January 1, 1998, the Board of Directors adopted the 1998 Stock Option
Plan ("1998 Plan") which provides for issuance of non-qualified options to
employees. A maximum of 300,000 shares of common stock of the Company will be
reserved for issuance in accordance with the terms of the 1998 Plan.
 
     A summary of the status of the Company's stock option plans as of December
31, 1998 and December 31, 1997 are summarized as follows:
 
<TABLE>
<CAPTION>
                                                      DECEMBER 31, 1998        DECEMBER 31, 1997
                                                    ---------------------    ---------------------
                                                                 WEIGHTED                 WEIGHTED
                                                                 AVERAGE                  AVERAGE
                                                    NUMBER OF    EXERCISE    NUMBER OF    EXERCISE
                                                     OPTIONS      PRICE       OPTIONS      PRICE
                                                    ---------    --------    ---------    --------
<S>                                                 <C>          <C>         <C>          <C>
Outstanding at beginning of year..................   277,716      $1.56       288,972      $4.82
Granted...........................................   354,000       0.82        16,875       1.47
Exercised.........................................        --         --            --         --
Canceled..........................................   (85,598)      1.47       (28,131)      4.07
                                                     -------      -----       -------      -----
Outstanding at end of year........................   546,118      $1.10       277,716      $1.56
                                                     =======      =====       =======      =====
Exercisable at end of year........................    62,338      $1.77        59,778      $1.85
                                                     =======      =====       =======      =====
Weighted average fair value of options granted
  during the period...............................                $0.81                    $1.47
                                                                  =====                    =====
</TABLE>
 
     On August 14, 1997, the Board of Directors approved the repricing of
certain outstanding options with original exercise prices ranging from $4.00
-$20.00 to a $1.47 exercise price. The exercise price of the repriced options
equaled the fair market value of the Company's common stock on the date of
repricing.
 
     The following table summarizes information about stock options outstanding
at December 31, 1998:
 
<TABLE>
<CAPTION>
                                                                                        WEIGHTED
                                                                                        AVERAGE
                                                WEIGHTED AVERAGE                        EXERCISE
                                                    REMAINING         NUMBER OF         PRICE OF
                                   NUMBER       CONTRACTUAL LIFE,      OPTIONS          OPTIONS
EXERCISE PRICE                   OUTSTANDING        IN YEARS         EXERCISABLE      EXERCISABLE
--------------                   -----------    -----------------    -----------    ----------------
<S>                              <C>            <C>                  <C>            <C>
$0.73 - $1.47..................    537,560            8.53             54,600            $1.47
$4.00 - $8.00..................      8,425            5.33              7,605             4.36
$20.00.........................        133            0.97                133            20.00
                                   -------                             ------            -----
     Total.....................    546,118                             62,338            $1.77
                                   =======                             ======            =====
</TABLE>
 
                                      F-10
<PAGE>   30
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     The Company did not recognize any compensation expense under APB No. 25
during the years ended December 31, 1998 and December 31, 1997.
 
     As discussed in Note 2, the Company elected to adopt SFAS No. 123 through
disclosure only. Had compensation cost for the Company's option plans been
determined based on the fair value of the options at the grant dates, as
prescribed by SFAS No. 123, the Company's net loss and net loss per share would
have been as follows:
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED      YEAR ENDED
                                                             DECEMBER 31,    DECEMBER 31,
                                                                 1998            1997
                                                             ------------    ------------
<S>                                                          <C>             <C>
Net loss:
  As reported..............................................    $421,188       $1,212,566
  Pro forma................................................    $484,800       $1,304,272
Basic and diluted net loss per share:
  As reported..............................................    $   0.66       $     1.40
  Pro forma................................................    $   0.70       $     1.47
</TABLE>
 
     The fair value of each option grant under SFAS No. 123 was estimated on the
date of grant using the Black-Scholes option pricing model with the following
assumptions used for grants in 1998 and 1997, respectively:
 
     I.  Dividend yield of 0% for both periods;
 
     II.  Expected volatility of 158% and 291%;
 
     III.  Risk free interest rates of 5.37% -- 5.40% for options granted during
           the year ended December 31, 1998 and 6.34% -- 6.71% for the year
           ended December 31, 1997; and
 
     IV.  Weighted average expected option term of 10 years for both periods.
 
     Because options vest over several years and additional options grants are
expected to be made in subsequent years, the above pro forma disclosures are not
necessarily representative of the pro forma effects on reported net income
(loss) for future years.
 
