<PAGE>

                                 3/21/00 DRAFT

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549

                                    FORM 10-K
                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                   OF THE SECURITIES AND EXCHANGE ACT OF 1934
                   For the fiscal year ended December 31, 1999
                           Commission File No. 0-25326


                                ARIEL CORPORATION
                    ----------------------------------------
             (Exact name of registrant as specified in its charter)

              Delaware                                  13-3137699
----------------------------------------     -----------------------------------
      (State of incorporation)              (IRS Employer Identification Number)

 2540 Route 130, Cranbury, New Jersey                       08512
----------------------------------------     -----------------------------------
Address of principal executive offices)                  (Zip Code)

                                  609-860-2900
                     ---------------------------------------
                     (Telephone number, including area code)

Securities registered pursuant to Section 12(g) of the Act:

         Common Stock, par value $.001; Preferred Stock Purchase Rights
         --------------------------------------------------------------

Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
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 disclosure of delinquent filers in response to Item 405 of Regulation
S-K is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.[ ]

Aggregate market value of voting stock held by non-affiliates of registrant as
of March 15, 2000: $124,755,238

Number of shares outstanding of each of the issuer's classes of common stock, as
of the latest practicable date: Common Stock, $.001 par value, 13,038,920 shares
outstanding as of March 15, 2000.

Number of Pages -

Exhibit Index -

Documents incorporated by reference: None.



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Item 1.  Description of Business

Overview

         We are a leading provider of open systems-based digital remote access
equipment to Internet Service Providers (ISPs). Our remote access equipment is
compatible with open systems platforms running a variety of popular operating
systems, including Windows NT and Linux, and enables ISPs to build reliable,
scalable and easy to manage networks at a cost that is significantly below other
available alternatives.

         Remote access equipment enables a user dialing in over a standard
telephone line to connect to a computer network. Because of the increasing
number of Internet users, ISPs are faced with the challenge of providing access
to a growing number of subscribers, including those subscribers who are staying
connected to the Internet for longer periods of time. In addition, ISPs must
also find cost effective ways to expand their networks and computer systems to
provide additional services such as Internet telephony, fax and voice over the
Internet and unified messaging. Our products enable ISPs to use standard PC
systems to build remote access server concentrators (the equipment used to
connect multiple users simultaneously to the Internet). Leveraging our expertise
and experience in developing digital signal processing systems and led by new
senior management, we are targeting the approximately 6,000 small to mid-sized
ISPs (with less than 100,000 subscribers).

         We recently introduced a new family of dial-up Internet access
solutions we call the PowerPOP architecture, which leverages industry standard
hardware, software and applications. Our PowerPOP architecture enables us to
take advantage of the increasing performance and low prices of PC-based systems
to provide ISPs with more responsive, reliable and flexible networks while
significantly reducing capital equipment costs and simplifying network and
systems management. We sell our products to ISPs primarily through one
distributor.

         We have historically provided, and will continue to provide, remote
access and digital signal processing (DSP) products to Original Equipment
Manufacturers (OEMs) who integrate our components into their products. Because
integration of our complex components involves a significant amount of technical
development and testing by the OEM, our product is generally used for the
duration of the OEM's product-life. We sell our products to OEMs though our
direct sales force. We intend to continue to offer all our component products to
OEMs, including those OEMs who sell products in the ISP market.

Our Corporate History

         Founded in 1982, we were one of the first providers of DSP application
development tools. In the mid-1990s, we evolved from being a provider of DSP
application development tools to supplying digital signal processing-based
subsystems to OEMs and government contractors. Our products are incorporated
into a variety of applications, including medical instrumentation, machine
vision, professional audio, sonar, radar and multimedia.

         In the mid-1990s, we introduced a series of products aimed at the
computer telephony integration market. Computer telephony integration products
provide additional functionality which allows standard computers to connect to
telephone lines, initiate, receive, transmit, store and otherwise manipulate
voice and data telephone communications. Our initial product, the CTI Modem,
which we still provide to OEM customers, is used for Internet access, online
services and transaction processing.


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         In 1996, we formed a communications systems group (CSG) to begin
development of an Asymmetrical Digital Subscriber Line ("ADSL") carrier-class
product targeting the needs of major telecommunications and network service
providers. ADSL adds a high-speed data connection to a standard voice telephone
line. Carrier-class is a term used to describe equipment that meets the
stringent reliability and environmental needs of telephone carriers. As a result
of our strategic decision to reposition ourselves in 1997, we decided to sell
our communications systems group, and in September 1998, we completed the sale
of the group's assets to Cabletron Systems, Inc. for approximately $30 million.

         In 1997, we also announced our intention to focus on the remote access
equipment market through product offerings that provide high density and cost
effective remote access solutions based on industry standard PC platforms. We
developed a Windows NT-based remote access solution, which was adopted by Compaq
Computers. By late 1998, widespread use of the Internet and improved Internet
security led enterprises to outsource their remote access needs to ISPs.


         While sales to OEM customers generate a majority of our revenues, today
we are focused on developing and marketing remote access solutions that leverage
industry standard hardware, software and applications to small and mid-sized
ISPs.

Industry Overview

The ISP market

         The Internet has emerged as a global communications medium, enabling
millions of people to gather information, communicate and conduct business
electronically. International Data Corporation estimates that there will be
approximately 196 million Internet users worldwide in 1999 and that the number
of users will grow to over 500 million by the end of 2003. As a result, the
demand for equipment to expand Internet access is growing at an unprecedented
rate.

         ISPs are commonly grouped into categories based on the size of their
customer or subscriber base. Large ISPs are generally those with more than
100,000 subscribers. These include ISPs such as America Online, EarthLink, The
Microsoft Network, AT&T, Concentric Network and MCI WorldCom. Mid-sized ISPs
typically have between 20,000 and 100,000 subscribers and are generally focused
in a defined geography, either a metropolitan area or region. Small ISPs have
under 20,000 subscribers. Boardwatch Magazine's directory of ISPs lists more
than 6,000 small and mid-sized ISPs in the United States.

         The vast majority of Internet access is through dial-up, or analog,
telephone connections using a PC and a modem. An ISP's network consists of
points of presence (POPs) established in various locations throughout its
service area, and a network operations center where the ISP's high speed
connection to the Internet resides. When a subscriber's call reaches the POP, it
is connected to a port. A port is one of many modems located within a remote
access concentrator, which allows multiple persons to be connected
simultaneously. The subscriber's call is converted to a digital network
connection in the POP from which an ISP maintains a high-bandwidth connection-
called the backhaul- connecting the POPs to its network operations center.

         As demand for Internet access grows, ISPs are expanding the number of
POPs that they maintain and are increasing the number of ports within many of
their POPs to accommodate a growing number of new subscribers and subscribers
staying connected to the Internet for longer periods of time. Remote access
server

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concentrators range in size from 24 ports to hundreds of ports, with the highest
sales volume models generally supporting 24 to 48 ports.

Market Trends

         Due to a broad combination of factors including deregulation of the
telecommunication industry, competition between network service providers and
advances in technology, ISPs are experiencing significant change. In this
context, we believe we are well positioned to take advantage of the following
major trends in our industry:

         Proliferation of PC-based servers. Remote access concentrators have
traditionally been designed as closed "black box" systems using proprietary
hardware and software. Customer-driven modifications or the need for additional
features can only be accommodated by each respective manufacturer, which can be
expensive and slow to market. Further, given that the systems are proprietary,
end users are required to understand the specific details associated with each
system. The combination of the increase in the processing power of PC central
processing units, and the rapid maturation of PC operating systems such as
Windows NT/Windows 2000 and Linux, have enabled the functions of a remote access
concentrator to be delivered as an upgrade to a standard PC server instead of
requiring a "black box." This approach offers ISPs many advantages, including
equipment cost savings and easier operation.

         Demand for new services. Advances in the technology underlying the
Internet have made it possible to use the Internet to carry two-way voice
conversations. To remain competitive, ISPs must offer new services including
voice and fax services using voice over the Internet protocol ("VOIP") and fax
over the Internet protocol ("FOIP"). The system requirements imposed by these
and other new services will strain the capabilities of existing networking
equipment. In particular, it is impossible to upgrade many remote access
concentrators to provide voice call handling, or, where upgrades are available,
their cost can significantly exceed the purchase price of the original
equipment. ISPs expanding their services to add voice and fax services must
often purchase entirely new remote access concentrators.

         Emergence of CompactPCI standard to meet Telco needs. Supported by many
industry leaders, the CompactPCI standard enables the development of equipment
using PC system standards that meet the requirements for high reliability
carrier-grade applications. We were the first company to offer CompactPCI remote
access plug-in cards (our RS2000C) that adhere to this new standard.
Improvements in open systems capabilities, price reductions and the advent of
CompactPCI combine to create new opportunities for standards-based systems in
high-end ISP environments.

Ariel's Approach

         We have developed a new ISP network architecture and a new family of
products that enable ISPs and other network service providers to build and scale
their infrastructure using open systems platforms. The proprietary means by
which we have integrated our products' capabilities into standard PCs enables
our products to more fully and more easily integrate the hardware/system/network
models expected by Windows NT and Linux operating systems. This ensures
compatibility with the full repertoire of communications systems services and
applications built for these operating systems.

         PowerPOP architecture. Introduced in 1999, the PowerPOP architecture is
a new approach to designing ISP networks. The PowerPOP architecture provides an
alternative to the "dumb" remote access concentrators that ISPs currently use to
equip POPs. The PowerPOP architecture combines standard PC

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servers running a standard off-the-shelf PC operating system (Windows NT or
Linux) with one or more of our plug-in cards. ISPs use these new servers to
perform all the functions of a remote access concentrator and to enable the POP
to autonomously provide critical network services. The typical ISP network
architecture is based on a central network operations center, connected to a
number of dumb POPs. These include services needed to obtain the numerical
addresses of Internet Resources ("Domain Name Services"), the mechanisms that
allow a subscriber to log in to an ISP's network with a user name and password
(called RADIUS) and tools to improve the response time for both recently and
frequently accessed web content (called web caching).

         By providing key network services at the POPs, ISPs can significantly
reduce network traffic between the POPs and their network operating centers,
thereby improving response time, reducing backhaul requirements and improving
operating performance. This also enables ISPs to significantly reduce equipment
costs while increasing the flexibility, efficiency, manageability and
scalability of their networks.

         New ISPs face the challenge of building an entirely new network from
scratch. These ISPs can also use the PowerPOP architecture to substantially
reduce the initial cost and complexity of their network. A traditional approach
would require a minimum of three boxes: a remote access concentrator, a PC
server and a router, for connection to the Internet. Using the PowerPOP
architecture, all the services and capabilities required to become an ISP can be
deployed in a single PC server system. Additional capacity can be added by
installing additional systems either in the network operations center or in new
remote POPs.

         PowerPOP offers ISPs the following benefits:

         Reduced equipment costs. We believe our PowerPOP architecture redefines
the economics of remote access. Using a standards-based platform reduces
equipment costs and operating expenses. By leveraging the price erosion and
performance increases in PC systems and compared to traditional remote access
equipment, a solution built with our technology can be priced at approximately
40% less per port using standard rackmount PC Systems and open standard
operating systems.

         Deliver better performance to subscribers. Placing key network services
closer to the user creates a more responsive network by reducing the time it
takes for subscribers' requests to be filled. In addition, PC-based systems in
the POPs have additional available computing capacity that ISPs can use to
deploy new services.

         Build more reliable and manageable networks. In a traditional ISP
network design, servers at the network operations center provide critical
network services. ISPs install multiple redundant servers to avoid having a
critical service outage and a backup server automatically takes the place of one
that fails. Our PowerPOP architecture uses the PC systems in POPs to duplicate
these previously centralized services into each POP with built-in backup
systems.

         Add new services with a software upgrade. Our technology, and the power
available in today's PC servers, enable the upgrade of our data access solutions
from a data-only remote access service to full support of Internet telephony
without requiring new hardware. As a result, ISPs will be able to offer VOIP and
FOIP services using network-updateable software.




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Products

         We offer two families of products: remote access products that are sold
to ISPs and OEMs and high-performance general purpose digital signal processing
products that are sold only to OEM customers for inclusion in their products.

         Remote Access Products. Our remote access products are plug-in cards
and software that enable standards-based systems to provide remote access
services using off-the-shelf operating systems such as Windows NT and Linux.
Plug-in cards are electronic circuits that are compatible with the system
expansion connectors built into standard PC systems.

         We recently launched our fourth generation of remote access products
for Windows NT and Linux the RS4200 family based upon the Ariel Access
Architecture and incorporating the most recent developments in digital signal
processing technology. The RS4200 family was built to meet the demanding
requirements of ISPs; previous generations were built to OEM specifications.

<TABLE>
<CAPTION>


       Product                            Technical Specifications                                             Date
       -------                            ------------------------                                             ----
<S>                    <C>                                                                                    <C>

RS4200                 2 PCI card set; Up to 120 DSP-based Modems, V.90, FOIP and VOIP                         1999
                       capable; 4 T1/E1 Telco Interfaces, Windows NT and Linux
RS2000                 PCI; Up to 30 V.90 Digital Modems 2 T1/E1 Telco                                         1998
RS2000C                CompactPCI bus; Up to 30 Digital V.90 Modems; 2 T1/E1 Telco Interfaces                  1998
RS1000                 2 PCI card set; Up to 30 56K Modems 2 T1/E1 Telco                                       1997
T1 Modem Plus          ISA bus; Up to 30 Analog Modems, 56K Capable                                            1996
T1 Modem               ISA bus; Up to 30 Analog Modems                                                         1996
</TABLE>

         Digital Signal Processing Products. Our family of general purpose, high
performance digital signal processing products for OEMs uses the
industry-standard VMEbus and the PC standard ISAbus, and are aimed at
applications in audio, instrumentation/telemetry, radar, sonar, and imaging.
OEMs selecting high performance digital signal processing products do so for the
life of their project, therefore OEMs tend to continue to purchase these
products for many years after the design is no longer state of the art.
<TABLE>
<CAPTION>



            Product                              Technical Specifications                                      Date
            -------                              ------------------------                                      ----
<S>                              <C>                                                                          <C>

DC-5                             ISA: Custom-built Telco/Modem                                                 1994
COMMIO / IP                      VME: DSP320C40; modular expansion for signal Input/Output                     1995
DSP 56                           ISA: DSP56001; 2 channels of Auto Input/Output                                1988
DSP 96                           ISA: DSP96002; 2 channels of Audio Input/Output                               1990
DSP C40                          ISA: DSP320C40; 2 channels of Audio Input/Output                              1993

</TABLE>

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<TABLE>
<CAPTION>



            Product                             Technical Specifications                                       Date
            -------                             ------------------------                                       ----
<S>                              <C>                                                                          <C>
HYDRA II & VSB                   VME: Quad DSP320C40                                                           1995
KEOPS                            PCI: Quad DSP3210 with optical Audio Input/Output                             1995
VC 40 / HYDRA PLUS               VME: Quad DSP320C40                                                           1995
</TABLE>

Research and Development

         We believe that strong product development capabilities as well as
enhancements and upgrades to our present products are essential to our strategy
of building on our position as a technological leader in our industry,
maintaining the competitiveness of our current products and adding new features,
functions and products. We have, in the past, made and intend to continue to
make, significant investments in product and technological development.

         We are focusing our development efforts on next generation voice plus
data network equipment using standards-based components. We will continue to
aggressively develop new capabilities to extend our PowerPOP architecture in
such areas as handling combined voice and data applications, system management,
performance, density and reduced product cost.

         Our research and development expenditures totaled $8.2 million, $6.7
million and $5.7 million in 1997, 1998 and 1999, respectively. We perform our
research and product development activities at our facilities in Cranbury, New
Jersey and Paris, France.

Manufacturing and Quality Control

         Substantially all of the manufacturing of our products is outsourced to
K-Byte/Hibbing Manufacturing and JRE Inc. in the United States and FEDD in
France. This allows us to focus our resources on product research and
development, marketing and sales and customer support. Our internal
manufacturing operations consist primarily of production of prototypes, testing,
manufacturing and test engineering, materials purchasing and inspection and
quality control. We monitor the performance and quality of the work performed by
our outside contractors by using internal quality assurance procedures and by
making regular visits to manufacturing facilities.

         Ensuring adequate and flexible production capacity, continuous cost
reduction and superior product quality are top priorities of our manufacturing
efforts. We achieve our manufacturing goals by:

         o    working closely with our contract manufacturers during the product
              design phase;

         o    effectively managing a limited number of the most qualified
              suppliers; and

         o    constantly improving upon our product performance tests.

         Our products are manufactured with components and subassemblies
supplied by subcontractors to our specifications. We purchase digital signal
processing chips and certain other components from Texas Instruments, Lucent
Technologies, Conexant, Motorola and Analog Devices, each of which manufactures
and is the sole supplier of the digital signal processing chips upon which some
of our products have been developed.

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Although we have not experienced any material difficulties in obtaining supplies
or manufactured products, any reduction or interruption in supply or
manufacturing from these third parties would adversely affect our ability to
deliver products.

Sales and Marketing

         We market our products principally to ISPs and networking and
communications OEMs. We sell our products to ISPs through value added resellers
and systems integrators as part of an arrangement with Pioneer-Standard/KeyLink
Systems. KeyLink Systems sells to larger ISPs directly and to smaller ISPs via a
network of 4,500 resellers. Pioneer custom-configures systems with components
from Intel, IBM, Compaq, Ariel and others to ISP specifications and delivers
directly to ISPs.

         We market our OEM products in the United States and Europe primarily
through a direct sales force and through independent sales representatives.
Internationally, we also sell our products through value added resellers and
distributors in Europe, Israel and the Far East. We maintain sales offices in
Berlin and Dortmund, Germany, Paris, France and Fareham, UK.

         All of our marketing communications activities have been outsourced to
a number of specialized outside agencies. We obtain most new sales prospects
through advertising, existing customers, strategic relationships and trade show
participation. Our principal marketing activities include display advertising in
trade publications, direct mail, trade show participation and our website.

Customer Support

         Technical support is provided by customer support employees located at
our headquarters. We also offer telephone and electronic mail support to assist
our customers. ISPs are supported by our telephone support staff, a private
customers-only section of our website and, when required, by onsite visits by
support and engineering personnel.

         OEMs provide support to their own customers. Our telephone support
staff provides support for OEMs and, given that OEMs have substantial technical
knowledge, they are often also supported directly by our engineering department.
Development consultation support for OEM engineers in developing their products
is provided on a for-fee basis.

         In addition to assisting OEM customers in their own development
projects, we also have processes and capabilities in place to perform custom
engineering to provide OEMs with products that meet their precise requirements.

         Our products are covered by a 5-year limited warranty against defects
in manufacture. Product replacement is the most common mechanism used to resolve
product defect issues. Our support engineering staff has created an innovative
"Spare In The Air" program to ensure the delivery of replacement products within
24 hours of a reported failure.

Customers

         We market our products to two distinct groups of customers-- small and
mid-sized ISPs in the United States and networking and communications OEMs
worldwide. Some of our OEM customers include Transaction Network Systems,
Motorola, Qualcomm, Lockheed Martin, Cabletron and AT&T. Three

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customers represented 46% of sales for the twelve months ended December 31,
1999, including sales to Motorola, Transaction Network Services and Lockheed
Martin, which represented 22%, 11% and 12% respectively. In Europe, we sell our
full range of products to telecommunications OEMs and we sell a line of ISDN
terminal adapters (acquired with Scii Telecom S.A.) to enterprise end-user
customers via a network of resellers. During 1998 three of our customers
represented 52% of our sales. Sales to Compaq accounted for 25% of our total
sales and sales to Cabletron and Transaction Network Systems represented 14% and
13%, respectively. As a result of the decline of the enterprise remote access
market in late 1998, there have been no sales to Compaq in 1999.

Competition

         The markets for our products are intensely competitive, continually
evolving and subject to changing technologies. We compete principally on the
basis of (1) the flexibility, scalability, quality, ease of use, reliability and
cost effectiveness of our products and (2) our reputation and the depth of our
expertise, customer service and support.

         We compete directly or indirectly with the following categories of
companies: (1) other small companies that sell remote access server equipment,
such as Cyclades and Netaccess, (2) large well-established companies that sell
remote access server equipment such as Ascend/Lucent, Cisco, and 3Com, (3) third
party modem board manufacturers, such as Equinox and Digi International and (4)
manufacturing departments within our OEM customers. Because the markets in which
we compete are rapidly evolving, additional competitors with significant market
presence and financial resources, including large telecommunications equipment
manufacturers and computer hardware and software companies, may enter these
markets and further intensify competition.

Intellectual Property and Other Proprietary Rights

         We believe that our success is dependent, in part, on proprietary
technology. We seek to maintain the proprietary nature of our technology by
several methods, including:

         o     copyright, trade secret and trademark laws;

         o     confidentiality agreements with employees and third parties;

         o     contractual provisions contained in license and other agreements
               with consultants, suppliers, strategic partners, resellers and
               end-user customers; and

         o     patents.

         Substantially all of our hardware products contain security codes which
deter duplication by third parties. We also assert copyright in relation to
certain aspects of our products and we generally enter into confidentiality
agreements with our employees and limit access to our proprietary information.
Despite these precautions, it may be possible for unauthorized third parties to
copy certain aspects of our products or to obtain information that we regard as
proprietary. We have filed patent applications for patent protection covering
some aspects of our next generation products. To date, these patents have not
been granted, and we cannot assure you that they will ever be granted. We do not
hold patents on any of our other products, and in the event competitors are able
to create substantially similar or duplicate products, we will not be able to
avail ourselves of the protection afforded by the patent laws.

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         We believe that due to the rapid pace of innovation within our
industry, factors such as the technological expertise of our personnel and
ongoing reliable product maintenance and support are more important in
establishing and maintaining a leadership position within the industry than the
pursuit of various legal protections of our technology.

         We also depend upon development, supply, marketing, licensing and other
operative relationships with third parties for complementary technologies
incorporated in our products. These cooperative relationships are with hardware
and software developers pursuant to which both parties make their respective
technology available to the other for the purpose of achieving compatible
products. Some of these relationships are based upon annually renewable license
agreements under which we obtain technology necessary to produce our products.
Although we have no reason to believe that these mutually beneficial
relationships will end, these relationships are generally non-exclusive and
terminable, and we cannot assure you that we will be able to maintain these
relationships or to initiate additional similar relationships. The loss of
certain cooperative relationships, particularly with any of the digital signal
processing chip suppliers, may have a material adverse effect on our business.

