ODS NETWORKS INC, 10-K405, 2000-03-10

ODS NETWORKS INC
10-K405, 2000-03-10
COMPUTER COMMUNICATIONS EQUIPMENT

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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

FORM 10-K

(MARK ONE)

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]

For the transition period from ________________ to ______________.

COMMISSION FILE NUMBER 0-20191
______________________________

ODS NETWORKS, INC.

(Exact name of registrant as specified in its charter)

<TABLE>
<S> <C>
DELAWARE 75-1911917
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
1101 EAST ARAPAHO ROAD 75081
RICHARDSON, TEXAS
(Address of principal executive offices) (Zip Code)
</TABLE>

Registrant's telephone number, including area code: (972) 234-6400
Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
(Title of class)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No

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

As of February 21, 2000, the aggregate market value of the Registrant's
voting stock held by non-affiliates of the Registrant was approximately
$225,668,312 (affiliates being, for these purposes only, directors, executive
officers and holders of more than 5% of Registrant's Common Stock). As of
February 21, 2000, 18,688,323 shares of the Registrant's Common Stock were
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's definitive Proxy Statement filed in connection
with the Registrant's 2000 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Form 10-K.

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PART I

ITEM 1. BUSINESS.

In addition to the historical information contained herein, the discussion
in this Form 10-K contains certain forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, that involve risks and uncertainties, such as
statements concerning: growth and future operating results, developments in the
Company's markets and strategic focus; new products and product enhancements;
potential acquisitions and the integration of acquired businesses, products and
technologies; strategic relationships and future economic and business
conditions. The cautionary statements made in this Form 10-K should be read as
being applicable to all related forward-looking statements whenever they appear
in this Form 10-K. The Company's actual results could differ materially from the
results discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
under the section captioned "Factors That May Affect Future Results of
Operations" in Item 1 of this Form 10-K as well as those cautionary statements
and other factors set forth elsewhere herein.

GENERAL

ODS Networks, Inc. ("ODS", the "Company" or the "Registrant") operates
through two divisions: the Security division which focuses on security software
and integrated solutions, and the Networking division which focuses on high
performance network solutions. The Company's wholly-owned subsidiary,
Intrusion.com, Inc. ("Intrusion.com"), develops and markets products which allow
customers to create networks that are protected from access, theft and damage by
unauthorized network users and protected from misuse by curious or disgruntled
employees, contractors and other authorized users. The Company's Essential
Communication division ("Essential") develops and markets products which enable
customers to connect computers and supercomputers to form clusters, workgroups
and local area networks ("LANs") and to build backbones for enterprise-wide
networks.

The Company markets and distributes its products through a direct sales
force to end-users, distributors and by numerous domestic and international
system integrators, service providers and value-added resellers. The Company's
end-user customers include manufacturing, telecommunications, retail,
transportation, health care, insurance, entertainment, utilities and energy
companies, government agencies, financial institutions, and academic
institutions.

The Company was organized in Texas in September 1983 and reincorporated in
Delaware in October 1995. The Company changed its name in April 1997 from
Optical Data Systems, Inc. to ODS Networks, Inc. The Company's principal
executive offices are located at 1101 E. Arapaho Road, Richardson, Texas 75081,
and its telephone number is (972) 234-6400.

INDUSTRY BACKGROUND

The power of personal computers ("PCs"), workstations and network servers
has increased dramatically during the past decade. The rapid proliferation of
these devices has created a demand for an effective, secure method to enable
users to communicate with each other to access common databases, software and
peripheral devices. The LAN industry evolved to provide a means by which
computers and related devices ("nodes") located within a limited geographical
area, such as a single office building or a campus, can be interconnected by
means of a common cabling system to permit communication and the sharing of data
and resources. These LANs can then be interconnected into wide area networks
("WANs") that enable all of the client and server devices in an enterprise to
communicate with each other.

In the past, LAN technologies such as Ethernet and Token Ring required
networked devices to take turns communicating on a singe LAN. Such technologies
are often referred to as shared-media or shared-bandwidth technologies because
they require computers to contend for the total capacity or "bandwidth"

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of a LAN. The performance of these shared-bandwidth LANs has declined in recent
years due to the increased processor speeds of computers, increased size of LANs
and higher bandwidth requirements of software applications such as document
image processing, medical imaging, video and the World Wide Web.

In the mid-1990's, a new generation of LAN technology emerged utilizing
"switching" to relieve the performance issues experienced in shared-bandwidth
LANs. Some switches were designed to enhance the performance of existing
shared-bandwidth LANs by reducing the number of devices taking turns and sharing
the capacity of a single LAN Ethernet segment or token ring. Other switches such
as the Company's InfiniteSwitch and LANBlazer product lines have been designed
to replace the traditional hub and router architecture. In a totally switched
network, each PC, workstation and server has its own dedicated network
connection; thus, networked devices do not experience the performance
constraints of taking turns transmitting information over the LAN.

In addition, high-end workstations, servers and supercomputers are
increasingly being networked to form solutions for manipulating 3D models for
computer-aided design, calculating complex formulas for chemistry and geographic
information systems applications, video editing, animation rendering, technical
publishing, World Wide Web and intranet authoring and serving, and software
development. The Company's acquisition of Essential Communication Corporation in
May of 1998 established ODS as a leader in providing high performance networking
switches and network interface cards ("NICs") to create clusters and workgroups
of such high-end workstations, servers and supercomputers.

The migration of data from tightly controlled mainframe computers onto LANs,
workstations and personal computers and connectivity of an organization's
network to the Internet have created security issues. In the past, an
organization could rely on tight mainframe access controls to restrict access to
sensitive data. However, many networks now contain proprietary, intellectual
property and other sensitive data being carried by insecure network protocols.
Today, firewalls represent the most common form of network security, forming
barriers to entry into an organization's network. However, the hacker community
has developed innovative techniques for circumventing firewalls. Furthermore,
firewalls do not adequately address the security issues related to disgruntled
employees or those who would commit corporate espionage. Thus, a need has
evolved to assess the vulnerability of networks and for the implementation of
comprehensive monitoring of installed networks and real-time response to
security violations. The Company's exclusive license of Kane security software
products from RSA Security, Inc. ("RSA") in September of 1999 provides ODS with
a product suite that is designed to help organizations perform security audits
of their networked systems, monitor critical networked resources for suspicious
activities, and collect information for data analysis, alarm processing and
audit management functions. The Company's acquisition of certain products and
technologies, including the Computer Misuse Detection System ("CMDS") product
line from Science Applications International Corporation ("SAIC") in September
of 1998 significantly enhanced ODS' ability to create trusted networks that are
protected from access, theft and damage by unauthorized network users and
protected from misuse by curious or disgruntled employees, contractors and other
authorized users.

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ODS PRODUCTS

SECURITY

INTRUSION DETECTION SOFTWARE. Intrusion.com's CMDS software permits
information security administrators to monitor an organization's network for
suspicious events, unauthorized activity and misuse of the computer network.
CMDS profiles user behavior and usage patterns across multiple statistical
categories. Variations from a usage pattern can indicate a variety of potential
computer misuses and intrusions. Using a graphical user interface, a security
administrator can define rules and desired reactions to unauthorized events on
an organization's network. CMDS analyzes audit log files from
UNIX-Registered Trademark-, Windows NT-Registered Trademark-, Cisco IOS routers,
Check Point Firewall-1-Registered Trademark-, Oracle-Registered Trademark- and
numerous other sources of audit log data. CMDS monitors for overt intrusion
signatures such as failed login attempts, attempted root access, system
configuration modifications, unauthorized software installations and attempts to
subvert security systems. CMDS can alert the security administrator of
deviations from defined rules, intrusion signatures and deviations from normal,
authorized computer user behavior.

VULNERABILITY ASSESSMENT SOFTWARE. Intrusion.com's KANE SECURITY ANALYST
instantly assesses the security of an organization's NT and Novell servers and
workstations evaluating potential security holes in the corporate network.
Intrusion.com's KANE SECURITY MONITOR is a host based intrusion detection tool
that continuously reviews and analyzes NT security event logs for patterns of
misuse and alerts the security manager in real-time.

NETWORK SECURITY APPLIANCES. Intrusion.com's SECURECOM product family is
designed to provide comprehensive security solutions through network security
appliances that are easy to implement and manage. Intrusion.com believes that
its integrated approach to networks and security products provides a more
comprehensive security solution than the single product offerings marketed by
many of its competitors. The SecureCom products are modular solutions offering
simultaneous connections to multiple network segments, integrated firewalls,
network based and host based intrusion detection systems, CMDS computer misuse
detection system, Kane vulnerability assessment system, URL filters, virus
scanners, virtual private network systems and other security applications.

NETWORKING

HIGH PERFORMANCE NETWORK INTERCONNECTIVITY. Essential's PERFORMANCE AREA
NETWORK SOLUTIONS ("PANSolutions") products are built upon the industry's
fastest and most mature high speed standard available today. Essential offers a
complete line of switches and Network Interface Cards ("NICs") for networking
environments that demand high data throughput and extremely low latency such as
the oil and gas industry, film and video, automotive and e-commerce.
PANSolutions provide high speed interconnectivity for new and legacy servers and
workstations from market leaders including Compaq Computer Corporation
("Compaq"), Hewlett-Packard Company ("Hewlett-Packard"), SGI, Inc. ("SGI"),
International Business Machines Corporation ("IBM"), and Sun Microsystems, Inc.
("Sun"). Essential is one of the leaders in the development of the world's
fastest networking standard, Gigabyte System Network ("GSN"). GSN is the highest
bandwidth and lowest latency interconnect standard, providing full duplex dual
6400 megabit (800 megabyte) per second of error free, flow controlled data.

ODS' LANBLAZER 7000 and 7017 gigabit Ethernet and Fast Ethernet switches are
designed for high bandwidth server farms, corporate backbone switching and
high-end applications at the individual user level. With up to 139 gigabits of
backplane bandwidth the LANBlazer switch family provides one of the highest
capacity gigabit Ethernet switching solutions available. Offering six or sixteen
multi-media module slots, respectively, the switches support up to 128 full
duplex gigabit Ethernet ports, up to 768 10/100 Ethernet ports or up to 60 fiber
Fast Ethernet ports. Additional features of the LANBlazer include high-speed
Layer 3 switching, VLAN management and flexible network management capabilities.
The Company also offers ATM and HIPPI uplinks in either LANBlazer chassis to
integrate Ethernet enterprise backbone architecture with other high performance
network solutions.

