<PAGE>
                                    
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549
                       ----------------------------------

                                    FORM 10-K

                  ANNUAL Report pursuant to Section 13 or 15(D)
                     of the securities exchange act of 1934

                   For the fiscal year ended December 31, 1998

                         Commission file number: 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 there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B 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-KSB
or any amendment to this Form 10-K. _____


Aggregate market value of voting stock held by non-affiliates of registrant as
of March 15, 1999, $17,826,637.

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, 9,775,150 shares
outstanding as of March 15, 1999.

Number of pages -
Exhibit Index -
Documents incorporated by reference: None.





<PAGE>

Item 1.  Description of Business

General

         The Company, incorporated in 1982 in Delaware is a technology company
that has historically had Digital Signal Processing ("DSP") as its core
strength. DSP is an enabling technology driving the emergence of rapidly growing
technology markets such as Internet Service Providers ("ISP") and Remote Access
Server ("RAS") markets (see "Industry Background"). In August 1997, the Company
announced its intent to focus on the RAS market opportunity through product
offerings that provide high density and cost effective remote access data
solutions for open system platforms. The Company's remote access products target
open system servers spanning a broad range of applications including
telecommuting, internet processing and unified messaging. The RAS market is
projected to grow from $2.5 billion in 1996 to over $8 billion by the year 2000
by International Data Corporation ("IDC"), a leading provider of information
technology data, analysis and consulting services.

     Prior to 1996, the Company historically produced and sold DSP boards
incorporating DSP processors developed by Texas Instruments, Inc. ("TI"),
Motorola Inc., Lucent Technologies and Analog Devices Inc. ("ADI") which are
designed to run on industry standard interfaces. The Company provided solutions
to a customer's high-end DSP system needs either by the use of a company
standard product, thereby reducing time-to-market, or by utilizing the Company's
DSP expertise to custom design a DSP hardware and software solution. These
products were marketed to Original Equipment Manufacturers ("OEMs") and the U.S.
Department of Defense through an internal sales force and independent sales
representatives in the United States and through independent sales
representatives and dealers internationally.

     Beginning in 1996, the Company commenced shipping its first product aimed
at the rapidly growing Computer Telephony Integration ("CTI") market. This
product, the CTI-modem, incorporated multiple standard DSP chips in a single PC
plug-in board and was targeted for the transaction processing market. To date,
the majority of such shipments have been to one customer. During the third
quarter of 1996, the Company began shipments of its T1-modem product which
provides up to thirty v.34 modems in a single ISA bus slot and is incorporated
by OEMs in RAS systems. During the third quarter of 1997, the Company began
shipments of its T1-Modem+ product which provides up to thirty 56 kbps modems in
a single ISA bus slot.

     In January 1996, the Company formed the Communications Systems Group (CSG)
to begin development of an ADSL carrier class product targeting the needs of
major telecommunications and network service providers and developed Horizon, a
carrier class product. In October 1996, the Company retained Needham and
Company, Inc. ("Needham") as a financial adviser to contact prospective
strategic marketing partners for purposes of developing a strategic marketing
relationship with regard to the Company's ADSL product. The Company's recent
strategic decision to focus on the RAS marketplace led to the Company announcing
in November 1997 its intent to seek a buyer for the CSG and the Horizon product.
The carrier class product did not fit well into the Company's markets and
customer base and the Company's working capital position could not sustain the
continued investment needed to bring ADSL products to market. In June 1998, the
Company agreed to sell the assets of the CGS to Cabletron Systems, Inc.
(Cabletron). The transaction was completed in September 1998 and all members of
the communications systems team were transitioned to the buyer.

     In May 1997, the Company introduced an open system networking solution,
that allows Windows NT-based servers manufactured by various PC OEMs to
function as a remote access server. This product is sold through the Company's
internal sales force and value added resellers directly to end-users.

     In October 1998 the Company introduced its next generation RAS products -
the RS2000 and RS2000c which utilize Peripheral Computer Interface (PCI) &
Compact Peripheral Computer Interface (cPCI) technologies. This product will be
sold through the Company's internal sales force, independent sales
representatives, and value added resellers directly to end-users. The Company
believes certain features and capabilities of these products make them more
suitable for Internet Service Providers.

                                       2
<PAGE>


     For 1998, the Company reported sales of $17,445,829, an operating loss of
$16,218,113, and net income of $12,076,506 or $1.25 basic earnings per share and
$1.11 diluted earnings per share. Working capital amounted to $12,632,033,
including $17,996,575 of cash and cash equivalents. For a more complete
description of the results of operations please refer to Management's Discussion
and Analysis of Financial Condition and Results of Operations, Item 7, page 8.

Industry Background

         DSP is the conversion of signals - electrical representations of light,
sound and other naturally occurring analog waveforms - into a stream of digital
values (i.e., ones and zeroes) which may then be processed, manipulated,
exchanged or stored by electronic systems in ways not possible when the signals
are in analog form. DSP provides several processing advantages over analog
technologies, including: (i) higher degrees of audio and video compression,
resulting in greater storage and communication capacity; (ii) a greater ability
to process and manipulate digital data, resulting in enhanced product
performance; (iii) easier development and upgrades of multi-functional products
through the use of reconfigurable software rather than dedicated analog hardware
components, and (iv) the ability to provide a wide range of functions including
integrated computer telephony, fax and data modems, voice mail, Internet access
and CD quality audio in a single plug-in board which is upgradable over time.
The Company believes that DSP's processing advantages over analog position DSP
as an important technology for future generations of communications and consumer
electronics products and personal computers, as well as emerging multimedia
products. These advantages, combined with the declining cost and improved
performance of DSP chips, have resulted in significant growth in the uses of
DSP.

Data Communications Market

   The Company offers the industry's highest density and most cost-effective
remote access data solutions for open systems platforms. The Company's standard
and custom remote access products target open systems servers spanning a broad
range of applications, including telecommuting, Internet access, corporate
Intranet access, on-line services, transaction processing, and unified
messaging. The company's high density RS1000, RS2000 and T1-Modem+ product
families are remote access and modem pool solutions support V.90(56kbps), V.32,
V.34, and ISDN remote access sessions and connect to T1, E1, ISDN and POTS
lines.

General Purpose DSP Board Market and Applications

         DSP technology has been applied in a wide range of commercial and
defense applications which often require the processing power of multiple DSP
chips. Multiprocessing is often required in specialized applications such as
medical imaging, instrumentation, professional audio, telecommunications, and
defense electronics. The Company's multiprocessing DSP products enable
signal-processing tasks to run concurrently on a low-cost computer platform. The
Company will continue to sell and support such products to applications that
provide returns sufficient to meet the Company's business model.

Products

         The Company currently offers a number of DSP hardware and software
products. They include:

Data Communications Products

         CTI-Modem. CTI-Modem currently provides sixteen V.32 modems in a single
ISA slot and supports both MVIP and SCSA protocols. CTI-Modem runs on the
Company's DC-5 product which implements multiple DSP's on a single ISA plug in
board. Coordination and control of simultaneous modem tasks running on multiple
processors is managed by AT&T's VCOS operating system running on the DC-5 board.
In addition, the Company has developed a modem API (Application Programing
Interface) to ease the task of software integration. The Company believes that
CTI-Modem addresses the requirements of the transaction processing markets.

         T1-Modem. T1-Modem provides a twenty-four V.34 modem port solution in a
single ISA slot for network OEMs. T1-Modem+ provides sixteen, twenty-four or
thirty K56FLEX modems in a single ISA bus slot for network OEMs. The Company
believes that T1-Modem product line and its successors address the requirements
of the RAS concentrator market place.

         RS1000(TM) is an easy to install PC-board set that enhances any
existing Windows NT-based server with a complete departmental remote access
solution. RS1000 includes up to forty-eight 56-kbps digital modems and a single
or dual PRI/T1 digital telephony interface providing the lowest cost per port
available.

                                       3
<PAGE>

         RS2000 is the next generation to the RS1000 and T1-Modem+ product
families. RS2000 utilizes PCI and cPCI interface Bus structures as found in
standard PC and CompactPCI enclosures. All RS2000 family products support the
V.90 (56kps) modem standard.

         As a result of its November 1998 acquisition of Scii Telecom, the
Company now offers PCI adapters for one, two and four ISDN Basic Rate Interface
(BRI) interfaces with support on both Windows and MAC-OS platforms.


DSP OEM Products

         Hydra Series VME Boards. The Hydra series comprises VMEbus DSP boards
based on two, four or eight TI TMS320C4x DSP chips. The Company believes that
Hydra is well-suited to large processing tasks that require multiple DSP chips
in an industrial or defense environment. The Company introduced an enhanced
version of Hydra, called HydraPlus, in mid 1995, which supports a memory
capacity approximately four times greater than the original Hydra.


         Hammer Head V200. Hammer Head V200 was introduced in March 1997. It is
a SHARC VME bus board equipped with six 40-MHZ SHARC floating point digital
signal processors. The Hammer Head V200 also features two open I/O based board
access sites based on Ariel's Open Hardware Architecture ("OHA"). The two sites
enable designers to take advantage of off-the-shelf radar and sonar I/O modules.
Hammer Head V200 is based on Analog Devices 40-MHZ ADSP210260 and 21062 DSPs.


Manufacturing and Quality Control

         The Company utilizes contract manufacturing for substantially all of
its manufacturing processes, thereby allowing the Company to focus resources on
product research and development, marketing and sales, and customer support. The
Company's internal manufacturing operations consist primarily of production of
prototypes, testing of non-turnkey products, manufacturing and test engineering,
materials purchasing and inspection and quality control. In 1996, the Company
implemented systems within operations to be full turnkey on its high volume
product lines. The procurement of components, assembly, testing and quality
control of these printed circuit board assemblies will be coordinated through a
limited number of high quality contract manufacturers. The Company believes that
such manufacturers are able to meet the Company's needs by reducing working
capital requirements, producing high quality products and allowing the Company
to focus its efforts on design rather than production. The Company monitors the
performance and quality of the work performed by its outside contractors by
using the Company's internal quality assurance procedures and by making regular
visits to manufacturing facilities.

         The Company purchases DSP chips and certain other components from
Lucent Technologies, Rockwell International, Inc., Motorola Inc., TI, and ADI,
each of which manufacturers and is the sole supplier of DSP chips upon which
specific products have been developed. The Company is currently investigating
long-term agreements with these key suppliers and partners. Although the Company
has not experienced any material difficulties in obtaining supplies or
manufactured products, any reduction or interruption in supply or manufacturing
from these third-party contractors would adversely affect its ability to
continue to deliver its products.

Sales, Marketing and Customers

         The Company markets its product in the United States and Europe
primarily through a direct sales force and through independent sales
representatives. The Company recently hired a Senior Vice President-Marketing
with over 20 years experience in marketing high-technology computer and
communications products. Internationally, the Company sells its products through
value added resellers and distributors in Europe, Israel and the Far East and
maintains a sales office for one salesman in Berlin, Germany. In November 1998,
the Company acquired Solutions for Communications for International ISDN, SA
(SCii), in Paris and is in the process of integrating its existing European
sales group and product offerings with this subsidiary.