Backlog

         Firm backlog shippable within a twelve-month period was approximately
$519,000 at December 31, 1999 compared to approximately $2.1 million at December
31, 1998. Our order trend is characterized by delivery cycles that range from
several days to quantities deliverable over several months. Further, customers
may revise scheduled delivery dates or cancel orders. Accordingly, the portion
of sales in each fiscal quarter derived from backlog at the beginning of such
quarter varies based on the customer's required delivery dates.

Employees

         As of December 31, 1999, we had 91 employees, including 14 in Europe
and 12 part-time employees. None of our employees is represented by a collective
bargaining agreement nor have we experienced any work stoppage. We believe our
relationship with our employees is satisfactory.

Risk Factors

We have incurred substantial operating losses and an accumulated deficit. We
expect to continue to have operating losses and a growing accumulated deficit in
the future.

         Our business operations have generated operating losses since 1993. For
the year ended December 31, 1999, our business operations generated operating
losses of $12,474,160. We had an accumulated deficit of $26,137,692 at December
31, 1999. We expect to continue to generate net operating losses while we
continue to launch new products and penetrate the ISP market. We can give no
assurance that we will obtain a customer base sufficient to support the costs of
our operations.

         We cannot assure you that we will become profitable or that our cash
flow will become positive at any time in the foreseeable future, or at all, or
that we will generate sufficient cash flow from product sales to liquidate
liabilities as they become due. In the event that we are unable to liquidate our
liabilities, we may delay or eliminate some expenditures and we may scale back
our planned operations. We may need additional funds to meet our planned
obligations, and we will seek to raise such amounts through a variety of
options, including future cash from operations, borrowings and proceeds from
equity financings. Additional funding may not be available when needed or on
terms acceptable to us, which could have a material adverse

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effect on our business, financial condition and results of operations. In
addition, if we raise additional funds through the issuance of equity,
equity-linked or debt securities, those securities may have rights, preferences
or privileges senior to those of the rights of our common stock and our
stockholders may experience additional dilution.

We have substantial debt and debt service requirements and this may adversely
affect our financial and operating flexibility.

         We have a significant amount of indebtedness. At December 31, 1999, we
had $3.7 million of outstanding indebtedness under our credit agreement, of
which $1.2 million will be due on June 12, 2000.

         The amount of indebtedness we have could have important consequences to
our stockholders. For example, it could:

         o      make it more difficult for us to meet our obligations;

         o      increase our vulnerability and limit our ability to react to
                general adverse economic and industry conditions;

         o      limit our ability to use operating cash flow to fund operating
                expenses, working capital, research and development and other
                general corporate purposes because we must dedicate a
                substantial portion of our cash flow to make payments on our
                debt;

         o      place us at a competitive disadvantage compared to some of our
                competitors that have less debt; and

         o      limit our ability to borrow additional funds.

         Our ability to pay interest under our credit facility or to refinance
our indebtedness and to satisfy our other debt obligations will depend upon our
future operating performance, which in turn depends upon the successful
implementation of our new business strategy and upon financial, competitive,
regulatory, technical and other factors, many of which are beyond our control.

         If we are not able to generate sufficient cash from operations to make
payments under our credit agreement or to meet any other debt service
obligations, we will need to refinance our indebtedness. If such refinancing is
not possible, we could be forced to dispose of assets at unfavorable prices or
default on our debt obligations. Even if we obtain such financing, we cannot
assure you that it would be on terms that are favorable to us.

We have recently changed our business strategy to focus on a new class of
products for the ISP market. This represents a new market for us and we have had
limited experience selling our products in this market.

         Our ability to successfully execute our new business strategy is
critical to the future performance of our business. During the second quarter of
1999, we changed our business strategy to focus on the ISP market following the
decline of the enterprise remote access market. Historically, we have derived,
and expect to continue to derive in the near term, substantially all of our
revenues from product sales to OEMs and PC manufacturers. As we focus our
efforts on the ISP market, we expect sales to OEMs to represent a declining

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percentage of our total revenue in the future if our new business strategy is
successful. Because the ISP market is a new market for us and the equipment we
have developed for that market has only recently been introduced, we have had
limited experience in selling our products. Currently, only a limited number of
ISPs have purchased our products.

         Successful execution of our new business strategy will depend on our
ability to:

         o      penetrate the ISP market;

         o      achieve market acceptance of our products;

         o      successfully develop and introduce new products;

         o      identify, recruit and retain qualified engineers and sales
                personnel;

         o      provide adequate customer care and technical support;

         o      manage our growth; and

         o      secure adequate financing.

         We cannot assure you that we will be successful in executing our new
business strategy and, if we are not, our business, financial condition and
results of operations could be adversely effected and the price of our common
stock will likely decline.

Our PowerPOP architecture is new and may not be accepted by our target market.

         The market success of our ISP products depends significantly upon the
acceptance of our PowerPOP architecture by the small to mid-sized ISPs we are
targeting. The PowerPOP architecture represents a different approach to
addressing ISP remote access equipment needs. Our approach uses a standard PC
system running Windows NT or Linux to build remote access server concentrators,
in contrast to traditional products that are custom-built for this purpose. ISPs
may not be willing to use our approach which would significantly hinder our
growth potential and would negatively affect our business.

Our OEM sales are concentrated among a small number of customers and in 1998,
our most significant OEM customer discontinued products that used our
components.

         Substantially all of our revenue is derived from sales to OEMs. Our
sales are concentrated among a small number of OEM customers. For the year ended
December 31,1999, approximately 45% of our revenue was generated by three of our
customers. The loss of any of these customers would negatively impact our
revenues. For example, following the decline of the enterprise remote access
market in late 1998, our most significant OEM customer, Compaq, representing 25%
of our total revenue for the year ended December 31, 1998, and a number of other
customers discontinued their networking groups. As a result, revenues from
Compaq declined from $4.4 million for the year ended December 31,1998 to zero
for the year ended December 31, 1999. Until we are able to penetrate the ISP
market, we expect that a small number of OEM customers will continue to account
for a substantial portion of our revenue.



                                       11

<PAGE>



We are highly dependent on KeyLink Systems to distribute our products to ISPs
and the ISP market is a new market for KeyLink.

         We are highly dependent on KeyLink Systems to distribute our products
to ISPs. Our direct sales efforts have focused principally on OEM customers and
we do not have a direct sales force that focuses on sales to ISPs. Our
arrangement with KeyLink is not set out in a written agreement and does not
include specific commitments undertaken by KeyLink. As a result, KeyLink is not
required to meet any performance criteria or to commit any specific level of
resources to the marketing of our products and is not prohibited from selling
products that compete with ours. In addition, KeyLink has no previous experience
as a distributor in our target market. Any failure by KeyLink to support sales
of our products or failure by KeyLink to establish itself as a distributor in
the ISP market would have a material adverse affect on our ability to penetrate
the ISP market and on the future performance of our business.

If we fail to establish and maintain strategic distribution, marketing or other
collaborative relationships with industry-leading companies, we may not be able
to build our ISP customer base.

         Our success depends on our ability to continue to establish and
maintain strategic distribution, marketing and other collaborative relationships
with industry-leading hardware manufacturers, distributors, software vendors and
enterprise solutions providers. These relationships allow us to offer our
products and services to a much larger customer base than we would otherwise be
able to through our direct sales and marketing efforts. Most of our existing
relationships can be terminated on short notice by any party. We cannot assure
you that we will be able to maintain these relationships or replace them on
attractive terms.

         In addition, our existing strategic relationships do not, and any
future strategic relationships may not, afford us any exclusive marketing or
distribution rights. As a result, the companies with which we have strategic
relationships are free to pursue alternative technologies and to develop
alternative products and services in addition to or in lieu of our products and
services, either on their own or in collaboration with others, including our
competitors. Moreover, we cannot guarantee that the companies with which we have
strategic relationships will distribute our products effectively or continue to
devote the resources necessary to provide us with effective sales, marketing and
distribution.

We must accurately forecast our customer demand for our plug-in cards. If there
is unexpected fluctuation in demand for our products, we may incur inventory
write-downs, excessive operating costs or lose product revenues.

         We must forecast and place purchase orders for components of our
products several months before we receive purchase orders from our own
customers. This forecasting and order lead time requirements limit our ability
to react to unexpected fluctuations in demand for our products. These
fluctuations can be unexpected and may cause us to have excess inventory, or a
shortage, of a particular product. In the event that our forecasts are
inaccurate, we may need to write down excess inventory. For example, we were
required to write down inventory in the fourth quarter of 1998 in connection
with the termination of our sales to Compaq and a reduction in sales to other
OEM customers. Significant write-downs of excess inventory or declines in
inventory value in the future could adversely affect our financial results.
Similarly, if we fail to purchase sufficient supplies on a timely basis, we may
incur additional rush charges or we may lose product revenues if we are not able
to meet a purchase order. These failures could also adversely affect our
customer relations.




                                       12

<PAGE>



Undetected errors or defects found in our products may result in loss of
customers or delay in market acceptance of our products.

         Despite testing by us and by our customers, errors may be found in new
products after commencement of commercial shipments, resulting in loss of
customers, delay in market acceptance of our products and damage to our
reputation. In addition, if errors are discovered, we may have to spend a
significant amount of money to eliminate them and yet may not be able to
successfully correct them in a timely manner, or at all.

         Failures in our products may also cause system failures for our
customers who could then assert warranty and other claims for damages against
us. Although our customer agreements typically contain provisions designed to
limit our exposure to potential product liability claims, it is possible that
these provisions may not be effective or enforceable under the laws of some
jurisdictions. Our insurance policies may not adequately limit our exposure to
this type of claim. These claims, even if successful, could be costly and time
consuming to defend and could divert management's attention from our business.
We cannot assure you that the occurrence of any of these events would not have a
material adverse effect on our business, financial condition and results of
operations.

Average selling prices of our products may decrease which could hurt our
operating results.

         The average selling prices for our products may be lower than expected
as a result of competitive pricing pressures, technological advances,
promotional programs and customers who negotiate price reductions. The pricing
of products depends on the specific features and functions of the product, the
extent to which the product can be integrated within ISPs' and OEMs' existing
hardware and software operating systems, purchase volumes and the level of sales
and service support. Historically, the trend in our industry has been for prices
to decrease as technological innovations become widespread. We expect this trend
and price competition to continue and possibly increase in the future, both in
the OEM and the ISP remote access equipment markets, and anticipate that the
average selling prices of our current products will decrease. We cannot assure
you that we will be successful in developing and introducing on a timely basis
new products with enhanced features that can be sold at our projected selling
prices.

We depend on a limited number of third-party suppliers some of which are the
sole suppliers of the product we purchase from them.

         We purchase digital signal processing chips and certain other
components from Texas Instruments, Conexant Systems, Lucent Technologies and
Analog Devices, each of which manufactures and is the sole supplier of the
digital signal processing chips upon which our products have been developed. We
do not have long-term agreements with any of these suppliers. Any reduction or
interruption in supply or manufacturing from these third party contractors would
adversely affect our ability to continue to deliver our products. We also depend
upon development, supply, marketing, licensing and other relationships with
third parties for complementary technologies incorporated in our products. These
cooperative relationships, many of which have been in place for a number of
years, are with hardware and software developers pursuant to which we each make
our technology available to the other for the purpose of achieving compatible
products. Some of these relationships are based upon annually renewable license
agreements under which we obtain technology necessary to produce our products.
These relationships are generally non-exclusive and terminable, in some cases on
short notice or at any time, and there can be no assurance that we will be able
to maintain these relationships or to initiate similar additional relationships.
The loss of certain cooperative relationships, particularly with any of the
digital signal processing chip suppliers, may have a material adverse effect on
our business.

                                       13

<PAGE>



The market for remote access equipment is highly competitive and we compete with
large, well established companies. If we are unable to compete effectively, the
demand for, or prices of, our products may be reduced.

         The remote access equipment market is intensely competitive. We may not
be able to compete successfully against current or potential competitors and our
failure to do so could seriously harm our business, operating results and
financial condition.

         In the ISP market, we compete directly with other small companies that
sell remote access equipment as well as large well-established companies such as
Ascend/Lucent, Cisco, and 3Com. These and many of our current and potential
competitors have significantly greater financial, selling and marketing,
technical, manufacturing and other resources than we have. As a result, these
competitors may be able to devote greater resources toward the development,
promotion, sale and support of their products than we can. These companies may
introduce additional products that compete with ours or enter into strategic
relationships to offer complete solutions which we do not currently offer.

         In addition, we recently introduced our PowerPOP architecture to the
market and we have not had enough experience selling the product to fully assess
its competitiveness. If we find that our new products are not competitive, our
business could be materially harmed.

Our financial results may fluctuate from period to period as a result of several
factors which could adversely affect our stock price.

         Because of the change in our business strategy, the loss of a major OEM
customer, the sale of our communications systems group and other factors, we
believe that period to period comparisons of our operating results may not be a
good indication of our future performance. It is possible that in some future
periods our operating results may be below the expectations of public market
analysts and investors. In this event, the price of our common stock may fall.
In the past, we have experienced fluctuations in our revenue and operating
results and our revenue and operating results may continue to vary significantly
from period to period due to a number of factors, many of which are beyond our
control. These factors include:

         o     fluctuations in demand for our products and services;

         o     variations in the timing of orders and shipments of our products;

         o     the timing of new product and service introductions by us or our
               competitors;

         o     the mix of products sold and the mix of distribution channels
               through which they arc sold;

         o     our ability to obtain sufficient supplies of sole or limited
               sourced components for our
               products;

         o     unfavorable changes in the prices of the components we purchase;

         o     our ability to achieve cost reductions;

         o     our ability to maintain quality levels for our products;


                                       14

<PAGE>



         o     our ability to integrate new technologies we develop or acquire
               into our products; and

         o     timing of acquisitions and dispositions of businesses and assets.

         The amount and timing of our operating results generally will vary from
quarter to quarter depending on the level of actual and anticipated business
activities and as we develop and launch new products. We have experienced
sharply increased revenue in periods that involved new product introductions and
significant sales to OEMs, with equally sharp decreases in revenue in subsequent
periods as distributors and OEMs complete their inventory build-up process.
Furthermore, we have a limited backlog of orders and revenue for any future
quarter is difficult to predict. Supply, manufacturing or testing constraints
could result in delays in the delivery of our products. Any delay in the product
deployment schedule of one or more of our new products would likely adversely
affect our operating results for a particular period.

Our technology is not patented and we will not be protected by patent laws.

         We believe that our success is dependent upon our proprietary
technology. However, since we have not in the past actively pursued patent
protection on our products and do not hold patents on any of our current
products, we will not be protected by patent laws in the event competitors are
able to create substantially similar or duplicate products. We principally rely
upon copyright, trade secret and contract law to protect our proprietary
technology. We cannot assure you that we will be able to prevent
misappropriation of our technology or that our competitors will not
independently develop technologies that are substantially equivalent or superior
to our technology.

Intellectual property claims against us could be costly and result in the loss
of significant rights.

         The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement or other violations of intellectual property rights. Patent,
trademark and other intellectual property rights are important to us and other
technology companies. Many companies devote significant resources to developing
patents that could affect many aspects of our business. Other parties may assert
infringement or unfair competition claims against us that could relate to any
aspect of our technologies or other intellectual property. We may also be
subject to claims relating to components we purchase from our suppliers and
integrate into our products. We cannot predict whether third parties will assert
claims of infringement against us, the subject matter of any of these claims or
whether these assertions or prosecutions will harm our business. If we are
forced to defend ourselves against any of these claims whether they are with or
without merit or are determined in our favor, then we may face costly
litigation, diversion of technical and management personnel, inability to use
our current technology or product shipment delays. As a result of a dispute, we
may have to develop non-infringing technology or enter into royalty or licensing
agreements. These royalty or licensing agreements, if required, may be
unavailable on terms acceptable to us, or at all. If there is a successful claim
of patent infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology on a timely basis, our
business and competitive position may be adversely affected.

We do not have our own manufacturing facilities and we depend on a limited
number of outside companies to manufacture substantially all the equipment we
sell.

         We do not have our own manufacturing facilities and we rely on
K-Byte/Hibbing Manufacturing and JRE Inc. in the United States, and to a lesser
extent on FEDD in France, to manufacture substantially all of our equipment.
These agreements can be terminated on short notice by any party. We cannot
assure you that

                                       15

<PAGE>



we will be able to maintain these relationships or replace them on attractive
terms. There are risks associated with our relationship with these third
parties, including reduced control over:

         o     delivery schedules;

         o     quality assurance;

         o     manufacturing costs;

         o     capacity during periods of excess demand; and

         o     availability of access to process technologies.

We depend on our key personnel and we may be unable to replace key executives if
they leave. Our failure to attract, assimilate and retain other highly qualified
personnel in the future could seriously harm our business.

         Our success is largely dependent upon the personal efforts of our
executive officers as well as other key personnel and our future success is also
dependent on our ability to recruit and retain additional experienced
engineering and sales personnel. We intend to appoint additional senior
management personnel as well as to hire additional engineering, sales and
support personnel in the future. Competition for personnel, especially engineers
and sales personnel in New Jersey is intense. There can be no assurance that we
will be able to retain or hire other necessary personnel. Loss of the services
of, or failure to recruit, key personnel could materially harm our business.

Our management team may not be able to successfully implement our business
strategy because it has only recently begun to work together.

         Our business is highly dependent on the ability of our management to
work together effectively to execute our business strategy. Several members of
our senior management have been employed by us for a relatively short period of
time and we are in the process of recruiting additional senior management. These
individuals have not previously worked together as a management team. In
addition, the members of our management team who have been with us for a longer
period have had only limited experience within our new target markets. The
failure of our management team to work together effectively could prevent
efficient decision making by our executive team, affecting product development
and sales and marketing efforts, which would negatively impact our results of
operations.

We must keep pace with rapid technological change to remain competitive.

         The telecommunications industry is subject to rapid technological
change and frequent new product introductions and enhancements, particularly in
the area of equipment for remote access and related network services. We believe
that our success will depend upon our ability to continuously develop new
products and product enhancements as well as provide quality technical support
services and be in a position to promptly introduce our products and services to
the market. We may experience difficulties that could delay or prevent the
successful development, introduction or marketing of new products and
enhancements, or our new products and enhancements may not adequately meet the
requirements of the marketplace and achieve market acceptance. Announcements of
currently planned or other new product offerings by us or our competitors may
cause customers to defer or cancel the purchase of our existing products. Our
inability to develop on a timely

                                       16

<PAGE>



basis new products or enhancements to existing products, or the failure of our
new products or enhancements to achieve market acceptance, could have a material
adverse effect on our business, financial condition and results of operations.

         The development of new, technologically advanced products is a complex
and uncertain process requiring the accurate anticipation of technological and
market trends. The introduction of new or enhanced products also requires us to
manage the transition from older products in order to minimize disruption in
customer ordering patterns, avoid excessive levels of older product inventories
and ensure that adequate supplies of new products can be delivered to meet
anticipated customer demand. We cannot assure you that we will be able to
successfully develop, introduce or manage the transition to new products.

         There can also be no assurance that our competitors will not develop
future generations of competitive products that will offer superior price,
features or performance advantages which would render our products
uncompetitive. There are currently competing technologies that offer alternative
solutions which allow for faster Internet access compared to dial-up access.
These competing technologies include digital subscriber line, wireless and
cable. We cannot assure you that, in order to remain competitive, we will be
successful in developing and introducing on a timely basis new products and
technologies.

Our success in the ISP market depends on the continued growth and use of
Internet and dial-up access technologies.

         Demand for our ISP remote access solutions is being driven by the
increase in the use of the Internet. Our future performance depends
substantially upon the continued widespread acceptance and use of the Internet
and other online services. Rapid growth in the use of the Internet and other
online services is a relatively recent phenomenon, and we cannot assure you that
acceptance and use will continue to develop or that a sufficiently broad base of
consumers will adopt, and continue to use, the Internet and other online
services as a medium of communication and commerce. The emergence of alternative
technologies may substantially reduce our potential markets. If dial-up access
technologies become obsolete, we would have to develop and market new products
in order to continue our operations. We cannot be certain that we will succeed
in adapting our product strategies to compete effectively with these alternative
technologies.

Item 2.  Properties

         We maintain office and light assembly space comprising approximately
30,000 square feet at 2540 Route 130, Cranbury, New Jersey pursuant to a lease,
expiring January 2001. The annual rent is approximately $387,600. We have two
five-year options to renew the lease at fair market value. We also maintain
branch or subsidiary offices in Paris, France, Fareham, UK and Dortmund, Germany
as well as a regional sales office in Berlin, Germany.

Item 3.  Legal Proceedings

         On June 8, 1999, we received a letter from legal counsel representing
Dr. Brent Townshend notifying us that Dr. Townshend believes that modem products
which comply with the V.90 standard necessarily practice the inventions claimed
in his patents. Dr. Townshend alleges that products which incorporate a modem
and modem chipset acquired from a supplier that has not itself entered into a
license agreement with Dr. Townshend would also fall within the claims of the
patents. The letter included an offer to enter into a license agreement under
Dr. Townshend's patents. The letter also states that should legal action to
enforce patent rights be required, the offered terms in the license may be
different. The ultimate outcome of this matter is not currently

                                       17

<PAGE>



determinable, however, management believes that the outcome of this matter will
not have a material adverse effect upon our business, financial condition and
results of operations.

         We are not engaged in any other material legal proceedings. We may from
time to time become a party to various legal proceedings in the ordinary course
of business.

Item 4.  Submission of Matters to a Vote of Securities Holders

         None.

Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters

         Our common stock is traded on the Nasdaq National Market under the
symbol "ADSP". The following table sets forth, for the periods indicated, the
high and low closing sale prices per share of our common stock, as reported by
the Nasdaq National Market:


                                             High                Low
1997
1st Quarter . . . . . . . . . . . . . .    $13   3/8         $  6 1/2
2nd Quarter . . . . . . . . . . . . . .      8   3/4            5 5/8
3rd Quarter . . . . . . . . . . . . . .      9                  6 7/8
4th Quarter . . . . . . . . . . . . . .      8   1/4            5 1/4

1998
1st Quarter . . . . . . . . . . . . . .    $11   1/8         $  5 3/8
2nd Quarter . . . . . . . . . . . . . .     10  5/16            6
3rd Quarter . . . . . . . . . . . . . .      8 11/16            2 7/8
4th Quarter . . . . . . . . . . . . . .      4  3/16            2 1/8

1999
1st Quarter . . . . . . . . . . . . . .    $ 3   3/8         $  1 5/8
2nd Quarter . . . . . . . . . . . . . .      3 15/16            2
3rd Quarter . . . . . . . . . . . . . .      6  9/16            1 7/8
4th Quarter . . . . . . . . . . . . . .     37                  2 3/4

2000
January 1 through March 15, 2000 . . . .   $12   3/8         $  6 3/4

         On March 15, 2000 the closing price of our common stock as reported by
the Nasdaq National Market, was $10 1/16. As of December 31, 1999, the closing
historical high and low prices of our common stock were $37 occurring on
November 26, 1999 and $1 5/8 occurring on March 23, 1999, respectively. As of
March 15, 2000, we had 127 holders of record of our common stock. There are
approximately 4,600 beneficial owners of our common stock.

Dividend Policy

         No cash dividends have been declared on the Company's common stock
through March 15, 2000 and the Board of Directors has no current intention to
declare or pay dividends on the common stock in the foreseeable future.

                                       18

<PAGE>



         On October 9, 1998, the Board of Directors of the Company adopted a
rights plan pursuant to which it declared a dividend of one preferred share
purchase right for each outstanding share of common stock. Each right entitles
the registered holder to purchase one one-hundredth of a share of Series A
Preferred Stock, par value $.001 per share. The purchase price is $25 per one
one-hundredth of a share of Preferred Stock, subject to adjustment. Until the
occurrence of certain triggering events, the rights will be evidenced only by
the outstanding common stock certificates on the books and records of the
Company maintained by its transfer agent and will not be separately issued.

Item 6.  Selected Financial Data

         The following data has been derived from financial statements audited
by PricewaterhouseCoopers LLP, independent accountants. Consolidated balance
sheets as of December 31, 1998 and 1999 and the related consolidated statements
of income for each of the three years ended December 31, 1999 and notes thereto
appear elsewhere in this Form 10-K.
<TABLE>
<CAPTION>


                                                                     Year Ended December 31,
                                                                     -----------------------
Consolidated Statements of
Operations Data:                             1995            1996             1997             1998             1999
                                             ----            ----             ----             ----             ----
<S>                                         <C>            <C>             <C>              <C>              <C>

Sales . . . . . . . . . . . . . . . .       $ 9,515,433    $ 13,030,637     $ 13,201,916     $ 17,445,829     $ 11,626,546
Cost of goods sold . . . . . . . . .          4,615,349       6,482,147        7,180,241       11,965,220        5,096,014
                                             ----------      ----------      -----------      -----------      -----------
Gross profit                                  4,900,084       6,548,490        6,021,675        5,480,609        6,530,532
Operating Expenses:
     Selling and marketing                    2,922,826       3,952,723        4,400,786        5,265,542        5,634,070
     General and administrative               2,914,835       6,383,192        6,145,088        9,710,275        7,312,680
     Research and development net             2,482,561       5,758,413        8,182,584        6,722,905        5,688,414
     Restructuring charge                            --              --          379,454               --          369,528
                                             ----------      ----------      -----------      -----------      -----------
Total operating expenses                      8,320,222      16,094,328       19,107,912       21,698,722       19,004,692
Loss from operations                         (3,420,138)     (9,545,838)     (13,086,237)     (16,218,113)     (12,474,160)
Gain on sale of assets                               --              --               --       29,537,896               --
Total other income (expense)                    196,737         744,381          324,838        (874,645)          (25,655)
Income/(loss) before provision for
income taxes                                 (3,223,401)     (8,801,457)     (12,761,399)      12,445,138      (12,499,815)
Provision for income taxes                           --              --               --          368,632               --
Net income/(loss)                            (3,233,401)     (8,801,457)     (12,761,399)      12,076,506      (12,499,815)
Earnings/(loss) per share
     Basic                                        (0.68)          (1.10)           (1.39)            1.25            (1.27)
     Diluted                                      (0.68)          (1.10)           (1.39)            1.11            (1.27)
Weighted average number of
     common shares outstanding:
     Basic                                    4,739,083       7,979,249        9,161,758        9,652,664        9,843,402
                                             ----------      ----------      -----------      -----------      -----------
     Diluted                                  4,739,083       7,979,249        9,161,758       10,843,215        9,843,402
                                             ----------      ----------      -----------      -----------      -----------

</TABLE>


                                       19

<PAGE>

<TABLE>
<CAPTION>



Consolidated Balance Sheet Data:             1995            1996             1997             1998             1999
                                             ----            ----             ----             ----             ----
<S>                                        <C>            <C>              <C>              <C>               <C>
Cash, cash equivalents and
marketable securities . . . . . . . . .   $ 13,979,009    $ 10,625,960     $  2,645,864     $ 17,996,575      $ 7,088,431
Working capital . . . . . . . . . . . .     16,084,594      13,795,614        4,329,018       12,632,033        7,827,522
Equipment, net  . . . . . . . . . . . .        567,941       2,036,897        2,382,645        1,365,354        1,387,128

Total assets  . . . . . . . . . . . . .     18,932,434      20,103,064       11,121,667       33,682,380       19,817,072
                                           -----------      ----------       ----------       ----------       ----------
Long-term liabilities . . . . . . . . .             --              --        2,367,147          332,834        2,004,886
Stockholders equity . . . . . . . . . .     16,989,104      16,198,896        5,133,213       19,705,497       10,997,239

</TABLE>

Item 7.  Management's Discussion and Analysis of Financial Condition and
         Results of Operations

         The discussion and analysis below should be read in conjunction with
the Financial Statements of the Company and the accompanying notes set forth on
pages F-1 through F-22.

Overview

         We are a leading provider of open systems-based digital remote access
equipment to ISPs. Our remote access equipment is compatible with open systems
platforms running a variety of popular operating systems, including Windows NT
and Linux, and enables ISPs to build reliable, scalable and easy to manage
networks at a cost that is significantly below other available alternatives.

         Historically, our core strength has been supplying digital signal
processing-based (DSP) sub-systems to OEMs and government contractors. Our DSP
OEM products are incorporated into a variety of applications, including medical
instrumentation, machine vision, professional audio, sonar, radar and
multimedia.

         In the mid-1990s, we introduced a series of data communications
products aimed at the computer telephony integration market or CTI products. Our
initial product, the CTI Modem, which we still provide to OEM customers, is used
in Internet access, on-line services and transaction processing markets.

         In 1996, we formed a communications systems group to begin development
of an Asymmetrical Digital Subscriber Line ("ADSL") carrier-class product
targeting the needs of major telecommunications and network service providers.
As a result of our strategic decision to reposition our company in 1997, we
decided to sell our communications systems group, and in September 1998 we
completed the sale of the group's assets to Cabletron Systems, Inc. for
approximately $30 million.

         In 1997, we also announced our intention to focus on the remote access
equipment market through product offerings that provide high density and
cost-effective remote access solutions based on industry standard PC platforms.
We developed the T1 Modem and T1 Modem Plus products, Windows NT-based remote
access solutions, for this market. Target customers for these products were OEMs
that wanted to integrate remote access capability into their computers. A major
PC manufacturer, Compaq, adopted the T1 Modem Plus remote access solution in
March 1998.

                                       20

<PAGE>

         By late 1998, widespread use of the Internet and improved Internet
security led enterprises to outsource their remote access needs to ISPs. This
led to the decline of Compaq's primary remote access market, the enterprise
remote access market, and our revenues from Compaq decreased from a total of
$4.4 million in 1998 to zero for the period ended December 31, 1999.

         Our ability to successfully execute our new business strategy is
critical to the future performance of our business. During the second quarter of
1999 we changed our business strategy to focus on the ISP market following the
decline of the enterprise remote access market. Historically, we have derived
substantially all of our revenues from product sales to OEM's and PC
manufacturers. As we focus on efforts on the ISP market, we expect sales to OEMs
to represent a declining percentage of our total revenue in the future if our
business strategy is successful. Because the ISP market is a new market for us,
and the equipment we have developed for that market has only recently been
introduced, we have limited experience in selling our products. Currently, only
a limited number of ISPs have purchased our products.

         To expand our international operations, in November 1998 we acquired
all of the outstanding common stock of Solutions for Communications and
International ISDN, S.A. (Scii) headquartered in Paris, France. The transaction
was accounted for using the purchase method of accounting and consideration,
including related transaction costs, consisted of $3,389,029 in cash.

         Revenue is derived from the sale of hardware and software products for
DSP and remote access applications. Our customers consist primarily of OEMs,
computer equipment distributors and ISPs. We recognize revenue at the time the
product is shipped to the customer when there is no additional significant
post-contract customer support obligation.

Results of Operations

         The following table sets forth statements of operations data as a
percentage of sales for the periods indicated.

<TABLE>
<CAPTION>

                                                                     Year Ended December 31,
                                             1995            1996             1997             1998             1999
                                             ----            ----             ----             ----             ----
<S>                                        <C>              <C>              <C>             <C>              <C>

Sales . . . . . . . . . . . . . . . .       100.0%          100.0%           100.0%           100.0%           100.0%
Cost of goods sold . . . . . . . . . .       48.5            49.7             54.4             68.6             43.8
Gross profit                                 51.5            50.3             45.6             31.4             56.2
Operating Expenses:
     Selling and marketing                   30.7            30.3             33.3             30.2             48.5
     General and administrative              30.6            49.0             46.5             55.7             62.9
     Research and development net            26.1            44.2             62.0             38.5             48.9
     Restructuring charge                     0.0             0.0              2.9              0.0              3.2
Total operating expenses                     87.4           123.5            144.7            124.4            163.5
Loss from operations                        (35.9)          (73.3)           (99.1)           (93.0)          (107.3)
Gain on sale of assets                        0.0             0.0              0.0            169.3              0.0

</TABLE>

                                       21

<PAGE>

<TABLE>
<CAPTION>


                                                                     Year Ended December 31,
                                                                     -----------------------
                                                 1995             1996            1997              1998           1999
                                                 ----             ----            ----              ----           ----
<S>                                             <C>             <C>              <C>                <C>            <C>

Total other income (expense)                       2.1             5.7              2.5             (5.0)           (0.2)
Income/(loss) before provision for               (33.9)          (67.5)           (96.7)            71.3          (107.5)
income taxes
Provision for income taxes                         0.0             0.0              0.0              2.1             0.0
Net income/(loss)                                (33.9)          (67.5)           (96.7)            69.2          (107.5)

</TABLE>

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998.

         Worldwide sales were $11,626,546 for the year ended December 31, 1999,
a decrease of $5,819,283 compared to net sales of $17,445,829 for the twelve
months ended December 31, 1998. Domestic sales were $10,459,550 for the twelve
months ended December 31, 1999 compared to $15,720,887 for the twelve months
ended December 31, 1998, a decrease of $5,207,214. The decrease is related to
the decline of the enterprise remote access market in late 1998 after which,
Compaq, our most significant OEM customers and a number of other customers
discontinued their networking groups. As a result, revenues from Compaq declined
from $4.4 million for the year ended December 31,1998 to zero for the year ended
December 31, 1999. The loss of sales to other PC integrators selling to the
enterprise market comprised the remaining 1999 domestic sales variances from the
previous year.

         International sales were $1,166,996 for the year ended December 31,
1999 including U.S. exports of $769,531 and sales from European subsidiaries of
$397,465 compared to international sales of $1,724,942 for 1998. The decrease is
attributable to a reduction in demand by an OEM customer for our audio mixing
product, as well as a reduction in sales of T1 Modem Plus products due to the
release of our RS2000 product. Such decreases were partially offset by sales
from the Company's European subsidiaries.

         Gross profit increased by $1,049,923 or 19% to $6,530,532 for the year
ended December 31, 1999 from $5,480,609 for the twelve months ended December 31,
1998. Gross profit margin was 56% for the twelve months ended December 31, 1999
compared to 31% for the twelve months ended December 31, 1998. The increase in
gross profit margin as a percent of sales reflects the continued shift in
product mix from lower margin shipments to PC integrators to shipments to OEM's
customers that carry higher gross margins. 1999 gross profit was reduced by
$195,000 for the write down of RS2000 inventory. We introduced the RS4200 in the
fall of 1999 which has improved price and performance compared to the RS2000. As
a result, we expect to reduce the price of the RS2000 and wrote down inventory
to effect lower of cost or market valuation. 1999 gross profit margins were 58%
before this write-down. Additionally, 1998 profit margins reflect a charge of
approximately $2.0 million for the write-down of certain inventory primarily
related to T1 Modem Plus and RS1000 products. The write-down was the result of a
substantial reduction in demand from several major customers including Compaq.
We negotiated additional sales with Compaq in the fourth quarter of 1998 and
have sought new markets for these products. However, due to the introduction of
the Company's next generation RS2000 product family in September 1998, and the
Company's change in focus from enterprise customers to ISPs, management expected
substantially reduced demand for these products from Compaq and other T1 Modem
Plus customers in 1999 and beyond. 1998 gross profit margins were 42.9% before
this write-down.

         Sales and marketing expenses were $5,634,070 or 48% of sales for the
year ended December 31, 1999 compared to $5,265,542 or 30% of sales for the
twelve months ended December 31,1998. The increase of

                                       22

<PAGE>



$368,528 reflects incremental spending in 1999 of $391,331 for advertising, and
marketing programs related primarily to the launch of the Company's ISP PowerPOP
architecture and $459,598 for European operations. Such increases were offset by
decreases in commissions of $128,383 and related sales travel of $25,046 due to
lower sales volume. Other decreases include a reduction in consulting fees of
$86,139 for focus groups related to integration of the Scii acquisition.
Additionally, depreciation was reduced by $214,289 due to the disposition of
certain trade show and demonstration material resulting from the Company's
market shift.

         General and administrative expenses were $7,312,680 for the year ended
December 31, 1999 compared to $9,710,275 for the twelve months ended December
31, 1998. The decrease of $2,397,595 is due in part to certain expenses recorded
in 1998 which did not reoccur in 1999. Those expenses included bonuses paid in
September 1998 of $1.1 million in connection with the sale of the CSG in that
month and a reduction in staff salaries as a result of the sale. Other one time
expenses incurred in 1998 included approximately $842,000 related to separation
agreements with respect to an officer of the Company and a consultant. Other
decreases include $175,000 related to the settlement of a licensing dispute and
$292,923 of warranty expense related to the return of custom equipment from a
major customer. Additionally, 1998 general and administrative expenses included
a provision for doubtful accounts for Hayes Microcomputer, Inc. and its
affiliates when Hayes filed for bankruptcy protection. Accordingly, provisions
for doubtful accounts decreased during fiscal 1999 by approximately $231,000 as
compared to the twelve months ended December 31, 1998. Additional expense
reductions include a decrease of approximately $1,170,000 in consulting fees
resulting from the termination of consulting agreements early in 1999. Such
decreases were partially offset by an increase of $588,734 in general and
administrative expenses and $918,572 in amortization of goodwill both related to
the Company's European subsidiaries acquired in November 1998. (See Note 3 to
the financial statements).

         As a result of our strategic decision to focus on the ISP market and
our newly created sales channel through KeyLink Systems, we terminated our Vice
President of OEM Sales effective August 20, 1999. Two additional field
sales-reps were also terminated in the third quarter of 1999. As a result, we
recorded a restructuring charge in September 1999 of $369,528, which reflects
severance and related benefits payments, of which $288,010 was paid as of
December 31, 1999. The remaining amounts are expected to be paid over a three
month period ending March 31, 2000.

         Research and development expenses were $5,688,414 or 49% of sales for
the year ended December 31, 1999 compared to $6,722,905 or 39% of sales for the
year ended December 31, 1998, a decrease of $1,034,491. Expenses declined by
$2,309,430 from the same period last year due to the sale of the CSG to
Cabletron in September 1998. 1998 R&D expenses also included in-process
research and development costs of $297,330 related to the acquisition of Scii
Telecom, SA in November 1998. (See Note 3 to the financial statements). These
decreases were offset by an increase in research and development of $667,932
resulting from investments in products and technologies at this subsidiary.
Additionally, expenses increased due to bonuses paid to certain engineers in
conjunction with employment contracts of approximately $885,000.

         Interest expense of $527,611 for the year ending December 31, 1999
consisted primarily of interest on the term and revolving credit notes
outstanding under our credit facility with Transamerica. Interest expense of
$1,371,970 for the year ending December 31, 1998 included interest related to
the Transamerica facility as well as a one-time charge of $750,000 in accordance
with the terms of a $2.0 million bridge loan drawn down on February 19, 1998
against the anticipated proceeds of the sale of the communications systems
group. Interest income of $440,477 and $432,596 for the twelve months ended
December 31, 1999 and 1998, respectively, consisted of income from the
investment of our cash.


                                       23

<PAGE>



         There was no tax provision for the twelve months ending December 31,
1999 due to losses reported for that period. For the twelve months ending
December 31, 1998 a tax provision of $368,632 was recorded to reflect our
estimated federal and state income tax liability for 1998 income. This liability
was partially offset by the use of the net operating losses we incurred in
previous years. Alternative minimum tax rules limit the use of such operating
losses to entirely offset our 1998 income tax liability.

         For the foregoing reasons we reported a net loss of ($12,499,815) for
the year ended December 31, 1999 as compared to net income of $12,076,506 for
the year ended December 31, 1998.

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

         Worldwide sales were $17,445,829 for 1998, an increase of $4,243,913 or
32.1% from $13,201,916 for 1997. Domestic sales for 1998 were $15,720,887
compared to $12,035,000 for 1997, an increase of $3,685,887 or 30.6%. This
increase in domestic sales for 1998 reflects increased shipments of our remote
access RS1000, T1 Modem and T1 Modem Plus products primarily to PC
manufacturers. Such increases were offset by decreased shipments of various DSP
products. During 1998, we focused our sales and marketing efforts on the rapidly
growing remote access equipment market targeting enterprises and PC
manufacturers and going forward, decided to continue to focus on the remote
access market. However, we decided to change the focus of our selling and
marketing efforts from PC manufacturer customers and enterprise markets to end
users such as ISPs. OEM customers, who require customized applications of our
products, will continue to be a part of our customer base. Sales internationally
were $1,724,942 for 1998 compared to $1,166,916 for 1997. This growth resulted
from an increase in export sales of DSP products to existing customers. Sales
for remote access products did not increase as rapidly in the international
markets because our selling and marketing efforts were largely directed towards
the domestic markets.

         Gross profit decreased $541,066 to $5,480,609 for 1998 compared to
$6,021,675 for 1997. Gross profit margin decreased from 45.6% for 1997 to 31.4%
for 1998. The decrease in margin was due, in part, to the continued shift in
product mix from higher margin DSP products to lower margin data communications
products as sales to PC manufacturers typically yield lower gross margins.
Additionally, 1998 profit margins reflect a charge of approximately $2.0 million
for the write-down of certain inventory primarily related to T1 Modem Plus and
RS 1000 products. The write-down was the result of a substantial reduction in
demand from several major PC manufacturer customers including Compaq. We
negotiated additional sales with Compaq in the fourth quarter and sought new
markets for these products. However, due to the introduction of our next
generation RS2000 product family in September 1998, and our change in focus from
PC manufacturers to ISPs, we do not expect additional demand for these products
from Compaq and other T1 Modem Plus customers going forward. In 1998 gross
profit margins were 42.9% before the write-down for inventory levels exceeding
expected consumption.

         Sales and marketing expenses were $5,265,542 or 30.2% of sales for 1998
compared to $4,400,786 or 33.3% of sales for 1997. The increase of $864,756
reflects increased wages, benefits and related travel of approximately $675,000
as we changed the composition of our sales force to include more experienced
data communications personnel in 1998. Consulting expenses increased $207,000,
due primarily to fees for international sales representatives as we expanded our
European presence. Depreciation expenses increased $165,000 reflecting an
increase in customer demonstration and loan programs. These increases were
offset by decreases in marketing, advertising and trade show costs of
approximately $135,000, and commissions of $147,000 that were consistent with
the shift from DSP OEM customers to larger PC manufacturers in 1998.



                                       24

<PAGE>



         General and administrative expenses were $9,710,275 or 55.7% of sales
for 1998 compared to $6,145,088 or 46.5% in 1997, an increase of $3,565,187.
Included in general and administrative expenses for 1998 were non-recurring
expenses related to severance and separation agreements of approximately
$842,000 with respect to one of our officers and a consultant. Recruitment
expenses increased by approximately $208,000 in 1998 for fees paid to recruiting
firms for the CEO and CFO positions. Bonuses to management and other
administrative personnel were approximately $1,315,000 higher than 1997 due to
bonuses granted to individuals for efforts in selling the communications system
group to Cabletron. Provisions for doubtful accounts increased by approximately
$820,000 due primarily to one of our customers, Hayes Microcomputer Products,
Inc. and its affiliates, filing for bankruptcy under Chapter 11 of the Federal
Bankruptcy Code on October 9, 1998. Reserves for warranty expenses increased by
$223,000 primarily due to the return of custom products from one customer. We
have since shipped to that customer an upgraded product and we do not anticipate
any additional returns from that shipment. General and administrative expenses
in 1998 also include approximately $100,000 for our French subsidiary
representing expenses from the acquisition date through December 31, 1998. In
addition to these expenses, an expense of $92,000 was incurred in 1998 for the
amortization of goodwill and other intangible assets recognized in the
acquisition.

         Research and development expenditures were $6,722,905 or 38.5% of sales
for 1998 compared to $8,182,584 or 62.0% of sales for 1997, a decrease of
$l,459,679. Approximately $1,783,000 of the decrease is due to the sale of the
communications systems group on September 1, 1998. Other decreases include a
reduction in wages of approximately $376,000 and contract labor and materials of
$348,000 in connection with discontinued development projects that were not part
of the communications systems group. 1998 expenses also included approximately
$75,000 for research and development costs for the period from November 23, 1998
through December 31, 1998 for our French subsidiary and a charge of $297,330 for
in-process research and development expenses recognized at the time of the
acquisition. Included in 1997 expenses, as an offset, is a payment of $750,000
received from Texas Instruments for non-recurring engineering expenses in
connection with a cooperative and licensing agreement signed on September 12,
1997. We terminated this agreement on February 19, 1998.