8.  COMMON STOCK
 
     In January 1996, the Company entered into an agreement with a consulting
firm, whereby the Company would compensate the firm for their services through
the issuance of 31,192 shares of the Company's common stock. The value of these
shares at the time of issuance was estimated by management to be approximately
$156,000, which is being amortized to expense over the five year term of the
agreement. Unamortized amounts are presented as a reduction of stockholders'
equity in the accompanying balance sheet.
 
     On October 4, 1996, the Board of Directors approved an increase in the
number of authorized shares of Common Stock to 5,000,000 shares.
 
     At December 31, 1998, the Company had reserved 2,723,150 shares of common
stock for issuance upon the exercise of common stock options and warrants and
the conversion of preferred stock. After the issuance of the Series E
convertible preferred stock, the 1998 option grants and changes made to the
conversion terms of the previously issued Series B, C and D convertible
preferred stock in 1998, the Company is required to reserve additional shares of
common stock which have not yet been authorized.
 
     The Board of Directors of the Company will request approval from the
stockholders to increase the number of authorized shares in fiscal 1999. The
Company expects the shareholders to approve the authorization of the required
additional shares.
 
                                      F-11
<PAGE>   31
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
9.  CONVERTIBLE PREFERRED STOCK
 
     In the second quarter of 1996, the Board of Directors approved the
designation of 4,200 shares of the Company's unissued preferred stock, $.001 par
value, as Series B convertible preferred stock. During 1996, the Company sold
4,200 shares of the newly designated Series B convertible preferred stock for
net proceeds of approximately $3,685,200.
 
     In February 1997, the Board of Directors approved the designation of 900
shares of the Company's unissued preferred stock, $.001 par value, as Series C
convertible preferred stock. During 1997, the Company sold 900 shares of newly
designated Series C convertible preferred stock for net proceeds of
approximately $867,000. As payment of certain offering costs associated with the
issuance of the Series C convertible preferred stock, the Company issued 43,751
shares of unregistered common stock for a value of $32,813 based on the quoted
market price.
 
     In February 1997, the Board of Directors approved the designation of 350
shares of the Company's unissued preferred stock, $.001 par value, as Series D
convertible preferred stock. During 1997, the Company sold 350 shares of newly
designated Series D convertible preferred stock for net proceeds of
approximately $337,400. As payment of certain offering costs associated with the
issuance of the Series C convertible preferred stock, the Company issued 17,013
shares of unregistered common stock for a value of $12,764 based on the quoted
market price.
 
     In January 1998, the Board of Directors approved the designation of 500
shares of the Company's unissued preferred stock, $.001 par value, as Series E
convertible preferred stock. During 1998, the Company sold 500 shares of newly
designated Series E convertible preferred stock with attached warrants to
purchase up to 700,000 shares of common stock at $.75 per share, for net
proceeds of approximately $487,880. The proceeds of this financing were
allocated to the preferred shares and warrants based on management's estimation
of their fair values. This resulted in $214,000 being ascribed to warrants,
which was recorded as additional paid-in-capital and $273,880 being recorded as
preferred stock.
 
     In September 1998, the Board of Directors approved the designation of 175
shares of the Company's unissued preferred stock, $.001 par value, as Series F
convertible preferred stock. During 1998, the holders of the convertible note
payable to a related party, converted debt with an outstanding principal balance
of $175,000 into 175 shares of Series F convertible preferred stock at a stated
value of $1,000 per share.
 