         The Company's direct sales force has historically targeted high-volume
system integrators and OEM customers. An OEM customer who wishes to incorporate
DSP technology into an end product can either design the DSP sub-system
internally (make) or purchase (buy) the sub-system from a third party such as
the Company. In a make versus buy scenario, buy decisions are often driven by
time-to-market and cost consideration. The RS2000, RS1000 and T1-Modem+ products
are end-user products. Prior to their introduction, the Company's product
offerings have been components in an OEM product.

      While the Company will continue to seek OEM customers who require
customized applications of the Company's products, going forward, sales and
marketing efforts will shift from focusing on PC OEM's and enterprise markets to
end users such as Internet Service Providers.




                                       4
<PAGE>


         The Company obtains most new sales prospects through advertising,
existing customers, strategic relationships and trade show participation.
Principal marketing activities include display advertising in trade
publications, direct mail, trade show participation and a home page on the World
Wide Web.


         The Company markets its products to networking and communications
manufacturers and Internet Service Providers. In 1996, sales to Corsair Inc.
accounted for approximately 32% of the Company's sales. In 1997, sales to
Corsair and Cabletron accounted for approximately 19% and 11%, respectively, of
the Company's total sales. All outstanding purchase orders for Corsair were
completed during the first calendar quarter of 1997. In March 1998, the Company
announced it had reached an agreement to supply Compaq Computer Corporation
(Compaq) its T1-Modem+ product. In 1998 Compaq accounted for approximately 25%
of the Company's sales. Cabletron and Transaction Network Services accounted for
14% and 13%, respectively, in 1998.


Product Research and Development

         The Company has continued to focus its research and development efforts
on data communication products targeting the RAS and ISP markets. The Company's
ongoing product development activities also include the enhancement of current
products, the adaptation of third-party technologies to its products and the
development of new product options and features. From time to time, the Company
has employed consultants to perform certain research and development functions.
The Company has continued this practice in 1998 as a means of augmenting its
internal research and development capabilities.

         The Company incurred $6,722,905 (38.5% of sales) in research and
development expense for 1998, including In-Process Research and Development
costs of $297,330 incurred in its November acquisition of SCii. These costs
included approximately $2,309,430 (13% of sales) related to the CSG. This
compared to $8,182,584 or 62% of sales in 1997 and $5,750,413 or 44% of sales in
1996. 1997 expenses are net of a $750,000 payment received from TI for
non-recurring engineering expense related to a cooperative and licensing
agreement signed on September 12, 1997 (see "Intellectual Property").



         The Company believes that the timely enhancement of its existing
products and development of new products is critical to maintaining its
competitive position. The Company's ongoing product development activities also
include the enhancement of current products, the adaptation of third-party
technologies to its products and the development of new product options and
features. The Company is currently focusing its research and development efforts
on data communications products aimed at the Technical Original Equipment
Manufacturers and ISP markets.

Intellectual Property

         The Company believes its success is dependent, in part, on proprietary
technology. The Company seeks to maintain the proprietary nature of its
technology by several methods. First, substantially all of the Company's
hardware products contain security codes which deter duplication by third
parties. Second, the Company copyrights certain aspects of its products. Third,
the Company generally enters into confidentiality agreements with its employees
and limits access to its proprietary information. Despite these precautions, it
may be possible for unauthorized third parties to copy aspects of the Company's
products or to obtain information that the Company regards as proprietary. Since
the Company does not actively pursue patent protection on its products and does
not hold patents on any of its current products, in the event competitors are
able to create substantially similar or duplicate products, the Company will not
be able to avail itself of the protection afforded by the patent laws.

         The Company believes that due to the rapid pace of innovation within
its industry, factors such as the technological expertise of its 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 its technology.

                                       5
<PAGE>


         The Company also depends upon development, supply, marketing, licensing
and other operative relationships with third parties for complementary
technologies incorporated in the Company's 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 the Company and the
developers make their 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 the Company obtains technology
necessary to produce its products. Although the Company has no reason to believe
that these mutually beneficial relationships will end, these relationships are
generally non-exclusive and terminable, and there can be no assurance that the
Company will be able to maintain these relationships or to initiate additional
similar relationships. The loss of certain cooperative relationships,
particularly with any of the DSP chip suppliers, may have a material adverse
impact on the Company's business.

         On May 2, 1995, the Company obtained a two year license to port AT&T's
VCOS software for use with the Company's products running under the UNIX, OS/2,
Windows NT and Apple OS operating systems. During the term of the license, and
for a period of one year thereafter, AT&T will not compete with the Company by
using ported versions of VCOS. Any ownership of ported versions of VCOS remains
with AT&T. In March, 1996, the Company and AT&T Corp. executed an amendment to
such agreement to extend the term for an additional five years, through March
2001.

         On September 12, 1997, the Company announced it had signed a five year
cooperative development and licensing agreement with TI. Under terms of the
agreement, the Company was to participate in the development of products which
incorporate the Company's proprietary software into DSP products to be sold by
TI. The Company received an initial fee of $750,000 for its non-recurring
expenses, which is accounted for as an offset to research and development
expense for the three months and year ended December 31, 1997. Effective
February 1998, the Company terminated this agreement for convenience, as
stipulated in the agreement.


Backlog

         Firm backlog shippable within a twelve month period was approximately
$2.1 million at December 31, 1998, compared to approximately $7.2 million at
December 31, 1997. The Company's 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.


Competition

         The Company competes in its markets based upon price/performance
advantages offered by a number of its products, certain product features and its
ability to meet customer delivery requirements on a timely basis. Many of the
Company's competitors have substantially greater financial resources, larger
research and development and sales staffs and greater name recognition than the
Company. The primary competition for Ariel products are engineering and
manufacturing departments within OEMs, third party RAS manufacturers and third
party modem board manufacturers.

         There is no assurance that the Company will be able to compete
successfully or develop competitive products in the future. The Company believes
it has substantially strengthened its competitive position in the data
communications marketplace with the introduction of the T1-Modem, T1-Modem+,
RS1000 and , RS2000 products.


Employees

         As of December 31, 1998, the Company had 106 employees, including 15 in
Europe and 6 part-time employees. None of the Company's employees is represented
by a collective bargaining agreement nor has the Company experienced any work
stoppage. The Company believes its relationship with its employees is
satisfactory.

                                       6
<PAGE>


Item 2.  Properties

         The Company maintains 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, at an annual rental of approximately
$387,600. The Company has two five-year options to renew the lease at fair
market value. The Company also maintains branch or subsidiary offices in San
Diego, California, Paris and Montpilier, France and Portsmith, UK as well as
regional sales offices in, Nashville, Tennessee, and Berlin, Germany and a
regional marketing office in Santa Barbara, California.

         In December 1996, the Company leased 11,740 square feet in Piscataway,
New Jersey for office and laboratory use related to its ADSL product development
efforts. This lease was assigned to Cabletron on September 1, 1998 as part of
the sale of the CSG.

Item 3.  Legal Proceedings

         None.

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

         None.

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

         From January 24, 1995 to December 7, 1995, the Company's common stock
and warrants were traded principally on the NASDAQ Small Cap Market ("NASDAQ")
and also on the Boston Stock Exchange ("BSE"). Effective December 15, 1995, the
Company's common stock and warrants began trading on NASDAQ and ceased trading
on the BSE. In June 1996, all outstanding warrants were exercised by the
holders, leaving the Company's common stock as the sole trading security. The
following table sets forth the high and low closing prices for the Company's
common stock shares during the periods indicated:

                                                          High     Low
         1997
         1st Quarter                                      13 3/4   6 3/8
         2nd Quarter                                       8 7/8   5 1/8
         3rd Quarter                                       9 5/16  6 3/8
         4th Quarter                                       8 5/8   5 1/4

         1998
         1st Quarter                                      11 1/2   5 3/8
         2nd Quarter                                      10 1/2   5 13/16
         3rd Quarter                                      9 7/16   2 1/2
         4th Quarter                                      4 5/16   2 1/16

         1999
         January 1 through March 15, 1999                 3 7/16   1 11/16


         On March 15, 1999, the closing price of the Company's common stock was
$1.97.

         There are approximately 101 shareholders of record as of March 15,
1999, excluding the beneficial owners whose securities are held in street name
which the Company approximates at 4,600.

Dividend Policy

         No cash dividends have been declared on the Company's common stock
through March 13, 1999 and the Board of Directors has no current intention to
declare or pay dividends on the common stock in the foreseeable future.

                                       7
<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 shares 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 Selected Financial Data of Ariel Corporation, at and for the years
ended December 31, 1994, 1995, 1996, 1997 and 1998 have been derived from the
Company's audited financial statements, which were audited by
PricewaterhouseCoopers L.L.P., independent accountants. The reports of such
accountants with respect thereto, at December 31, 1998 and 1997 and for the
years ended December 31, 1998, 1997 and 1996 appear elsewhere in this Form 10-K.

         The Selected Financial Data should be read in conjunction with
"Management's Discussion and Analysis of Results of Operations and Financial
Condition," and the Financial Statements of the Company and the Notes to
Financial Statements included elsewhere in this Form 10-K.
<TABLE>
<CAPTION>



                                                1998           1997          1996          1995          1994       
--------------------------------------------------------------------------------------------------------------------
Statements of  Operation Data:                
<S>                                        <C>           <C>            <C>            <C>             <C>          
Sales                                      $ 17,445,829  $ 13,201,916   $ 13,030,637   $  9,515,433    $ 6,865,249  
Operating costs and expenses                 33,663,942    26,288,153     22,576,475     12,935,571      8,356,429  
Operating loss                              (16,218,113)  (13,086,237)    (9,545,838)    (3,420,138)    (1,491,180) 
Net income/(loss)                            12,076,506   (12,761,399)    (8,801,457)    (3,223,401)    (1,456,473)
Earnings/(loss) per share - Basic                  1.25         (1.39)         (1.10)          (.68)          (.47) 
Earnings/(loss) per share - Diluted                1.11         (1.39)         (1.10)          (.68)          (.47) 
--------------------------------------------------------------------------------------------------------------------
Balance Sheet Data:
Cash, cash equivalents and marketable
  securities                                $17,996,575    $2,645,864    $10,625,960    $13,979,009       $313,189  
Working capital                              12,632,033     4,329,018     13,795,614     16,084,594        844,478  
Equipment, net                                1,365,354     2,382,645      2,036,897        567,941        441,141  
Total assets                                 33,682,380    11,121,667     20,103,064     18,932,434      3,010,579  
Long-term debt                                  332,834     2,367,147            ---            ---            ---  
Stockholders' equity                         19,705,497     5,133,213     16,198,896     16,989,104      1,015,913  
</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-21.

Overview

         The Company was founded in September 1982 to design, manufacture and
market digital signal processing hardware and software products. Prior to 1993,
the Company devoted substantially all of its resources to supporting DSP chip
vendors and DSP users by providing hardware and software development tools to
applications developers. From 1993 to mid-1995, the Company directed its sales,
marketing and product development efforts towards the DSP OEM market. In
mid-1995, the Company began development of the CTI-Modem product targeting the
CTI market and commenced shipments in 1996. During the third quarter of 1996,
the Company began shipments of its T1-Modem product and during the third quarter
of 1997, began shipments of the Company's T1-Modem+ product which targets the
RAS markets. In 1997, the Company introduced its RAS open systems network
solution product family. The Company, which had been generally profitable since
inception, began to incur losses in 1993 and incurred net losses of $12,761,399,
$8,801,457, and $3,223,401 for calendar years 1997, 1996 and 1995, respectively.
In 1998, the Company showed net income of $12,076,506 which included a one time
gain of $29,537,896 on the sale of assets related to the CSG product.