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The ODS INFINITESWITCH product family comprises flexible switched Ethernet
connectivity while providing high-speed ATM, Fast Ethernet and Gigabit Ethernet
uplinks that fully integrate each LAN device into more complex, enterprise
networks. The ODS InfiniteSwitch product family includes modular chassis, switch
and uplink modules, and network management software. The modular chassis are
available with 12, 7, 4 and 2 slots. Each switch, uplink and management module
is re-deployable across these modular chassis platforms, including the Company's
prior generation Infinity intelligent hub chassis, thereby reducing the
operating costs associated with spare units and enabling a cost-effective
migration from shared-bandwidth network architectures and small work groups to
large switched networks.

THIRD-PARTY PRODUCTS

The Company believes that it is beneficial to work with third parties with
complementary technologies to provide integrated solutions to its customers. As
the Company also competes with these technology partners in certain segments of
the market, there can be no assurance that the Company will have access to all
of the third-party products which may be desirable in order to offer fully
integrated solutions to ODS customers.

CUSTOMER SERVICES

In addition to manufacturing broad lines of secure networking products, the
Company also offers a wide range of services, including consulting, design and
configuration, project planning and management, performance analysis and
installation and maintenance.

PRODUCT DEVELOPMENT

The data security and networking industry is characterized by rapidly
changing technology, standards and customer demands. Management believes that
the Company's future success depends in large part upon the timely enhancement
of existing products as well as the development of technologically advanced new
products which meet industry standards, perform successfully and achieve market
acceptance. The Company is currently developing and marketing next-generation
data security and switching products. The Company is also investing in the
development of products which comply with emerging industry standards and is
continuously engaged in testing to ensure that the Company's products
interoperate with other manufacturers' products which comply with industry
standards.

During 1999, 1998 and 1997, the Company's research and development
expenditures were $11.7 million, $12.2 million and $10.8 million, respectively.
All of the Company's expenditures for hardware and software research and
development costs have been expensed as incurred. At December 31, 1999, the
Company had 62 employees engaged in research and product development.

MANUFACTURING AND SUPPLIES

The Company's manufacturing operations consist primarily of replication of
software on CDs, packaging, final assembly, testing and quality control of
subassemblies and finished units. Materials used by the Company in its
manufacturing processes include semiconductors such as microprocessors, memory
chips and application specific integrated circuits ("ASICs"), printed circuit
boards, power supplies and enclosures.

The Company's operational strategy relies on outsourcing of printed circuit
board assembly and certain other operations to reduce fixed costs and to provide
flexibility in meeting market demand. The Company inserts the printed circuit
board-based modules, assembled by a variety of domestic third-party contract
assembly companies, into product enclosures in combination with power supplies,
software and other components to configure systems to meet the needs of end-user
customers.

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INTELLECTUAL PROPERTY AND LICENSES

The Company's success and its ability to compete is dependent, in part, upon
its proprietary technology. While the Company has applied for certain patents,
the Company does not hold any issued patents and currently relies on a
combination of contractual rights, trade secrets and copyright laws to establish
and protect its proprietary rights in its products. The Company has also entered
into confidentiality agreements with its employees and enters into
non-disclosure agreements with its suppliers, resellers and certain customers to
limit access to and disclosure of proprietary information. There can be no
assurance that the steps taken by the Company to protect its intellectual
property will be adequate to prevent misappropriation of its technology or that
the Company's competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technology.

The Company has entered into several software and product license
agreements. These license agreements provide the Company with additional
software and hardware components that add value to its data security, switch and
network management products. These license agreements do not provide proprietary
rights which are unique or exclusive to the Company and are generally available
to other parties on the same or similar terms and conditions, subject to payment
of applicable license fees and royalties.

On September 30, 1999, the Company entered a technology licensing agreement
with RSA Security Inc. ("RSA") under which the Company is the exclusive licensee
of RSA's Kane Security products in North America and Europe. The Kane Security
Products include the Kane Security Analyst, a vulnerability assessment tool, and
the Kane Security Monitor, a 24-hour tool that continuously reviews and analyzes
NT security event logs for patterns of misuse and alerts the security
administrator in real-time. The Company is responsible for marketing, sales,
support, maintenance and development for Kane Security software.

SALES, MARKETING AND CUSTOMERS

The Company markets and distributes its products primarily through a direct
sales force to end users supplemented by several domestic and international
distributors, system integrators and value added resellers. At December 31,
1999, the Company's direct sales and marketing organization consisted of 103
individuals, including managers, sales representatives, marketing personnel and
technical support personnel.

FIELD SALES FORCE. The Company's direct sales organization focuses on major
account sales, promotes the Company's products to current and potential
customers, and monitors evolving customer requirements. The Company's channel
sales force promotes its products to distributors, system integrators and value
added resellers. The field sales and technical support force provides training
and technical support to the Company's resellers and end users and assists ODS
customers to design secure data networking solutions.

The Company currently conducts sales and marketing efforts from its
principal office in Richardson (Dallas), Texas; through domestic field offices
located in the following metropolitan areas: Albuquerque, Atlanta, Chicago,
Denver, Minneapolis, San Diego, San Francisco and Vienna (Washington, D.C.); and
through its foreign sales offices located in the following countries: Canada,
England, France, Germany, Malaysia, New Zealand, Singapore, South Korea and
Taiwan.

DISTRIBUTORS. The Company has signed distribution agreements with
distributors in the United States, Europe and Asia. In general these
relationships are non-exclusive. Distributors typically maintain an inventory of
ODS products. Under these agreements, ODS provides certain protection to the
distributors for their inventory of ODS products for price reductions as well as
products that are slow-moving or have been discontinued by the Company.
Recognition of sales to distributors and related gross profits are deferred
until the merchandise is resold by the distributors.

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RESELLERS. Domestic and international system integrators and value added
resellers (collectively, "resellers") sell ODS products as stand-alone solutions
to end users and integrate ODS products with products sold by other vendors into
networking and data security systems that are sold to end users. The Company's
field sales force and technical support organization provide support to these
resellers. The Company's agreements with resellers are non-exclusive, and the
Company's resellers generally sell other products which may compete with ODS
products. Resellers may place higher priority on products of other suppliers who
are larger than and have more name recognition than ODS, and there can be no
assurance that resellers will continue to sell and support the Company's
products.

FOREIGN SALES. The Company believes that rapidly evolving international
markets are important sources of future net sales for the Company. The Company's
export sales are currently being made through a direct sales force supplemented
by international resellers in Europe, Asia, Latin America and Canada. Export
sales accounted for approximately 12.5%, 20.0% and 27.2% of net sales in 1999,
1998 and 1997, respectively. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in this report for a
geographic breakdown of the Company's product revenue in 1999, 1998 and 1997.
Sales to foreign customers and resellers generally have been made in United
States dollars.

MARKETING. The Company has implemented several methods to market its
products, including regular participation in trade shows and seminars,
advertisement in trade journals, telemarketing, distribution of sales literature
and product specifications and ongoing communications with its resellers and
installed base of end-user customers.

CUSTOMERS. The Company's end-user customers include manufacturing,
telecommunications, retail, transportation, health care, insurance, utilities
and energy companies, government agencies, financial institutions and academic
institutions. Sales to certain customers and groups of customers can be impacted
by seasonal capital expenditure approval cycles, and sales to customers within
certain geographic regions can be subject to seasonal fluctuations in demand.

Although the Company sells its products to many customers, direct sales to
four such resellers and end-user customers, Electronic Data Systems Corporation
("EDS"), SGI, Microage Federal and various agencies of the U. S. government
(aggregated as one), have each accounted for 10% or more of the Company's net
sales in at least one of the past three fiscal years as indicated in the
following schedule.

<TABLE>
<CAPTION>
PERCENTAGE OF NET
SALES
------------------------------
CUSTOMER 1999 1998 1997
- -------- -------- -------- --------
<S> <C> <C> <C>
EDS......................................................... 2.2% 7.0% 16.1%
SGI......................................................... 10.9 1.7 0.0
Microage Federal............................................ 11.8 7.4 4.0
U.S. Government............................................. 9.7 13.2 11.7
</TABLE>

A large portion of the products sold to Microage Federal, SGI and EDS during
the periods shown were integrated with other products or services and sold to
end users by Microage Federal, SGI and EDS. No other customer accounted for 10%
or more of the Company's net sales in 1999, 1998 or 1997, respectively. The loss
of any of these customers could have a material adverse effect on the Company
and its operating results if not replaced.

Most of the Company's business with the U.S. Government is on a fixed-price
basis. Government contracts customarily include provisions which provide for
cancellation at the convenience of the Government. In addition, upon
cancellation by the Government, the Company generally would be entitled to
reimbursement of costs incurred, plus a pro rata share of profit. The Company
has never received a cancellation of a material government contract and has no
reason to anticipate any such cancellation. The products sold, characteristics
and business risks associated with the Company's sales to U.S. Government

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agencies do not differ materially from those associated with sales of the
Company's products to commercial customers.

BACKLOG. The Company believes that only a small portion of its order
backlog is noncancelable and that the dollar amount associated with the
noncancelable portion is immaterial. The Company manufactures its products based
upon its forecast of customer demand and maintains inventories of sub-assemblies
and finished products in advance of receiving firm orders from customers. Orders
are generally fulfilled by the Company within one to four weeks following
receipt of an order. Due to the generally short cycle between order and shipment
and occasional customer-initiated changes in delivery schedules or cancellation
of orders which are made without significant penalty, the Company does not
believe that its backlog as of any particular date is indicative of future net
sales.

CUSTOMER SUPPORT, SERVICE AND WARRANTY. The Company services, repairs and
provides technical support for its products. The ODS field sales and technical
support force work closely with resellers and end-user customers on-site and by
telephone to assist with pre- and post-sales support services such as network
design, system installation and technical consulting. By working closely with
the Company's customers, ODS employees gain a thorough understanding of end-user
requirements and provide input to the product development process.

The Company warrants all its products against defects in materials and
workmanship for periods ranging from 90 days to 12 months. Before and after
expiration of the product warranty period, the Company offers both on-site and
factory-based support, parts replacement and repair services. Extended warranty
services are separately invoiced on a time and materials basis or under an
annual maintenance contract.

COMPETITION

The market for network switches and data security solutions is intensely
competitive and subject to frequent product introductions with improved
price/performance characteristics. Industry suppliers compete in areas such as
conformity to existing and emerging industry standards, interoperability with
other networking products, network management and security capabilities,
performance, price, ease of use, scalability, reliability, flexibility, product
features and technical support. The Company believes that its solutions-oriented
approach (combining network design services, ODS products and third-party
products to provide superior, secure networking systems to customers) provides
the Company a competitive advantage with large organizations with complex
networking requirements.