     The Series B, Series C, Series D, Series E, and Series F convertible
preferred stock have the following characteristics:
 
  Voting:
 
     Holders of the Series B, Series C, Series D, Series E, and Series F
convertible preferred stock are entitled to a number of votes equal to the
number of shares of common stock into which these shares of convertible
preferred stock are then convertible. All shares of convertible preferred stock
are entitled to vote with the holders of common stock as a single class.
 
  Dividends:
 
     Holders of the Series B, Series C, Series D, Series E, and Series F
convertible preferred stock are entitled to receive dividends, when and if
declared by the Company's Board of Directors, prior and in preference to common
shareholders, equal to the amount of the per share dividend of common stock
declared, multiplied by the number of shares of common stock into which the
convertible preferred shares are then convertible.
 
                                      F-12
<PAGE>   32
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
  Interest:
 
     In addition to the dividend preference, the holders of the Series B, Series
C, Series D, and Series F convertible preferred stock shall receive interest per
annum based on the stated value of such shares. Series B convertible preferred
shareholders are entitled to receive interest equal to 8% per annum, Series C,
Series D and Series F convertible preferred shareholders are entitled to receive
interest equal to 6% per annum. Such interest will accrue from the original
issuance date, and shall be payable in cash or common stock, at the Company's
option, on a quarterly basis, commencing on the first quarter ended after
issuance. Payment of interest due with respect to those shares that remain
issued and outstanding at the end of the Company's fiscal quarters, shall be
made within 15 days after the filing with the Securities and Exchange Commission
of the applicable report.
 
     During the years ended December 31, 1998 and December 31, 1997, the Company
incurred interest in the amount of $413,625 and $404,750, respectively for
Series B, Series C, Series D, and Series F convertible preferred stock for which
the Company has recorded a charge to accumulated deficit. During 1998, 380,650
shares were issued in satisfaction of the accrued interest due for 1998 and
99,252 shares were issued in satisfaction of the accrued and unpaid interest due
for 1997. In addition, $105,375 of interest remains unpaid and is recorded as
168,600 shares of common shares issued at December 31, 1998. During 1997,
276,604 shares were issued in satisfaction of the accrued interest due for 1997.
In addition, $102,750 of interest remained unpaid and is included in accrued
interest at December 31, 1997.
 
  Liquidation Preference:
 
     Upon liquidation of the Company, the holders of Series B, Series C, Series
D, Series E, and Series F convertible preferred stock have preference over the
common stockholders to receive liquidating distributions which equal the stated
value of such shares of stock, plus all accrued and unpaid dividends.
 
  Conversion:
 
     In connection with the issuance of Series E convertible preferred stock,
the Company, with the approval of the shareholders of Series B, Series C, and
Series D convertible preferred stock changed the conversion price of the Series
B, Series C, and Series D convertible preferred stock to $2.74 and provided
these shareholders with certain anti-dilution provisions. If at any time prior
to January 31, 2003, the Corporation's stockholders' equity at the end of any
fiscal quarter as reported on the Company's Form 10-KSB, or quarterly on Form
10-QSB filing with the Securities and Exchange Commission does not exceed
$1,500,000 plus 50% of the net proceeds of any future equity financing, then the
conversion price shall equal the lesser of $2.74 or sixty percent of the
Corporation's average closing price for the five trading days prior to the
conversion.
 
     Each share of the Series B, Series C, Series D and Series E convertible
preferred stock is convertible at any time, at the option of the holders into
shares of common stock computed by dividing the stated value of the preferred
stock by the conversion price. The Series F convertible preferred stock is not
convertible until one year after issuance
 
     The shareholders of Series E convertible preferred stock shall have the
right to convert each share of Series E convertible stock into an amount of
shares of common stock equal to the stated value of $1,000 per share divided by
the conversion price of $0.75.
 