                                       8
<PAGE>


Results of Operations

         The following table sets forth certain Statements of Operations data as
a percentage of sales for the periods indicated.
                                          For the Years Ended December 31,  
                                          --------------------------------  
                                           1998         1997         1996   
                                           ----         ----         ----   
Sales                                     100.0%       100.0%       100.0%  
Cost of goods sold                         68.6         54.4         49.7   
Gross profit                               31.4         45.6         50.3  
Sales and marketing expenses               30.2         33.3         30.3   
General and administrative expenses        55.7         46.5         49.0   
Research and development expenses          38.5         62.0         44.2  
Restructuring charge                          -          2.9            -   
Loss from operations                      (93.0)       (99.1)       (73.3)  
Other, net                                164.3          2.5          5.7 
                                          -----        -----        -----
    Income/(loss) before income
          tax benefit                      71.3        (96.7)       (67.5)  
Provision for income taxes                  2.1            -            -
                                          -----        -----        -----
    Net Income/(loss)                      69.2%       (96.7)%      (67.5)% 
                                          =====        =====        =====

Year Ended December 31, 1998 Compared to 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 the
Company's remote access RS1000, T1 modem and T1 Modem+ products primarily to pc
OEM's. Such increases were offset by decreased shipments of various DSP OEM
products. During the past twelve months, the Company has focused its sales and
marketing efforts on the rapidly growing remote access market targeting
enterprises and PC manufacturers. Going forward, the Company will continue to
target remote access customers. However, selling and marketing efforts will
shift from pc OEM customers and enterprise markets to focus primarily on end
users such as Internet Service Providers. Technical OEM customers who require
customized applications of the Company's products will continue to be a part of
the Company's customer base. Since a significant portion of 1998 sales were
derived from pc OEM customers, the Company expects revenues in first half of
1999 to fall below the same period in 1998 as marketing and sales efforts shift
to those markets. Sales internationally were $1,724,942 for 1998 compared to
$1,166,916 for 1997. This growth is a result of an increase in export sales of
DSP OEM products to existing customers. Sales for remote access products has not
increased as rapidly in the international markets due to focusing selling and
marketing efforts largely on 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 is due, in part, to the continued shift in
product mix from higher margin DSP OEM products to lower margin data
communications products. Sales to OEMs 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+ and
RS1000 products. The write-down was the result of a substantial reduction in
demand from several major customers including Compaq Computer Corp. The Company
negotiated additional sales with Compaq in the fourth quarter and has 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 pc OEM's to Internet Service Providers, management does not
expect additional demand for these products from Compaq and other T1-Modem+
customers going forward. Consequently, current inventory levels are projected to
be in excess of expected consumption in 1999. 1998 gross profit margins were
42.9% before this write-down.

                                       9
<PAGE>


         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 the Company shifted its sales force to a more senior data communications
group in 1998. Consulting expenses increased $207,000 due primarily to fees for
international sales reps as the Company expanded its European presence.
Depreciation expenses increased $165,000 reflecting an increase in customer
demonstration and "loaner" programs. These increases were offset by decreases in
marketing, advertising and trade show costs of approximately $135,000, and
commissions of $147,000 that are consistent with the shift from DSP OEM
customers to larger pc OEM's in 1998.

         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 was non-recurring
expense related to severance and separation agreements of approximately $842,000
with respect to an officer of the Company and a consultant. Recruitment expense
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 for
efforts in selling the CSG. Provisions for doubtful accounts increased by
approximately $820,000 due primarily to 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
due mostly to the return of custom products from one customer. That customer was
shipped an upgraded product and the Company does not anticipate any additional
returns from that shipment. General and administrative expenses in 1998 also
include approximately $100,000 from the Company's European subsidiary
representing expenses from the acquisition date through December 31, 1998. In
addition to these expenses, $92,000 of expense was incurred in 1998 for the
amortization of goodwill and other intangible assets recognized in the
acquisition. (See Financial Statement Note 3 for details.)

         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
$1,459,679. Approximately $1,783,000 of the decrease is due to the sale of the
CSG on September 1, 1998. Other decreases include a reduction to wages of
approximately $376,000 and contract labor and materials of $348,000 related to
certain discontinued development projects that were not part of the CSG. 1998
expenses also included approximately $75,000 for research and development costs
for the period from November 23, 1998 through December 31, 1998 related to the
Company's French subsidiary and a charge of $297,330 for in-process research and
development expense recognized at the acquisition. Included in 1997 expense, as
an offset, is a payment of $750,000 received from TI for non-recurring
engineering expenses in conjunction with a Cooperative and Licensing Agreement
signed on September 12, 1997. The Company subsequently terminated this agreement
on February 19, 1998.

         Other income included a gain on the sale of assets related to the CSG
of $29,537,896. 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 for $33,500,000.
Expenses of the transaction netted against the proceeds were approximately
$3,962,104. (See Note 9 to the Financial Statements.)

         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 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. Other
interest expense consisted primarily of interest on the term and revolving
credit notes outstanding under a credit facility with Transamerica. (See Note 8
to the Financial Statements.

         Interest income of $432,596 consisted of income from the investment of
the Company's cash.

         A tax provision of $368,632 reflects the Company's estimated federal
and state income tax liability for its 1998 income. This liability was partially
offset by the use of net operating losses (NOL's) the Company incurred in
previous years. Alternative Minimum Tax rules limits the use of such NOL's to
entirely offset 1998 income taxes.

         For the foregoing reasons the Company reported net income of
$12,076,506 for the year ending December 31, 1998 as compared to a net loss of
$12,761,399 for the year ending December 31, 1997.
<PAGE>

Year Ended December 31, 1997 Compared to December 31, 1996

         Worldwide sales were $13,201,916 for 1997, an increase of $171,279 or
1.3% from $13,030,637 for 1996. Domestic sales for 1997 were $12,035,000
compared to $11,476,056 for 1996, an increase of $558,944 or 4.9%. This increase
in domestic sales for 1997 reflects increased shipments of the Company's T1
modem and CTI modem products offset by decreased shipments of various DSP OEM
products. During the past twelve months, the Company has focused its sales and
marketing efforts on the rapidly growing remote access market in conjunction
with its data communications products. Export sales were $1,166,916 for 1997
compared to $1,554,581 for 1996. The decrease is a result of lower export sales
to certain DSP OEM customers in the audio and medical industries.

         Gross profit decreased to $6,021,675 for 1997 compared to $6,548,490
for 1996. Gross profit margin decreased from 50.3% for 1996 to 45.6% for 1997.
The decrease in margin reflects the shift in product mix from higher margin DSP
OEM products to lower margin data communications products. Initially, the cost
to the Company to produce data communications products through its outside
contract manufacturer is higher due to small volumes. The Company expects to
lower its materials costs related to such products through volume discounts and
competitive bidding. Sales to OEMs typically yield lower gross margins, but such
lower margins are somewhat offset by lower advertising and marketing expenses
due to the direct sales channel.

         Sales and marketing expenses were $4,400,786 or 33.3% of sales for 1997
compared to $3,952,723 or 30.3% of sales for 1996. The increase of $448,063
reflects increased trade show expenses of approximately $263,000 relating to
first time attendance at certain trade shows where the Company's T1-Modem+ and

                                       10
<PAGE>

Horizon products were introduced. Additionally, marketing expenses increased by
approximately $105,000 reflecting initial promotional expenses incurred for the
Company's RS1000 product line. Salaries and related benefits increased by
approximately $86,000 reflecting the addition of a Vice President of Sales in
July 1997 and a change in the mix of the direct sales force to a more
experienced data communications background. Recruitment expenses increased by
$95,000 as a result of the change in the direct sales force. Advertising
expenses decreased by approximately $135,000 reflecting a decrease in DSP OEM
advertising over the second half of 1997.

         General and administrative expenses were $6,145,088 or 46.5% of sales
for 1997 compared to $6,383,192 or 49.0%, a decrease of $238,104. Included in
general and administrative expenses for 1996 was non-recurring severance expense
of approximately $284,000 with respect to certain management personnel and
relocation costs of approximately $142,000 related to an officer of the Company.
Recruitment expense decreased by approximately $80,000 in 1997 reflecting a
decrease in fees paid to recruiters and for recruitment print advertising.

         Research and development expenditures were $8,182,584 or 62.0% of sales
for 1997 compared to $5,758,413 or 44.2% of sales for 1996, an increase of
$2,424,171. Included in expense as an offset is a payment of $750,000 received
from TI for non-recurring engineering expenses in conjunction with a Cooperative
and Licensing Agreement signed on September 12, 1997. The Company subsequently
terminated this agreement on February 19, 1998. Salaries and related expenses
increased by approximately $1,394,000 reflecting an increase in engineers to
meet the increased demands for internal product development in the data
communications and Horizon product groups. Additionally, outside contract labor
increased by approximately $329,000 related to projects for Horizon and data
communications products offset by a decrease in DSP OEM projects of
approximately $61,000. Depreciation expense increased by approximately $220,000
reflecting depreciation of leasehold improvements for the Piscataway office
space and a higher rate of depreciation rate related to the increase in capital
equipment for engineers. The Company anticipates that the level of research and
development spending will decrease during 1998 due to a combination of the
discontinuance of certain project and either the sale or spin-off of the Horizon
product group by June 30, 1998.

         1997 operating expenses include a provision for restructuring of
$379,454. These expenses relate to severance and related benefits expenses for
the Company's vice-chairman and other terminated employees. The expenses were
paid in 1998.

         For the foregoing reasons the Company reported a net loss of
$12,761,399 for the year ending December 31, 1997 as compared to a net loss of
$8,801,457 for the year ending December 31, 1996.

Liquidity and Capital Resources

         As of December 31, 1998 working capital amounted to $12,632,033,
including $17,996,575 of cash and cash equivalents. The Company expects to incur
operating costs and expenses in excess of expected revenues as the Company
executes its business strategy in the Remote Access market.

         The Company maintains a credit facility with Transamerica Business
Credit Corporation's Technology Finance Division, of Farmington, Connecticut.
This facility provides for a five-year, term loan and a three-year, $4.0 million
revolving credit facility ("Revolver"). The term loan provided for an initial
advance of $3.0 million. The Revolver provides for up to $4.0 million in
advances based on a formula of cash, eligible accounts receivable and inventory.
As of December 31, 1998 the Company had drawn $2.5 million against the Revolver.
Additionally, the Revolver can be extended for two additional one-year periods.
As of December 31, 1998, there was $2,684,009 outstanding under the term loan.
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, 1998, the interest rate in effect was 11.66%. The
interest rate in effect under the Revolver is based on the prime rate plus
2.50%.

         In addition, the credit agreement includes a material adverse effect
clause, whereby Transamerica can accelerate the due date of the loans 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.