There are numerous companies competing in various segments of the data
security and network switch markets. The Company's principal competitors include
Cisco Systems, Inc. ("Cisco"), Cabletron Systems, Inc. ("Cabletron"), Lucent
Technologies ("Lucent"), Nortel Networks ("Nortel"), 3Com Corporation ("3Com"),
Alcatel USA, Inc. ("Alcatel"), IBM, Nokia Corporation ("Nokia"), Axent
Technologies, Inc. ("Axent"), Internet Security Systems, Inc. ("ISS"), and
Network Associates, Inc. Several of the Company's competitors have substantially
greater financial, technical, sales and marketing resources, better name
recognition and a larger customer base than the Company. In addition, many of
the Company's competitors offer customers a broader product line which provides
a more comprehensive networking and security solution than the Company currently
offers. Even if the Company does introduce advanced products which meet evolving
customer requirements in a timely manner, there can be no assurance that the new
Company products will gain market acceptance.

Certain companies in the networking and security industry have expanded
their product lines or technologies in recent years as a result of acquisitions.
Further, more companies have developed products which conform to existing and
emerging industry standards and have sought to compete on the basis of price.
The Company anticipates increased competition from large telecommunication
equipment vendors which are expanding their capabilities in the data networking
market. For example, Lucent and Nortel have acquired several networking
companies to enhance their capabilities in data networking. Further the

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Company anticipates increased competition from private "start-up" companies that
have developed or are developing advanced network switching and security
products. Increased competition in the networking and security industry could
result in significant price competition, reduced profit margins or loss of
market share, any of which could have a material adverse effect on the Company's
business, operating results and financial condition.

There can be no assurance that the Company will be able to compete
successfully in the future with current or new competitors.

EMPLOYEES

As of December 31, 1999, the Company employed a total of 266 persons,
including 103 in sales, marketing and technical support, 76 in manufacturing and
operations, 62 in research and product development, and 25 in administration and
finance.

None of the Company's employees are represented by a labor organization, and
the Company is not a party to any collective bargaining agreement. The Company
has not experienced any work stoppages and considers its relations with its
employees to be good.

Competition in the recruiting of personnel in the networking and data
security industry is intense. The Company believes that its future success will
depend in part on its continued ability to hire, motivate and retain qualified
management, sales and marketing, and technical personnel. To date, the Company
has not experienced significant difficulties in attracting and retaining
qualified employees.

FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

In addition to the other information in this Form 10-K, the following
factors should be considered in evaluating the Company and its business.

TECHNOLOGICAL CHANGES. The market for the Company's products is
characterized by frequent product introductions, rapidly changing technology and
continued evolution of new industry standards. The market for network switches,
management and security products requires the Company's products to be
compatible and interoperable with products and architectures offered by various
vendors, including other networking products, workstation and personal computer
architectures and computer and network operating systems. The Company's success
will depend to a substantial degree upon its ability to develop and introduce in
a timely manner new products and enhancements to its existing products that meet
changing customer requirements and evolving industry standards. The development
of technologically advanced products is a complex and uncertain process
requiring high levels of innovation as well as the accurate anticipation of
technological and market trends. There can be no assurance that the Company will
be able to identify, develop, manufacture, market and support new or enhanced
products successfully in a timely manner. Further, the Company or its
competitors may introduce new products or product enhancements that shorten the
life cycle of or obsolete the Company's existing product lines any of which
could have a material adverse effect on the Company's business, operating
results and financial condition.

MARKET ACCEPTANCE. The Company is pursuing a strategy to increase the
percentage of its revenue generated through indirect sales channels including
distributors, value added resellers, system integrators, original equipment
manufacturers and network service providers. There can be no assurance that the
Company's products will gain market acceptance in these indirect sales channels.
Further, competition among networking and security companies to sell products
through these indirect sales channels could result in significant price
competition and reduced profit margins.

The Company is also pursuing a strategy to broaden and further differentiate
its product line by introducing complementary network switching, management and
security products and incorporating new technologies into its existing product
line. There can be no assurance that the Company will successfully introduce
these products or that such products will gain market acceptance. The Company
anticipates

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competition from networking companies, network security companies and others in
each of its product lines. The Company anticipates that profit margins will vary
among its product lines and that product mix fluctuations could have an adverse
effect on the Company's overall profit margins.

ACQUISITIONS. Cisco, Cabletron, Lucent, Nortel and other competitors have
recently acquired several networking and security companies with complementary
technologies, and the Company anticipates that such acquisitions will continue
in the future. These acquisitions may permit such competitors to accelerate the
development and commercialization of broader product lines and more
comprehensive solutions than the Company currently offers. In the past, the
Company has relied upon a combination of internal product development and
partnerships with other networking and security vendors to provide competitive
solutions to customers. Certain of the recent and future acquisitions by the
Company's competitors may have the effect of limiting the Company's access to
commercially significant technologies. Further, the business combinations and
acquisitions in the networking and security industry are creating companies with
larger market shares, customer bases, sales forces, product offerings and
technology and marketing expertise. There can be no assurance that the Company
will be able to compete successfully in such an environment.

On May 7, 1998, the Company acquired Essential Communication Corporation, a
privately held company based in Albuquerque, New Mexico. Essential designs and
manufactures high-speed computer network equipment. In September 1998, the
Company completed an acquisition of certain assets of the Computer Misuse and
Detection System ("CMDS") Division from Science Applications International
Corporation ("SAIC"), a privately held company in San Diego, California. On
September 30, 1999, the Company entered a technology licensing agreement with
RSA under which the Company is the exclusive licensee of RSA's Kane Security
products in North America and Europe. The Company may, in the future, acquire or
invest in additional companies, business units, product lines, or technologies
to accelerate the development of products and sales channels complementary to
the Company's existing products and sales channels. Acquisitions involve
numerous risks, including: difficulties in assimilation of operations,
technologies, and products of the acquired companies; risks of entering markets
in which the Company has no or limited direct prior experience and where
competitors in such markets have stronger market positions; the potential loss
of key employees of the acquired company; and the diversion of management's
attention from normal daily operation of the Company's business. There can be no
assurance that any potential acquisition or investment will be consummated or
that such acquisition or investment will be realized.

PRODUCT TRANSITIONS. Once current networking and security products have
been in the market place for a period of time and begin to be replaced by higher
performance products (whether of the Company's or a competitor's design), the
Company expects the net sales of such products to decrease. In order to achieve
revenue growth in the future, the Company will be required to design, develop
and successfully commercialize higher performance products in a timely manner.
There can be no assurance that the Company will be able to introduce new
products and gain market acceptance quickly enough to avoid adverse revenue
transition patterns during current or future product transitions. Nor can there
be any assurance that the Company will be able to respond effectively to
technological changes or new product announcements by competitors, which could
render portions of the Company's inventory obsolete.

The Company's sales of commodity LAN switches and hubs have declined over
the past three years as certain of the Company's large competitors gained market
share. The Company's goal is to transition an increasing proportion of its
revenues to growing markets in which the Company offers differentiated products,
such as data security solutions and high performance switches. The Company's
ability to achieve its revenue objectives over the next several quarters will
largely depend upon the extent to which growth in these differentiated product
lines compensates for the expected decline in the commodity LAN switch and hub
product lines.

MANUFACTURING AND SUPPLIERS. All of the materials used in the Company's
products are purchased under contracts or purchase orders with third parties.
While the Company believes that many of the materials used in the production of
its products are generally readily available from a variety of sources,

10
<PAGE>
certain components such as microprocessors and ASICs are available from one or a
limited number of suppliers. The lead times for delivery of components vary
significantly and exceed twelve weeks for certain components. If the Company
should fail to forecast its requirements accurately for components, it may
experience excess inventory or shortages of certain components which could have
an adverse effect on the Company's business and operating results. Further, any
interruption in the supply of any of these components, or the inability of the
Company to procure these components from alternative sources at acceptable
prices within a reasonable time, could have an adverse effect on the Company's
business and operating results.

The Company's operational strategy relies on outsourcing of product assembly
and certain other operations. There can be no assurance that the Company will
effectively manage its third-party contractors or that these contractors will
meet the Company's future requirements for timely delivery of products of
sufficient quality and quantity. Further, the Company intends to introduce a
number of new products and product enhancements in 2000 which will require that
the Company rapidly achieve volume production of those new products by
coordinating its efforts with those of its suppliers and contractors. The
inability of the third-party contractors to provide ODS with adequate supplies
of high-quality products could cause a delay in the Company's ability to fulfill
orders and could have an adverse effect on the Company's business, operating
results and financial condition.

INTELLECTUAL PROPERTY AND LICENSES. There are many patents held by
companies which relate to the design and manufacture of data security and
networking systems. Potential claims of infringement could be asserted by the
holders of those patents. The Company could incur substantial costs in defending
itself and its customers against any such claim regardless of the merits of such
claims. In the event of a successful claim of infringement, the Company may be
required to obtain one or more licenses from third parties. There can be no
assurance that the Company could obtain the necessary licenses on reasonable
terms.

THIRD-PARTY PRODUCTS. The Company believes that it is beneficial to work
with third parties with complementary technologies to broaden the appeal of the
Company's switches and network security products. These alliances allow ODS to
provide integrated solutions to its customers, combining ODS developed
technology with third-party products. As the Company also competes with these
technology partners in certain segments of the market, there can be no assurance
that the Company will have access to all of the third-party products which may
be desirable or necessary in order to offer fully integrated solutions to ODS
customers.

DEPENDENCE ON KEY CUSTOMERS. A relatively small number of customers have
accounted for a significant portion of the Company's revenue. U.S. government
agencies and large system integrators are expected to continue to account for a
substantial portion of the Company's net revenue. The Company continuously faces
competition from Cisco, Cabletron, Lucent, Nortel, Alcatel, 3Com, Axent, ISS and
others for U.S. government networking and security projects and corporate
networking and security installations. Any reduction or delay in sales of the
Company's products to these customers could have a material adverse effect on
the Company's operating results.

INTERNATIONAL OPERATIONS. The Company's international operations may be
affected by changes in demand resulting from fluctuations in currency exchange
rates and local purchasing practices, including seasonal fluctuations in demand,
as well as by risks such as increases in duty rates, difficulties in
distribution, regulatory approvals and other constraints upon international
trade. The Company's sales to foreign customers are subject to export
regulations. In particular, certain sales of the Company's high performance
networking and data security products require clearance and export licenses from
the U.S. Department of Commerce under these regulations. Any inability to obtain
such clearances or any required foreign regulatory approvals on a timely basis
could have a material adverse effect on the Company's operating results.

11
<PAGE>
IMPACT OF GOVERNMENT CUSTOMERS. A significant portion of the Company's
revenue is derived from sales to the U.S. government, either directly by the
Company or through system integrators and other resellers. Sales to the
government present risks in addition to those involved in sales to commercial
customers, including potential disruptions due to appropriation and spending
patterns and the government's reservation of the right to cancel contracts and
purchase orders for its convenience.