         Other income included a gain on the sale of assets related to the
communications systems group of $29,537,896. On September 1, 1998, we completed
the sale of all of the assets of the CSG to publicly held Cabletron Systems,
Inc. of Rochester, New Hampshire for $33,500,000. Expenses of the transaction
netted against the proceeds were approximately $3,962,104.

         Interest expense of $1,371,970 reflects a one-time charge of $750,000
in accordance with the terms of a $2.0 million bridge loan we drew down on
February 19, 1998 against the anticipated proceeds of the sale of the
communications systems group. The credit note issued under the terms of the
bridge loan matured on the date of sale. Other interest expense consisted
primarily of interest on the term and revolving credit notes outstanding under
our credit facility with Transamerica. Interest income of $432,596 consisted of
income from the investment of our cash.

         A tax provision of $368,632 reflects our estimated federal and state
income tax liability for 1998 income. This liability was partially offset by the
use of the net operating losses we incurred in previous years. Alternative
minimum tax rules limit the use of such operating losses to entirely offset our
1998 income tax liability.

         For the foregoing reasons we reported net income of $12,076,506 for the
year ended December 31, 1998 as compared to a net loss of ($12,761,399) for the
year ended December 31, 1997.


                                       25

<PAGE>



Liquidity and Capital Resources

         Our principal sources of liquidity as of December 31, 1999, consisted
of $7,088,431 in cash and cash equivalents and a $4 million revolving credit
facility, (Revolver). Cash flow for the year ended December 31, 1999
includes proceeds from the exercise of stock options and warrants of
approximately $4.3 million. Our ability to draw against the Revolver is based on
a monthly computation of eligible assets and amounts drawn in excess must be
repaid at the time they are computed. During 1999 we repaid $1,300,163 and no
additional amounts were drawn against the Revolver.

         We have incurred substantial operating losses and had an accumulated
deficit of $26,137,692 at December 31, 1999. We expect to have operating losses
and a growing accumulated deficit in the future. If we do not successfully
execute our business strategy in the ISP and OEM markets, there is no assurance
that we will generate sufficient cash flow from operations to meet the Company's
anticipated operating needs for 2000. However, we believe our existing cash and
cash equivalents together with the proceeds from the sale of securities
completed in the first quarter of 2000, (See Note 18) will be sufficient to meet
our presently anticipated cash needs through the end of 2000. Even if our cash
requirements vary from those now planned, we believe that our sources of
liquidity are sufficient to continue operations through the end of 2000.
However, if necessary, we may delay or eliminate some expenditures and planned
operations may be scaled back or, we may need to raise additional funds to meet
obligations. We would seek to raise such amounts through a variety of options
including borrowings, proceeds from equity financing and scaling back
operations. Additional funding may not be available when needed or on terms
acceptable to us, which could have a material adverse effect on our business
financial condition, and results of operations.

         The Company maintains a credit facility with Transamerica Business
Credit Corporation. Currently the Company has a five-year, $3 million term loan
and a $4 million revolving credit facility ("Revolver"). As of December 31,
1999, there was $2,293,973 outstanding under the term loan and $1,199,837 under
the Revolver. (See Note 8 to the Financial Statements.)

         Term loan payments of principal and interest are due in arrears in
twenty consecutive quarterly installments, payable on the first day of each
calendar quarter commencing October 1, 1997. The interest rate under the term
loan is based on the weekly average of the interest rate on five year U.S.
Treasury Securities for stated periods plus an agreed upon number of additional
basis points. At December 31, 1999, the interest rate in effect was 12.230%.

         The Revolver provides for up to $4.0 million in advances based on a
formula of eligible accounts receivable and inventory. Amounts drawn under the
Revolver mature on June 12, 2000. Eligibility is computed monthly and amounts
drawn that are not supported by the formula are to be repaid at that time. The
Revolver balance is reflected as a current liability on the balance sheet. The
interest rate in effect under the Revolver is based on the prime rate plus 2.50%
and is payable monthly in arrears.

         In addition, the credit agreement includes a material adverse effect
clause, whereby Transamerica can accelerate the due date of the loan if certain
changes in conditions (financial or otherwise) are deemed to have a material
adverse effect on us or our ability to meet our obligations.

         On October 18, 1999 we executed a further amendment to the credit
agreement that substantially reduced the amended financial covenants as of and
for the year ending December 31, 1999. As of December 31, 1999 only financial
covenants that we were required to comply with were as follows:




                                       26

<PAGE>



         (1)      As of December 31, 1999, working capital shall be no less
                  than $2,000,000.

         (2)      The ratio of current assets to current liabilities shall not
                  be less than 1.25 to 1.00.

         (3)      Tangible net worth shall not be less than $2,000,000.

         (4)      Gross profit margins for the year ending December 31, 1999
                  shall not be less than 35%.

         As of December 31, 1999 we were in compliance with these covenants. The
amendment eliminates financial covenants thereafter.

        During the twelve months ended December 31, 1999, there was a net
decrease in cash and cash equivalents of $10,908,144. At December 31, 1999, cash
and cash equivalents amounted to $7,088,431. Working capital amounted to
$7,827,522 at December 31, 1999 as compared to working capital of $12,632,033 at
December 31, 1998.

         Net cash used in operating activities for the twelve months ended
December 31, 1999 amounted to $12,567,511. The negative cash flows from
operations were the due primarily to our net loss of $12,499,815 which was
offset by non-cash expenditures related to depreciation, amortization, reserves
and allowances of $2,938,550. Other operating cash uses included decreases in
accounts payable and accrued liabilities of $2,683,382 as we paid down
obligations of our French subsidiary and accrued costs related to the sale of
the CSG and executive bonuses. Additionally, increases in inventory related the
introduction of the RS2000 and RS4200 resulted in a decrease in operating cash
of $729,945. These were partially offset by decreases in receivables of
$69,335.

         Net cash used in investing activities for the twelve months ended
December 31, 1999 amounted to $593,851 due to the purchases of computer and
peripheral equipment related mainly to a research and development test lab and
final test and assembly equipment in manufacturing.

         Cash from financing activities increased $2,215,963 for the twelve
months ended December 31, 1999 as a result of proceeds of $4,326,540 from the
exercise of outstanding stock options and warrants. Such increases were offset
by principal payments on debt of $2,085,316.

         During the twelve months ended December 31, 1998, there was a net
increase in cash and cash equivalents of $15,350,711, including an amount of
$31,348,753 in proceeds net of transaction costs from the sale of assets related
to the communications systems group. On July 27, 1998 we received a deposit of
$5,000,000 on the sale and on September 1, 1998 we received the remaining gross
proceeds of $28,500,000. At December 31, 1998, cash and cash equivalents
amounted to $17,996,575. Working capital amounted to $12,632,033 at December 31,
1998 compared to $4,329,018 at December 31,1997.

         Net cash used in operating activities for 1998 amounted to $16,176,526.
The negative cash flow from operations was primarily the result of our net
operating loss of $16,218,113. Additional operating decreases include accounts
receivable of $2,813,966, reflecting an increase in collection days, and
increases in inventory balances of $1,700,796 related to slow moving and excess
inventory.

         Net cash provided by investing activities for 1998 amounted to
$27,284,599. This included proceeds net of transaction costs of $31,348,753 from
the sale of the communications systems group and a decrease due

                                       27

<PAGE>



to acquisitions of $3,340,122 net of cash acquired of $48,908. Capital
expenditures of $724,032 reflected purchases of computer and peripheral
equipment for the engineering staff and final test and assembly in
manufacturing.

         Net cash provided by financing activities for the year ended December
31, 1998 amounted to $4,242,638, reflecting net proceeds of $2,500,000 received
as a result of a draw on the Transamerica revolving credit facility and
$2,051,412 in proceeds from the exercise of common stock options. Additionally,
decreases of $308,774 were incurred on principal payments of long-term debt.

         During the year ended December 31, 1997, there was a net decrease in
cash and cash equivalents of $1,980,719, including a net amount of $5,993,634 in
proceeds from the maturity and sale of investments in marketable securities
which were used to fund operations. On June 13, 1997, we received gross proceeds
of $3,000,000 under our term loan. At December 31, 1997, cash and cash
equivalents amounted to $2,645,864. Working capital amounted to $4,329,018 at
December 31, 1997 compared to $13,795,613 at December 31, 1996.

         Net cash used in operating activities for 1997 amounted to $10,581,713.
The negative cash flow from operations was primarily the result of our net loss
of $12,761,399, partially offset by a decrease in accounts receivable of
$1,773,918 reflecting lower sales in the fourth quarter of 1997 compared to the
fourth quarter of 1996.

         Net cash provided by investing activities for 1997 amounted to
$4,549,577. This included net proceeds of $5,993,634 from the maturity and
subsequent sale of high quality government agency securities. Capital
expenditures of $1,444,057 reflected purchases of computer and peripheral
equipment for the engineering staff, final test and assembly in manufacturing
and the purchase of office furniture in connection with our relocation of the
communications systems group to Piscataway, New Jersey in January 1997.

         Net cash provided by financing activities for the year ended December
31, 1997 amounted to $4,051,417, reflecting proceeds of $3,000,000 received as a
result of the Transamerica term loan and $1,084,270 in proceeds from the
exercise of common stock options.

         On February 24, 2000 we entered into an agreement with a number of
investors to sell 2,151,000 shares of our common stock at a purchase price of
$4.00 per share in a private placement. We also issued 2,151,000 warrants to
purchase common stock with an exercise price of $6.875. The warrants are not
exercisable until September 1, 2000. The exercise price of the warrants will be
reset to the average market price for the five trading days preceding the one
year anniversary date of the issuance of the warrant provided the average price
is less than $6.875. Under the terms of the agreement, we agreed to file a
registration statement on or before April 4, 2000 to register the shares sold
and those underlying the warrants and to have the registration statement
declared effective by the Securities and Exchange Commission within 120 days
thereafter. In the event we fail to meet these deadlines, the agreement provides
for liquidated damages.

         The agreement also provides for the issuance of additional shares at no
cost to these investors in the event that we sell shares of common stock, or
securities convertible into common stock, at a price less than $4.00 per share
within twenty four months of the date of this agreement. This provision requires
us to issue additional shares such that the average share price of these
investors is equal to the then offered price.

         Additionally, these investors have the right of first refusal to
participate in any sale of our common stock, or securities convertible into
common stock, within the next twenty four months.

                                       28

<PAGE>



Readiness of Year 2000

         As of the date of this filing, we have not experienced any problems
with our internal business systems or products and have not been notified of any
problems by our suppliers.

Item 7A. Qualitative and Quantitative Disclosures About Market Risk

         The results of our operations and the valuation of some of our assets
and liabilities are sensitive to changes in the general level of interest rates
in the United States and foreign exchange rate fluctuations.

         Interest rate risk. Our interest income is sensitive to changes in the
general level of interest rates in the United States, as our investments are in
United States dollar cash equivalents and short-term instruments.

         Our interest expense is sensitive to changes in the general level of
interest rates in the United States, because the computation of interest due on
our debt in the United States is based on key interest rate indicators used in
the United States such as the prime rate.

         Foreign exchange risk. We currently have foreign subsidiaries that
conduct and report their operations in local currency. The primary foreign
currency is the French Franc. Other currencies include the British Pound and the
German Deutschmark. On January 1, 1999, eleven member countries (including
France and Germany) of the European Union established fixed conversion rates
between their existing, or local, currencies and one common currency, the euro.
The euro trades on currency exchanges and may be used in business transactions.
Conversion to the euro eliminates currency exchange risk between the
participating member countries.

         Due to the limited contribution of our foreign subsidiaries to our
results of operations, we do not believe we have material market risk exposure.

Adoption of Statements of Financial Accounting Standards

         The following table sets forth a reconciliation and the components of
comprehensive income for the twelve months ended December 31, 1998 and the
twelve months ended December 31, 1999:
<TABLE>
<CAPTION>

                                                  Twelve Months Ended         Twelve Months Ended
                                                   December 31, 1999            December 31, 1998
                                                   -----------------            -----------------
<S>                                                <C>                           <C>

Net income/(loss)...............................    $  (12,499,815)               $ 12,076,506
Other comprehensive income/(loss):
     Unrealized gain/(loss) on foreign currency
     translation................................          (534,983)                     31,272
                                                     -------------                ------------

Comprehensive income............................     $ (13,034,798)               $ 12,107,778
                                                     =============                ============

</TABLE>

         Also in June 1997, the FASB issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information", which revises disclosure
requirements about operating segments and establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS

                                       29

<PAGE>



No. 131 requires that public business enterprises report financial and
descriptive information about their reportable operating segments. The statement
is effective for fiscal years beginning after December 15, 1997, and requires
restatement of prior years in the initial year of application. SFAS No.131 is
expected to affect our segment disclosures, but will not affect our results of
operations, financial position or cash flows. On September 1, 1998 we sold the
assets of the communications systems group to Cabletron Systems, Inc. Operating
expenses for the group were approximately $2,309,430, $4,093,756 and $2,004,812
for the years ended December 31, 1998, 1997 and 1996, respectively. As of June
30, 1999, our operations qualified as reportable segments under SFAS No.131. We
report segments on a geographic basis, which are North America and Europe.

         In June 1998, the Financial Accounting Standards Board issued SFAS
No.133, "Accounting for Derivative Instruments and Hedging Activities". This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires recognition of all
derivatives as either assets or liabilities on the balance sheet and measurement
of those instruments at fair value. We currently do not hedge foreign currency
denominated transactions or enter into any derivative instruments. This
statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 2000. The effect of adopting SFAS No. 133 is not expected to be
material to our operations.

         In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use". Among other provisions, SOP
98-1 requires that entities capitalize certain internal use software costs once
certain criteria are met. Under SOP 98-1, overhead, general and administrative
and training costs are not to be capitalized. SOP 98-1 is effective for
financial statements for fiscal years beginning after December 15, 1998;
therefore, we adopted these provisions as of January 1, 1999.

Item 8. Financial Statements and Supplementary Data.

         See Financial Statements beginning on page F-1.

Item 9.  Changes and Disagreement with Accountants on Accounting and Financial
         Disclosure

         Not applicable.

Item 10. Directors, Executive Officers, Promoters and Control Persons:
         Compliance with Section 16(a) of the Exchange Act

         The following table sets forth our executive officers and directors as
of December 31, 1999. Our Board of Directors currently consists of six
directors. Except as otherwise stated, executive officers serve at the
discretion of the Board of Directors.

Name                     Age     Position

Jay H. Atlas             55      President, Chief Executive Officer and Director
Anthony M. Agnello       50      Chairman of the Board of Directors
Dennis I. Schneider      48      Senior Vice President - Marketing
John R. Loprete          39      Vice President - Finance
Carlos G. Borgialli      57      Vice President - Engineering
Esmond T. Goei           48      Vice Chairman of the Board of Directors
Edward D. Horowitz       52      Director
Harold W. Paul           51      Director and Secretary
Charles S. Strauch       64      Director

                                       30
<PAGE>


         Jay H. Atlas was appointed as our Chief Executive Officer and President
in December 1998. He was appointed a director in January 1999. From 1995 to
1998, he served as the President and CEO of CTF Group, a management consulting
firm. Since 1998, he has served as a trustee of the Kobrick Investment Trust, a
group of mutual funds. Mr. Atlas has more than 30 years' experience in the
industry, including 20 years at Digital Equipment Corporation, in senior
management positions in sales, service and marketing.

         Anthony M. Agnello co-founded Ariel in 1982 and serves as Chairman of
the Board. He has been a member of the compensation committee since June 1995.
He also held the title of President from 1988 until September 1996. In December
1998, Mr. Agnello resigned as Chief Executive Officer simultaneously with the
appointment of Mr. Atlas to that position.

         Dennis I. Schneider was appointed Senior Vice President - Marketing in
December 1998. For more than five years, he was a marketing consultant to major
corporations in the computer, networking and telecommunications industry
including Chase Manhattan Bank, Andersen Consulting, IBM and Lucent
Technologies. He has more than 25 years' experience in the industry, holding
senior marketing and general management positions with Digital Equipment
Corporation and as an officer of Motorola Inc.

         John R. Loprete joined Ariel in April 1998 and was appointed Vice
President - Finance in January 1999. He is a certified public accountant with
over 15 years' experience in finance and accounting. His experience includes
eleven years with Concurrent Computer Corporation, a Florida-based computer
manufacturer.

         Carlos G. Borgialli was appointed to the position of Vice President -
Engineering in May 1999. Mr. Borgialli joined Ariel from Digital/Compaq, where
he spent more than 20 years, leading and improving organizations in the design
of client/server business-critical production systems. In his most recent
position at Digital/Compaq, he served as Director of Engineering for the Network
and application Communication Products division. Prior to that,he was
instrumental in developing and managing the development of a number of key
telephony, videotext, and transaction processing products for Digital. Mr.
Borgialli has also worked at the NASA Goddard Space Flight Center and spent five
years at the Pan American Health Organization/World Health Organization.

         Esmond T. Goei joined Ariel as Vice-Chairman of the Board in August
1999. He is a member of the audit and compensation committees. Prior to joining
us, he worked at Northern Telecom, where he last served as director of the
corporate Venture Capital Division. Prior to that, he was Vice President of the
Venture Capital Division at Toronto Dominion Bank and a senior systems
consultant at Touche Ross (now Deloitte & Touche).

         Edward D. Horowitz has been a director and a member of the audit
committee since August 1995. From 1989 to 1996, Mr. Horowitz was employed by
Viacom International Inc., most recently as Senior Vice President Technology. He
was also the Chairman and Chief Executive Officer of Viacom Interactive Media,
and is a director of Star Sight Telecast. In January 1997, Mr. Horowitz
became Executive Vice President of Advanced Development of CitiCorp and Chief
Executive Officer of its e-citi division.



                                       31

<PAGE>



         Harold W. Paul has been a director since June 1995 and was appointed
secretary in March 1998. He is a member of the compensation committee. Mr. Paul
has been a partner at Paul & Rosen LLP, a New York law firm specializing in
securities matters. Since 1999, he is a director of Kirlin Holding Corp., a
brokerage and investment banking company.

         Charles S. Strauch was appointed a director in September 1999. He is a
member of the audit committee. Mr. Strauch is currently Chairman of the Board of
PairGain, a telecommunications company. He has served on PairGain's board of
directors since 1991. Mr. Strauch previously served as CEO of MST Data
Corporation. He was President and COO of Memorex and Executive Vice President of
the Electronics and Electrical Group at Gould. Mr. Strauch has been active in
the technology sector for almost 30 years.

         Our Board of Directors is composed of six directors. The Board is
divided into three classes and the members of each class are elected at the
annual meeting of the stockholders held in the year in which the terms for that
class expire, as follows: Mr. Horowitz has a term expiring in 2000; Messrs.
Agnello and Paul have terms expiring in 2001; and Messrs. Atlas, Goei and
Strauch have terms expiring in 2002. The incumbent board nominates the new
directors.

Committees of Our Board of Directors

         Compensation committee. The compensation committee is responsible for
reviewing our general compensation strategy establishing salaries and reviewing
benefit programs (including pensions) for the Chief Executive Officer and those
persons who report directly to him; reviewing, approving, recommending and
administering our stock option plans and certain other compensation plans; and
approving certain employment contracts. The compensation committee met three
times in the 1999 fiscal year. The current members of the compensation committee
are messrs. Goei, Agnello and Paul. All committee members attended the meetings.

         Audit committee. The audit committee's functions are to recommend the
appointment of independent accountants; review the arrangements for, and scope
of the audit by our independent accountants; review the independence of our
independent accountants; consider the adequacy of our system of internal
accounting control and review any proposed corrective actions; review and
monitor our policies relating to ethics and conflicts of interests; discuss with
management and the independent accountants our draft annual financial statements
and key accounting and/or reporting matters, including year 2000 issues; and
review the activities and recommendations of our financial team. The audit
committee met twice during the 1999 fiscal year. The current members of the
audit committee are Messrs. Goei, Horowitz and Strauch, each of whom attended
all meetings.

Compensation Committee Interlocks and Insider Participation

         None of the current or former members of our compensation committee is
currently or has been an employee or officer of ours other than Mr. Agnello who
was Chief Executive Officer of the Company until December, 1998. No member of
the Board of Directors or the compensation committee serves as a member of the
Board of Directors or compensation committee of any entity that has one or more
executive officers serving as a member of our Board of Directors or compensation
committee.

         Mr. Agnello was paid $54,166 for management consulting services
rendered in the year ending December 31, 1999. For the year ending December 31,
1998 Mr. Agnello received a bonus in the amount of $950,000 in connection with
his role in the sale of our communications systems group in November 1998.

                                       32

<PAGE>



         Mr. Paul is a non-employee director who provides legal services for us.
His firm received fees of approximately $120,000, $124,000 and $75,000, for the
years ended December 31, 1999, 1998 and 1997, respectively.

         Section 16 (a) of the Securities and Exchange Act of 1934 requires
Ariel's directors and executive officers to file with the SEC initial reports of
ownership and reports of changes in ownership of Ariel's common stock. Ariel
believes that during the fiscal year ended December 31, 1999, its officers and
directors complied with all these filings requirements. Ariel has relied upon
the representations of its directors and executive officers. The Company does
not believe any other stockholders are subject to Section 16(a) filing
requirements.