         The Company was not in compliance with certain financial covenants at
December 31, 1998, and is in discussions with Transamerica to obtain an
unconditional waiver with respect to those covenants for the fiscal year ending
December 31, 1998. Such covenants, as amended, are as follows: minimum gross
profit margin of 35% for the fiscal year ended December 31, 1998; and accounts
receivable collection period of 55 days. The Company anticipates being in

                                       11
<PAGE>

compliance with such financial covenants in the future, based on increased
levels of new product sales. Transamerica has reviewed the Company's forecasted
balance sheets and statements of operations for 1999, and does not deem the
information contained in such documents as a material adverse event. However, as
these forecasts do not comply with certain covenants for 1999, the Company is
also in discussions to amend those covenants as appropriate. Management
acknowledges that such statements involve risks and uncertanties but believes
they are reasonable and the likelihood of the occurrence of a material adverse
event is remote.


         During the year 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 CSG. On
July 27, 1998 the Company received a deposit of $5,000,000 on the sale and on
September 1, 1998 the Company received the remaining gross proceeds of
$28,500,000 under the above referenced sale. 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, an increase of
$8,303,015.


         Net cash used in operating activities for 1998 amounted to $16,176,526.
The negative cash flow from operations was primarily the result of the Company's
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 CSG and a decrease due 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 related to 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 the Company received gross
proceeds of $3,000,000 under the above referenced 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,
a decrease of $9,466,595.

         Net cash used in operating activities for 1997 amounted to $10,581,713.
The negative cash flow from operations was primarily the result of the Company's
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 related to engineering staff and final test and assembly in
manufacturing and also office furniture related to the Company's relocation of
its Horizon 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.

         During 1996, there was a net decrease in cash and cash equivalents of
$9,352,426, of which a net amount of $5,924,544 was used to purchase marketable
securities, resulting in a year-end cash balance of $4,626,583.

                                       12
<PAGE>



         Net cash used in operating activities for 1996 was $9,153,539. The
negative cash flow from operations was the result of the Company's net loss of
$8,801,457 for the year ended December 31, 1996. Additionally, accounts
receivable increased by $1,729,020 reflecting increased sales volume during the
fourth quarter of 1996, and specifically in the month of December 1996.
Inventories increased by $1,312,492 as a result of the Company's decision to
order key raw material components in ample quantity to meet anticipated demand
of its CTI T1-Modem product which began shipping during the third quarter of
1996.

         Net cash used in investing activities for 1996 amounted to $8,005,951
reflecting a net amount of $5,924,544 used to purchase high quality government
agency securities with maturities greater than three months, and $2,081,407
reflecting purchases of computer and peripheral equipment to support the
increase in engineering and professional staff and purchase of the equipment and
leasehold improvements related to the Company's relocation to a larger facility
in January 1996.

         Effective January 24, 1996, the Company's outstanding publicly traded
warrants became eligible for exercise and under certain circumstances, could be
called for redemption by the Company at a price per warrant of $0.01. On May 26,
1996, the Company notified all registered holders of warrants that it had
elected to redeem on or after June 28, 1996 all warrants outstanding on the
redemption date. Each holder of a warrant called for redemption could, within 30
days, elect to preempt the redemption by exercising the warrant and purchasing
one share of common stock of the Company at an exercise price of $3.50. The
Company received net proceeds of approximately $6,555,000 with respect to the
exercise of such warrants.

         Cash flows from financing activities for 1996 amounted to $7,807,064.
As previously discussed, the Company received $6,554,501 from the exercise of
the outstanding publicly traded warrants. Additionally, the Company received
$768,000 resulting from the exercise of 150,000 unit purchase options issued to
the Company's underwriters in conjunction with its initial public offering. Such
options entitled the holders to purchase for an aggregate consideration of
$768,000, 150,000 Underwriter Units. Upon exercise, each Underwriter Unit
entitled the holder to one share of common stock and one warrant. The Company
also received $516,087 from the exercise of outstanding stock options. 

         Statements contained in this Form 10-K that are not historical facts
are forward looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Forward
looking statements involve risks and uncertainties, including the timely
development and acceptance of new products, the impact of competitive products
and pricing, changing market conditions and the other risks detailed in the
Company's prospectus and from time to time in other filings. Actual results may
differ materially from those projected. These forward looking statements
represent the Company's judgment as of the date of this document. The Company
disclaims, however, any intent or obligation to update these forward looking
statements.
<PAGE>


Readiness of Year 2000

Until recently, many computer programs were written using two digits as a space
saving measure rather than four digits to define the applicable year in the
twentieth century. Such software may recognize a date using "00" as the year
1900 rather than the year 2000. The Company is in the process of defining,
assessing and converting, or replacing various internal computer programs and
systems to ensure that these Information Technologies will be Year 2000 (Y2k)
compliant. Implementation is expected to be completed before September 30, 1999
at which time the Company expects to have completed its plans to test Y2k
compliance of critical systems. While the estimated Y2k costs of these efforts
are not expected to be material to the Company's financial position or any
year's results of operations, there can be no assurance to this effect.

Non-Information Technology systems, which include embedded technology such as
micro-controllers used in fax machines, photocopiers, telephone switches,
security systems, and other common devices may also be affected by the Y2k
Problem. The Company is currently assessing the potential effect, if any, and
the cost of remediating the Y2k Problem with respect to its office and
facilities equipment.

While the Company continues to test its products, it believes these products,
which do not utilize date codes, are Y2k compliant. However, the fact that these
products interact with other third party vendor products and operate on computer
systems which are not under the Company's control, it is not possible to be
completely certain that all of the Y2k problems have been foreseen.

In addition, the Company has initiated communications with third party suppliers
to determine that the supplier's operations and the products and services they
provide are Y2k compliant. Where practicable the Company will attempt to
mitigate its risks with respect to the failure of suppliers to be Y2k ready. A
survey of the Company's major suppliers has revealed that 82% have Y2K
compliance programs in place and are, or will be, Y2k compliant in a timely
manner. In the event that these third parties are not Y2k compliant, the Company
will seek alternative sources of supplies. However, such failures remain a
possibility and could have an adverse impact on the Company's results of
operations or financial condition.

Recovery under existing insurance policies should be available depending upon
the circumstances of a Y2k related event and the type of facility involved.
Generally, no recovery would be available in the event of an orderly shutdown
which does not result in damage to a facility. Potential recoveries in the event
of facility damage, including business interruption, would be subject to
deductibles in place under these policies.

The above expectations are subject to uncertainties. For example, if we are
unsuccessful in identifying or fixing all Y2k problems in our critical
operations, or if we are affected by the inability of suppliers or major
customers to continue operations due to such a problem, our results of
operations could be materially impacted.

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 periods ending December 31, 1997 and 1996.


                                       13
<PAGE>

The following table sets forth a reconciliation and the components of
comprehensive income for the twelve months ending December 31, 1998:

                                                          12 Months Ending
                                                          December 31, 1998    
                                              Net Income    $12,076,506    
           Other comprehensive income/(loss) net of tax:
  Unrealized gain/(loss) on foreign currency translation         20,640    
                                                            -----------
                                    Comprehensive income    $12,097,146    
                                                            ===========

         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, $4,093,756 and
$2,004,812 for the years ending December 31, 1998, 1997 and 1996, respectively.
As of December 31, 1998 the Company has no segments that qualify for reporting
under SFAS No. 131.

         In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.
133"). 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. If certain conditions are met, a derivative
may be designated specifically as: (a) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized asset or firm
commitment (a fair value hedge); (b) a hedge of the exposure to variable cash
flows of a forecasted transaction (a cash flow hedge); or (c) a hedge of the
foreign currency exposure of net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. The Company currently does
not hedge foreign-currency-denominated-transactions. This statement is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
effect of adopting SFAS No. 133 is not expected to be material.

         In March 1998, the American Institute of Ceritified 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 will adopt the provisions as of January 1, 1999.



Item 8.  Financial Statements and Supplementary Data.

         See Financial Statements beginning on page F-1.

Item 9.  Changes in and Disagreements 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 sets forth certain information regarding the Company's
executive officers and directors. Except as otherwise set forth herein,
executive officers serve at the discretion of the Board of Directors.

        Name          Age                      Position    

Jay H. Atlas          54        Chief Executive Officer, President, and Director
Anthony M. Agnello    49        Chairman of the Board of Directors 
Brian A. Hoerl        43        Vice President of Sales    
John R. Loprete       38        Vice President of Finance    
Dennis Schneider      50        Senior Vice President of Marketing 
Edward D. Horowitz    51        Director    
Harold W. Paul        50        Director, Secretary    
Etienne A. Perold     43        Director    
Robert J. Ranalli     61        Director    
Theodore J. Coburn    44        Director    

                                       14
<PAGE>

         Jay H. Atlas joined the Company as its Chief Executive Officer and
President in December 1998. He was appointed a director of the Company 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. He has more than 30 years
experience in the industry including 20 years at Digital Equipment Corp.
including senior management positions in sales, service and marketing.

         Anthony M. Agnello co-founded the Company in 1982 and has served as
Chairman of the Board and Chief Executive Officer. He has been a member of the
compensation committee since June 1995. He also held the title of President from
1988 until September 17, 1996. In December 1998, Mr. Agnello resigned as Chief
Executive Officer simultaneously with the appointment of Mr. Atlas to that
position.

         Dennis Schneider joined the Company as Vice President of Marketing in
December 1998. For more than the past five years, he has been 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.

         Brian A. Hoerl joined the Company in November 1993 as Vice President of
Sales. He was appointed President and Chief Operating Officer effective
September 17, 1996. On December 21, 1998, Mr. Hoerl resumed the position of Vice
President of Sales with the appointment of Jay Atlas as President and CEO. 

         John R. Loprete joined the Company in April 1998, and was appointed
Vice President of Finance in January 1999. He is a CPA with over 15 years
experience in finance and accounting. His experience includes eleven years with
Concurrent Computer Corporation, a Florida based computer manufacturer.

         Edward D. Horowitz has been a Director of the Company 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. Effective January
1997, Mr. Horowitz became Executive Vice President of Advanced Development of
CitiCorp.

         Harold W. Paul has been a Director of the Company since June 1995 and
was appointed Secretary in March 1998. For more than five years, Mr. Paul has
been a partner at Berger & Paul, L.L.P., a New York law firm specializing in
securities matters.

         Etienne A. Perold has been a Director of the Company since August 1995.
For more than five years Mr. Perold has been a management consultant
specializing in the area of organizational communication and leadership
development.

         Robert J. Ranalli has been a Director of the Company and a member of
the Audit Committee since August 1995. He has been a member of the Compensation
Committee since March 1998. Mr. Ranalli served as President of AT&T Consumer
Services from 1984 until his retirement in 1994, and three year terms each as
Chairman of the Board for AT&T Universal Card Services and AT&T Transtech
Services.

         Theodore J. Coburn was appointed a Director of the Company and a member
of the Compensation and Audit Committees of the Board of Directors in March
1998. Mr. Coburn is a co-founder and principal in Brown, Coburn & Co., an
investment banking service company founded in 1994. Mr. Coburn was a managing
director of Merrill Lynch's Capital Markets Group from 1982 to 1986 and head of
the Global Equity Transactions Group for Prudential Securities from 1986 to
1990. Mr. Coburn is a member of the Board of Directors of Nicholas - Applegate
Fund, Inc.; the Emerging German Fund; Moovies Inc. and Measurement Specialties,
Inc.

                                       15
<PAGE>



         The Company's Board of Directors is composed of seven directors. The
Board of Directors are 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: Messrs. Perold and Atlas have terms
expiring in 1999; Messrs. Ranalli and Horowitz have terms expiring in 2000; and
Messrs. Agnello, Paul and Coburn have terms expiring in 2001. The incumbent
Board serves as a nominating committee for new directors.