GENERAL. Sales of the Company's products fluctuate, from time to time,
based on numerous factors, including customers' capital spending levels and
general economic conditions. While certain industry analysts believe that there
is a significant market for network switches and security products, there can be
no assurance as to the rate or extent of the growth of such market or the
potential adoption of alternative technologies. Future declines in networking
and security product sales as a result of general economic conditions, adoption
of alternative technologies or any other reason could have a material adverse
effect on the Company's business, operating results and financial condition.

Due to the factors noted above and in "Management's Discussion and Analysis
of Financial Condition and Results of Operations", the Company's future earnings
and common stock price may be subject to significant volatility, particularly on
a quarterly basis. Past financial performance should not be considered a
reliable indicator of future performance and investors should not use historical
trends to anticipate results or trends in future periods. Any shortfall in
revenue and earnings from the levels anticipated by securities analysts could
have an immediate and significant effect on the trading price of the Company's
common stock in any given period. Also, the Company participates in a highly
dynamic industry which often results in volatility of the Company's common stock
price.

12
<PAGE>
ITEM 2. PROPERTIES.

The Company's headquarters is located in a modern, two-story building in
Richardson, Texas, with an aggregate of approximately 95,000 square feet of
floor space. This facility includes the Company's corporate administration,
manufacturing, marketing, research and development, sales and technical support
personnel. The Company occupies this facility under a lease, the base term of
which expires in February 2005, with two seven-year options to extend the lease
term, subject to compliance with certain conditions. The Company also leases a
separate warehouse facility consisting of approximately 8,000 square feet
adjacent to its headquarters under a lease that expires in June 2000.

On December 23, 1999, the Company sold a one-story building consisting of
approximately 50,000 square feet of floor space adjacent to the Company's
headquarters. This building was vacated in the first quarter of 1999 when the
Company's research and development personnel were moved from this building to
the Company's headquarters.

Essential division personnel are located in a 15,120 square foot leased
property in Albuquerque, New Mexico. The lease will expire in February 2009.
Research and development, administrative, manufacturing, marketing and sales
personnel occupy this property.

The Company's security software research and development staff is located in
an 11,400 square foot leased property in San Diego, California. The lease will
expire in August 2002. Research and development, sales and administrative
personnel occupy this facility.

The Company has a sales office located in Vienna, Virginia occupying a
56,500 square foot leased property. The lease will expire in April 2004, with a
five-year option to extend the lease term, subject to compliance with certain
conditions.

In addition, the Company and its subsidiaries lease small amounts of office
space for sales and technical support personnel domestically in California,
Colorado, Georgia, Illinois, Minnesota, New Mexico and Texas, and
internationally in Canada, England, France, Germany, Malaysia, New Zealand,
Singapore, South Korea and Taiwan. The Company believes that these existing
facilities will be adequate to meet its requirements through 2000. See Note 8 of
Notes to Consolidated Financial Statements for additional information regarding
the Company's obligations under leases.

ITEM 3. LEGAL PROCEEDINGS.

The Company is not a party to any material litigation and is not aware of
any threatened litigation which would have a material adverse effect on the
Company, its operating results or its financial position.

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

There were no matters submitted to a vote of security holders of the Company
during the fourth quarter of 1999.

PART II

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

The Company's common stock is traded on The Nasdaq Stock Market (National
Market System) under the symbol "ODSI". As of February 21, 2000 there were
approximately 310 holders of record of the

13
<PAGE>
common stock. The following table sets forth, for the periods indicated, the
high and low sales prices for the common stock, as reported by The Nasdaq Stock
Market.

<TABLE>
<CAPTION>
1999 1998 1997
----------------------------- ----------------------------- ---------------------------
HIGH LOW HIGH LOW HIGH LOW
------------- ------------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter....................... $ 5 5/8 $ 2 1/2 $ 7 15/16 $ 5 13/16 $18 1/4 $11 5/16
Second Quarter...................... 4 3/8 2 1/2 9 5 3/8 16 3/8 11 3/8
Third Quarter....................... 7 15/32 3 15/16 7 3/4 3 3/16 13 3/4 10 1/64
Fourth Quarter...................... 14 15/16 4 7/8 4 1/16 2 1/4 13 5 1/2
</TABLE>

ITEM 6. SELECTED FINANCIAL DATA.

The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in Item 7 of this Form 10-K and the consolidated
statements and notes thereto included in Item 14 of this Form 10-K.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net sales:
Security products..................... $ 7,963 $ 1,920 $ -- $ -- $ --
Networking products................... 49,988 72,690 92,327 117,864 111,450
-------- -------- ------- -------- --------
Total net sales....................... 57,951 74,610 92,327 117,864 111,450
Cost of sales:
Security products..................... 3,877 968 -- -- --
Networking products................... 28,227 49,262 55,795 60,737 55,499
-------- -------- ------- -------- --------
Total cost of sales................... 32,104 50,230(1) 55,795 60,737 55,499
-------- -------- ------- -------- --------
Gross profit.............................. 25,847 24,380 36,532 57,127 55,951
Operating expenses:
Sales and marketing................... 20,277 29,378 30,390 25,969 22,555
Research and development.............. 11,700 12,244 10,810 10,417 8,021
In-process research and development... -- 3,347(2) -- -- --
General and administrative............ 5,430 4,882 4,912 3,844 4,215
Amortization of intangibles........... 1,591 968 -- -- --
Restructuring charge.................. -- 3,932(3) -- -- --
-------- -------- ------- -------- --------
Operating income (loss)................... (13,151) (30,371) (9,580) 16,897 21,160
Interest income, net...................... 1,104 1,398 1,639 944 938
Other income (expense).................... 7 (1,122) -- -- --
-------- -------- ------- -------- --------
Income (loss) before income taxes......... (12,040) (30,095) (7,941) 17,841 22,098
Income taxes (benefit).................... -- (4,345) (3,004) 6,790 8,420
-------- -------- ------- -------- --------
Net income (loss)......................... $(12,040) $(25,750) $(4,937) $ 11,051 $ 13,678
======== ======== ======= ======== ========
Dilutive earnings (loss) per share........ $ (0.65) $ (1.50) $ (0.30) $ 0.66 $ 0.81
======== ======== ======= ======== ========
Weighted average shares outstanding
assuming dilution......................... 18,565 17,190 16,437 16,825 16,876
======== ======== ======= ======== ========
</TABLE>

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

(1) In connection with the Company's restructuring plan, cost of sales in fiscal
1998 includes a $6.7 million charge to write-down the value of inventory
with reduced utility, generally associated with older technologies.

(2) The write-off of acquired in process research and development in the year
ending December 31, 1998, is comprised of $2.3 million resulting from the
Company's acquisition of Essential Communication

14
<PAGE>
Corporation and approximately $1.0 million resulting from the Company's
acquisition of Computer Misuse and Detection System assets from Science
Applications International Corporation.

(3) In connection with the Company's restructuring plan, the Company recorded a
$3.5 million charge to write off the value of certain fixed assets which are
no longer in use and to be disposed of and incurred approximately
$0.4 million in severance costs resulting from the Company's reduction in
workforce.

BALANCE SHEET DATA:

<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Working capital............................... $ 66,578 $31,763 $51,847 $54,529 $49,645
Total assets.................................. 120,502 61,710 77,178 81,935 71,685
Total liabilities............................. 38,925 12,204 10,799 10,997 12,987
Total stockholders' equity.................... 81,577 49,506 66,379 70,938 58,698
</TABLE>

See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Notes to the Consolidated Financial Statements.

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

"SAFE HARBOR" STATEMENT UNDER THE PRIVATE LITIGATION REFORM ACT OF 1995This
Annual Report, other than historical information, may include forward-looking
statements, including statements with respect to financial results, product
introductions, market demand, sales channels, industry trends, sufficiency of
cash resources and certain other matters. These statements are made under the
"safe harbor" provisions of the Private Securities Litigation Reform Act of 1995
and involve risks and uncertainties which could cause actual results to differ
materially from those in the forward-looking statements, including those
discussed in the section entitled "Factors That May Affect Future Results of
Operations" in Item 1 and elsewhere in this Annual Report on Form 10-K and other
filings with the Securities and Exchange Commission.

15
<PAGE>
RESULTS OF OPERATIONS

The following tables set forth, for the periods indicated, certain financial
data as a percentage of net sales.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net Sales:
Security products......................................... 13.7% 2.6% 0.0%
Networking products....................................... 86.3 97.4 100.0
----- ----- -----
Total net sales........................................... 100.0 100.0 100.0
Cost of sales:
Security products......................................... 6.7 1.3 0.0
Networking products....................................... 48.7 66.0 60.4
----- ----- -----
Total cost of sales....................................... 55.4 67.3 60.4
----- ----- -----
Gross profit................................................ 44.6 32.7 39.6
Operating expenses:
Sales and marketing....................................... 35.0 39.4 32.9
Research and development.................................. 20.2 16.4 11.7
In-process research and development....................... -- 4.5 --
General and administrative................................ 9.4 6.5 5.3
Amortization of intangibles............................... 2.7 1.3 --
Restructuring charge...................................... -- 5.3 --
----- ----- -----
Operating loss.............................................. (22.7) (40.7) (10.3)
Interest income, net........................................ 1.9 1.9 1.7
Other expense............................................... -- (1.5) --
----- ----- -----
Loss before income taxes.................................... (20.8) (40.3) (8.6)
Income tax benefit.......................................... -- (5.8) (3.3)
----- ----- -----
Net loss.................................................... (20.8)% (34.5)% (5.3)%
===== ===== =====
</TABLE>

<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Domestic sales.............................................. 87.5% 80.0% 72.8%
Export sales to:
Europe.................................................... 9.3 12.2 9.6
Canada.................................................... 1.2 3.0 3.6
Asia...................................................... 1.3 3.8 11.6
Latin America............................................. 0.7 1.0 2.4
----- ----- -----
Net sales................................................... 100.0% 100.0% 100.0%
===== ===== =====
</TABLE>

1999 COMPARED WITH 1998

NET SALES

Net sales decreased 22.3% to $58.0 million in 1999 from $74.6 million in
1998. This decrease occurred because sales of the Company's high performance
switching and security products did not increase quickly enough to offset the
decrease in sales of its prior generation shared bandwidth intelligent hubs and
commodity LAN switches. Net sales of the Company's security segment increased to
$8.0 million, or 13.7% of net sales, in 1999 compared to $1.9 million, or 2.6%
of net sales, in 1998. Net sales in the Company's networking segment decreased
to $50.0 million, or 86.3% of net sales, in 1999 compared to $72.7 million,

16
<PAGE>
or 97.4% of net sales, in 1998. The Company's goal is to transition an
increasing proportion of its net sales to data security and high performance
switching solutions in 2000.