Item 11.  Executive Compensation

         The following table summarizes the compensation earned over the last
three fiscal years by the Chief Executive Officer, four executive officers and
one other individual who was not serving as an executive officer at year end,
whose earned compensation exceeded $100,000 for the year ended December 31,
1999.
<TABLE>
<CAPTION>

                                      Annual Compensation                                 Long-Term Compensation
                                      -------------------                                 ----------------------
                                                                               Other Annual     Number of        All other
                          Year               Salary           Bonus            Compensation      Options        Compensation
<S>                      <C>             <C>               <C>                  <C>              <C>           <C>

Jay H. Atlas              1999            $  275,502        $ 137,500            $ 5,119              --          $ 11,000
                          1998                 5,288(1)            --                 --         486,000                --
                          1997

Dennis Schneider          1999               200,000          120,000              5,119          95,000             4,615
                          1998                 7,692(1)            --                 --          95,000                --
                          1997

Brian A. Hoerl            1999               124,231           35,250             12,261              --       3,413,109(2)
                          1998               189,269          255,417(3)          19,609          20,000             5,000
                          1997               181,231           47,104             20,393              --             3,228

John Loprete              1999               118,462           85,500             14,286              --             1,798
                          1998                84,231               --             10,462          30,000                --
                          1997

John F. Lynch             1999               150,000            7,500              6,142          53,000           394,069(4)
                          1998               155,769           28,077             15,096          35,000            84,363(5)
                          1997               150,000               --             31,569              --             8,536

Carlos G. Borgialli       1999               113,333(6)        20,000              8,912          50,000             1,569
                          1998
                          1997
</TABLE>

(1)  Reflects employment commencement date of December 21, 1998.
(2)  Includes option exercises of $3,163,460 and severance of $234,769.
(3)  Includes CSG sale bonus of $200,000 and executive quarterly bonuses.
(4)  Includes option exercise of  $378,327.
(5)  Includes option exercise of $77,140.
(6)  Reflects employment commencement date of May 1, 1999.


                                       33

<PAGE>

Directors' Compensation

         Current compensation plan. In August 1999, the Board of Directors
approved a new compensation plan for our non-employee directors. Each director
is paid an annual amount of $6,000 for serving on the Board. In addition, under
the 1996 directors stock option plan, 50,000 stock options are granted to each
director upon appointment to the Board. The strike price for these options is
the price of the common stock on the date of appointment. An additional 15,000
options are granted for each subsequent year of service. Directors are also
compensated in the amount of $1,000 for each meeting attended in person, and
$500 for each meeting attended by telephone.

         In August and September 1999, respectively, we granted each of Messrs.
Goei and Strauch 80,000 options when they joined the Board.

         Previous compensation plan. In March 1998, the Board of Directors
adopted a standardized method for compensating non-employee directors. Each
non-employee director received a retainer based on an annualized rate of $6,000.
Directors who were also employees received no additional compensation for
service as directors. Under this compensation plan, we also reimbursed our
non-employee directors for their expenses incurred in attending meetings of the
Board of Directors.

         Effective June 1998, each non-employee director received an automatic
grant, upon his election, of options to purchase 10,000 shares of common stock
for each year of service, vesting in equal installments over three years. These
options have a ten-year term and allow the holder to purchase shares at their
fair market value on the date of grant.

         Prior to June 1998, we granted options pursuant to previous
compensation plans approved by the Board. In 1995, we compensated non-employee
directors by issuing options to purchase 30,000 shares of common stock to Mr.
Paul, options to purchase 110,000 shares of common stock to Mr. Perold (a former
director), and options to purchase 50,000 shares of common stock to each of
Messrs. Horowitz and Ranalli (a former director). In 1996, we granted 36,000
options under the 1996 directors plan to Mr. Perold, representing 12,000 options
per year of service, for his continued services as a director through the 1999
annual stockholders meeting. In 1997, we granted to each of Messrs. Ranalli and
Horowitz 25,000 options for each additional year he serves on the Board. In
1998, we granted Mr. Paul 15,000 options for each additional year of service on
the Board.

Option Grants During the Year Ended December 31, 1999

         The following table sets forth information regarding stock options
granted to the executive officers named in the summary executive compensation
table. The table also shows a hypothetical potential realizable value of these
options based upon assumed rates of an annual compounded stock price
appreciation of 5% and 10% from the date the options were granted and over the
full term. The assumed rates of growth were selected for illustrative purposes
only, and are not intended to predict future stock prices which will depend upon
market conditions and our future performance and prospects. Based upon the
closing stock price and the number of common shares outstanding at the end of
1999, an assumed annual stock price appreciation of 10% would produce a
corresponding aggregate pretax gain over the full option term of approximately
$122 million for our common stockholders.


                                       34

<PAGE>

<TABLE>
<CAPTION>



                                             % of Total                                      Potential Realized Value at
                             Number of        Options                                          Assumed Annual Rates of
                             Securities      Granted to                                      Stock Price Appreciation for
                             Underlying      Employees       Per Share                                   Term
                              Options        in Fiscal        Exercise       Expiration
           Name               Granted           Year           Price            Date              5%              10%
           ----               -------           ----           -----            ----              --              ---
<S>                           <C>             <C>             <C>             <C>             <C>              <C>

Carlos G. Borgialli            50,000           7.3%           $2.375         7/02/09          $193,431        $308,087
Dennis I. Schneider (1)        95,000          13.8%           $2.375         7/02/09          $367,519        $585,213
</TABLE>

(1) Some options may vest at an accelerated rate if certain performance goals
    are achieved.

Option Exercises During the Year Ended December 31, 1999 and Aggregate Fiscal
Year-end Option Value

         The following table sets forth information concerning stock option
exercises by the executive officers named in the summary executive compensation
table during 1999, including the aggregate value of gains on the date of
exercise. In addition, this table includes the number of shares covered by both
exercisable and non-exercisable stock options as of December 31, 1999. Also
reported are the values for "in-the-money" options which represent the excess of
the closing market price of the common stock at December 31, 1999 over the
exercise price of the option.

<TABLE>
<CAPTION>

                                                                Number of Securities
                                                               Underlying Unexercised        Value of Unexercised In-
                              Shares                           Options At December 31,         The-Money Options At
                           Acquired On          Value                 1999 (#)                 December 31, 1999 ($)
         Name                Exercise       Realized ($)      Exercisable/Unexercisable      Exercisable/Unexercisable
         ----                --------       ------------      -------------------------      -------------------------
<S>                          <C>             <C>                 <C>                          <C>
Jay H. Atlas                   -0-               -0-              141,750 / 344,250            $664,524 / $1,613,844
Brian A. Hoerl               145,000         $3,163,460               -0- / -0-                     -0- / -0-
John F. Lynch                 41,250          $378,327                -0- / 63,750                  -0- / $211,673
Dennis I. Schneider            -0-               -0-               30,000 / 160,000            $140,640 / $750,080
Jack Loprete                   -0-               -0-                  -0- / 50,000                  -0- / $234,400
Carlos G. Borgialli            -0-               -0-                7,500 / 22,500              $29,223 / $87,668
</TABLE>
Employment Agreements

         Jay H. Atlas, our CEO and President, is employed under a three-year
employment agreement effective December 21, 1998 pursuant to which he is paid a
base salary of $275,000. He is eligible for a bonus of 50% of his annual base
salary based upon the attainment of certain goals set by the Board of Directors.
Upon execution of the employment agreement, Mr. Atlas was granted an aggregate
of 486,000 common stock purchase options exercisable at $2.375 per share,
vesting over a four year period from December 21, 1999 through December 21,
2002. Some of his options may vest at an accelerated rate if certain performance
goals are achieved.

         Dennis I. Schneider, our Senior Vice President - Marketing, is employed
under an employment agreement effective December 21, 1998 pursuant to which he
is paid a base salary of $200,000. He is eligible for a bonus of 60% of his
annual base salary based upon the attainment of certain goals set by management.

                                       35

<PAGE>



Upon execution of the employment agreement, Mr. Schneider was granted an
aggregate of 95,000 common stock purchase options exercisable at $2.375 per
share, vesting over a five-year period commencing December 21, 2000 through
December 21, 2004. Some of his options may vest at an accelerated rate if
certain performance goals are achieved. In July 1999, he was granted an
additional 95,000 options at an exercise price of $2.375 per share vesting over
a five year period commencing December 21, 1999 through December, 21, 2003.

         Anthony M. Agnello, our Chairman, resigned as CEO in December 1999 upon
the appointment of Jay Atlas as our CEO and President. Mr. Agnello's employment
agreement provided for an annual salary of $200,000 and bonus to be determined
annually at the discretion of the Board. Upon his resignation as CEO, Mr.
Agnello entered into a two-year consulting agreement pursuant to which he is
paid $50,000 per year.

         Brian A. Hoerl, our former Vice President of Sales, was employed under
a three-year employment agreement effective September 3, 1996 pursuant to which
he was paid a base salary of $190,000 and an annual bonus of $47,000. Pursuant
to this agreement, Mr. Hoerl has been granted the common stock purchase options
outlined in the above table. On August 20, 1999, Mr. Hoerl's employment with us
was terminated.

         John F. Lynch, our former Chief Technology Officer, was employed under
a three-year agreement effective November 5, 1996 pursuant to which he was paid
a base salary of $150,000. Pursuant to this agreement, Mr. Lynch has been
granted the common stock purchase options outlined in the above table.

         Carlos G. Borgialli is employed under a three-year employment agreement
effective May 4, 1999 pursuant to which he is paid a base salary of $170,000 and
is eligible for an incentive bonus of up to $30,000 based upon the attainment of
certain goals. Mr. Borgialli was granted 50,000 common stock purchase options as
set forth in the table above.

         Severance Packages. Each of these employees has executed
non-competition and non-solicitation agreements pursuant to which for a
specified period following the termination of their employment, they have agreed
not to solicit any of our customers or employees or to become associated with
any of our competitors.

         Pursuant to the employment agreements of Messrs. Atlas and Schneider,
we have the right to terminate their employment for "cause" or as a result of
the employee's disability.

         Upon the early termination of his employment agreement by us without
cause or by Mr. Atlas for "good reason", which includes a "change in control",
Mr. Atlas is entitled to receive a severance payment in the amount of his annual
salary, the reasonable value of his employee benefits, a pro rata portion of his
bonus (based on the number of months of employment prior to termination and
which cannot be less than 25% of the bonus that we granted him during the
previous fiscal year), payable within one year of termination and accelerated
vesting of options. If termination occurs prior to December 21, 1999, the
severance payment will be paid for an additional year, less the number of months
Mr. Atlas was employed prior to termination. If termination occurs within two
years of a change in control, the full amount of the severance payment is to be
paid within ten days of the change in control.

         Upon the early termination of his employment agreement, by us without
cause or by Mr. Schneider for "good reason", Mr. Schneider is entitled to
receive one-half of his annual salary and one-half of his bonus actually accrued
prior to termination, and a pro rata portion of his bonus (which cannot be less
than 25% of the bonus that we granted him during the previous fiscal year),
payable within six months of termination. In addition, in the event of a change
in control, Mr. Schneider is entitled to accelerated vesting of options. If

                                       36

<PAGE>



termination occurs prior to December 21, 1999, the severance payment will be
paid for an additional six months.

         A "change in control" includes an acquisition of 15% or more of our
voting securities by any person, changes in the composition of the Board of
Directors, or an approval by the stockholders of a merger, consolidation,
reorganization, liquidation, dissolution or sale of all or substantially all of
our assets.

         Mr. Agnello resigned as CEO effective upon Mr. Atlas' appointment as
CEO in December 1998. We entered into an agreement with Mr. Agnello in December
1998 providing for a one time severance payment of $600,000 in March 1999 and
the issuance of 100,000 common stock purchase options at $2.38 per share. His
non-competition and non-solicitation agreements have been extended through
December 2001.

The 1992 Stock Option and Restricted Stock Plan

         During 1992, the Board of Directors approved, and our stockholders
ratified, the adoption of the 1992 stock option and restricted stock plan. The
plan provided for a maximum of 600,000 shares of our common stock to be issued
to employees, directors and consultants in connection with stock option grants
or restricted stock awards.

         During 1994, we granted a total of 268,875 options under the plan,
entitling the holders to acquire an equal number of shares of our common stock
at an exercise price per share of $2.27 or $2.45. The options vest over a
four-year period.

         Effective October 31, 1994, the Board terminated the plan and,
accordingly, no additional options or awards will be issued under the plan. At
December 31, 1999, 22,625 options remain outstanding.

The 1994 Stock Option Plan

         In 1994, the Board of Directors approved, and our stockholders
ratified, the adoption of the 1994 stock option plan. The plan provides for a
maximum of 500,000 shares of our common stock to be issued to employees,
directors and consultants in connection with stock option grants. Stock options
are granted by the Board or a committee appointed by the Board. Each stock
option entitles the holder to acquire an equal number of shares of common stock
at an exercise price equal to the fair market value of the common stock on the
date of grant as determined by the Board and 110% of the fair market value for
an employee who owns 10% or more of our common stock. The Board will determine
the stock option vesting period and expiration date not to exceed ten years from
the date the stock options were granted. At the discretion of the Board, we may
make loans to employees in order to enable them to exercise their stock options.
The plan also provides for the Board, at its discretion, to accelerate the
vesting of all outstanding stock options so that they become fully and
immediately exercisable.


                                       37

<PAGE>




         All outstanding options vest over periods ranging from immediate
vesting to four years and have ten-year terms. At December 31, 1999, 11,200
options remain outstanding.

1995 Stock Option Plan

         In 1995, the Board of Directors adopted our 1995 incentive stock option
plan, which was approved by our stockholders at the annual meeting of
stockholders on May 14, 1996. The stockholders ratified an amendment to the plan
at the annual meeting of stockholders held on June 23, 1999, increasing the
number of shares issuable under the plan from 1,700,000 to 2,200,000.

         The Board believes that the plan is desirable to attract and retain
executives and other key employees of outstanding ability. Under the plan,
options to purchase a maximum aggregate of 2,200,000 shares of our common stock
may be granted.

         During 1999, we granted a total of 167,050 options entitling the holder
to acquire an equal number of shares of our common stock at exercise prices
ranging from $2.63 to $4.00. The options vest over periods ranging from
immediate vesting to four years and have ten-year terms. At December 31, 1999,
461,986 options remain outstanding.

         The plan is administered by the Board of Directors, which may delegate
its powers to a committee of directors. The Board is generally empowered to
interpret the plan, prescribe rules and regulations relating thereto, determine
the terms of the option agreements, amend them with the consent of the optionee,
determine the employees to whom options are granted and determine the number of
shares subject to each option and the applicable exercise price. The per share
exercise price for incentive stock options and for non-qualified stock options
cannot be less than the greater of $4.00 per share or 100% of the fair market
value of a share of the common stock on the date the option is granted (110% of
fair market value on the date of grant of an incentive stock option if the
optionee owns more than 10% of our common stock). Upon exercise of an option,
the optionee may pay the exercise price with previously acquired securities of
ours, or at the discretion of the Board, we may loan a portion or all of the
purchase price to the optionee.

         Options are exercisable for a term determined by the Board, which
cannot be greater than ten years from the date of grant. Options may be
exercised only as long as the original grantee maintains a relationship with us
which confers eligibility to be granted options, or within three months after
termination of such a relationship with us, or for up to one year following
death or total and permanent disability. In the event of the termination of the
relationship between us and the original grantee for cause, all options granted
to that original optionee terminate immediately. In the event of certain changes
affecting us, including a change in control, and in the discretion of the Board,
each option may become fully and immediately exercisable. Incentive stock
options are not transferable other than by will or the laws of descent and
distribution. Non-qualified stock options may be transferred to the optionee's
spouse or lineal descendants, subject to certain restrictions. Options may be
exercised during the holder's lifetime only by the holder or his or her guardian
or legal representative.



                                       38

<PAGE>



         Options granted pursuant to the plan may be designated as incentive
stock options, with the attendant tax benefits provided under Sections 421 and
422 of the Internal Revenue Code of 1986. Accordingly, the plan initially
provided that the aggregate fair market value (determined at the time an
incentive stock option is granted) of the common stock subject to incentive
stock options exercisable for the first time by an employee during any calendar
year (under all of our plans or those of any of our subsidiaries) may not exceed
$100,000. The Board may modify, suspend or terminate the plan; provided,
however, that certain material modifications affecting, and any changes in, the
plan must be approved by the stockholders. Any change in the plan that may
adversely affect an optionee's rights under an option previously granted under
the plan requires the consent of the optionee.

Non-Plan Options

         During 1998, we granted 1,016,500 stock options to certain employees
and outside consultants. The options were issued outside the 1995 plan and
entitle the holders to acquire an equal number of shares of our common stock at
exercise prices ranging from $2.37 to $4.00. The options vest over periods
ranging from immediate vesting to four years and have ten-year terms. At
December 31, 1999, a total of 1,051,504 non-plan options remain outstanding.

1996 Directors Plan

         The 1996 directors plan was adopted by the Board of Directors on
January 24, 1996 and approved by the stockholders at the annual meeting of
stockholders held on May 14, 1996. This plan provides for the issuance of up to
250,000 stock options to non-employee directors. At the annual meeting of
stockholders held on June 24, 1998, the stockholders ratified an amendment to
the plan increasing the number of issuable shares to 450,000. The plan is
administered by a committee appointed by the Board of Directors and is effective
for a period often years from the date it was adopted. The plan is not subject
to any provisions of the Employee Retirement Income Security Act of 1974
("ERISA").

         At December 31, 1999, 341,000 options remain outstanding pursuant to
the 1996 directors plan. The ability of a grantee to purchase the common stock
under the 1996 directors plan is terminated if his or her service is terminated,
provided that in certain circumstances the grantee or his estate will have the
right to purchase the common stock after termination of service for a limited
period of time. The right to acquire common stock is not transferable except in
the event of death of the grantee. In the event that a reorganization, merger,
consolidation, reclassification, recapitalization or capital adjustment
including a stock dividend or other similar change in our common stock, the
committee will adjust the number and kind of shares that may be acquired under
the 1996 directors plan. Common stock that may be acquired under the 1996
directors plan may be acquired by the surrender of other shares of common stock
owned by a director or the surrender of an unexercised portion of the right to
acquire common stock under the 1996 directors plan.

Report on Repricing of Stock Options

         Stock options were granted under the 1994 and 1995 stock option plans
to many of our employees from June 1995 through July 1998 with exercise prices
ranging from $4.50 to $l1.75 per share. Subsequent to these grants the market
price of our common stock suffered a significant decline. In order to ensure
that the options previously granted would provide a meaningful incentive to
motivate and retain employees, employees were given the opportunity to cancel
such options and receive in exchange a like number of options granted as of
November 15, 1998 with an exercise price of $4.00 providing for a newly
commenced vesting period as of the repricing date.

                                       39

<PAGE>



Item 12.  Security Ownership of Certain Beneficial Owners and Management

         The following table sets forth information regarding beneficial
ownership of our common stock as of December 31, 1999 by: (i) each stockholder
known by us to be the beneficial owner of 5% or more of the outstanding common
stock, (ii) each director and executive officer of the company individually, and
(iii) all directors and executive officers as a group. Except as otherwise
indicated in the footnotes below, we believe that each of the beneficial owners
of the common stock listed in the table, based on information furnished by such
owner, has sole investment and voting power with respect to such shares.

         We are, as of December 31, 1999, not aware of any individual or group
of individuals that is the beneficial owner of more than 5% of our common stock,
other than Mr. Agnello, our Chairman and former Chief Executive Officer. Unless
otherwise specified, the address of the principal stockholders is Ariel
Corporation, 2540 Route 130, Cranbury, NJ 08512.

<TABLE>
<CAPTION>


Directors and Executive Officers                            Number of Shares
                                                           Beneficially Owned          Percentage
<S>                                                          <C>                      <C>

Jay H. Atlas                                                   202,500 (1)               1.6 %
Anthony M. Agnello                                             876,000 (2)               6.7 %
Esmond T. Goei                                                  50,000 (3)                *
Edward D. Horowitz                                             100,000 (3)                *
Harold W. Paul                                                  51,000 (4)                *
Charles S. Strauch                                              50,000 (3)                *
Carlos G. Borgialli                                             12,500 (1)                *
John R. Loprete                                                  8,500 (5)                *
Dennis I. Schneider                                             35,000 (1)                *
All officers and directors as a group (nine people)          1,385,500                  10.7 %
</TABLE>

*        Less than l%.

(1)      All shares subject to presently exercisable options.
(2)      Includes 175,000 shares subject to presently exercisable options.
(3)      All shares beneficially owned by Messrs. Horowitz, Goei, and Strauch
         reflect options issued in exchange for their services as directors.
(4)      Includes 47,500 shares subject to presently exercisable options.
(5)      Includes 7,500 shares subject to presently exercisable options.

Item 13.  Certain Relationships and Related Transactions

         In June 1998, we entered into an agreement to sell our CSG to Cabletron
Systems for approximately $33,500,000 net of amounts paid to engineers and other
members of the group which were paid directly to them by Cabletron. As part of
the transaction, we paid bonuses to three directors who played an integral role
in the

                                       40

<PAGE>



transaction. These bonuses included $950,000 to Mr. Agnello, $140,000 to Mr.
Coburn and $75,000 to Mr. Ranalli, a director until September 1999. In addition,
we paid Mr. Perold a fee of $1,541,673 for his consulting services in the
transaction. Mr. Perold was a director at the time he performed these services.

         Paul & Rosen, LLP, a law firm of which Mr. Paul, also one of our
directors, is a partner, received fees of approximately $120,000, $124,000 and
$75,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
These fees were for legal services which it performed on our behalf.

         Mr. Perold, who was a director until the 1999 annual stockholders
meeting, has provided us management advisory services. Fees incurred for the
years ended December 31, 1998 and 1997 were approximately $450,000 and $218,000,
respectively. No fees were incurred for the year ended December 31, 1999. In
addition, in December 1998, Mr. Perold received 80,000 immediately exercisable
stock options for his management advisory services. Mr. Perold had an
outstanding loan of $100,000 owed to us as of December 31,1998, which was repaid
in full in January 1999.

         Brown, Coburn & Co., of which Mr. Coburn, one of our directors until
September 1999, received fees of $22,000, $156,200 and $88,000 for the years
ended December 31, 1999,1998 and 1997 respectively, in connection with
investment banking advisory services. In addition, 40,000 stock options
previously granted to Mr. Coburn for investment banking advisory services,
20,000 in each of July 1996 and May 1997, vested during 1998.

         In February 1999, we entered into a consulting agreement with GIOS
Incorporated to advise our senior management in connection with the installation
of new product development process capabilities, including assessing process
issues and providing strategic decision support. GIOS was co-founded in
September 1998 by Dennis Schneider, our Senior Vice President - Marketing. The
agreement provides that Mr. Schneider will represent only our interests during
the course of the consulting relationship. Compensation to GIOS under the
agreement is $2,000 per day, three days per week for the first month of the
agreement, and $1,750 per day for the remainder of the relationship, with
specific time commitments to be negotiated by the parties. At December 31, 1999,
we had paid approximately $162,000 to GIOS for consulting services.