         Mr. Atlas is a full-time employee who does not receive additional
renumeration for serving as a director. In 1995, the Company compensated outside
(i.e. non-employee) directors by issuing options to purchase 30,000 shares of
common stock to Mr. Paul, options to purchase 10,000 shares of common stock to
Mr. Perold, and options to purchase 50,000 shares of common stock to each of
Messrs. Horowitz and Ranalli. In 1996, the Company granted 36,000 options from
the 1996 Directors Plan to Mr. Perold - 12,000 per year, for his continued
services as a director through the 1999 Annual Stockholders Meeting. In 1997,
the Company granted Messrs. Ranalli and Horowitz 25,000 options each for each
year he serves on the Board. In 1998, the Company granted Mr. Paul 15,000
options for each year he serves on the Board. On March 2, 1998, the Company
granted Mr. Coburn options for joining the Board. The Company also reimburses
its outside directors for their expenses incurred in attending meetings of the
Board of Directors. Effective June 1998, the Board of Directors adopted a policy
to standardize compensation to outside directors at 10,000 common stock purchase
options for each year of service together with an annual cash payment of $6,000.

Key Employees

         The following employee is recognized by Ariel to play an important part
in the Company's operations.

         John Lynch, 42, has been employed since June 1995 and serves as Chief
Technology Officer. Prior thereto, he was Research and Development Director of
the AT&T ME Modem and Multimedia Department. From 1989 to 1993, he was Program
Manager of VCOS Multimedia Products for AT&T Microelectronics.

         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, 1998, its officers and
directors complied with all these filing requirements except for one option
exercise transaction by Etienne Perold and the initial report of ownership by
Theordore Coburn both of which were inadvertently omitted and later reported in
an amended filing. In making this statement, 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, three executive officers and
two other individuals who were not serving as executive officers at year end,
whose earned compensation exceeded $100,000 for the year ended December 31,
1998.

                                       16
<PAGE>

                          SUMMARY COMPENSATION SCHEDULE
<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>   
1. Jay H. Atlas             1998      $5,288(1)       ---            ---             486,000            ---
                            1997                  
                            1996                                  
2. Anthony Agnello          1998    $193,077     $950,000(2)     $17,792             175,000        $605,000(3)
                            1997    $193,462          ---        $18,780                 ---          $5,338    
                            1996     202,408       65,000         19,669                 ---           4,476    
3. Brian Hoerl              1998    $189,269     $255,417(4)     $19,609               20,000          5,000    
                            1997     181,231       47,104         20,393                  ---          3,228    
                            1996     159,470       36,888         13,214               50,000            ---    
4. Jeffrey Sasmor           1998         ---          ---            ---                  ---        227,750(5)
                            1997     140,539          ---         14,507               40,000         84,019 
                            1996     154,166       30,000        137,747                  ---          3,578    
                            1995     140,000          ---         15,775                  ---          2,800    
5. Gerard E. Dorsey         1998      61,268          ---         14,092                  ---        125,139(6) 
                            1997     146,538          ---         24,461                  ---          4,396    
                            1996     150,000          ---         20,020                  ---          4,500
                            1995         ---          ---            ---                  ---            ---    
6. John Lynch               1998     155,769       28,077         15,096               25,000         84,363(7)
                            1997     150,000          ---         31,569(6)               ---          8,536
                            1996     148,847          ---         12,092                  ---          4,465
                            1995         ---          ---            ---                  ---            ---    
----------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Reflects employment commencement date of December 21, 1998

(2) Reflects CSG sale bonus of $950,000

(3) Includes accrued severance of $600,000 paid in 1999 and 401K match - $5,000

(4) Includes CSG sale bonus of $200,000 and executive quarterly bonus

(5) Includes severance pay of $205,000 and option exercise of $22,750

(6) Includes 401K match of $1,809 and option exercise of $123,330

(7) Includes option exercise of $77,140, accrued vacation payout 1998 of $2,458
    and 401K match of $4,765

Employment Agreements

         Jay H. Atlas 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 $2.38 per share, vesting over a four year
period from December 21, 1999 through December 21, 2002. Dennis Schneider is
employed under a written 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 80% of his annual base salary based upon the attainment of certain
goals set by the Company's management. Upon execution of the employment
agreement, Mr. Schneider was granted an aggregate of 95,000 common stock
purchase options exercisable at $2.38 per share vesting over a five year period
commencing December 21, 1999 through December 21, 2002. Brian Hoerl is employed
under a three year employment agreement effective September 3, 1996 pursuant to
which he is paid a base salary of $190,000 and an annual bonus of $47,000. John
Lynch is employed under a five year agreement commencing November 5, 1996
pursuant to which he is paid a base salary of $150,000. Both Mr. Hoerl and Mr.
Lynch have previously been granted common stock purchase options from time to
time pursuant to their employment agreements. Each of these employees have
executed non-competition and non-solicitation agreements with the Company
pursuant to which for a specified period following the termination of their
employment, they have agreed not to solicit the Company's customers or employees
or to become associated with the Company's competitors. Mr. Agnello resigned as
Chief Executive Officer of the Company effective upon Mr. Atlas' employment in
December 1998. Mr. Agnello entered into an agreement with the Company 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. Additionally, Mr. Agnello entered into a two year consulting agreement
with the Company pursuant to which is paid $50,000 per year. His non-competition
and non-solicitation agreements have been extended through December 2001.

                                       17
<PAGE>

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 annual meeting of stockholders held on June 24, 1998, increasing the
number of shares issuable under the Plan from 1,200,000 to 1,700,000.

         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.

         The Plan is administered by the Board of Directors, which may empower a
committee of Directors to administer the Plan. 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 defined 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.

                                       18

<PAGE>

         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 initially provided 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 any 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.

 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 on May 14, 1996. The Plan provides for the issuance
of up to 250,000 stock options to non-employee directors in the aggregate. The
stockholders ratified at the annual meeting of Stockholders held on June 24,
1998, an amendement 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. 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").

         238,500 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.

Item 12. Security Ownership of Certain Beneficial Owners and Management

         The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of December 31, 1998 by: (i) each
stockholder known by the Company to be the beneficial owner of five percent 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, the Company
believes 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.

                                     Number of Shares
Name and Address                    Beneficially Owned              Percentage 
----------------                    ------------------              ---------- 
Jay H. Atlas                               ---                               *
         2540 Route 130
         Cranbury, NJ 08512
Anthony M. Agnello                     838,500 (1)                        8.1% 
         2540 Route 130
         Cranbury, NJ 08512      
Brian Hoerl                             39,500 (2)                           *
         2540 Route 130
         Cranbury, NJ 08512      
Dennis Schneider                           ---                               *
         2540 Route 130
         Cranbury, NJ 08512  
Jack Loprete                               ---                               *
         2540 Route 130 
         Cranbury, NJ 08512
Robert J. Ranalli                       50,000 (3)                           * 
         2540 Route 130 
         Cranbury, NJ 08512  

                                       19
<PAGE>

Edward D. Horowitz                      50,000 (3)                           *
         2540 Route 130
         Cranbury, NJ  08512            
Etienne A. Perold                      180,000 (4)                        1.7%
         2540 Route 130
         Cranbury, NJ  08512           
Harold Paul                             31,000 (5)                           *
         630 Third Ave.
         New York, NY  10017            
Theodore J. Coburn                      60,000 (6)                           * 
         2540 Route 130
         Cranbury, NJ  08512          
All Officers and Directors as a group 
  (ten people)                       1,249,000                           12.1%

* Less than one percent.

(1) Includes 137,500 shares subject to presently exercisable options.

(2) Includes 32,500 shares subject to presently exercisable options.

(3) All shares beneficially owned by Messrs. Ranalli and Horowitz reflect 
    options issued in exchange for their services as directors.

(4) Includes 172,000 shares subject to presently exercisable options and 6,000 
    owned by Mr. Perold's wife and children.

(5) Includes 27,500 shares subject to presently exercisable options.

(6) Includes 60,000 shares subject to presently exercisable options.

Item 13. Certain Relationships and Related Transactions

         In June 1998, the Company entered into an agreement to sell its
Communication Systems Group (CSG) to Cabletron Systems for approximately
$33,500,000 net of amount paid to engineers and other members of the group paid
directly to them by Cabletron. As part of the transaction, the Company paid
bonuses to three outside directors who played an integral role in the
transaction. These bonuses included $1,541,673 to Mr. Perold, $950,000 to Mr.
Agnello, $140,000 to Mr. Coburn and $75,000 to Mr. Ranalli.

         Mr. Perold, a director of the Company, has provided management advisory
services to the Company. Fees incurred for the year ended December 31, 1998,
1997, and 1996 were approximately $450,000, $218,000, and $208,000. Mr. Perold
had an outstanding loan of $100,000 owed to the Company as of December 31, 1998,
which was repaid in full in January, 1999.

         Berger & Paul, LLP, a law firm of which Mr. Paul, a director of the
Company, is a partner, received fees of approximately $125,000, $75,000, and
$70,000, for the year ended December 31, 1998, 1997 and 1996 respectively, for
legal services which it performs on behalf of the Company.

         Brown, Coburn & Co., of which Mr. Coburn is a co-founder and principal,
received fees of $156,200, $88,000 and $23,000 for the years ended December 31,
1998, 1997 and 1996 in connection with investment banking advisory services.

         Mr. Atlas has provided management advisory services to the Company in
1998 prior to joining as President, CEO and his appointment as a director. Fees
incurred for the year ended December 31, 1998 were approximately $25,000.

         Mr. Schneider has provided services to the Company as a marketing
consultant in 1998 prior to joining as Senior Vice-President of Marketing. Fees
incurred for the year ended December 31, 1998 were approximately $50,000.

                                       20
<PAGE>


         The Company believes that the transactions described above were on
terms no less favorable than could have been obtained from unaffiliated third
parties. The Company has undertaken that all future transactions with its
executive officers, directors and 5% stockholders will be on terms no less
favorable than could be obtained from unaffiliated third parties and will be
approved by a majority of the directors of the Company disinterested in the
transaction.

Item 14. Exhibits, Consolidated Financial Statement, Schedules and Reports on 
         Form 8-K

(a)(1)  Financial Statements

<TABLE>
<CAPTION>

                                                                                                                        Page
                                                                                                                        ----
<S>                                                                                                                        <C>
Report of Independent Accountants ...................................................................................    F-1
Consolidated Balance Sheets as of December 31, 1998 and  1997........................................................    F-2
Consolidated  Statements of Operations  for  the  years  ended  December  31,  1998,  1997  and  1996................    F-3
Consolidated Statements of Changes in Stockholder's  Equity for the years ended December 31, 1998, 1997 and  1996....    F-4
Consolidated  Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996..........................    F-5
Notes to Financial  Statements.......................................................................................    F-6 - F-19
</TABLE>

(a)(2) Financial Statement Schedules - Schedules are omitted as not required or
applicable or because the required information is provided in the financial
statements including the notes thereto.

(a)(3)  Exhibits

         Exhibit 23 - Consent of PricewaterhouseCoopers L.L.P.