Export sales in 1999 decreased to $7.2 million, or 12.5% of net sales,
compared to $14.9 million, or 20.0% of net sales in 1998 primarily due to slower
international acceptance of the Company's security products and a continued
decline in the Company's networking products.

Direct net sales to various agencies of the U.S. government (aggregated as
one) were 9.7% and 13.2%, respectively, of net sales in 1999 and 1998. Sales to
Microage Federal in 1999 and 1998 were 11.8% and 7.4%, respectively of net
sales. Sales to SGI, Inc. ("SGI") in 1999 and 1998 were 10.9% and 1.7%,
respectively of net sales. In addition, a portion of the Company's sales to
Microage Federal, SGI and other corporations were resold by those organizations
to various agencies of the U.S. Government.

GROSS PROFIT

Gross profit increased 5.7% to $25.8 million in 1999 from $24.4 million in
1998. As a percentage of net sales, gross profit increased to 44.6% for 1999
from 32.7% in 1998. Gross profit of the Company's security segment increased to
$4.1 million, or 51.3% of security net sales, in 1999 compared to $1.0 million,
or 49.6% of security net sales, in 1998. Gross profit of the Company's
networking segment decreased to $21.8 million, or 43.5% of networking net sales,
in 1999 compared to $23.4 million, or 32.2% of networking net sales, in 1998.

Gross profit as a percentage of net sales in 1999 was impacted by several
factors, including shifts in product mix, changes in channels of distribution,
sales volume, fluctuation in manufacturing costs, pricing strategies of the
Company and its competitors and fluctuations in sales of integrated third-party
products. Gross profit margins are typically lower on sales of integrated
third-party products. 1998 gross profit as a percentage of sales for the
Company's networking products was adversely affected due the Company's
restructuring plan implemented in the fourth quarter of 1998 in which the
company recorded a $6.7 million charge to cost of sales to write down the value
of inventory with reduced utility, generally associated with older technologies.

SALES AND MARKETING

Sales and marketing expenses decreased 31.0% to $20.3 million in 1999 from
$29.4 million in 1998. As a percentage of net sales, sales and marketing
expenses decreased to 35.0% in 1999 from 39.4% in 1998. The Company expects
sales and marketing expenses to increase in 2000 compared to 1999 as the Company
continues to invest in sales and marketing programs and personnel in its
security segment. Sales and marketing expenses may vary as a percentage of net
sales in the future.

RESEARCH AND DEVELOPMENT

Research and development expenses, excluding the 1998 one-time charges for
in-process research and development, decreased to $11.7 million, or 20.2% of net
sales, in 1999 compared to $12.2 million, or 16.4% of net sales, in 1998. The
Company's research and development costs are expensed in the period in which
they are incurred. The Company expects research and development expenses to
increase in 2000 compared to 1999 as the Company continues to invest in security
software and related products. Research and development expenses may vary as a
percentage of net sales in the future.

IN-PROCESS RESEARCH AND DEVELOPMENT

In 1998, the Company incurred one-time charges totaling $3.3 million
associated with the acquisition of Essential and certain assets of SAIC. Such
charges were necessary in order to expense the purchased in-process research and
development that had not yet reached technological feasibility.

17
<PAGE>
GENERAL AND ADMINISTRATIVE

General and administrative expenses, excluding amortization expenses,
increased 10.2% to $5.4 million in 1999 from $4.9 million in 1998. This increase
in general and administrative expense was due primarily to the formation of ODS
Investments, Inc. and the preparation to form Intrusion.com, Inc. The Company
expects general and administration expenses to increase in 2000 compared to 1999
as the Company establishes the legal, accounting and business infrastructure of
the Company's Security segment. As a percentage of net sales, general and
administrative expenses increased to 9.4% in 1999 from 6.5% in 1998. General and
administrative expenses may vary as a percentage of net sales in the future.

AMORTIZATION OF INTANGIBLES

Amortization of intangibles increased 60.0% to $1.6 million in 1999 from
$1.0 million in 1998. As a percentage of net sales, amortization of intangibles
increased to 2.8% in 1999 from 1.3% in 19998 related to the acquisition of
Essential and the acquisition of certain assets of SAIC in May 1998 and
September 1998, respectively. Amortization expenses may vary as a percentage of
net sales in the future.

INTEREST INCOME, NET

Interest income decreased 21.4% to $1.1 million in 1999 from $1.4 million in
1998 primarily due to a decrease in the Company's average cash and
interest-bearing investment balances during 1998. As a percentage of net sales,
interest income was 1.9% in both 1999 and 1998. Net interest income may vary in
the future based on the Company's cash flow and rate of return on investments.

INCOME TAXES

The Company's effective income tax rate was 0% in 1999 compared to an income
tax benefit of 14.4% in 1998. The Company fully utilized its net operating loss
carryback in 1998. The Company did not record an income tax benefit as of
December 31, 1999 related to the net operating losses which can be carried
forward to offset taxable income in future years. The Company will recognize the
benefit of its net operating loss carryforwards at such time as the Company
generates taxable income and can be assured that such net operating loss
carryforwards can be utilized. See Note 11 of the Notes to Consolidated
Financial Statements.

1998 COMPARED WITH 1997

NET SALES

Net sales in 1998 decreased to $74.6 million from $92.3 million in 1997 as
sales of the Company's new network switching and security products did not
increase quickly enough to offset the decrease in sales of its prior generation
shared bandwidth intelligent hubs.

Export sales in 1998 decreased to $14.9 million, or 20.0% of net sales,
compared to $25.1 million, or 27.2% of net sales in 1997 primarily due to
adverse economic developments in Malaysia and South Korea.

Direct net sales to various agencies of the U.S. government (aggregated as
one) were 13.2% and 11.7%, respectively of net sales in 1998 and 1997. Sales to
EDS in 1998 and 1997 were 7.0% and 16.1%, respectively of net sales. In
addition, a portion of the Company's sales to EDS and other corporations were
resold by those organizations to various agencies of the U.S. Government.

GROSS PROFIT

Gross profit decreased to $24.4 million or 32.7% of net sales in 1998
compared to $36.5 million or 39.6% of net sales in 1997. Gross profit as a
percentage of net sales in 1998 was impacted by several factors, including the
Company's restructuring plan, an increase in reserves for slow-moving inventory
of

18
<PAGE>
such prior generation products, product mix and lower sales volumes. In
connection with the change of the Company's product focus under the Company's
restructuring plan, the company recorded a $6.7 million charge to cost of sales
to write down the value of inventory with reduced utility, generally associated
with older technologies. In the fourth quarter of 1998, the Company implemented
a more extensive manufacturing outsourcing and vendor consolidation program and
reduced its headcount of manufacturing operations staff by approximately 72
positions as part of a restructuring plan designed to improve performance.

SALES AND MARKETING

Sales and marketing expenses decreased to $29.4 million in 1998 from
$30.4 million in 1997. As a percentage of net sales, sales and marketing
expenses increased to 39.4% in 1998 from 32.9% in 1997.

RESEARCH AND DEVELOPMENT

Research and development expenses, excluding the one-time charges for
in-process research and development, increased to $12.2 million or 16.4% of net
sales in 1998 compared to $10.8 million or 11.7% of net sales in 1997. The
increase in research and development expenses was primarily due to an increase
in the number of development personnel and increased costs related to the
acquisition of Essential's engineering personnel in May of 1998 and the hiring
of certain CMDS research and development personnel in September 1998.

IN-PROCESS RESEARCH AND DEVELOPMENT

The Company incurred one-time charges associated with the acquisition of
Essential and the acquisition of certain assets of SAIC of $3.3 million in 1998
to expense the purchased in-process research and development that had not
reached technological feasibility.

GENERAL AND ADMINISTRATIVE

General and administrative expenses, excluding amortization expenses,
remained constant at $4.9 million in 1998 and 1997. General and administrative
expenses increased as a percentage of net sales to 6.5% in 1998 from 5.3% of net
sales in 1997.

AMORTIZATION

The Company incurred $1.0 million of amortization expense in 1998 primarily
associated with the amortization of intangible assets related to the acquisition
of Essential and the acquisition of certain assets of SAIC.

19
<PAGE>
RESTRUCTURING CHARGE

On December 31, 1998, the Company's management, with the approval of the
Board of Directors (the "Board") committed to and implemented a series of
measures to refocus the Company's efforts on long-term strategic objectives. The
restructuring plans are designed to focus the Company's efforts on
high-performance network and data security solutions while reducing the
Company's cost structure and improving its responsiveness to customers,
operating efficiencies, and return on assets. The necessity of restructuring to
focus on key growth opportunities was required due to the Company's performance
levels resulting from declining markets for modular shared media hubs and
intense competition in the rapidly consolidating local area network market.

The restructuring plan included (i) writing down the value of inventory
associated with older technologies, (ii) the write-off of certain fixed assets,
(iii) preparation for closure of one of the two facilities in Richardson, Texas,
(iv) the reorganization and/or closure of certain sales offices,
(v) streamlining of research, product development and other functional
activities, and (vi) workforce reductions.

The Company also recorded a $3.5 million restructuring charge to write off
the value of certain fixed assets which are no longer in use and are to be
disposed of.

Implementation of the plan in the fourth quarter of 1998 resulted in
workforce reductions of approximately 45 professional staff positions and
approximately 72 manufacturing operations positions. Overall employment at the
Company decreased, predominately due to the restructuring, from approximately
415 employees in September 1998 to approximately 265 employees as of
December 31, 1998, a decrease of 150 employees. In connection with these cost
reduction actions, the Company incurred approximately $0.4 million of severance
costs. The Company recognized a liability and expense for the cost of the
involuntary termination benefits in fiscal 1998 as the Company's management
approved the plan of termination during fiscal 1998 and terminations were
complete as of December 31, 1998.

INTEREST INCOME, NET

Interest income decreased to $1.4 million in 1998 compared to $1.6 million
in 1997 primarily due to a decrease in the Company's average cash and investment
balances during 1998. As a percentage of net sales, interest income was 1.9% in
1998 and 1.7% in 1997.

INCOME TAXES

The Company's effective income tax rate decreased to 14.4% in 1998 compared
to 37.8% in 1997. The Company's income tax benefit for 1998 primarily reflects
the amount that the Company expects to recover as a refund of income taxes paid
by the Company in prior years. The Company did not record an income tax benefit
as of December 31, 1998 related to the net operating losses which can be carried
forward to offset taxable income in future years.

LIQUIDITY AND CAPITAL RESOURCES

The Company's principal sources of liquidity at December 31, 1999 were
$12.6 million of cash and cash equivalents, $6.1 million of short-term
investments and $2.8 million of investments with a stated maturity beyond one
year. As of December 31, 1999, working capital was $66.6 million compared to
$31.8 million as of December 31, 1998.