Item 14.  Exhibits

         (a)

         (1)      Financial Statements Annexed

         (2)      None

                                       41

<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS








To the Board of Directors and Stockholders of ARIEL CORPORATION:


In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and comprehensive income, of stockholders'
equity, and of cash flows present fairly, in all material respects, the
financial position of ARIEL CORPORATION and subsidiaries (the Company), as of
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
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 statements in accordance with
auditing standards generally accepted in the United States which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatements. 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 our audits provide a reasonable basis for the
opinion expressed above.




                                                      PricewaterhouseCoopers LLP





February 24, 2000



                                      F-1

<PAGE>


                                ARIEL CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                                     ASSETS
<TABLE>
<CAPTION>

                                                                                            December 31,
                                                                                  --------------------------------
                                                                                      1999                 1998
                                                                                      ----                 ----
<S>                                                                               <C>                  <C>

Current assets:
     Cash and cash equivalents                                                     $7,088,431          $17,996,575
     Accounts receivable, net of allowance for doubtful accounts of $1,019,731
      in 1999 and $1,460,855 in 1998, respectively.                                 3,091,362            3,593,709
     Other receivables                                                                383,676            1,378,781
     Inventories, net                                                               3,303,057            2,857,326
     Prepaid expenses                                                                 775,943              449,691
                                                                                      -------              -------
             Total current assets                                                  14,642,469           26,276,082

Equipment, net of accumulated depreciation and amortization                         1,387,128            1,365,354

Goodwill, intangible and other assets                                               3,787,475            6,040,944
                                                                                  -----------         ------------
              Total assets                                                        $19,817,072         $ 33,682,380
                                                                                  ===========         ============

</TABLE>

<TABLE>
<CAPTION>
                      LIABILITIES and STOCKHOLDERS' EQUITY

<S>                                                                               <C>                   <C>

Current liabilities:
     Accounts payable                                                              $1,190,807           $2,679,548
     Accrued expenses                                                               3,510,566            5,388,661
     Current portion of long term debt                                              1,895,926            5,480,430
     Current portion of capital-lease obligation                                      126,438                    -
     Royalties payable                                                                 91,210               95,410
                                                                                  -----------         ------------
         Total current liabilities                                                  6,814,947           13,644,049

Capital-lease obligation, net of current portion                                      215,901                    -
Long-term debt                                                                      1,788,985              332,834

Commitments and contingencies  (See Note 12)

Stockholders' equity:
     Preferred stock, $.001 par value:
          Authorized - 2,000,000
          Issued and outstanding - none

     Common stock, $.001 par value:
          Authorized - 20,000,000
          Issued and outstanding -  10,832,597 in 1999 and                             10,833                9,760
               9,760,150 in 1998
     Additional paid-in capital                                                    37,627,809           33,302,342
     Unrealized gain/(loss) on foreign currency translation                          (503,711)              31,272
       Accumulated deficit                                                        (26,137,692)         (13,637,877)
                                                                                 ------------         ------------
         Total stockholders' equity                                                10,997,239           19,705,497
                                                                                  -----------         ------------
         Total liabilities and stockholders' equity                              $ 19,817,072         $ 33,682,380
                                                                                 ============         ============
</TABLE>

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

                                      F-2

<PAGE>


                                ARIEL CORPORATION
           CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME



<TABLE>
<CAPTION>
                                                                            For the Years Ended December 31,
                                                                     ----------------------------------------------
                                                                         1999            1998               1997
                                                                         ----            ----               ----
<S>                                                                  <C>              <C>               <C>
Sales                                                                $11,626,546      $17,445,829       $13,201,916

Cost of goods sold                                                     5,096,014       11,965,220         7,180,241
                                                                     -----------      -----------       -----------

Gross profit                                                           6,530,532        5,480,609         6,021,675

Selling and marketing expenses                                         5,634,070        5,265,542         4,400,786
General and administrative expenses                                    7,312,680        9,710,275         6,145,088
Research and development expenses                                      5,688,414        6,722,905         8,182,584
Restructuring charge                                                     369,528                -           379,454
                                                                     -----------      -----------       -----------
Total operating expenses                                              19,004,692       21,698,722        19,107,912
                                                                     -----------      -----------       -----------
     Loss from operations                                            (12,474,160)     (16,218,113)      (13,086,237)

Gain on sale of assets                                                         -       29,537,896                 -
Interest income                                                          440,477          432,596           333,465
Interest expense                                                        (527,611)      (1,371,970)         (240,450)
Other income                                                              61,479           64,729           231,823
                                                                     -----------      -----------       -----------
     Income / (Loss) before provision for income taxes               (12,499,815)      12,445,138       (12,761,339)

Provision for income taxes                                                     -          368,632                 -
                                                                     -----------      -----------       -----------
     Net Income / (Loss)                                             (12,499,815)      12,076,506       (12,761,399)

--------------------------------------------------------------------------------------------------------------------
Other comprehensive income:

     Foreign currency translation adjustments                           (534,983)          31,272                 -
                                                                    ------------      -----------      ------------
Comprehensive Income / (Loss)                                       $(13,034,798)     $12,107,778      $(12,761,399)
                                                                    ============      ===========      ============
-------------------------------------------------------------------------------------------------------------------
Basic and Diluted Per Share Data:

     Weighted average number of common
           shares outstanding - Basic                                  9,843,402        9,652,664         9,161,758
                                                                    ============      ===========      ============
     Earnings/(Loss) per share - Basic                              $      (1.27)     $      1.25      $      (1.39)
                                                                    ============      ===========      ============
     Weighted average number of common
         Shares outstanding - Diluted                                  9,843,402       10,843,215         9,161,758
                                                                    ============      ===========      ============
     Earnings/(Loss) per share - Diluted                            $      (1.27)     $      1.11      $      (1.39)
                                                                    ============      ===========      ============

</TABLE>

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

                                      F-3

<PAGE>


                                ARIEL CORPORATION
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>


                                                                            Unrealized     Unearned      Retained
                                                                Additional  Gain/(Loss)  Compensation    Earnings         Total
                                               Common Stock      Paid-In    on Currency   related to   (Accumulated
                                               Stockholders'
                                                                                            Stock
                                              Shares    Amount    Capital   Translation    Options       Deficit)        Equity
                                              ------    ------    -------   -----------    -------       -------         ------
<S>                                        <C>          <C>      <C>         <C>         <C>          <C>              <C>

Balance at December 31, 1996                8,949,975    8,950   29,321,748         --    (178,819)   (12,952,984)     16,198,895

Issuance of common stock in
      connection with exercise of
      259,275 common stock options            259,275      260    1,036,407         --          --             --       1,036,667
Issuance of common stock in
      connection with exercise of 25,000
      common stock purchase warrants           25,000       25       67,975         --          --             --          68,000
Value of common stock warrants
      in connection with debt financing                             321,808         --          --             --         321,808
Costs incurred in connection with
      the issuance of common stock                 --       --      (20,396)        --          --             --         (20,396)
Unearned compensation related to
      Stock Options                                --       --      221,638         --    (221,638)            --              --
Amortization of unearned compensation              --       --           --         --     289,638             --         289,638
1997 Net Loss                                      --       --           --         --         ---    (12,761,399)    (12,761,399)
                                            ---------  -------  -----------  ---------   ---------    -----------     -----------
Balance at December 31, 1997                9,234,250    9,235   30,949,180         --    (110,819)   (25,714,383)      5,133,213

Issuance of common stock in
      connection with exercise of
      425,900 common stock options            425,900      425    1,828,115         --          --             --       1,828,540
Issuance of common stock in
      connection with exercise of 100,000
      common stock purchase warrants          100,000      100      271,900         --          --             --         272,000
Costs incurred in connection with
      the issuance of common stock                 --       --      (49,128)        --          --             --         (49,128)
Unearned compensation related to
      Stock Options                                --       --      302,275         --    (302,275)            --              --
Amortization of unearned compensation              --       --           --         --     413,094             --         413,094
Unrealized gain/(loss) on currency translation     --       --           --     31,272          --             --          31,272
1998 Net Income                                    --       --           --         --          --     12,076,506      12,076,506
                                            ---------  -------  -----------  ---------   ---------   -----------     ------------
Balance at December 31, 1998                9,760,150    9,760   33,302,342     31,272          --    (13,637,877)     19,705,497

Issuance of common stock in
      connection with exercise of
      866,364 common stock options            866,364      867    3,728,979         --          --             --       3,729,846
Issuance of common stock in
      connection with exercise of 206,083
      common stock purchase warrants          206,083      206      264,794         --          --             --         265,000
Costs incurred in connection with
      the issuance of common stock                 --       --      (48,869)        --          --             --         (48,869)
Value of common stock warrants
      in connection with debt financing            --       --      380,563         --          --             --         380,563
Unrealized gain/(loss) on currency translation     --       --           --   (534,983)         --             --        (534,983)
1999 Net Loss                                      --       --           --         --          --    (12,499,815)    (12,499,815)
                                           ----------  -------  -----------  ---------    --------   ------------    ------------
Balance at December 31, 1999               10,832,597  $10,833  $37,627,809  $(503,711)   $     --   $(26,137,692)   $ 10,997,239
                                           ==========  =======  ===========  =========   =========   ============    ============

</TABLE>

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

                                      F-4



<PAGE>


                                ARIEL CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>


                                                                     For the Years Ended December 31,
                                                        --------------------------------------------------
                                                               1999             1998              1997
                                                               ----             ----              ----
<S>                                                     <C>              <C>             <C>

Cash flows from operating activities:
Net income / (loss)                                     $ (12,499,815)    $ 12,076,506     $ (12,761,399)
Adjustments to reconcile net loss to net cash used in
          operating activities:
      Depreciation and amortization                           932,409        1,265,801         1,143,287
      Amortization of goodwill and intangibles              1,010,677           92,105                 -
      Amortization of discount on royalties payable                 -                -             2,998
      Acquired in process research and development                  -          297,330                 -
      (Gain) / Loss on sale of assets                          60,911      (29,537,896)                -
      Loss on sale of marketable securities                         -                -            12,812
      Amortization of debt issuance costs                     122,988           64,719            66,870
      Provision for doubtful accounts                         546,144          851,415            30,000
      Provision for inventory obsolescence                    265,421        2,293,500           160,000
      Non-cash compensation expense                                 -          413,094           289,638
 (Increase) decrease in assets:
        Accounts receivable                                   (69,335)      (2,813,966)        1,773,918
        Other receivables                                     545,883         (522,361)          116,713
        Inventories                                          (729,945)      (1,700,796)         (167,938)
        Other assets                                          (65,267)         (34,176)         (309,288)
 Increase (decrease) in liabilities:
        Accounts payable and accrued expenses              (2,683,382)       1,062,523          (770,981)
        Royalties payable, related parties                     (4,200)          15,676           (14,322)
        Notes payable                                               -                -          (154,021)
                                                          -----------      -----------       -----------
          Net cash (used in) operating activities         (12,567,511)     (16,176,526)      (10,581,713)
                                                          -----------      -----------       -----------

Cash flows from investing activities:
     Proceeds from sale of assets                                   -       31,348,753                 -
     Proceeds from the sale and maturity of investments             -                -         5,993,634
     Acquisition of businesses (net of cash acquired)               -       (3,340,122)
    Purchase of equipment                                    (593,851)        (724,032)       (1,444,057)
                                                          -----------      -----------       -----------
Net cash provided by (used in) investing activities          (593,851)      27,284,599         4,549,577
                                                          -----------      -----------       -----------

Cash flows from financing activities:
   Proceeds from debt financing                                     -        4,500,000         3,000,000
   Proceeds from exercise of common stock options
       and warrants, net of expenses                        4,326,540        2,051,412         1,084,270
   Principal payments on capital lease obligations            (25,261)               -                 -
   Principal payments on debt                              (2,085,316)      (2,308,774)                -
                                                          -----------      -----------       -----------
          Net cash provided by financing activities         2,215,963        4,242,638         4,051,417
                                                          -----------      -----------       -----------

Effect of exchange rate changes on cash                        37,255                -                 -

Net increase (decrease) in cash                           (10,908,144)      15,350,711        (1,980,719)
   Cash and cash equivalents, beginning of year            17,996,575        2,645,864         4,626,583
                                                          -----------      -----------       -----------

   Cash and cash equivalents, end of period               $ 7,088,431    $  17,996,575     $   2,645,864
                                                          ===========    =============     =============

</TABLE>

     The accompanying notes are integral parts of the financial statements.


                                      F-5

<PAGE>
                                ARIEL CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1. Business Description:

         Ariel Corporation (the "Company") is a technology company that has
historically had digital signal processing (DSP) as its core strength. DSP is an
enabling technology driving rapidly growing technology markets such as Remote
Access Service and Internet Service Providers ("ISPs").

         The Company has incurred substantial operating losses and had an
accumulated deficit of $26,137,692 at December 31, 1999. It expects to have
operating losses and a growing accumulated deficit in the future. If the Company
does not successfully execute its business strategy in the ISP and Original
Equipment Manufacturers (OEM) Markets, there is no assurance that the Company
will generate sufficient cash flow from operations to meet the Company's
anticipated operating needs for 2000. However, the Company believes its existing
cash and cash equivalents together with the proceeds from the sale of securities
in the first quarter of 2000 (See Note 18) will be sufficient to meet its
presently anticipated cash needs through the end of 2000. Even if the Company's
cash requirements vary from those now planned, management believes that its
sources of liquidity are sufficient to continue operations through the end of
2000. However, if necessary, the Company may delay or eliminate some
expenditures and planned operations may be scaled back or the Company may need
to raise additional funds to meet obligations. We would seek to raise such
amounts through a variety of options including borrowings, proceeds from equity
financing and scaling back operations. Additional funding may not be available
when needed or on terms acceptable to the Company, which could have a material
adverse effect on its business, financial condition, and results of operations.

2. Summary of Significant Accounting Policies:

Principles of Consolidation

         The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries as of and for the years ended December
31, 1999, 1998, and 1997. All significant intercompany accounts and transactions
have been eliminated in consolidation.

Revenue Recognition

         Revenue is derived from the sale of hardware and software products for
use in DSP Original Equipment Manufacturers ("OEM"), Internet Service Providers
and Data Communications applications. The Company recognizes the sale of a
product at the time the product is shipped to the customer and when both the
collection of the resulting receivable is probable and no significant vendor
and/or post-contract customer support obligations remain.

In December 1999, the SEC issued Staff Accounting Bulletin ("SAB") No. 101,
"Revenue Recognition in Financial Statements", which provides additional
guidance applying generally accepted accounting principles for revenue
recognition in financial statements. The Company has completed its preliminary
evaluation of SAB 101 and does not believe it will have a material effect on the
Company's historical results of operations or financial position.

Cash and Cash Equivalents

         The Company considers all highly liquid investments with original
maturities of three months or less, to be cash equivalents.

Investments

         The Company's current investment policy is to invest available cash
balances in high quality debt securities. The cost of securities sold is based
on the specific identification method.

Concentration of Credit Risk

         Financial instruments which potentially subject the Company to a
concentration of credit risk consist principally of cash, cash equivalents and
trade receivables. The Company places its cash and cash equivalents with
commercial banks. From time to time the Company had significant sales to a few
customers which created a concentration of credit risk. Generally, the Company
does not require collateral to support customer receivables.

Inventories

         Inventories are stated at lower of cost or market using the average
cost method. The Company computes inventory reserves using the specific
identification method based upon an estimate of future customer product orders.


                                      F-6
<PAGE>

         The markets for the Company's products are characterized by rapidly
changing technology and the consequential obsolescence of relatively new
products. The Company has recorded certain estimated reserves against
inventories related to such technological obsolescence.

Equipment

         Equipment consists principally of computer equipment and software,
office equipment and furniture and fixtures and is stated at cost. Depreciation
is provided for using the straight-line method over the estimated useful lives
of the assets, which are generally three to five years. Expenditures for
maintenance and repairs, which do not extend the economic useful life of the
related assets, are charged to operations as incurred. Gains or losses on
disposal of equipment are reflected in the statements of operations.

Goodwill and Intangible Assets

         Purchased technology and other intangible assets are recorded at cost
and are amortized on a straight-line basis over five years. Goodwill represents
the excess of cost over the fair value of identifiable assets acquired and is
being amortized on a straight-line basis over 5 years. In accordance with SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets to Be Disposed Of,"
the Company reviews for impairment of long-lived assets and certain identifiable
intangibles whenever events or changes in circumstances indicated that the
carrying amount of an asset may not be recoverable. In general, the Company will
recognize an impairment loss when the sum of undiscounted expected future cash
flows is less than the carrying amount of such assets. The measurement for such
an impairment loss is based on the fair value of the asset.

         At each balance sheet date, the Company reviews recoverability of
goodwill, not identified with long-lived assets, based on estimated undiscounted
future cash flows from operating activities compared with the carrying value of
the goodwill, and recognizes any impairment on the basis of such comparison.

Other Assets

         Other assets include deferred financing costs associated with debt
financing which are stated at cost. Amortization of deferred financing costs is
on a straight-line basis over the life of the debt agreement.

Foreign Currency Translation

         Financial position and results of operations of the Company's
international subsidiaries have been measured using local currencies as the
functional currency. Assets and liabilities of these operations are translated
at the exchange rates in effect at the end of the period. Statement of operation
accounts are translated at the average rates of exchange prevailing during the
period presented. Translation adjustments arising from the use of differing
exchange rates from period to period are included in the cumulative translation
account in stockholders' equity.

Estimates Used in Preparation of Financial Statements

         The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates. Estimates
are used for, but not limited to, the accounting for: allowance for
uncollectible accounts receivable, allowance for inventory obsolescence,
depreciation and amortization, and accrued expenses.

Software Development Costs

         The Company accounts for software development costs in accordance with
Statement of Financial Accounting Standards No. 86, ("SFAS"), "Accounting for
the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed". SFAS
No. 86 requires that certain software product development costs incurred after
technological feasibility has been established, be capitalized and amortized,
commencing upon the general release of the software product to the Company's
customers, over the economic life of the software product. Costs incurred after
technological feasibility has been established are not material.


                                      F-7

<PAGE>

Research and Development

         Research and development expenditures are charged to expense as
incurred. Included in research and development expenses in 1997 is a $750,000
payment received from Texas Instruments for reimbursement of non-recurring
engineering expenses in connection with a Cooperative and Licensing Agreement.
This agreement was terminated by the Company in February 1998 for convenience in
accordance with the agreement.

Earnings Per Share Data

         The Company adopted SFAS No. 128, "Earnings per Share", in 1997. SFAS
No. 128 requires presentation of both basic and diluted earnings per share.
Basic earnings per share has been calculated based on the weighted average
number of shares of common stock outstanding during the reporting period.
Diluted earnings per share is calculated giving effect to all potentially
dilutive common shares, assuming such shares were outstanding during the
reporting period. Option prices ranged from $2.12 to $10.63 per share for the
twelve month period. These options, which expire on various dates ranging from
October 1, 2004 through November 15, 2009, were still outstanding as of December
31, 1999.

         A reconciliation of the weighted average number of common shares
outstanding to common shares outstanding assuming dilution is as follows:

                                                      Twelve Months Ending
                                                       December 31, 1998
                                                      --------------------
        Weighted Average Common Shares Outstanding         9,652,664
                   Options Assumed to be Exercised         2,411,736
   Shares Acquired using the Treasury Stock Method        (1,221,185)
                                                          ----------
      Common Sharers Outstanding Assuming Dilution        10,843,215
                                                          ==========

         The exercise of such potentially dilutive common shares has not been
assumed for the years ended December 31, 1997 and 1999 since the result is
antidilutive. Options and warrants to purchase 508,097 shares of common stock
were outstanding as of December 31, 1998 but were not included in the
computation of diluted earnings per share because the options and warrants
exercise price were greater than the average market price of the Company's
common stock.

Income Taxes

         The Company accounts for income taxes in accordance with the provisions
of SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 requires
recognition of deferred tax liabilities and assets for the expected future tax
consequences of events that have been included in the financial statements or
tax return. Under this method, deferred tax liabilities and assets are
determined based on the differences between the financial statement and tax
basis of assets and liabilities ("temporary differences") using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount that is "more likely than not" to be realized.

Advertising / Marketing

         Advertising and Marketing costs are expensed as incurred and amounted
to $1,102,211, $703,625, and $913,199 for the years ended December 31, 1999,
1998 and 1997, respectively.


                                      F-8

<PAGE>

Supplemental Cash Flow Information

         Interest paid for the years ended December 31, 1999, 1998 and 1997 was
$549,411, $1,362,978, and $144,258, respectively. Income taxes paid in 1998 were
$342,110. No income taxes were paid in 1999 and 1997.

         Excluded from the statements of cash flows were $62,273 and $72,665 of
equipment purchases which were included in accounts payable and accrued expenses
at December 31, 1998 and 1997. There were no such purchases accrued as of
December 31, 1999.

         The Company incurred capital lease obligations of $351,195 during 1999.
There were no capital lease obligations incurred in 1998 and 1997.

         Also see Notes 12 and 14 for additional non-cash transactions in
connection with the issuance of shares of common stock in consideration for
services rendered and the discount related to royalties payable to related
parties.

Adoption of Statements of Financial Accounting Standards

         In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income", which establishes standards for
reporting and displaying comprehensive income and its components in a full-set
of general-purpose financial statements. This statement is effective for fiscal
years beginning after December 15, 1997, and requires reclassification of
prior-period financial statements. There were no items classified as other
comprehensive income for the year ending December 31, 1997.

The following table sets forth a reconciliation and the components of
comprehensive income for the years ended:
<TABLE>
<CAPTION>

                                                                   December 31, 1999             December 31, 1998
                                                                   -----------------             -----------------
<S>                                    <C>                         <C>                           <C>

                                         Net Income / (loss)         ($12,499,815)                  $12,076,506
               Other comprehensive income/(loss):
     Unrealized gain/(loss) on foreign currency translation              (534,983)                       31,272
                                                                      ------------                  -----------
                                       Comprehensive income          ($13,034,798)                  $12,107,778
                                                                      ============                  ===========
</TABLE>

         Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information", which revises disclosure
requirements about operating segments and establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS No. 131 requires that public business enterprises report financial and
descriptive information about their reportable operating segments. The statement
is effective for fiscal years beginning after December 15, 1997, and requires
restatement of prior years in the initial year of application. SFAS No. 131 is
expected to affect the Company's segment disclosures, but will not affect the
Company's results of operations, financial position or cash flows. On September
1, 1998 the Company sold the assets of the CSG to Cabletron Systems, Inc.
Operating expenses for the CSG were approximately $2,309,430 and $4,093,756 for
the years ending December 31, 1998 and 1997, respectively. As of December 31,
1998 the Company had no segments that qualified for reporting under SFAS No.
131.