     On or after December 31, 1998, the conversion price for the Series E
convertible preferred stock shall equal sixty percent of the Corporation's
average closing bid price for the twenty trading days preceding the date of such
conversion, but in no event less than $0.60 and no more than $0.75 per share. If
at any time prior to January 31, 2003 the Company's stockholders' equity at the
end of any fiscal quarter does not exceed $1.5 million plus 50% of the net
proceeds of any future equity financing by any third party, then the conversion
price shall equal the lesser of $0.75 or sixty percent of the Company's bid
price for the five trading days prior
                                      F-13
<PAGE>   33
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
to the date of such conversion notice. The Shareholders of Series E convertible
preferred stock may not convert for a period of forty days from the date of
issuance.
 
     The shareholders of Series F convertible preferred stock shall have the
right to convert each share of Series F convertible stock into an amount of
shares of common stock equal to the stated value of $1,000 per share divided by
the conversion price of $1.00. During the six month period commencing on the one
year anniversary of the date upon the Series F shares are originally issued and
continuing until the eighteen month anniversary of the issue date, the
conversion price shall equal $1.00.
 
     During the period after this eighteen month anniversary and continuing
until all shares are converted, the conversion price of the Series F convertible
preferred stock shall equal the lesser of (i) $1.00 and (ii) if the closing
price shall trade below $1.00 for any ten consecutive trading days, then the
conversion price shall equal 70% of the Company's average bid price for the ten
days preceding the date of the conversion notice. The shareholders of Series F
convertible preferred stock may not convert for a period of a year from the date
of issuance.
 
  Conversion discount:
 
     The estimated discount of $46,601 and $262,662 implicit in the conversion
terms of the Series C and Series D convertible preferred stock at the date of
the issuance, based upon the quoted bid price for the Company's common stock on
those dates, has been included in the computation of net loss per share (Note 2)
for the years ended December 31, 1998 and December 31, 1997, respectively. The
estimated discount was recorded as a discount on the preferred stock and an
increase to additional paid-in capital. The amortization of the conversion
discount of $46,601 and $262,662 has been recorded as an increase to the
preferred stock and a decrease to additional paid-in capital for the years ended
December 31, 1998 and December 31, 1997, respectively.
 
     The estimated discount of $150,000 implicit in the conversion terms of the
Series E and Series F convertible preferred stock at the date of the issuance,
based upon the quoted bid price for the Company's common stock on those dates,
has been included in the computation of net loss per share (Note 2) for the year
ended December 31, 1998. The estimated discount was recorded as a discount on
the preferred stock and an increase to additional paid-in capital. The
amortization of the conversion discount of $75,000 and $18,750 has been recorded
as an increase to the preferred stock and a decrease to additional paid-in
capital for Series E and Series F convertible preferred stock, respectively for
the year ended December 31, 1998.
 
  Redemption:
 
     In the event that the price of the Company's common stock, as reported by
the NASDAQ SmallCap market or the National Association of Securities Dealers,
Electronic Bulletin Board, equal or exceeds $20.00 per share for a period of
twenty consecutive trading days, the Company may redeem the Series B, Series C
and Series D convertible preferred stock at a price of $1,000 per share, subject
to certain anti-dilution provisions.
 
     In addition, in connection with the issuance of the Series E convertible
preferred stock, the shareholders of the Series B convertible preferred stock
agreed to place into escrow 2,100 shares of the Series B convertible preferred
stock. The Company may at its option and at any time through January 31, 2000
redeem the escrowed shares of Series B convertible preferred stock at a price of
$1,250 per share.
 
     At any time, on and after the expiration of the restrictions of conversion,
if the closing bid price of the Company's common stock as reported by the
principal stock exchange in which the Corporation's common stock then trades
equals or exceeds $5.00 for twenty consecutive trading days, then the Company at
its option may redeem the then issued and outstanding shares of Series E
convertible preferred stock at a price of $1,000 per share, subject to certain
anti-dilution provisions.
                                      F-14
<PAGE>   34
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     At any time, the Company may in its sole discretion, but shall not be
obligated to, redeem, in whole or in part, the then issued and outstanding
shares of Series F convertible preferred stock at a price of $1,200 per share,
subject to certain anti-dilution provisions.
 