Net cash flows used in operating activities in 1999 were $1.3 million,
primarily due to a net loss for the year partially offset by a decrease in
income tax receivable and an increase in accounts payable. Future fluctuations
in accounts receivable, inventory balances and accounts payable will be
dependent upon several factors, including but not limited to quarterly sales,
ability to collect accounts receivable timely, and the accuracy of the Company's
forecasts of product demand and component requirements.

20
<PAGE>
Net cash used in investing activities in 1999 was $2.9 million, consisting
of $4.1 million for net purchases of investments and $1.4 million for purchases
of property and equipment, partially offset by proceeds of $2.6 million from the
sale of real property.

Net cash provided by financing activities in 1999 was $0.09 million,
consisting of $0.4 million related to the exercise of certain employee stock
options, partially offset by the repurchase of $0.4 million of the Company's
common stock.

The Company held 770,745 shares of the common stock of Alteon
WebSystems, Inc. ("Alteon") (Nasdaq:ATON) valued at $67.6 million as of
December 31, 1999. Alteon, previously a privately-held company, announced its
initial public offering of 4 million shares of its common stock at $19 per share
on September 24, 1999. The closing selling price per share of Alteon common
stock as reported on the Nasdaq National Market on December 31, 1999 was $87.75
per share. The Company entered into a lock-up agreement with the representatives
of the underwriters for Alteon pursuant to which the Company had agreed, among
other things, not to sell shares of Alteon held by the Company for a period of
150 days from the date of the final prospectus related to the offering. This
lock-up expired on February 20, 2000. On March 2, 2000, the Company sold the
Alteon stock for $87.00, net, per share generating cash of $67.1 million.

On October 14, 1999, the Company announced a stock repurchase program under
which up to 1.0 million shares of the Company's outstanding common stock may be
acquired in the open market over the next 12 months at the discretion of
management. In the fourth quarter of 1999, the Company repurchased 40,000 shares
at an average price of $9.05 per share.

Pursuant to the terms of the acquisition of certain assets of the CMDS
division of SAIC in September 1998, the Company issued 1.5 million warrants to
SAIC; 750,000 were granted at $8.00 per share and expire March 25, 2000 and
750,000 were granted at $10.50 per share and expire September 25, 2000.

At December 31, 1999, the Company did not have any material commitments for
capital expenditures. During 1999, the Company funded its operations solely
through cash flows from operations.

The Company believes that its cash, cash equivalents and investment balances
will provide sufficient cash resources to finance its operations and currently
projected capital expenditures through 2000. However, there can be no assurance
the Company's cash resources will be sufficient for 2000.

The Company intends to explore the possible acquisitions of businesses,
products and technologies that are complementary to those of the Company. The
Company is continuing to identify and prioritize additional networking and
security technologies which it may wish to develop, either internally or through
the licensing or acquisition of products from third parties. While the Company
engages from time to time in discussions with respect to potential acquisitions,
there can be no assurances that any such acquisitions will be made or that the
Company will be able to successfully integrate any acquired business. In order
to finance such acquisitions, it may be necessary for the Company to raise
additional funds through public or private financings. Any equity or debt
financings, if available at all, may be on terms which are not favorable to the
Company and, in the case of equity financings, may result in dilution to the
Company's stockholders.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Foreign Exchange. The Company's revenue originating outside the U.S. in
1999, 1998 and 1997 was 12.5%, 20.0% and 27.2% of total revenues, respectively.
Revenues generated from the European region in 1999, 1998 and 1997 was 9.3%,
12.2% and 9.6% of total revenues, respectively. International sales are made
mostly from the Company's foreign sales subsidiaries in the local countries and
are typically denominated in U.S. dollars. These subsidiaries incur most of
their expenses in the local currency.

21
<PAGE>
The Company's international business is subject to risks typical of an
international business, including, but not limited to: differing economic
conditions, changes in political climate, differing tax structures, import and
export regulations, other regulations and restrictions, and foreign exchange
rate volatility. Accordingly, the Company's future results could be materially
adversely impacted by changes in these or other factors. The effect of foreign
exchange rate fluctuations on the Company in 1999, 1998 and 1997 was not
material.

INTEREST RATES. The Company invests its cash in a variety of financial
instruments, including bank time deposits, fixed rate obligations of
corporations, municipalities, and state and national governmental entities and
agencies. These investments are denominated in U.S. dollars. Cash balances in
foreign currencies overseas are operating balances and are invested in
short-term time deposits of the local operating bank.

Interest income on the Company's investments is carried in "Interest income,
net." The Company accounts for its investment instruments in accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"). All of the cash
equivalents and short-term investments are treated as available-for-sale under
SFAS 115.

Investments in fixed rate interest earning instruments carry a degree of
interest rate risk. Fixed rate securities may have their fair market value
adversely impacted due to a rise in interest rates. Due in part to these
factors, the Company's future investment income may fall short of expectations
due to changes in interest rates or the Company may suffer losses in principal
if forced to sell securities which have seen a decline in market value due to
changes in interest rates. The Company's investment securities are held for
purposes other than trading. Certain of the investment securities had maturities
in excess of one year. The weighted-average interest rate on investment
securities at December 31, 1999 was 5.0%. The fair value of investments held at
December 31, 1999 approximated amortized cost.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The information required by this item is included in Part IV Item 14(a)(1
and 2).

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

Not applicable.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND OFFICERS OF THE REGISTRANT.

DIRECTORS

The information regarding Directors of the Company appearing under the
captions "Election of Directors" and "Compliance with Section 16 Reporting
Requirements" contained in the Company's

22
<PAGE>
definitive Proxy Statement filed in connection with the Company's 2000 Annual
Meeting of Stockholders is incorporated herein by reference.

EXECUTIVE OFFICERS

The following table sets forth the names and ages of all executive officers
of the Company, their respective positions with the Company, and the period
during which each has served as an officer.

<TABLE>
<CAPTION>
SERVED AS
NAME AGE POSITION(S) OFFICER SINCE
- ---- -------- ------------------------------------- -------------
<S> <C> <C> <C>
G. Ward Paxton 64 Chairman of the Board of Directors, 1983
President and Chief Executive Officer

T. Joe Head 43 Executive Vice President and Director 1983

Timothy W. Kinnear 36 Executive Vice President, Chief 1996
Operating Officer, Corporate
Secretary and Director

Billy E. Austin 29 Vice President--Marketing 1999

Patrick R. Gooden 52 Vice President--Operations and 2000
Engineering

Eric H. Gore 46 Vice President--Strategic Business 1994
Development

John W. Howland 40 Vice President--North American Sales 1998

Jay R. Widdig 36 Vice President, Chief Financial 1999
Officer and Treasurer
</TABLE>

G. WARD PAXTON is a co-founder of the Company and has served as Chairman of
the Board of Directors, President and Chief Executive Officer since the
Company's inception in September 1983 and served as Chief Financial Officer from
1983 until 1994. Prior to founding the Company, Mr. Paxton was Vice President of
Honeywell Optoelectronics, a division of Honeywell, Inc., from 1978 to 1983.
From 1969 to 1978, Mr. Paxton was Chairman of the Board of Directors, President,
Chief Executive Officer and founder of Spectronics, Inc., which was acquired by
Honeywell, Inc. in 1978. Prior to founding Spectronics, Inc., Mr. Paxton held
various managerial and technical positions at Texas Instruments Incorporated
from 1959 to 1969. Mr. Paxton holds Ph.D., M.S. and B.S. degrees in Physics from
the University of Oklahoma.

T. JOE HEAD is co-founder of the Company and has served as Executive Vice
President since 1998 and a Senior Vice President and a director since the
Company's inception in September 1983. Prior to co-founding the Company,
Mr. Head held the positions of Product Marketing Manager and Marketing Engineer
at Honeywell Optoelectronics from 1980 to 1983. Mr. Head holds a B.S. degree in
Electrical Engineering from Texas A & M University.

TIMOTHY W. KINNEAR has served as Executive Vice President, Chief Operating
Officer and director of the Company since November 1998 and has served as
Corporate Secretary of the Company since September 1996. Mr. Kinnear joined the
Company in September 1996 as Vice President, Chief Financial Officer and
Treasurer. Prior to joining the Company, Mr. Kinnear held various managerial
positions, including Vice President of Finance, at Cyrix Corporation from 1992
to 1996. Prior to joining Cyrix Corporation, Mr. Kinnear held various positions,
including Audit Manager, at Ernst & Young LLP from 1986 to 1992. Mr. Kinnear
holds a B.B.A. degree in Accounting from Texas Tech University.

23
<PAGE>
BILLY E. AUSTIN has served the Company as Vice President--Marketing since
June 1999. Prior to joining the Company, Mr. Austin served as general manager at
Verisign SecureIT Services. Previously, Mr. Austin managed business development
at Enstar Networking Corporation. Mr. Austin holds a degree in Science and Math
from Mountain View College.

PATRICK R. GOODEN has served the Company as Vice President--Operations and
Engineering since February 2000. Between 1992 and 1999, Mr. Gooden served in a
number of management assignments with Thomas Group, Inc., including Vice
President of Operations--Europe, Corporate Vice President and most recently as
Senior Vice President. Previously, from 1967 to 1992, Mr. Gooden served Texas
Instruments Incorporated in various management positions where he led
engineering and operations teams and implemented world-class manufacturing
practices. Mr. Gooden holds a M.B.A. from Southern Methodist University and a
B.A. degree in Business Administration and Economics from Austin College.

ERIC H. GORE has served the Company as Vice President--Strategic Business
Development since February 1994. Mr. Gore previously held positions with the
Company as Director of Strategic Business Development from 1992 to 1994, Area
Sales Manager from 1989 to 1992 and Regional Sales Manager from 1984 to 1989.
Prior to joining the Company, Mr. Gore served Texas Instruments Incorporated as
Marketing Manager--Eastern United States from 1982 to 1983 and Product Marketing
Representative from 1979 to 1982. Mr. Gore holds a M.B.A. degree from
Hardin-Simmons University and a Bachelor of Business Administration degree from
the University of North Texas.

JOHN W. HOWLAND has served the Company as Vice President--North American
Sales since October 1998. Mr. Howland previously held positions with the Company
as Director of Federal Sales from 1995 to 1998, Regional Sales Manager from 1993
to 1995 and Account Manager from 1991 to 1993. Prior to joining the Company,
Mr. Howland held the position of Program Manager for American Systems
Corporation from 1986 to 1991 and Design Engineer for Media General Cable from
1981 to 1986. Mr. Howland holds a B.A. degree in Psychology with a
specialization in Industrial Psychology and Mass Communications from the
University of Delaware.