         Exhibit 27 - Financial Data Schedule (filed electronically)

(b)  Reports on Form 8-K

         The Company has filed reports on Form 8-K as follows:

              -  Form 8-K filed October 23, 1998

              -  Form 8-K filed December 8, 1998

                                       21

<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 operations, cash flows and stockholders' equity
present fairly, in all material respects, the financial position of ARIEL
CORPORATION and subsidiaries (the Company), as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. 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 generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe our audits
provide a reasonable basis for the opinion expressed above.



                                                      PricewaterhouseCoopers LLP



March 22, 1999

                                      F-1



<PAGE>


                                ARIEL CORPORATION
                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

                                    ASSETS                                                   December 31,  
                                                                                  ---------------------------------
                                                                                      1998                  1997
<S>                                                                               <C>                    <C> 
Current assets:
     Cash and cash equivalents                                                    $17,996,575            $2,645,864
     Accounts receivable, net of allowance for doubtful accounts of
        $1,460,855 in 1998 and $187,446 in 1997, respectively                       3,593,709             1,395,624
     Other receivables                                                              1,378,781                73,311
     Inventories, net                                                               2,857,326             3,536,190
     Prepaid expenses                                                                 449,691               299,336 
                                                                                  -----------          ------------
             Total current assets                                                  26,276,082             7,950,325

Equipment, net of accumulated depreciation and amortization                         1,365,354             2,382,645

Intangible Assets                                                                     997,225                    --
Goodwill                                                                            4,344,374                    --
Other Assets                                                                          699,345               788,697       
                                                                                  -----------          ------------
              Total assets                                                        $33,682,380         $ 11,121,667 
                                                                                  ===========         =============


                      LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities
     Accounts payable                                                              $2,679,548            $1,186,876
     Accrued expenses                                                               5,388,661             1,754,697
     Current portion of long term debt                                              5,480,430               600,000
     Royalties payable                                                                 95,410                79,734
                                                                                  -----------          ------------
         Total current liabilities                                                 13,644,049             3,621,307

Long-term debt                                                                        332,834             2,367,147

Commitments and contingencies  (See Note 11)

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 -  9,760,150 in 1998 and                               9,760                 9,235
               9,234,250 in 1997
     Additional paid-in capital                                                    33,302,342            30,949,180
     Unearned compensation expense related to stock options                                 -              (110,819)
     Unrealized gain/(loss) on foreign currency translation                            31,272                    -
       Accumulated deficit                                                        (13,637,877)          (25,714,383)  
                                                                                  -----------          ------------
         Total stockholders' equity                                                19,705,497              5,133,213   
                                                                                  -----------          ------------
         Total liabilities and stockholders' equity                               $33,682,380          $ 11,121,667
                                                                                  ===========          ============
</TABLE>

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

                                      F-2
<PAGE>


                                ARIEL CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>

                                                                           For the Years Ended December 31,
                                                                           --------------------------------
                                                                         1998            1997               1996
                                                                         ----            ----               ----
<S>                                                                  <C>              <C>               <C>        
Sales                                                                $17,445,829      $13,201,916       $13,030,637

Cost of goods sold                                                    11,965,220        7,180,241         6,482,147        
                                                                     -----------     ------------       -----------
  Gross  profit                                                        5,480,609        6,021,675         6,548,490

Selling and marketing expenses                                         5,265,542        4,400,786         3,952,723

General and administrative expenses                                    9,710,275        6,145,088         6,383,192

Research and development expenses                                      6,722,905        8,182,584         5,758,413

Restructuring charge                                                           -          379,454                 -
                                                                     -----------     ------------       -----------

Total operating expenses                                              21,698,722       19,107,912        16,094,328
                                                                     -----------      -----------      -----------

     Loss from operations                                            (16,218,113)     (13,086,237)       (9,545,838)

Gain on sale of assets                                                29,537,896                -                 -

Interest income                                                          432,596          333,465          702,665

Interest expense                                                      (1,371,970)        (240,450)          (36,552)

Other income                                                              64,729          231,823            78,268 
                                                                     -----------     ------------       -----------

     Income/(loss) before provision for income taxes                  12,445,138      (12,761,339)       (8,801,457)

Provision for income taxes                                               368,632                -                 -          
                                                                     -----------     ------------       -----------

     Net Income / (Loss)                                              12,076,506      (12,761,399)       (8,801,457) 

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

Other comprehensive income, net of tax:

     Foreign currency translation adjustments                             20,640                -                 -
                                                                     -----------     ------------       -----------

Comprehensive income / (loss)                                        $12,097,146     $(12,761,399)      $(8,801,457)
                                                                     ===========    =============      ============

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

Basic and Diluted Per Share Data:

     Weighted average number of common

           shares outstanding - Basic                                  9,652,664        9,161,758         7,979,249      
                                                                     ===========    =============      ============

     Earnings/(loss) per share                                       $      1.25     $      (1.39)      $     (1.10)
                                                                     ===========    =============      ============

     Weighted average number of common

         Shares outstanding - Diluted                                 10,843,215        9,161,758         7,979,249
                                                                     ===========    =============      ============

     Earnings/(loss) per share                                       $      1.11    $       (1.39)     $      (1.10)
                                                                     ===========    =============      ============
</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, 1998, 1997 and 1996

<TABLE>
<CAPTION>
                                                                             Unrealized     Unearned       Retained
                                                Common Stock    Additional   Gain/(Loss)  Compensation      Earnings       Total
                                                ------------     Paid-In     on Currency   related to    (Accumulated  Stockholders'
                                             Shares    Amount    Capital     Translation  Stock Options     Deficit)     Equity
                                             ------    ------    -------     -----------  -------------     --------     ------
<S>                                       <C>          <C>     <C>            <C>          <C>           <C>           <C>
Balance at December 31, 1995               6,798,625   $6,799  $21,133,832      ----         ----        $(4,151,527)  $16,989,104

Issuance of 1,872,630 shares of
      common stock in connection
      with the exercise of
      redeemable common stock
      purchase warrants                    1,872,630    1,873    6,552,628      ----         ----            ----        6,554,501
Issuance of common stock in
      connection with exercise of
      150,000 underwriter purchase
      options                                150,000      150      767,850      ----         ----            ----          768,000
Issuance of common stock in
      connection with exercise of
      128,720 common stock options           128,720     129       515,958      ----         ----            ----          516,087
Costs incurred in connection with
      the issuance of common stock              ----     ----     (31,524)      ----         ----            ----          (31,524)
Unearned compensation related to
      stock options                             ----     ----      383,004      ----    $(383,004)           ----             ----
Amortization of unearned compensation           ----     ----         ----                204,185            ----          204,185
1996 Net Loss                                   ----     ----         ----      ----          ---      (8,801,457)      (8,801,457)
                                           ---------   ------  ----------- ---------     --------    ------------     ------------

Balance at December 31, 1996               8,949,975    8,951   29,321,748      ----     (178,819)    (12,952,984)      16,198,896
Issuance of common stock in
      connection with exercise of
      259,275 common stock options           259,275      259    1,036,407      ----         ----            ----        1,036,666
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 $(180,377)    $   ----    $(13,637,877)    $ 19,705,497
                                           =========   ======  =========== =========     ========    ============     ============
</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,
                                                           ---------------------------------------------
                                                                1998            1997            1996
                                                           ------------      -----------     -----------
<S>                                                               <C>           <C>              <C>
Cash flows from operating activities:
Net income / (loss)                                        $ 12,076,506    $ (12,761,399)    $(8,801,457)
Adjustments to reconcile net loss to net cash used in
          operating activities:
      Depreciation and amortization                           1,265,801        1,143,287         624,552
      Amortization of goodwill and intangibles                   92,105                -               -
      Amortization of discount on royalties payable                   -            2,998          29,623
      Acquired in process research and development              297,330                -               -
      (Gain) / Loss on sale of assets                       (29,537,896)               -               -
      (Gain) / Loss on sale of marketable securities                ---           12,812          (5,900)
      Amortization of discounts on investments                      ---              ---         (68,933)
      Amortization of debt issuance financing costs              64,719           66,870             ---
      Provision for doubtful accounts                           851,415           30,000          45,000
      Provision for inventory obsolescence                    2,293,500          160,000          45,000
      Non-cash compensation expense                             413,094          289,638         204,185
 (Increase) decrease in assets:
        Accounts receivable                                  (2,813,966)       1,773,918      (1,729,020)
        Other receivables                                      (522,361)         116,713        (145,587)
        Inventories                                          (1,700,796)        (167,938)     (1,312,492)
        Other assets                                            (34,176)        (309,288)         42,377
 Increase (decrease) in liabilities:
        Accounts payable and accrued expenses                 1,062,523         (770,981)      2,109,323
        Royalties payable, related parties                       15,676          (14,322)          6,063
        Notes payable, related parties                                -         (154,021)       (196,273) 
                                                           ------------      -----------     -----------
          Net cash (used in) operating activities           (16,176,526)     (10,581,713)     (9,153,539)
                                                           ------------      -----------     -----------

Cash flows from investing activities:
     Proceeds from sale of assets                            31,348,753                -               -
     Proceeds from the sale and maturity of investments               -        5,993,634       7,470,080
     Purchase of investments                                          -                -     (13,394,624)
     Acquisition of businesses (net of cash acquired)        (3,340,122)               -               -
    Purchase of equipment                                      (724,032)      (1,444,057)     (2,081,407)
                                                           ------------      -----------     -----------
Net cash provided by (used in) investing activities          27,284,599        4,549,577      (8,005,951)
                                                           ------------      -----------     -----------

Cash flows from financing activities:
   Proceeds from debt financing                               4,500,000        3,000,000               -
   Proceeds from exercise of redeemable common stock
   purchase warrants                                                  -                -       6,554,501
   Proceeds from exercise of underwriter purchase options             -                -         768,000
   Proceeds from exercise of common stock options
       and warrants, net of expenses                          2,051,412        1,084,270         516,087  
   Principal payments on short-term debt                     (2,000,000)               -               -
   Deferred financing cost                                            -                -         (31,524)
   Principal payments on long-term debt                        (308,774)         (32,853)            ---
                                                           ------------      -----------     -----------
          Net cash provided by financing activities           4,242,638        4,051,417       7,807,064 
                                                           ------------      -----------     -----------

Net increase (decrease) in cash                              15,350,711       (1,980,719)     (9,352,426)
   Cash and cash equivalents, beginning of year               2,645,864        4,626,583      13,979,009 
                                                           ------------      -----------     -----------

   Cash and cash equivalents, end of period                $ 17,996,575      $ 2,645,864     $ 4,626,583 
                                                           ============      ===========     ===========

</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 as its core strength. DSP is an
enabling technology driving the emerging or rapidly growing technology markets
such as Remote Access Service and Internet Service Providers.



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 year end December
31, 1998. 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") 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. Subsequent to the sale of a product, the Company has
agreed to provide insignificant vendor and/or post-customer support at no cost
to the customer. The cost of such additional support is accrued for at the time
of the sale; however, such amount is not material.

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 first-in,
first-out method. The Company computes the lower of cost or market in accordance
with the specific identification method based upon an estimate of future
customer product orders.

         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 

                                      F-6

<PAGE>

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.


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. Approximately $90,000 was
recorded for amortization of Goodwill for the period from the acquisition date
until December 31, 1998.