10.  ISSUANCE OF WARRANTS
 
     On January 17, 1996, the Company issued warrants to purchase 90,000 shares
of the Company's common stock at $5.24 per share to all of the former holders of
the Company's Series A Convertible Preferred Stock. These warrants were
immediately exercisable and expire after three years. These warrants were issued
in consideration of the conversion of the Series A Convertible Preferred Stock.
The fair value of these warrants was estimated by management and determined to
be materially consistent with the amount of dividends waived by the holders of
Series A Convertible Preferred Stock.
 
     In September 1997, the Company issued warrants to purchase 700,000 shares
of the Company's common stock at $4.00 per share to the Series B stockholders.
These warrants are exercisable immediately and expire on September 30, 2000. The
value of these warrants at the time of issuance was estimated by management to
be negligible, based primarily upon the market price of the Company's stock,
accordingly, no compensation cost has been recorded. In March 1998, these
warrants were canceled in conjunction with the issuance of the Series E
Convertible Preferred Stock.
 
     In March 1998, in connection with the issuance of Series E convertible
preferred stock, the Company issued warrants to purchase a total of 700,000
shares of the Company's common stock at an exercise price of $0.75 per share.
These warrants were exercisable immediately and expire on January 1, 2001. The
fair value of these warrants at the time of issuance was estimated by management
to be $214,000 using a Black-Scholes pricing model based upon the quoted market
price assuming a dividend yield of 0%, expected volatility of 172%, a risk-free
interest rate of 5.65% and an expected term of two years. The value of the
warrant was recorded as decrease to Series E convertible preferred stock and an
increase to additional paid-in-capital.
 
11.  CASHLESS OPTION EXERCISE PROGRAM
 
     On March 1, 1994, the Board of Directors approved the 1994 cashless option
exercise program for all employees. The program allows employees to purchase
shares of common stock, payable with both recourse and non-recourse long term
promissory notes receivable. Under the above program, employees purchased a
total of 87,817 shares of common stock at a price of $4.00 per share. The notes
receivable, plus accrued interest, are due in March 2004, and are presented as a
reduction of stockholders' equity in the accompanying balance sheet.
 
12.  COMMITMENTS
 
     The Company leases its office facilities under an operating lease expiring
September 30, 2000. The lease contains an option for renewal and requires the
payment of taxes and other operating costs. At December 31, 1998, future minimum
rental payments under the operating lease amounted to approximately $300,000
payable as follows:
 
<TABLE>
<S>                                                  <C>
1999...............................................  171,000
2000...............................................  129,000
</TABLE>
 
     Rent expense totaled $171,376 and $171,376 during the years ended December
31, 1998 and December 31, 1997, respectively.
 
                                      F-15
<PAGE>   35
                          NATIONAL DATACOMPUTER, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     The Company also leases certain equipment under capital leases expiring at
various dates through the year 2001. Future minimum lease payments under capital
leases consist of the following at December 31, 1998:
 
<TABLE>
<S>                                                  <C>
1999...............................................   48,000
2000...............................................   30,000
2001...............................................    1,000
                                                     -------
Total minimum lease payments.......................  $79,000
Less: amount representing interest.................    9,300
                                                     -------
Present value......................................  $69,700
                                                     =======
</TABLE>
 
13.  FINANCIAL INSTRUMENTS
 
     The Company enters into various types of financial instruments in the
normal course of business. Fair values are estimated based on assumptions
concerning the amount and timing of estimated future cash flows and assumed
discount rates reflecting varying degrees of perceived risk. Accordingly, the
fair values may not represent actual values of the financial instruments that
could have been realized as of year end or that will be realized in the future.
 
     Fair values for cash and cash equivalents, accounts receivable, accounts
payable and accrued expenses and convertible debt approximate their carrying
values at December 31, 1998 and December 31, 1997.
 
                                      F-16