         In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use". Among other provisions, SOP
98-1 requires that entities capitalize certain internal use software costs once
certain criteria are met. Under SOP 98-1, overhead, general and administrative
and training costs are not to be capitalized. SOP 98-1 is effective for
financial statements for fiscal years beginning after December 15, 1998;
therefore, the Company adopted these provisions as of January 1, 1999.

         In June 1998, the Financial Accounting Standards Board issued SFAS
No.133, "Accounting for Derivative Instruments and Hedging Activities". This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires recognition of all
derivatives as either assets or liabilities on the balance sheet and measurement
of those instruments at fair value. We currently do not hedge foreign currency
denominated transactions. This statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 2000. The effect of adopting SFAS No. 133
is not expected to be material to the Company's operations.



                                      F-9

<PAGE>


3. Acquisitions

     On November 23, 1998, the Company acquired all of the outstanding common
stock of Solutions for Communications and International ISDN, S.A. (SCii). The
transaction was accounted for using the purchase method of accounting.
Accordingly, the purchase price was allocated to the estimated fair value of the
assets acquired and liabilities assumed. Purchase consideration, including
related transaction costs, consisted of $3,389,029 in cash.

     Valuation of the intangible assets acquired was determined by an
independent appraisal company and consists of purchased in-process research and
development (IPR&D), proven technology and an assembled workforce. The purchase
price exceeded the estimated fair value of tangible and intangible assets
acquired by $4,419,284 which was recorded as goodwill.

     The table below is an analysis of the purchase price allocation:

         Cash                                                         $3,080,073

         Direct Acquisition Costs                                        308,957

         SCii liabilities assumed, including estimated
          contingent liabilities                                       3,686,527
                                                                     -----------

                                            Total Purchase Price      $7,075,557
                                                                      ==========

         Estimated Fair Value of Tangible Assets Acquired              1,344,523

         Estimated Fair Value of IPR&D                                   297,330

         Estimated Fair Value of Indentifiable intangible assets       1,014,420

         Goodwill                                                      4,419,284
                                                                     -----------

                                            Total                     $7,075,557
                                                                      ==========

     Management, based upon an independent appraisal, estimated that $297,330 of
the purchase price represents the fair value of purchased IPR&D that had not yet
reached technological feasibility and has no alternative future use. The amount
allocated to IPR&D was expensed as a non-recurring, non-tax-deductible charge
upon consummation of the acquisition. The Company is using acquired in-process
research and development in the area of mid-range ISDN remote access technology
which it believes will broaden the Company's product line over the next several
years.

     The identifiable intangible assets of $1,014,420 included in the purchase
price allocation set forth above are comprised of proven technology with
appraised fair value of $926,970 and an assembled workforce with an appraised
fair value of $87,450, which will have estimated useful lives of five years. The
remaining unallocated purchase price represents goodwill, which is being
amortized over five years. During 1999, intangibles were reduced by
approximately $600,000 related to revisions of estimates for contingent
liabilities.

     The Company is currently pursuing legal action against the former owner of
SCii. The amount, if any, resulting from a settlement from litigation or
arbitration would serve to reduce the purchase price when realized.

4. Inventories:

     Due to the introduction of the Company's new product line, the RS4200, in
the fall of 1999, the Company anticipates reduced demand for its RS2000 product.
The Company plans to initiate reduced pricing in an effort to sell the remaining
RS2000 inventory of approximately $1,500,000 on hand at December 31, 1999. As a
result, reserves of $195,000 were recorded at December 31, 1999.

     In 1998, due to reduced demand from several major customers of the
Company's T1/Modem, T1-Modem+ and RS10000 products, reserves of $2,270,000 were
recorded. Approximately $1,500,000 of material related to these products was
consumed during the twelve months ending December 31, 1999. Amounts on hand of
approximately $1,400,000 as of December 31, 1999 are fully reserved.

         Inventories, net of allowance, consists of the following:

                                                   December 31,
                                               1999            1998
                                               ----            ----
         Component materials                 $371,821       $1,040,115
         Work-in-progress                     814,923        1,536,870
         Finished goods                     2,116,313          280,341
                                           ----------        ---------
                                           $3,303,057       $2,857,326
                                           ==========       ==========



                                      F-10
<PAGE>

The following table sets forth the activity in the Company's
 inventory reserves:

January 1, 1997                                         $  147,495
Additions charged to costs and expenses                    160,000
Net write-offs                                             (50,656)
                                                       -----------
December 31, 1997                                          256,839

Additions charged to costs and expenses                  2,293,500
Additions due to valuation of assets acquired              135,923
Net write-offs                                            (326,267)
                                                       -----------
December 31, 1998                                        2,359,995

Additions charged to costs and expenses                    265,421
Net write-offs                                            (498,545)
                                                       -----------
December 31, 1999                                      $ 2,126,871
                                                       ===========


5. Equipment:

      Equipment consists of the following:
                                                              December 31,
                                                          1999           1998
                                                          ----           ----
      Computer and other equipment                  $ 3,391,195     $ 2,694,876
      Computer software                                 933,483         770,719
      Office equipment and furniture and fixtures       654,502         803,328
      Vehicles                                           89,972          89,972
      Loaner equipment                                  183,014         220,726
      Leasehold improvements                            191,471         185,906
                                                    -----------     -----------
                                                      5,443,637       4,765,527
      Less, accumulated depreciation and
      amortization                                  (4,056,509)      (3,400,173)
                                                    -----------     -----------
                                                    $ 1,387,128     $ 1,365,354
                                                    ===========     ===========

         Depreciation expense was $932,409, $1,265,801 and $1,143,287 during
1999, 1998 and 1997 respectively. 1999 expenses included approximately $29,000
of depreciation for equipment acquired under capital lease. There was no
depreciation incurred for items under capital leases in 1998 and 1997.

6. Goodwill, Intangible and Other Assets

         Goodwill, intangible and other assets consist of the following:
                                                               December 31,
                                                            1999         1998
                                                            ----         ----
         Goodwill and Intangible Assets, net of
          accumulated amortization of $1,102,782
           and $92,105 in 1999 and 1998 respectively     $3,098,889   $5,341,599

         Other Assets                                       688,586      699,345
                                                         ----------   ----------
                                                         $3,787,475   $6,040,944
                                                         ==========   ==========

         Amortization expense was $1,010,677 and $92,105 for the years ended
December 31, 1999 and 1998, respectively.

7.       Accrued Expenses:

         Accrued expenses consists of the following:
                                                               December 31,
                                                         1999            1998
                                                         ----            ----
         Salaries, severance and related benefits   $  1,203,579       1,883,005
         Professional fees                                28,206       1,251,424
         Commissions                                     109,167         112,448
         Interest payable                                 80,520         102,321
         Inventory purchases                           1,611,918         926,366
         Contingent liabilities                          163,580         612,128
         Due to factor                                         -         117,500
         Warranty reserves                               148,491         136,706
         Other                                           165,105         246,763
                                                      ----------      ----------
                                                      $3,510,566      $5,388,661
                                                      ==========      ==========


                                      F-11
<PAGE>

         Included in salaries and related benefits in 1998 is $600,000 related
to an employee termination agreement which was paid in March of 1999.

8. Credit Facility

         The Company maintains a credit facility with Transamerica Business
Credit Corporation's Technology Finance Division, of Farmington, Connecticut.
Currently the Company has a five-year, $3 million term loan and a $4 million
revolving credit facility ("Revolver"). As of December 31, 1999, there was
$2,293,973 outstanding under the term loan and $1,199,837 under the Revolver.

         The Company took down the term loan on June 12, 1997 when it signed the
agreement. Term loan payments of principal and interest are due in arrears in
twenty consecutive quarterly installments, payable on the first day of each
calendar quarter commencing October 1, 1997. The interest rate under the term
loan is based on the weekly average of the interest rate on five year U.S.
Treasury Securities for stated periods plus an agreed upon number of additional
basis points. At December 31, 1999, 1998 and 1997 the interest rates in effect
on the term loan were 12.230%. 12.099% and 11.660%, respectively.

         The Revolver provides for up to $4.0 million in advances based on a
formula of eligible accounts receivable and inventory. Amounts drawn under the
Revolver mature on June 12, 2000 and are secured by accounts receivable and
inventory. It can be renewed for two additional one year periods. Eligibility is
computed monthly and amounts drawn that are not supported by the formula are to
be repaid at that time. The Revolver balance is reflected as a current liability
on the balance sheet. The interest rate in effect under the Revolver is based on
the prime rate plus 2.50% and is payable monthly in arrears.

         In addition, the credit agreement includes a material adverse effect
clause, whereby Transamerica can accelerate the due date of the loan if certain
changes in conditions (financial or otherwise) are deemed to have a material
adverse effect on the Company or its ability to meet its obligations.

         In 1997 the Company incurred financing costs of $576,234 associated
with the completion of the credit facility, which are being amortized over the
life of the loan. Additional financing costs of $380,562 were recorded in 1999
as consideration for waivers and amendments to certain financial covenants.
There were no financing costs incurred during 1998.

         Amortization expenses for the years ended December 31, 1999, 1998 and
1997 were $122,988, $64,719 and $66,870, respectively.

         On October 18, 1999 the Company executed an amendment to the credit
agreement that substantially reduces the amended financial covenants that the
Company must be in compliance with as of and for the year ending December 31,
1999. The only financial covenants that the Company is now required to comply
with are as follows:
o As of December 31, 1999, working capital shall be no less than $2,000,000.
o The ratio of current assets to current liabilities shall not be less than 1.25
  to 1.00.
o Tangible net worth shall not be less than $2,000,000.
o Gross profit margins for the year ending December 31, 1999 shall not be less
  than 35%.

    The amendment also eliminates financial covenants thereafter. As of December
31, 1999 the Company is in compliance with these covenants.

         Based on the Company's currently available borrowing rate of 11.50% for
bank loans with similar terms and maturities, the fair value of long-term debt
at December 31, 1999 is approximately $1,415,000. The Company believes the fair
value of this financial instrument approximated its carrying value at December
31, 1998.

                                      F-12

<PAGE>


Total debt as of December 31, 1999 consisted of the following:
<TABLE>
<CAPTION>


                                             Short Term Debt         Long Term Debt       Total Debt
                                             ---------------         --------------       ----------
<S>                                          <C>                       <C>              <C>


       Transamerica Revolver                   $1,199,837                $    --        $ 1,199,837
       Transamerica Term Note                     504,988              1,788,985          2,293,973
       COFACE Credit                              171,144                     --            171,144
       Bank Nationale de Paris                     14,586                     --             14,586
       ANVAR                                        5,371                     --              5,371
                                               ----------             ----------         ----------
                                               $1,895,926             $1,788,985         $3,684,911
                                               ==========             ==========         ==========




         Total debt as of December 31, 1998 consisted of the following:
                                            Short Term Debt          Long Term Debt     Total Debt
                                            ---------------          --------------     ----------
       Transamerica Revolver                  $ 2,500,000              $      --        $ 2,500,000
       Transamerica Term Note                   2,684,009                     --          2,684,009
       COFACE Credit                              210,945                178,541            389,486
       Bank Nationale de Paris                      4,117                113,487            117,604
       ANVAR                                       46,600                     --             46,600
       Other Obligations                           34,759                 40.806             75,565
                                              -----------              ---------        -----------
                                              $ 5,480,430              $ 332,834        $ 5,813,264
                                              ===========              =========        ===========
</TABLE>

         The balance remaining as of December 31, 1999, on a $3,000,000 Term
Loan from Transamerica is payable quarterly in arrears over twenty consecutive
quarters commencing October 1, 1997.
         Acquired foreign debt of $191,101 is current and consists of three
notes with various institutions and interest rates ranging from 5.19% to 9.7%.
Payments are monthly or due at the end of the term with the last payment due
November 30, 2000.

         Principal payments on debt are as follows:

                                        For the Years Ended December 31,
                                        --------------------------------
2000.................................            $ 1,895,926
2001.................................                568,917
2002.................................              1,220,068
2003.................................                   ----
2004.................................                   ----
Thereafter...........................                   ----
                                                 -----------
Total................................            $ 3,684,911
                                                 ===========


9. Disposition of Assets:

         On September 1, 1998, the Company completed the sale of all of the
assets of its Communications Systems Group, (CSG or DSLAM unit), to publicly
held Cabletron Systems, Inc. of Rochester, New Hampshire. The Company received
$28.5 million in cash on September 1, 1998 in addition to a $5.0 million deposit
it took down on July 27, 1998, for total proceeds of $33.5 million for the
assets of the CSG. Expenses of the transaction netted against the proceeds were
approximately $3,962,104 including $1,541,673 to Mr. Etienne A. Perold, $140,000
to Mr. Theodore J. Coburn and $75,000 to Mr. Robert J. Ranalli, directors of the
Company, who have provided management advisory services to the Company in the
past.

         Additionally, interest expense reflects a one time charge of $750,000
in accordance with the terms of a $2.0 million bridge loan the Company drew down
on February 19, 1998 against the anticipated proceeds of this sale. Under the
terms of the Bridge Loan, the note matured upon the sale of the CSG. To avoid
additional interest, the Company amended the terms to pay the one time fee upon
receipt of the deposit on July 27, 1998. The outstanding principal balance of $2
million and any accrued interest was repaid at closing on September 1, 1998.

         In addition to these expenses approximately $1.2 million in employee
bonuses were paid as a result of the sale.


                                      F-13

<PAGE>
10. Income Taxes:

         The Company's income tax expense and benefits consists of the
following:
                                                        Years Ended
                                                        December 31,
                                          -------------------------------------
                                            1999         1998           1997
                                            ----         ----           ----
         Current:
                  Federal                 $   ---      $359,265        $  ---
                  State                       ---      $  9,367           ---
                                          -------      --------        ------
                                              ---      $368,632           ---
                                          -------      --------        ------
         Deferred:
                  Federal                     ---         ---             ---
                  State                       ---         ---             ---

                                              ---         ---             ---
                                          -------         ---             ---
         Income Tax Expense/(Benefit)     $     0     $368,632         $    0
                                          =======     ========         ======

         The differences between the United States federal statutory tax rate
and the Company's effective tax rate are as follows:
<TABLE>
<CAPTION>
                                                                          For the Years Ended December 31,
                                                                          --------------------------------
                                                                           1999          1998        1997
                                                                           ----          ----        ----
<S>                                                                         <C>          <C>          <C>
     United States federal statutory tax rate                               (34)%          34%        (34)%
     Benefit of net operating loss carryforward                             ---           (36)        ---
     Increases resulting from state income taxes, net of federal benefit    ---           ---          (6)
     Accounting losses for which deferred tax benefit cannot be
        currently recognized                                                 24           ---          39
     Foreign losses for which deferred tax benefit cannot be
        currently recognized                                                  9             2         ---
     Other                                                                    1           ---           1
     Alternative Minimum Tax                                                ---             3
                                                                         ------         -----      ------
         Effective tax rate                                                 ---%            3%        ---%
                                                                         ======         =====      ======
</TABLE>
         The tax effect of temporary differences and net operating loss
carryforwards which make up the significant components of the Company's net
deferred tax assets for financial reporting purposes are as follows:
<TABLE>
<CAPTION>
                                                                             December 31,
                                                                    --------------------------
                                                                           1999         1998
                                                                           ----         ----
<S>                                                                <C>             <C>
         Deferred tax assets:
               Accounts receivable                                  $    314,343    $  386,897
               Inventory                                                 806,707       906,782
               Accrued expenses                                          191,524       889,762
               Net operating loss carryforward                         8,107,292     4,269,291
               Foreign capital loss carryforward                           5,807         6,786
               Foreign net operating loss carryforward                 1,510,367     1,199,912
               Research and development tax credits                    1,780,391     1,222,342
               Depreciation                                              167,899       170,599
               AMT Credit                                                337,799       318,819
                                                                    ------------    ----------
               Total                                                  13,222,129     9,371,190
         Valuation allowance                                         (13,222,129)   (9,371,190)
                                                                    ------------    ----------
                          Net                                       $          0    $        0
                                                                    ============    ==========
</TABLE>
         At December 31, 1999 the Company had available net operating loss
carryforwards and research and development credits for federal income tax
purposes of approximately $34,100,000 and $930,000, respectively, which expire
in the years 2005 through 2019. At December 31, 1999 the Company had available
net operating loss carryforwards and research and development credits for state
income tax purposes approximately $34,820,000 and $850,000, respectively, which
expire in the years 2003 through 2006. The tax benefits related to approximately
$13,600,000 of the federal and state net operating losses at December 31, 1999,
relate to stock option deductions and will be credited to additional paid-in
capital if recognized. At December 31, 1999, the Company had available federal
AMT credits of approximately $338,000 that will carryforward indefinitely. The
timing and manner in which the net operating loss carryforwards and credits may
be utilized to reduce future taxable income, if any, may be limited by Internal
Revenue Code Section 382.

                                      F-14
<PAGE>
         At December 31, 1999, the Company had available net operating loss
carryforwards for foreign income tax purposes of $4,020,000 of which
approximately $3,860,000 expires in the years 2002 through 2004. Approximately
$160,000 of the foreign net operating loss carryforwards will carryover
indefinitely. At December 31, 1999, the Company had available foreign capital
loss carryforwards of $30,000 which expire in the year 2006.

11.      Employee Benefit Plans:

         Effective January 1993, the Company adopted a defined contribution
savings plan. The terms of the plan provide for eligible employees
("participants") who have met certain age and service requirements to
participate by electing to contribute up to 15% of their gross salary to the
plan, as defined, with the Company matching 50% of a participant's contribution
up to a maximum of 3% of gross salary. Company contributions vest after four
years of employment. The employees' contributions are immediately vested. The
Company's contribution to the savings plan for the years ended December 31,
1999, 1998 and 1997 was $120,411, $163,106, and $192,656, respectively.

     The Company also maintains a profit sharing plan for the benefit of its
employees. Contributions are determined at the discretion of the Company up to a
limit of 15% of the total compensation of eligible employees, as defined. No
contributions were made for 1999, 1998 or 1997.

12. Commitments and Contingencies:

     In December 1998, the Company's subsidiary, SCii, (See Note 3), received an
assessment for taxes, penalties and interest as a result of an audit of the
subsidiary's 1995 tax return. 1996 and 1997 are currently under audit and
additional assessments are anticipated. The subsidiary has also received notices
of additional customs taxes and related penalties and interest due to the French
government.

     The Company has contested the 1995 assessment and intends to contest any
future assessments to the extent the Company believes they are erroneous. The
Company also intends to fully pursue indemnification of claims against its
acquired subsidiaries as provided for in the acquisition agreement.

     However, as the Company believes that some assessment related to these
issues is probable, contingent liabilities of $163,580 and $612,128 were
recorded as of December 31, 1999 and 1998, respectively.

     The Company purchases certain components from sole source suppliers upon
which the Company has developed specific products. The Company does not have
long-term agreements with any of these suppliers. Although the Company has not
experienced any material difficulties in obtaining these components, any
reduction or interruption in supply or manufacturing from these third-party
contractors would adversely affect its ability to continue to deliver its
products.

     The Company leases office space for its corporate headquarters under an
operating lease which expires in January 2001. The lease provides for annual
minimum lease payments during the first year of $300,000, increasing annually
thereafter by $7,500. The lease also provides for the Company to pay a portion
of common area costs as defined. The Company has two five-year options to renew
the lease at terms as defined based upon fair market value. In addition,
$125,000 is held in escrow to be applied to future rental payments. Such amount
is classified as a long-term prepayment. The Company also paid a $200,000
security deposit relating to this lease. Additionally, the Company has a lease
on office space in Paris, France which expires June 30, 2007, Fareham England
which expires in December 31, 2000, and Dortmund Germany which expires July 1,
2003. The Company also has certain property and equipment under capital leases.
Future minimum lease payments under all leases at December 31, 1999 are as
follows:

    For the Year Ending December 31,          Operating Leases    Capital Leases
    --------------------------------          ----------------    --------------

    2000                                             528,950            148,465
    2001                                              82,224            132,060
    2002                                              19,489             99,045
    2003                                               6,218                 --
                                                   ---------           --------
    Total                                          $ 636,881            379,570
                                                   =========
    Less amounts representing interest                                  (37,231)
                                                                       --------
    Obligations under capital leases                                    342,339
    Less current portion                                               (126,438)
                                                                       --------
                                                                       $215,901
                                                                       ========

 Rent expense for the years ended December 31, 1999, 1998 and 1997 was $598,138,
$734,651, and $674,004, respectively.


                                      F-15

<PAGE>


Legal Contingencies
         On June 8, 1999, we received a letter from legal counsel representing
Dr. Brent Townshend notifying the Company that Dr. Townshend believes that modem
products which comply with the V.90 standard necessarily practice the inventions
claimed in his patents. Dr. Townshend alleges that products which incorporate a
modem and modem chipset acquired from a supplier that has not itself entered
into a license agreement with Dr. Townshend would also fall within the claims of
the patents. The letter included an offer to enter into a license agreement
under Dr. Townshend's patents. The letter also states that should legal action
to enforce patent rights be required, the offered terms in the license may be
different. No liability has been recorded for this matter as the ultimate
outcome is not currently determinable, however, management believes that the
outcome of this matter will not have a material adverse effect upon our
business, financial condition and results of operations.

13. Segment Data

     Segments are comprised of European and North American operations. The
accounting policies of the segments are the same as those described in the
"Summary of Significant Accounting Policies" in Note 2 of the Company's Form
10K. Segment profit includes operating expenses directly attributable to the
segment including administrative, selling, marketing, research and development
costs and taxes.

     On November 23, 1998 the Company acquired all of the outstanding stock of
SCii Telecom, SA, in Paris France and during 1999 the Company established Ariel
Deutschland, GmbH, a wholly owned German subsidiary. As a result, the Company
now reports segments on a geographic basis. European operations did not qualify
as a reportable segment as of December 31, 1998, therefore, there is no
comparable segment information presented.