         The Company periodically analyzes intangible assets for potential
impairment, assessing the appropriateness of lives and recoverability of
unamortized balances on a basis consistent with generally accepted accounting
principles.


Other Assets

         Other assets consist primarily of deferred financing costs associated
with debt financing which are stated at cost. Amortization is provided 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.



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


                                      F-7

<PAGE>
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 $2.37 to $11.63 per share for the
twelve month period. These options, which expire on various dates ranging from
April 1, 2004 through August 21, 2008, were still outstanding as of December 31,
1998.

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

                                                                Twelve Months Ending
                                                                  December 31, 1998
                                                                --------------------
                                   <S>                                   <C>
                  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
                                                                     ==========
</TABLE>


         The exercise of such potentially dilutive common shares has not been
assumed for the years ended December 31, 1997 and 1996 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 $703,625, $913,199, and $943,050 for the years ended December 31, 1998, 1997
and 1996, respectively.


Supplemental Cash Flow Information

         Interest paid for the years ended December 31, 1998, 1997 and 1996 was
$1,362,978, $144,258, and $65,657, respectively. Income taxes paid in 1998 were
$ 342,110. No income taxes were paid in 1997 and 1996.

         Excluded from the statements of cash flows were $62,273, $72,665, and
$27,688 of equipment purchases which were included in accounts payable and
accrued expenses at December 31, 1998, 1997 and 1996, respectively.

         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 


                                      F-8
<PAGE>


after December 15, 1997, and requires reclassification of prior-period financial
statements. There were no items classified as other comprehensive income for the
periods ending December 31, 1997 and 1996.

The following table sets forth a reconciliation and the components of
comprehensive income for the twelve months ending December 31, 1998:

                                                           Twelve Months Ending
                                                             December 31, 1998
                                                           --------------------
                                             Net Income        $12,076,506
           Other comprehensive income/(loss) net of tax:
  Unrealized gain/(loss) on foreign currency translation            20,640
                                                               -----------
                                    Comprehensive income       $12,097,146
                                                               ===========

         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. 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, $4,093,756 and
$2,004,812 for the years ending December 31, 1998, 1997 and 1996, respectively.
As of December 31, 1998, the Company has no segments that qualify for reporting
under SFAS No. 131.

Reclassifications

       Certain costs relating to corporate support costs, which previously were
included in Cost of Sales, Sales and Marketing and Research and Development have
been reclassified into General and Administrative expenses for the years ended
December 31, 1997 and 1996. Such amounts were $1,936,710 in 1997 and $948,495 in
1996. These reclassifications had no impact on previously reported operating
income or losses and net income or losses.


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 identifiable intangible
assets acquired by $4,419,284 which was recorded as goodwill.

     The table below is an analysis of the purchase price allocation:
<TABLE>
         <S>                                                                   <C>    
       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
                                                                             ==========
</TABLE>

                                      F-9
<PAGE>

     Management, based upon an independent appraisal, estimates 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.


4. Inventories:

         Due primarily 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 in 1998. Approximately $2,500,000 of material related to these products
was on hand at December 31, 1998. While demand for these products is expected
going forward, the Company believes that quantities on hand are in excess of
projected consumption.

         Inventories, net of allowance, consists of the following:
<TABLE>
<CAPTION>
                                                                     December 31,
                                                               1998              1997
                                                             ----------       ----------
               <S>                                              <C>                <C>
         Component materials                                 $1,040,115       $2,077,866
         Work-in-progress                                     1,536,870          843,428
         Finished goods                                         280,341          614,896     
                                                             ----------       ----------
                                                             $2,857,326       $3,536,190
                                                             ==========       ==========
</TABLE>


5. Equipment:

         Equipment consists of the following:
<TABLE>
<CAPTION>
                                                                     December 31,
                                                                1998             1997
                                                             ----------       ----------
                  <S>                                             <C>             <C>
         Computer and other equipment                        $2,694,876       $3,299,681
         Computer software                                      770,719          649,931
         Office equipment and furniture and fixtures            803,328          861,341
         Vehicles                                                89,972                -
         Loaner Equipment                                       220,726                -
         Leasehold improvements                                 185,906          257,562            
                                                             ----------       ----------
                                                              4,765,527        5,068,515
         Less, accumulated depreciation and
         amortization                                        (3,400,173)      (2,685,870)
                                                             ----------       ----------
                                                             $1,365,354       $2,382,645 
                                                             ==========       ==========
</TABLE>

6. Intangible Assets and Goodwill

         Intangible assets and goodwill consist of the following:
<TABLE>
<CAPTION>
                                                                    December 31,
                                                                1998             1997
                                                             ----------       ----------
              <S>                                                 <C>             <C>
         Intangible Assets                                   $1,014,420       $    ---
         Goodwill                                             4,419,284            ---             
                                                             ----------       ----------
                                                              5,433,704            ---
         Less accumulated amortization                          (92,105)           ---
                                                             ----------       ----------
                                                             $5,341,599       $    --- 
                                                             ==========       ==========
</TABLE>
                                      F-10

<PAGE>
7.       Accrued Expenses:

         Accrued expenses consists of the following:
<TABLE>
<CAPTION>
                                                                    December 31,
                                                                1998            1997
                                                             ----------      ----------
               <S>                                               <C>              <C>
         Salaries, severance and related benefits            $1,883,005      $  884,370
         Professional fees                                    1,251,424          97,619
         Commissions                                            112,448          80,791
         Interest payable                                       102,321          96,192
         Equipment purchases                                    926,366          37,098
         Contingent liabilities                                 612,128               -
         Due to Factor                                          117,500               -
         Other                                                  383,469         558,627 
                                                             ----------      ----------
                                                             $5,388,661      $1,754,697 
                                                             ==========      ==========
</TABLE>

         Included in salaries and related benefits in 1998 is $600,000 related
to an employee termination agreement which will be paid in March of 1999.
Included in salaries and related benefits in 1997 is $205,000 related to an
employee termination agreement which were paid in two equal installments of
$102,500 on January 2, and July 1, 1998. All other amounts in connection with
the 1997 restructuring activity were paid in 1997.

8. Credit Facility

         On June 12, 1997, the Company completed a $10 million credit facility
with the Technology Finance Division of Transamerica Business Credit Corporation
with the following terms and provisions:

         $6 million, 5 year term loan:

         o  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, 1998.

         o  Interest rate is based on the weekly average yield on five-year U.S.
            Treasury Securities plus 5.75 percent, fixed for five years as of
            the date of advance.

         o  Approximately $2.7 million is outstanding at December 31, 1998.
            Interest rate in effect at December 31, 1998 was 11.66%.

         $4 million, three-year revolving credit facility, which can be extended
for two additional one-year periods:

         o  Interest rate is based on the prime rate plus 2.50 percent as of the
            date the revolver is utilized.

         o  Available line of credit based on a formula of eligible accounts
            receivable and inventory.

         o  At December 31, 1998, the Company could have borrowed approximately
            $1.5 million under the current $4 million facility.

         Under terms of the credit agreement, the Company must maintain agreed
upon levels of financial performance as measured against specific financial
covenants. The covenants are as follows:

         o  Cash on hand - The Company must at all times maintain cash or cash
            equivalents on hand of not less than $3,000,000 during the fiscal
            year ended December 31, 1998, $4,000,000 during the fiscal year
            ending December 31, 1998, and $4,500,000 during the fiscal year
            ending December 31, 1999.

         o  Accounts Receivable Collection Period - The Company must maintain an
            accounts receivable collection period of not greater than 60 days
            for any fiscal quarter during the fiscal year ended December 31,
            1998 and 55 days for any fiscal quarter thereafter.

         o  The Tangible Net Worth on the last day of each fiscal year specified
            shall not be less than $10 million at December 31, 1997; $15 million
            at December 31, 1998; $20 million at December 31, 1999 and $30
            million at December 31, 2000 and each fiscal year thereafter.

         o  Gross Profit Margin / Operating Profit (Loss) Percentage / Net
            Income (Loss) Before Taxes Percentage - The Gross Profit Margin,
            Operating Profit (Loss) Percentage and the Net Income (Loss) Before
            Taxes Percentage must meet specified thresholds for the fiscal year
            ended December 31, 1998 and each fiscal year thereafter as specified
            in the credit agreement.

         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.

                                      F-11
<PAGE>

         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. Amortization expense for the years ended December 31, 1998 and 1997
was $64,719 and $66,870, respectively. The credit facility is collaterized by
the Company's cash, accounts receivables, inventory, and equipment.

         In the event of default, Transamerica has the right to declare the
total obligation immediately due and payable. The Company is not in compliance
with certain financial covenants at December 31, 1998, and is in discussions
with Transamerica to obtain an unconditional waiver with respect to those
covenants for the fiscal year ending December 31, 1998. Such covenants are as
follows: minimum gross profit margin of 35% for the fiscal year ended December
31, 1998; and accounts receivable collection period of 55 days. Accordingly the
Company has classified all debt relating to this facility as current at December
31, 1998.

         The Company believes that the fair value of this financial instrument
approximates the carrying value.

         Total debt as of December 31, 1998 consisted of the following:
<TABLE>
<CAPTION>
                                                 Short Term Debt          Long Term Debt         Total Debt
                                                 ---------------          --------------        -----------
             <S>                                         <C>                      <C>                 <C>
       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
       ANVAR                                              46,600                     ---             46,600
       Bank Nationale de Paris                             4,117                 113,487            117,604
       Other Obligations                                  34,759                  40,806             75,565
                                                     -----------             -----------        -----------
                                                     $ 5,480,430             $   332,834        $ 5,813,264
                                                     ===========             ===========        ===========
</TABLE>


Total debt as of December 31, 1997 consisted of the following:

                                Short Term Debt   Long Term Debt     Total Debt

     Transamerica Term Note       $ 600,000         $ 2,367,147      $ 2,967,147
                                  =========         ===========      ===========

         As of December 31, 1998 $2,500,000 remains due against a Revolver which
matures on June 12, 2000 but can be extended for two additional one year
periods. The interest rate in effect under the Revolver is based on prime rate
plus 2.50% and is payable monthly in arrears.

         The Company also has a balance remaining of $2,684,009 as of December
31, 1998, on a $3,000,000 Term Loan from Transamerica. This loan is payable
quarterly in arrears over twenty consecutive quarters commencing October 1,
1997. At December 31, 1998 the interest rate in effect on the term loan was
12.099%.

         The Company acquired foreign debt of $629,255 of which $296,421 is
current and $332,834 is due beyond December 31, 1999. The debt consists of five
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.