JAY R. WIDDIG has served the Company as Vice President, Chief Financial
Officer and Treasurer since December 1999 and previously held the position of
Corporate Controller and Chief Accounting Officer from April 1999 to
December 1999. Prior to joining the Company, Mr. Widdig held various managerial
positions, including senior director of finance and administration, at Cyrix
Corporation from 1992 to 1999. From 1985 to 1992, Mr. Widdig served Texas
Instruments Incorporated and Halliburton Company in various financial positions.
Mr. Widdig holds a M.B.A. degree from Oklahoma City University and a B.S. degree
in Accounting from Cameron University.

Neither the Company nor any of its subsidiaries has employment agreements
with any of its executives.

All executive officers of the Company are elected annually by the Board of
Directors and serve at the discretion of the Board. There are no other family
relationships between any director or executive officer and any other such
person.

ITEM 11. EXECUTIVE COMPENSATION.

The information set forth under the caption "Executive Compensation"
contained in the Company's definitive Proxy Statement filed in connection with
the 2000 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" contained in the Company's definitive Proxy
Statement filed in connection with the 2000 Annual Meeting of Stockholders is
incorporated herein by reference.

24
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information set forth under the caption "Certain Transactions" contained
in the Company's definitive Proxy Statement filed in connection with the 2000
Annual Meeting of Stockholders is incorporated herein by reference.

PART IV

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

(a) 1.CONSOLIDATED FINANCIAL STATEMENTS.

The following consolidated financial statements of ODS Networks, Inc. and
subsidiaries, are submitted as a separate section of this report (See F-pages,
and are incorporated by reference in Item 8:

<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Report of Independent Auditors.............................. F-1
Consolidated Balance Sheets at December 31, 1999 and 1998... F-2
Consolidated Statements of Income for the years ended
December 31, 1999, 1998 and 1997.......................... F-3
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1999, 1998 and 1997.............. F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.......................... F-5
Notes to Consolidated Financial Statements.................. F-6
</TABLE>

2. FINANCIAL STATEMENT SCHEDULES.

<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Schedule II--Valuation and Qualifying Accounts.............. S-1
</TABLE>

All other schedules are omitted because they are either not required or not
applicable or the required information is shown in the Consolidated Financial
Statements or Notes thereto.

(b) REPORTS ON FORM 8-K.

On October 15, 1999 the Company filed a Current Report on Form 8-K (Item
5) in order to report the authorization of a stock repurchase program pursuant
to which the Company may repurchase up to 1.0 million shares of the Company's
outstanding common stock on the open market over the 12 month period ending
October 14, 2000.

25
<PAGE>
(c) EXHIBITS

The following Exhibits are filed herewith pursuant to Item 601 of
Regulation S-K or corporated herein by reference to previous filings as noted:

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- --------------------- ------------------------------------------------------------
<S> <C>
3.1(1) Certificate of Incorporation of the Registrant.

3.2(1) Bylaws of the Registrant.

4.1(2) Speciman of Common Stock Certificate.

10.1(3) Lease Agreement, dated September 12, 1989, between G.D.A.F.
Associates and the Registrant for the Registrant's
headquarters and executive office building.

10.2(3) 1983 Incentive Stock Option Plan of ODS Networks, Inc.
(formerly Optical Data Systems, Inc.), as amended.

10.3(3) 1987 Incentive Stock Option Plan of ODS Networks,
Inc.(formerly Optical Data Systems, Inc.), as amended.

10.5(3) Form of Indemnification Agreement.

10.6(7) Amended and Restated ODS 401(k) Savings Plan, effective
April 1, 1997.

10.7(7) Amendment to the ODS 401(K) Savings Plan, effective November
1, 1997.

10.8(4) 1995 Stock Option Plan of ODS Networks, Inc. (formerly
Optical Data Systems, Inc.)

10.9(4) 1995 Non-Employee Directors Stock Option Plan of ODS
Networks, Inc.(formerly Optical Data Systems, Inc.)

10.11(5) Supplemental Lease Agreement, dated March 7, 1995, between
G.D.A.F. Associates, subsequently assigned to CIIF
Associates II Limited Partnership, Landlord, and the
Registrant, as Tenant, relative to the Registrant's
headquarters and executive office building.

10.12(6) 1997 Employee Stock Purchase Plan of ODS Networks,
Inc.(formerly Optical Data Systems, Inc.)

10.13(10) Amendment to the ODS 401(K) Savings Plan, effective May 29,
1998.

10.14(10) Amendment to the ODS 401(K) Savings Plan, effective October
1, 1998.

10.15(8) Asset and Securities Purchase Agreement, dated as of
September 25,1998, by and among the Registrant and Science
Applications International Corporation.

10.16(8) Registration Rights Agreement, dated as of September 25,
1998, by and between the Registrant and Science Applications
International Corporation.

10.17(8) $8.00 Warrant to Purchase Common Stock of the Registrant,
dated September 25, 1998, issued to Science Applications
International Corporation.

10.18(8) $10.50 Warrant to Purchase Common Stock of the Registrant,
dated September 25, 1998, issued to Science Applications
International Corporation.

10.19(8) Stockholder and Voting Agreement, dated as of September 25,
1998, by and among Science Applications International
Corporation, the Registrant and certain stockholders of the
Registrant.
</TABLE>

26
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- --------------------- ------------------------------------------------------------
<S> <C>
10.20(8) Strategic Alliance Agreement, dated as of September 25,
1998, by and between Science Applications International
Corporation and the Registrant.

10.21(8) Software Royalty, Grant Back and Improvements License
Agreement, dated as of September 25, 1998, by and between
Science Applications International Corporation and the
Registrant.

10.22(8) PartnersPlus Agreement, dated September 25, 1998, by and
between the Registrant and Science Applications
International Corporation.

10.23(9) Agreement and Plan of Merger, dated April 30, 1998, by and
among the Registrant, ECC Acquisition Corp., and Essential
Communication Corporation.

21(10) List of Subsidiaries of the Registrant

23(10) Consent of Independent Auditors

27(10) Financial Data Schedule
</TABLE>

(1) Filed as an Exhibit in the Registrant's Current Report on Form 8-K dated
November 6, 1995 (Date of Earliest Event Reported: October 31, 1995;
Commission File No. 0-20191), which Exhibit is incorporated herein by
reference.

(2) Filed as an Exhibit in the Registrant's Current Report on Form 8-K dated
May 7, 1997 (Date of Earliest Event Reported: April 24, 1997; Commission
File No. 0-20191), which Exhibit is incorporated herein by reference.

(3) Filed as an Exhibit in the Registrant's Registration Statement on Form S-1,
as amended (File No. 33-6899) which was declared effective on May 21, 1992,
by the Securities and Exchange Commission, which Exhibit is incorporated
herein by reference.

(4) Filed as an Exhibit to the Registrant's definitive Proxy Statement in
connection with the solicitation of proxies for its 1995 Annual Meeting of
Stockholders (File No. 0-20191), which Exhibit is incorporated herein by
reference.

(5) Filed as an Exhibit in the Registrant's Annual Report on Form 10-K, for the
fiscal year ended December 31, 1995 (File No. 0-20191), which Exhibit is
incorporated herein by reference.

(6) Filed as an Exhibit in the Registrant's definitive Proxy Statement filed in
connection with the solicitation of proxies for its 1997 Annual Meeting of
Stockholders (File No. 0-20191), which Exhibit is incorporated herein by
reference.

(7) Filed as an Exhibit in the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997 (File No. 0-20191), which Exhibit is
incorporated herein by reference.

(8) Filed as an Exhibit in the Registrant's Current Report on Form 8-K
(Item 5), dated October 13, 1998 (File No. 0-20191), which Exhibit is
incorporated herein by reference.

(9) Filed as an Exhibit in the Registrant's Current Report on Form 8-K
(Item 2), dated May 21, 1998 (File No. 0-20191), which Exhibit is
incorporated herein by reference.

(10) Filed herewith.

27
<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.

<TABLE>
<S> <C> <C>
ODS NETWORKS, INC.
Dated: March 10, 2000 (REGISTRANT)

By: /s/ G. WARD PAXTON
-----------------------------------------
G. Ward Paxton
CHAIRMAN OF THE BOARD OF DIRECTORS,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
</TABLE>

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

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
Chairman of the Board of
/s/ G. WARD PAXTON Directors, President and
------------------------------------------- Chief Executive Officer March 10, 2000
G. Ward Paxton (Principal Executive
Officer)

Executive Vice President,
/s/ TIMOTHY W. KINNEAR Chief Operating Officer,
------------------------------------------- Corporate Secretary, March 10, 2000
Timothy W. Kinnear and Director

/s/ T. JOE HEAD
------------------------------------------- Executive Vice President March 10, 2000
T. Joe Head and Director

/s/ J. FRED BUCY
------------------------------------------- Director March 10, 2000
J. Fred Bucy

/s/ DONALD M. JOHNSTON
------------------------------------------- Director March 10, 2000
Donald M. Johnston
</TABLE>

28
<PAGE>

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ WILLIAM A. ROPER, JR.
------------------------------------------- Director March 10, 2000
William A. Roper, Jr.

/s/ DOUGLAS M. SCHRIER
------------------------------------------- Director March 10, 2000
Douglas M. Schrier

Vice President, Chief
/s/ JAY R. WIDDIG Financial Officer
------------------------------------------- and Treasurer March 10, 2000
Jay R. Widdig (Prinicpal Financial and
Accounting Officer)
</TABLE>

29
<PAGE>
ANNUAL REPORT ON FORM 10-K
ITEM 14(A)(1)
LIST OF FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999
ODS NETWORKS, INC.
RICHARDSON, TEXAS
<PAGE>
REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders,
ODS Networks, Inc.

We have audited the accompanying consolidated balance sheets of ODS
Networks, Inc., and subsidiaries (the "Company") as of December 31, 1999, and
1998, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of ODS
Networks, Inc., and its subsidiaries at December 31, 1999 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1999, in conformity with accounting
principles generally accepted in the United States.