     Summary information by segment as of and for the twelve months ending
December 31, 1999 is as follows:

                                                               For the twelve
               NORTH AMERICA:                                   months ending
                                                              December 31, 1999
                                                              ------------------
               Revenues from external customers                  $ 11,229,081
               Intersegment revenues                                   19,318
               Net segment  (loss)                                 (9,918,643)
               Depreciation and amortization expense                  843,693
               Interest income and (expense), net                     (76,349)
               Segment assets                                      16,759,363


               EUROPE:
               Revenues from external customers                  $    397,465
               Intersegment revenues                                      -0-
               Net segment  (loss)                                 (2,577,618)
               Depreciation and amortization expense                1,099,393
               Interest income and (expense), net                     (10,785)
               Segment assets                                       3,057,709
                  A reconciliation of the Company's segment losses to the
corresponding consolidated amounts for the twelve months ending December 31,
1999 is as follows:

                   Segment profit / (loss)                      ($ 12,496,261)
                   Margins  on intersegment revenues                   (3,554)
                                                                -------------
                   Net loss                                      ($12,499,815)
                                                                =============


14. Share Rights Plan

         On October 15, 1998, the Board of Directors approved the declaration of
a dividend distribution of one preferred share purchase right on each
outstanding share of its Common Stock ("Rights"). Each Right will entitle
shareholders to buy one one-hundredth of a share of newly created Series A
Preferred Stock of the Company at an exercise price of $25. The Rights will be
exercisable if a person or group acquires 15% or more of the Common Stock of the
Company or announces a tender offer for 15% or more of the Common Stock. The
Board of Directors will be entitled to redeem the Rights at one cent per Right
at any time before such person acquires 15% or more of the outstanding Common
Stock. The Rights are more fully described in the Rights Plan dated as of
October 9, 1998.


                                      F-16

<PAGE>
         Under the Rights Plan if a person acquires 15% or more of the
outstanding Common Stock of the Company, each Right will entitle its holder to
purchase, at the Right's exercise price, a number of shares of Common Stock
having a market value at that time of twice the Right's exercise price. If the
Company is acquired in a merger or other business combination transaction after
a person acquires 15% or more of the Company's Common Stock, each Right will
entitle its holder to purchase, at the Right's then-current exercise price, a
number of the acquiring company's common shares having a market value at that
time of twice the Right's exercise price. The Board of Directors may also
exchange the Rights at an exchange ratio of one share of Common Stock per Right.
Rights held by a 15% holder will become void and will not be exercisable to
purchase Common Stock, or the acquiring person's common shares, at the
discounted purchase price, and will not be available for each exchange.

         The dividend distribution will be payable to shareholders of record as
of the close of business on October 9, 1998. The Rights will expire in ten
years.

15. Related Party Transactions:

Legal

         The Company's outside legal counsel owns shares of the Company's common
stock and is a member of the Company's Board of Directors. Total legal fees paid
to this outside attorney for the years ended December 31, 1999, 1998 and 1997
were approximately $120,000, $124,000, and $75,000, respectively.

Management Advisory Services

         A director and former executive officer of the Company was paid $54,166
for management consulting services consisting primarily of supporting our
efforts to raise additional capital in the year ending December 31, 1999.

         A director of the Company, has provided management advisory services to
the Company since 1995. Fees incurred for the years ended December 31, 1998, and
1997 were approximately $450,000 and $218,000, respectively. In December 1998,
the Company entered into a termination agreement with this director as a result,
no such fees were incurred in 1999.

         In addition, this director received a stock option grant of 80,000
options for management advisory services on December 31, 1998 which vested at
the grant date. These fees are in addition to fees received for management
advisory services rendered for the sale of the Company's DSLAM unit as disclosed
in note 9. This director also had an outstanding receivable of $100,000 to the
Company as of December 31, 1998. This amount was repaid to the Company in
January 1999.

Investment Banking Services

         A director of the Company, has provided investment banking advisory
services to the Company since 1996. Fees and expenses incurred for the years
ended December 31, 1999, 1998 and 1997 were approximately $22,000, $156,200, and
$88,000, respectively. In addition, this director received a stock option grant
of 40,000 options dated July 30, 1996 that vested 25% on July 30, 1996, 25% July
30, 1997 and 50% July 30, 1998 as well as an additional stock grant of 40,000
options dated May 1, 1997 that vested 50% on the effective date and 50% on May
1, 1998. These fees are in addition to fees received for management advisory
services rendered for the sale of the Company's DSLAM unit as disclosed in
note 9.

Program Management Services
         In February 1999, we entered into a consulting agreement with GIOS
Incorporated to advise our senior management in connection with the installation
of new product development process capabilities, including assessing process
issues and providing strategic decision support. GIOS was co-founded in
September 1998 by Dennis Schneider, our Senior Vice President - Marketing. The
agreement provides that Mr. Schneider will represent only our interests during
the course of the consulting relationship. Compensation to GIOS under the
agreement is $2,000 per day, three days per week for the first month of the
agreement, and $1,750 per day for the remainder of the relationship, with
specific time commitments to be negotiated by the parties. At December 31, 1999,
we had paid approximately $162,000 to GIOS for consulting services.

16. Sales:

       Sales by geographic area are as follows:

                                           For the years ended December 31,
                                      -----------------------------------------
                                          1999          1998            1997
                                          ----          ----            ----
       United States                  $10,459,550   $15,720,887    $ 12,035,000
       Export & Subsidiary Sales:
         Europe                         1,042,900     1,494,271         640,739
         Asia                              17,997       131,023         195,969
         Other                            106,099        99,648         330,208
                                       ----------   -----------    ------------
                                       11,626,546   $17,445,829    $ 13,201,916
                                       ==========   ===========    ============
                                      F-17
<PAGE>

         During 1999 three customers accounted 22%, 12% and 11% of sales
respectively. Combined, these customers comprised 45% of sales in 1999. During
1998, one customer accounted for 25% of the Company's sales. That customer
accounted for less than 3% of sales in 1997. Two other customers accounted for a
combined 27% and 19% of total Company sales during 1998 and 1997, respectively.

The following table sets forth the activity in the Company's allowance for
doubtful accounts:

January 1, 1997                                                  $ 212,678
Additions charged to costs and expenses                             30,000
Net write-offs                                                     (70,044)
Net recoveries                                                      14,812
                                                                ----------
December 31, 1997                                                  187,446

Additions charged to costs and expenses                            851,415
Additions due to assets acquired                                   486,688
Net write-offs                                                     (64,694)
Net recoveries                                                           -
                                                                ----------
December 31, 1998                                                1,460,855

Additions charged to costs and expenses                            546,144
Net write-offs                                                    (990,518)
Net recoveries                                                       3,250
                                                                ----------
December 31, 1999                                               $1,019,731
                                                                ==========


17. Stock Option and Restricted Stock Awards:

The 1992 Stock Option and Restricted Stock Plan

         During 1992, the Board of Directors approved and stockholders of the
Company ratified the adoption of the 1992 Stock Option and Restricted Stock Plan
(the "1992 Plan"). The 1992 Plan provided for a maximum of 600,000 shares of the
Company's common stock to be issued to employees, directors and consultants, as
defined in connection with stock option grants ("Options") or restricted stock
awards ("Awards").

         Also during 1994, the Company granted, from the 1992 Plan a total of
268,875 Options which entitle the holders to acquire an equal number of shares
of the Company's common stock at an exercise price per share of $2.27 or $2.45.
The Options vest over a four-year period.

         Effective October 31, 1994, the Board terminated the 1992 Plan and,
accordingly, no additional Options or Awards will be issued from the 1992 Plan.
As of December 31, 1999, 22,625 options remain outstanding.

The 1994 Stock Option Plan

         During 1994, the Board of Directors (the "Board") approved and
stockholders of the Company ratified the adoption of the 1994 Stock Option Plan
(the "1994 Plan"). The 1994 Plan provides for a maximum of 500,000 shares of the
Company's common stock to be issued to employees, directors and consultants
("employees"), as defined, in connection with stock option grants ("Stock
Options"). Stock Options will be granted by the Board or a committee appointed
by the Board ("the Committee"). Each Stock Option will entitle the holder to
acquire an equal number of shares of common stock at an exercise price equal to
the fair market value of the common stock on the date of grant as determined by
the Committee (110% of the fair market value for an employee who owns 10% or
more of the Company as defined). The Committee will determine the Stock Option
vesting period and expiration date not to exceed ten years from the date the
Stock Option was granted. The 1994 Plan contains a provision whereby an
employee, at the discretion of the Committee, may receive a loan from the
Company in order to exercise their Stock Options. The 1994 Plan also provides
for the Committee, at its discretion, to accelerate the vesting of all
outstanding Stock Options so that they become fully and immediately exercisable.
During October 1994, the Company granted, from the 1994 Plan, 150,000 Stock
Options to three members of the Company's Advisory Board. Each Stock Option
entitles the holder to acquire one share of the Company's common stock at
exercise prices, per share, of $2.45 for 75,000 Stock Options and $6.00 for the
remaining 75,000. All Stock Options are immediately exercisable and expire three
years from the date of grant. In connection with the Company's initial public
offering, the underwriting agreement entered into in connection therewith
prohibits the Company from granting future Stock Options at an exercise price
below $4.00.


                                      F-18
<PAGE>

         All outstanding options vest over periods ranging from immediate to
four years and expire in ten years. At December 31, 1999, 11,200 options remain
outstanding.

The 1995 Stock Option Plan

         The Company adopted its 1995 Incentive Stock Option Plan ("Plan"),
which was approved by the Company's stockholders at the annual meeting of
stockholders on May 14, 1996. The stockholders ratified an amendment to the Plan
at the 1997 annual meeting of stockholders held on June 13, 1997, increasing the
number of shares issuable under the Plan from 600,000 to 1,200,000. On June 24,
1998, the stockholders ratified an amendment to the Plan , increasing the number
of shares issuable under the Plan from 1,200,000 to 1,700,000. On June 23, 1999
the stockholders ratified another amendment to the Plan, increasing the number
of shares issuable under the Plan from 1,700,000 to 2,200,000.

         The Board believes that the Plan is desirable to attract and retain
executives and other key employees of outstanding ability. Under the Plan,
options to purchase an aggregate of not more than 1,700,000 shares of the
Company's common stock may be granted.

         At various times during 1999, the Company granted a total of 167,050
options which entitles the holder to acquire an equal number of shares of the
Company's common stock at exercise prices ranging from $2.63 to $4.00. The
options vest over periods ranging from immediate up to four years and expire in
ten years. At December 31, 1999, 461,986 options remain outstanding.

         The Plan is administered by the Board of Directors. The Board is
generally empowered to interpret the Plan, prescribe rules and regulations
relating thereto, determine the terms of the option agreements, amend them with
the consent of the optionee, determine the employees to whom options are to be
granted, and determine the number of shares subject to each option and the
exercise price thereof. The per-share exercise price for incentive stock options
("ISO") and for non-qualified stock options ("NQSO") will not be less than the
greater of $4.00 per share or 100% of the fair market value of a share of the
common stock on the date the option is granted (110% of fair market value on the
date of grant of an ISO if the optionee owns more than 10% of the common stock
of the Company). Upon exercise of an option, the optionee may pay the exercise
price with previously acquired securities of the Company, or at the discretion
of the Board, the Company may loan some or all of the purchase price to the
optionee.

         Options will be exercisable for a term determined by the Board, which
will not be greater than ten years from the date of grant. Options may be
exercised only while the original grantee has a relationship with the Company
which confers eligibility to be granted options or within three months after
termination of such relationship with the Company, or up to one year after death
or total and permanent disability. In the event of the termination of such
relationship between the original grantee and the Company for cause (as defined
in the Plan), all options granted to that original optionee terminate
immediately. In the event of certain basic changes in the Company, including a
change in control of the Company (as described in the Plan), in the discretion
of the Committee each option may become fully and immediately exercisable. ISOs
are not transferable other than by will or the laws of descent and distribution.
NQSOs may be transferred to the optionee's spouse or lineal descendants, subject
to certain restrictions. Options may be exercised during the holder's lifetime
only by the holder, his or her guardian or legal representative.

         Options granted pursuant to the Plan may be designated as ISOs, with
the attendant tax benefits provided under Section 421 and 422 of the Internal
Revenue Code of 1986. Accordingly, the Plan provides that the aggregate fair
market value (determined at the time an ISO is granted) of the common stock
subject to ISOs exercisable for the first time by an employee during the
calendar year (under all plans of the Company and its subsidiaries) may not
exceed $100,000. The Board may modify, suspend or terminate the Plan; provided,
however, that certain material modifications affecting the Plan must be approved
by the stockholders, and any change in the Plan must be approved by the
stockholders, and any change in the Plan that may adversely affect an optionee's
rights under an option previously granted under the Plan requires the consent of
the optionee.

                                      F-19

<PAGE>


Non-Plan Options

         During 1999, the Company granted 258,000 stock options to certain
employees. Such options were issued outside the 1995 Plan and entitle the
holders thereof to acquire an equal number of shares of the Company's common
stock at exercise prices ranging from $2.31 to $2.81. Such options vest over
periods ranging from immediate to four years and expire in ten years. At
December 31, 1999, a total of 1,051,504 non-plan options remain outstanding.

The 1996 Directors Plan

         The 1996 Directors Plan was adopted by the Board of Directors on
January 24, 1996 and approved by the stockholders of the Company at the Annual
Meeting of Stockholders held May 14, 1996. The stockholders ratified an
amendment to the Plan at the 1998 annual meeting of stockholders held on June
24, 1998, increasing the number of shares issuable under the Plan from 250,000
to 450,000. The Plan is administered by a committee appointed by the Board of
Directors. The Plan is effective for a period of ten years from the date it was
adopted. The Plan is not subject to any provisions of the Employee Retirement
Income Security Act of 1974 ("ERISA").

         341,000 options have been granted pursuant to the 1996 Directors Plan
to date. The ability of a grantee to purchase the common stock under the 1996
plan is terminated if his or her service with the Company is terminated,
provided that in certain circumstances the grantee or his estate will have the
right to purchase the common stock after termination of service for a limited
period of time. The right to acquire common stock is not transferable except in
the circumstances of death. In the event that a reorganization, merger,
consolidation, reclassification, recapitalization or capital adjustment
including a stock dividend or other similar change in the common stock of the
Company, equitable adjustment shall be made by the Company in the number of kind
and kind of shares that may be acquired under the 1996 Directors Plan. Common
stock that may be acquired under the 1996 Directors Plan may be acquired by the
surrender of other shares of common stock owned by the employee or the surrender
of an unexercised portion of the right to acquire common stock under the 1996
Directors Plan.

         The Company applies APB No.25, "Accounting for Stock Issued to
Employees", and related interpretations for stock options issued to employees in
accounting for its stock option plans. Accordingly, no compensation expense has
been recognized for the Company's stock-based compensation plans other than for
stock options granted to directors and outside consultants. During 1998 and
1997, the Company recorded a total of approximately $302,275, and $221,638,
respectively, of unearned compensation related to options granted to directors
and consultants. These amounts are being amortized over the period of benefit,
resulting in a $413,094 and, $289,638 charge to operations for the years ended
December 31, 1998 and 1997, respectively. No such charges were recorded during
1999. The exercise price for all stock options issued to employees and
non-employees during 1998 and 1997 was equal to the market price of the
Company's stock at the date of grant.

<PAGE>

         The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Had compensation cost for the
Company's stock options issued to employees been determined based upon the fair
value at the grant date for stock options issued under these plans pursuant to
the methodology prescribed under SFAS No. 123, the Company's net loss basic and
diluted loss per share would have resulted in a reduction in the net loss during
1999 due to significant number of forfeited options, as shown in the table
below. The weighted average fair value of stock options granted to employees
used in determining the pro forma amounts is estimated using the Black-Scholes
option-pricing model for the pro forma amounts with the following weighted
average assumptions:

                                                       December 31,
                                                       ------------
                                         1999             1998              1997
                                         ----             ----              ----
Risk-free interest rate                 6.08%            4.70%             6.40%
Expected life                       3.4 years        4.1 years         4.3 years
Expected volatility                       86%              80%               65%
Expected dividends                       None             None              None


         Net income/(loss) and basic and diluted earnings/(loss) per share as
reported, and on a pro forma basis as if compensation cost had been determined
on the basis of fair value pursuant to SFAS No. 123 is as follows:

<TABLE>
<CAPTION>

                                                            For the years ended December 31,
Net income/(loss):                                     1999             1998           1997
                                                       ----             ----           ----
<S>                                               <C>              <C>             <C>

    As reported                                  ($12,499,815)      $12,076,506    ($ 12,761,399)
    Pro forma                                    ($11,776,096)      $ 9,285,433    ($ 13,857,020)

Basic Earnings/(Loss) per share:
    As reported                                   $     (1.27)      $      1.25      $     (1.39)
    Pro forma                                     $     (1.20)      $      0.96      $     (1.51)

Diluted Earnings/(Loss) per share:
    As reported                                   $     (1.27)      $      1.11      $     (1.39)
    Pro forma                                     $     (1.20)      $      0.86      $     (1.51)
</TABLE>
                                      F-20

<PAGE>

         Pro forma amounts reflect options granted after 1994 and are not likely
to be representative of amounts in future years, as additional options are
awarded and vested.

         For the three years ended December 31, 1999, option activity for the
plans was as follows:
<TABLE>
<CAPTION>

                                                                                         Weighted
                                                                                          Average
                                                                        Options        Exercise Price
                                                                        -------        --------------
<S>                                                                  <C>                      <C>

Stock options outstanding at December 31, 1996                         2,032,075              5.92

Granted                                                                  485,500              7.49
Forfeited                                                               (189,875)             7.99
Exercised                                                               (251,525)             3.93
Stock options outstanding at December 31, 1997                         2,076,175              6.35

Granted                                                                2,697,300              3.82
Forfeited                                                             (1,568,375)             6.29
Exercised                                                               (425,900)             4.32
Stock options outstanding at December 31, 1998                         2,779,200              4.24

Granted                                                                  687,752              3.16
Forfeited                                                               (712,275)             5.45
Exercised                                                               (866,364)             4.31
Stock options outstanding at December 31, 1999                         1,888,313              3.37
</TABLE>

         The weighted average fair value of options granted during 1999, 1998
and 1997 was $3.06, $2.10, and $3.96, respectively.


The following table summarizes information about the outstanding and exercisable
stock options at December 31, 1999:

<TABLE>
<CAPTION>

                                    Stock Options Outstanding                          Stock Options Exercisable
                        --------------------------------------------------        -------------------------------------
                                                                Weighted
                                             Weighted            Average                                Weighted
       Range of                              Average            Remaining                                Average
   Exercise Prices            Shares      Exercise Price     Contractual Life              Shares    Exercise Price
   ---------------            ------      --------------     ----------------              ------    --------------
<S>     <C>    <C>    <C>    <C>    <C>    <C>

   $ 2.12 to $4.00         1,761,327          $ 3.01            9.1 years                 666,002        $  3.17
   $ 4.38 to $9.50            90,736          $ 7.46            7.3 years                  48,063        $  8.20
   $9.63 to $10.63            36,250          $10.60            6.37 years                 35,000        $ 10.63
                           ---------                                                      -------
                           1,888,313                                                      749,065


</TABLE>
                                      F-21
<PAGE>



18. Stock Warrants
         As of December 31, 1999 there were 100,000 stock warrants outstanding
entitling the holder to purchase 100,000 shares of common stock at a purchase
price of $3.763 per share. The warrants were issued on October 18, 1999 and are
valid for a period of seven years. They are exercisable at any time during the
seven year term.

19. Subsequent Event
         On February 24, 2000 the Company entered into an agreement with a
number of investors to sell 2,151,000 shares of its common stock at a purchase
price of $4.00 per share in a private placement resulting in gross proceeds of
$8.6 million. The Company also issued 2,151,000 warrants to purchase common
stock with an exercise price of $6.875. The warrants are not exercisable until
September 1, 2000. The exercise price of the warrants will be reset to the
average market price for the five trading days preceding the one year
anniversary date of the issuance of the warrants provided the average price is
less than $6.875. Under the terms of the agreement, the Company agreed to file a
registration statement on or before April 4, 2000 to register the shares sold
and those underlying the warrants and to have the registration statement
declared effective by the Securities and Exchange Commission within 120 days
thereafter. In the event the Company fails to meet these deadlines, the
agreement provides for liquidated damages.

         The agreement also calls for the issuance of additional shares at no
cost to these investors should the Company sell shares of common stock, or
securities convertible into common stock, at a price less than $4.00 per share
within twenty four months of the date of this agreement. This provision requires
the Company to issue additional shares such that the average share price to
these investors is equal to the then offered price.

         Additionally, these investors have the right of first refusal to
participate in any sale of the Company's common stock, or securities convertible
into common stock, within the next twenty four months.



                                      F-22
<PAGE>





                                   SIGNATURES

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


                                       ARIEL CORPORATION


                                       By: /s/ Jay Atlas
                                           -------------------------------------
                                           Jay Atlas, CEO and President

         Pursuant to the requirements of the Securities Act of 1933, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
<S>                                         <C>                                 <C>

                                            Chief Executive Officer,
/s/ Jay Atlas                               President and Director              March 29, 2000
----------------------------------------    -------------------------           -----------------
Jay Atlas                                   Title                               Date

                                            Senior Vice President and
/s/ John Loprete                            Principal Accounting Officer        March 29 2000
----------------------------------------    ----------------------------        -----------------
John Loprete                                Title                               Date


/s/ Anthony M. Agnello                      Chairman                            March 29, 2000
----------------------------------------    --------                            -----------------
Anthony M. Agnello                          Title                               Date


/s/ Esmond Goei                             Director                            March 29, 2000
----------------------------------------    --------                            -----------------
Esmond Goei                                 Title                               Date


/s/ Edward D. Horowitz                      Director                            March 29, 2000
----------------------------------------    --------                            -----------------
Edward D. Horowitz                          Title                               Date


/s/ Harold W. Paul                          Secretary and Director              March 29, 2000
---------------------------------------     ----------------------              -----------------
Harold W. Paul                              Title                               Date


/s/ Charles Strauch                         Director                            March 29, 2000
---------------------------------------     -------------------                 -----------------
Charles Strauch                             Title                               Date
</TABLE>