Principle payments on debt are as follows:

            For the Years Ended December 31,
            1999                              $   686,458
            2000                                3,337,822
            2001                                  568,917
            2002                                1,220,067
            2003                                        -
            Thereafter                                  -
                                              -----------
            Total                             $ 5,813,264
                                              ===========

<PAGE>

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-12

<PAGE>

10.   Income Taxes

   The Company's income tax expense and benefits consist of the following:

                                                   For the
                                                 Years Ended
                                                 December 31,                   
                                                 ------------
                                           1998      1997      1996
                                           ----      ----      ----
      Current:
            Federal                    $ 359,265    $ ---      $ ---
            State                          9,367      ---        --- 
                                       ---------    -----      -----
                                         368,632      ---        ---  
                                       ---------    -----      -----
      Deferred:
            Federal                          ---      ---        ---
            State                            ---      ---        --- 
                                                      ---      -----
                                             ---      ---        --- 
                                       ---------    -----      -----
      Income Tax Expense/(Benefit)     $ 368,632    $   0      $   0 
                                       =========    =====      =====


The differences between the United States federal statutory tax rate and the
Company's effective tax rate are as follows:

                                          For the Years Ended December 31, 
                                                1998    1997     1996
                                                ----    ----     ----
   United States federal statutory tax rate       34%  (34)%    (34)%
   Increases resulting from state income 
    taxes, net of federal benefit                ---    (6)      (7)
   Benefit of net operating loss 
    carrryforard                                 (36)  ---      --- 
   Accounting losses for which deferred
    tax benefit cannot be currently 
    recognized                                   ---    39       39
   Foreign losses for which deferred tax
    benefit cannot currently be recognized         2   ---      ---
   Other                                         ---     1        2 
   Alternative Minimum Tax                         3   ---      ---
                                                 ---   ---      ---
       Effective tax rate                          3%  ---%     ---%
                                                ====  ====     ====

      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:

                                                         December 31,         
                                                      -----------------      
      Deferred tax assets:                            1998         1997
                                                      ----         ----
          Accounts receivable                    $   331,137  $    63,732
          Inventory                                  776,095       89,025
          Accrued expenses                           761,527      170,232
          Net operating loss carry forward         3,617,481    8,328,750
          Foreign net operating loss carryforward  1,199,912          ---
          Foreign Capital loss carryforward            6,786          ---
          State Taxes                                991,079    2,335,664
          Research and development tax credits     1,222,342      534,835
          Depreciation                               146,012       55,512
          Alternative minimum tax credits            318,819          ---
      Valuation allowance                         (9,371,190) (11,577,750) 
                                                 -----------  -----------
                     Net                         $         0  $         0
                                                 ===========  ============

         At December 31, 1998, the Company had available net operating loss
carryforwards and research and development credits for federal income tax
purposes of approximately $10,640,000 and $617,000, respectively, which expire
in the years 2005 through 2018. At December 31, 1998, the Company had available
net operating loss carryforwards and research and development credits for state
income tax purposes of approximately $11,385,000 and $605,000, respectively,
which expire in the years 2003 through 2005. At December 31, 1998, the Company
had available net operating loss carryforwards for foreign income tax purposes
of $3,285,000 which expire in the years 2001 through 2003. The timing and manner
in which the net operating loss carry-forwards and credits may be utilized to
reduce future taxable income, if any, will be limited by Internal Revenue Code
section 382.
<PAGE>


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,
1998, 1997 and 1996 was $163,106, $192,656, and $110,592, 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 1998, 1997 or 1996.

                                      F-13
<PAGE>

12. Commitments and Contingencies:

     In December 1998, the Company's acquired French subsidiary, (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 $612,128 were recorded as of
December 31, 1998.

     Additionally, 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 San Diego, California which expires January 31, 2000, Paris,
France which expires June 30, 2007, Montpilier, France which expires December
31, 2003 and Portsmith England which expires in December 31, 1999. The Company
also has certain property and equipment under capital leases. Future minimum
lease payments under all leases at December 31, 1998 are as follows:
<TABLE>
<CAPTION>

                  For the Year Ending December 31,                  Operating Leases      Capital Leases
                  --------------------------------                  ----------------      --------------
                    <S>                                                      <C>                    <C>
                  1999                                                     $ 485,446             $38,135
                  2000                                                       408,566              18,447
                  2001                                                        66,615                 ---
                  2002                                                        58,170                 ---
                  2003                                                        58,170                 ---
                  Thereafter                                                 124,950                 ---
                                                                         -----------             -------
                  Total                                                  $ 1,201,917              56,582
                                                                         ===========
                  Less amounts representing interest                                              (3,525)
                                                                                                 -------
                  Obligations under capital leases                                                53,057
                  Less current portion                                                           (35,759)
                                                                                                 -------
                                                                                                 $17,298
                                                                                                 =======
</TABLE>

     Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$734,651, $674,004, and $537,329, respectively.




                                      F-14
<PAGE>
 



13.      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.

         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.



14. Related Party Transactions:

Royalties, Payable, Related Parties

         The Company's DSP products utilize certain proprietary technology
developed by three stockholders of the Company. In accordance with an informal
agreement, these stockholders received royalties based on the Company's net
sales. Effective September 30, 1994, two of these stockholders ("Stockholders")
entered into a written royalty agreement which terminated their informal
agreements and their right to receive further royalties from the Company. The
Company also agreed to pay to the Stockholders the accrued and unpaid royalties
payable at September 30, 1994, amounting to $353,292, in nine equal monthly
installments, without interest thereon, commencing August 1, 1996.

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, 1998, 1997 and 1996
were approximately $123,625, $75,000, and $70,000, respectively.

                                      F-15
<PAGE>

Management Advisory Services

         A director of the Company, has provided management advisory services to
the Company since 1995. Fees incurred for the years ended December 31, 1998,
1997 and 1996 were approximately $450,000, $218,000, and $208,000, respectively.
In addition, this director received a stock option grant of 80,000 options for
management advisory services. That grant is dated December 31, 1998 and 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 8. 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, 1998, 1997 and 1996 were approximately $156,200, $88,000 and
$23,000, 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
8.


15.      Sales:

         Sales by geographic area are as follows:
<TABLE>
<CAPTION>
                                                         For the years ended December 31,
                                                 ----------------------------------------------- 
                                                      1998              1997            1996
                                                 -------------      ------------    ------------
              <S>                                      <C>                <C>             <C>    
         United States                           $  15,720,887      $ 12,035,000    $ 11,476,056
         Export & Subsidiary Sales:
              Europe                                 1,494,271           640,739         705,230
              Asia                                     131,023           195,969         302,234
              Other                                     99,648           330,208         547,117      
                                                  ------------      ------------    ------------
                                                  $ 17,445,829      $ 13,201,916    $ 13,030,637 
                                                  ============      ============    ============
</TABLE>

         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% of total Company sales in 1998. During 1997 and
1996, two customers accounted for 19% and 11%, respectively, of the Company's
sales. During 1996 one customer accounted for 32% of the Company's total sales.

16.      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, 1998, 129,800 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 

                                      F-16

<PAGE>

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.

         All outstanding options vest over periods ranging from immediate to
four years and expire in ten years. At December 31, 1998, 111,450 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 another amendment to the Plan increasing the
number of shares issuable under the Plan from 1,200,000 to 1,700,000.

         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 1998, the Company granted a total of 1,302,300
options which entitles the holder to acquire an equal number of shares of the
Company's common stock at exercise prices ranging from $2.44 to $9.00. The
options vest over periods ranging from immediate up to four years and expire in
ten years. At December 31, 1998, 1,153,400 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-17

<PAGE>

Non-Plan Options

         During 1998, the Company granted 1,016,500 stock options to certain
employees and outside consultants. 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 $2.37 to $4.00. Such
options vest over periods ranging from immediate to four years and expire in ten
years. At December 31, 1998, a total of 1,146,000 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").

         238,500 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, 1997
and 1996, the Company recorded a total of approximately $302,275, $221,638 and
$383,004, 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, $289,638 and $204,185 charge to operations for
the years ended December 31, 1998, 1997 and 1996, respectively. The exercise
price for all stock options issued to employees and non-employees during 1998,
1997 and 1996 was equal to the market price of the Company's stock at the date
of grant.



         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 basic
earnings/(loss) and diluted earnings/(loss) per share would have been increased,
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:


<TABLE>
<CAPTION>
                                                        December 31,
                                       --------------------------------------------
                                            1998             1997              1996
                                            ----             ----              ----
  <S>                                       <C>               <C>               <C>
Risk-free interest rate                    4.70%            6.40%             6.38%
Expected life                          4.1 years        4.3 years         4.3 years
Expected volatility                          80%              65%               60%
Expected dividends                          None             None              None

</TABLE>

                                      F-18
<PAGE>


         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,
                                                           ----------------------------------------------
                                                                   1998             1997         1996
                                                                   ----             ----         ----
<S>                                                                <C>           <C>              <C>    
Net income/(loss):
    As reported                                             $12,076,506    ($12,761,399)     ($ 8,801,457)
    Pro forma                                               $ 9,285,433    ($13,857,020)     ($10,213,016)

Basic Earnings/(Loss) per share:
    As reported                                               $    1.25      $    (1.39)       $    (1.10)
    Pro forma                                                 $    0.96      $    (1.51)       $    (1.28)

Diluted Earnings/(Loss) per share:
    As reported                                               $    1.11      $    (1.39)       $    (1.10)
    Pro forma                                                 $    0.86      $    (1.51)       $    (1.28)
</TABLE>

         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, 1998, option activity for the
plans was as follows:
<TABLE>
<CAPTION>
                                                                                                  Weighted
                                                                                                   Average
                                                                                 Options    Exercise Price
                                                                               ---------    -------------- 
 <S>                                                                             <C>                  <C>    
Stock options outstanding at December 31, 1995                                 1,375,175              4.31

Granted                                                                          815,450              8.24
Forfeited                                                                        (26,775)             4.02
Exercised                                                                       (131,775)             4.05
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
</TABLE>

         The weighted average fair value of options granted during 1998, 1997
and 1996 was $2.10, $3.96 and $2.09, respectively.


The following table summarizes information about the outstanding and exercisable
stock options at December 31, 1998:
<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>    
    $2.27 to $4.00         2,071,150          $ 3.31            9.6 years                 463,550        $ 3.19
    $4.38 to $6.50           331,350          $ 5.48            7.8 years                 193,054        $ 5.34
    $6.75 to $9.50           296,200          $ 7.70            7.8 years                 240,900        $ 7.58
   $9.63 to $10.63            80,500          $10.38            7.4 years                  67,375        $10.45
                           ---------                                                      -------
                           2,779,200                                                      964,879
                           =========                                                      =======
</TABLE>

                                      F-19
<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 H. Atlas
                                       --------------------------
                                         Jay H. Atlas,
                                         CEO and President


         Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.

<TABLE>
<CAPTION>

             Signature                                      Title                               Date
             ---------                                      -----                               ----
                <S>                                           <C>                                <C>

        /s/ Jay H. Atlas              President - Chief Executive Officer and  Director       March 25, 1999
-------------------------------------
           (Jay H. Atlas)             


       /s/ John R. Loprete            Vice President - Finance; Chief Accounting              March 25, 1999
------------------------------------- Officer
         (John R. Loprete)            


      /s/ Anthony M. Agnello          Chairman of the Board of Directors                      March 25, 1999
-------------------------------------
        (Anthony M. Agnello)          


      /s/ Harold W. Paul              Director                                                March 25, 1999
-------------------------------------
          (Harold W. Paul)            


      /s/ Robert J. Ranalli           Director                                                March 25, 1999
-------------------------------------
        (Robert J. Ranalli)           


      /s/ Edward D. Horowitz          Director                                                March 25, 1999
-------------------------------------
        (Edward D. Horowitz)          


      /s/ Etienne A. Perold           Director                                                March 25, 1999
-------------------------------------
        (Etienne A. Perold)           


/s/ Theodore J. Coburn                Director                                                March 25, 1999
-------------------------------------
        (Theodore J. Coburn)          

</TABLE>


                                      F-20