[LOGO]

Dallas, Texas
January 19, 2000,
except for Note 16 which date is March 2, 2000

F-1
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 12,602 $16,791
Securities available for sale............................. 67,633 --
Short-term investments.................................... 6,100 4,760
Accounts receivable, net of allowance for doubtful
accounts and returns of $1,171 in 1999 and $880
in 1998................................................. 5,404 6,265
Income taxes receivable................................... -- 4,749
Inventories (Note 6)...................................... 10,692 9,262
Other assets.............................................. 1,392 759
-------- -------
Total current assets........................................ 103,823 42,586

Property and Equipment
Land...................................................... -- 602
Building and building improvements........................ -- 2,511
Machinery and equipment................................... 10,427 8,760
Furniture and fixtures.................................... 1,364 1,294
Leasehold improvements.................................... 1,060 970
-------- -------
12,851 14,137
Accumulated depreciation.................................. (8,630) (6,510)
-------- -------
4,221 7,627
Long-term investments....................................... 2,750 700
Goodwill and intangible assets, net (Note 6)................ 9,023 10,614
Other assets................................................ 685 183
-------- -------
TOTAL ASSETS................................................ $120,502 $61,710
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses (Note 6)............ $ 11,901 $ 7,700
Deferred revenue.......................................... 2,039 3,123
Deferred taxes--current (Note 11)......................... 23,305 --
-------- -------
Total current liabilities................................... 37,245 10,823

Deferred taxes--noncurrent (Note 11)........................ 1,669 1,361
Capital lease obligation.................................... 11 20
Stockholders' Equity (Note 12):

Preferred stock, $.01 par value:
Authorized shares--5,000................................
No shares issued and outstanding........................ -- --
Common stock, $.01 par value:
Authorized shares--80,000...............................
Issued shares--18,623 in 1999 and 18,513 in 1998........
Outstanding shares--18,583 in 1999 and 18,513 in 1998... 186 185
Additional paid-in-capital................................ 29,996 29,551
Common stock held in Treasury, at cost--40 shares in
1999.................................................... (362) --
Net unrealized gain on securities available for sale...... 44,083 --
Retained earnings......................................... 9,242 21,282
Note receivable from stockholder.......................... (1,177) (1,189)
Foreign currency translation adjustments.................. (391) (323)
-------- -------
Total stockholders' equity.................................. 81,577 49,506
-------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $120,502 $61,710
======== =======
</TABLE>

See accompanying notes.

F-2
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net Sales:
Security products......................................... $ 7,963 $ 1,920 $ --
Networking products....................................... 49,988 72,690 92,327
-------- -------- --------
Total net sales........................................... 57,951 74,610 92,327
Cost of sales:
Security products......................................... 3,877 968 --
Networking products....................................... 28,227 49,262 55,795
-------- -------- --------
Total cost of sales....................................... 32,104 50,230 55,795
-------- -------- --------
Gross profit................................................ 25,847 24,380 36,532
Operating expenses:
Sales and marketing....................................... 20,277 29,378 30,390
Research and development.................................. 11,700 12,244 10,810
In process research and development....................... -- 3,347 --
General and administrative................................ 5,430 4,882 4,912
Amortization of intangibles............................... 1,591 968 --
Restructuring charge...................................... -- 3,932 --
-------- -------- --------
Operating loss............................................ (13,151) (30,371) (9,580)
Interest income, net........................................ 1,104 1,398 1,639
Other income (expense)...................................... 7 (1,122) --
-------- -------- --------
Loss before income taxes.................................... (12,040) (30,095) (7,941)
Income tax benefit.......................................... -- (4,345) (3,004)
-------- -------- --------
Net loss.................................................... $(12,040) $(25,750) $ (4,937)
======== ======== ========
Basic and Dilutive loss per share........................... $ (0.65) $ (1.50) $ (0.30)
======== ======== ========
Weighted average shares outstanding......................... 18,565 17,190 16,437
======== ======== ========
Weighted average shares outstanding assuming dilution....... 18,565 17,190 16,437
======== ======== ========
</TABLE>

See accompanying notes.

F-3
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998 1997
- ----------------------- -------- -------- --------
<S> <C> <C> <C>
NUMBER OF SHARES--ISSUED
Balance, beginning of year................................ 18,513 16,486 16,328
Exercise of stock warrants................................ -- -- 59
Issuance of common stock under stock option and purchase
plans................................................... 110 121 99
Issuance of common stock for Essential Communication
acquisition............................................. -- 306 --
Issuance of common stock for SAIC transaction............. -- 1,600 --
-------- -------- -------
Balance, end of year...................................... 18,623 18,513 16,486
-------- -------- -------
NUMBER OF SHARES--OUTSTANDING
Balance, beginning of year................................ 18,513 16,486 16,328
Exercise of stock warrants................................ -- -- 59
Issuance of common stock under stock option and purchase
plans................................................... 110 121 99
Issuance of common stock for Essential Communication
acquisition............................................. -- 306 --
Repurchase of common stock into treasury.................. (40) -- --
Issuance of common stock for SAIC transaction............. -- 1,600 --
-------- -------- -------
Balance, end of year...................................... 18,583 18,513 16,486
-------- -------- -------
COMMON STOCK
Balance, beginning of year................................ $ 185 $ 165 $ 163
Exercise of stock warrants................................ -- -- 1
Issuance of common stock under stock option and purchase
plans................................................... 1 1 1
Issuance of common stock for Essential Communication
acquisition............................................. -- 3 --
Issuance of common stock for SAIC transaction............. -- 16 --
-------- -------- -------
Balance, end of year...................................... $ 186 $ 185 $ 165
-------- -------- -------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of year................................ $ 29,551 $ 19,488 $18,908
Exercise of stock warrants................................ -- -- 266
Issuance of common stock under stock option and purchase
plans................................................... 378 383 287
Issuance of common stock for Essential Communication
acquisition............................................. -- 2,941 --
Issuance of common stock for SAIC transaction............. -- 6,704 --
Tax benefit derived from exercise of employee stock
options................................................. 67 35 27
-------- -------- -------
Balance, end of year...................................... $ 29,996 $ 29,551 $19,488
-------- -------- -------
TREASURY SHARES
Balance, beginning of year................................ $ -- $ -- $ --
Purchase of treasury shares............................... (362) -- --
-------- -------- -------
Balance, end of year...................................... $ (362) $ -- $ --
-------- -------- -------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of year................................ $ (323) $ (306) $ (102)
Foreign currency translation adjustment (a)............... (68) (17) (204)
Unrealized gain from securities available for sale (b).... 44,083 -- --
-------- -------- -------
Balance, end of year...................................... $ 43,692 $ (323) $ (306)
-------- -------- -------
NOTE RECEIVABLE FROM STOCKHOLDER
Balance, beginning of year................................ $ (1,189) $ -- $ --
Note receivable from stockholder.......................... -- (1,265) --
Repayments on stockholder loan............................ 12 76 --
-------- -------- -------
Balance, end of year...................................... $ (1,177) $ (1,189) $ --
-------- -------- -------
RETAINED EARNINGS
Balance, beginning of year................................ $ 21,282 $ 47,032 $51,969
Net loss (c).............................................. (12,040) (25,750) (4,937)
-------- -------- -------
Balance, end of year...................................... $ 9,242 $ 21,282 $47,032
-------- -------- -------
TOTAL STOCKHOLDERS' EQUITY.................................. $ 81,577 $ 49,506 $66,379
======== ======== =======
TOTAL COMPREHENSIVE INCOME (LOSS) (a+b+c)................... $ 31,975 $(25,767) $(5,141)
======== ======== =======
</TABLE>

See accompanying notes.

F-4
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Operating Activities:
Net loss.................................................. $(12,040) $(25,750) $ (4,937)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Loss on sale of property and equipment.................... (7) -- --
Depreciation and amortization............................. 3,840 4,601 3,285
In process research and development....................... -- 3,347 --
Impaired investment in affiliate.......................... -- 1,122 --
Non-cash restructuring charge............................. -- 3,460 --
Provision for deferred income taxes....................... 763 979 (195)
Provision for doubtful accounts and returns............... 85 147 86
Changes in operating assets and liabilities:
Accounts receivable..................................... 776 3,115 7,819
Income tax receivable................................... 4,749 (1,555) (3,047)
Inventories............................................. (1,430) 5,755 10,902
Other assets............................................ (1,135) 349 (316)
Accounts payable and accrued expenses................... 4,201 (1,924) 26
Deferred revenue........................................ (1,084) 1,061 (251)
-------- -------- --------
Net cash provided by (used in) operating activities......... (1,282) (5,293) 13,372
Investing Activities:
Equity investment in affiliate............................ -- (1,250) --
Payments for corporate acquisition (net of cash
required)............................................... -- (5,604) --
Proceeds from sale of property and equipment.............. 2,611 -- --
Purchases of available for sale investments............... (16,372) (4,043) (23,632)
Maturities of available for sale investments.............. 12,282 17,118 24,637
Purchases of property and equipment....................... (1,446) (2,333) (3,382)
-------- -------- --------
Net cash provided by (used in) investing activities......... (2,925) 3,888 (2,377)
Financing Activities:
Issuance of common stock and warrants..................... -- 1,500 --
Note receivable secured by company's common stock......... 12 (1,189) --
Repayment of line of credit............................... -- (400) --
Exercise of warrants...................................... -- -- 267
Exercise of employee stock options........................ 445 384 288
Capital lease obligation.................................. (9) 7 --
Purchase of treasury stock................................ (362) -- --
-------- -------- --------
Net cash provided by financing activities................... 86 302 555
-------- -------- --------
Effect of foreign currency translation adjustment on cash
and cash equivalents...................................... (68) (17) (204)
Net increase (decrease) in cash and cash equivalents........ (4,189) (1,120) 11,346
Cash and cash equivalents at beginning of period............ 16,791 17,911 6,565
-------- -------- --------
Cash and cash equivalents at end of period.................. $ 12,602 $ 16,791 $ 17,911
======== ======== ========
</TABLE>

See accompanying notes.

F-5
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS

ODS Networks, Inc. ("ODS", the "Company" or the "Registrant") is a provider
of enterprise data security and networking solutions including switches, network
management and security software and related products that securely link
computer networks. The Company's products enable customers to connect computers
and supercomputers to form clusters, workgroups and local area networks
("LANs"), to build backbones for enterprise-wide networks, and to create
networks that are protected from access, theft and damage by unauthorized
network users and protected from misuse by curious or disgruntled employees,
contractors and other authorized users.

The Company operates through two divisions or segments: the Security
division which focuses on security software and integrated solutions and the
Networking division which focuses on high performance network solutions.

The Company markets and distributes its products through a direct sales
force to end users, distributors and by numerous domestic and international
system integrators, service providers and value-added resellers. The Company's
end-user customers include manufacturing, telecommunications, retail,
transportation, health care, insurance, entertainment, utilities and energy
companies, government agencies, financial institutions, and academic
institutions.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of ODS
Networks, Inc. and its wholly-owned subsidiaries. Intercompany balances and
transactions have been eliminated in consolidation.

CASH EQUIVALENTS

The Company considers cash and all highly liquid investments purchased with
an original or remaining maturity of less than three months as of the balance
sheet date to be cash equivalents.

SHORT-TERM INVESTMENTS

The Company's short-term investments consist of U.S. government obligations,
government agencies, and corporate securities with maximum maturities of one
year. Short-term investments are classified as available for sale. These
investments are valued at market value, which approximates amortized cost. The
difference between fair market value and amortized cost is not material.

SECURITIES AVAILABLE FOR SALE

F-6
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company's accounting for this investment is in accordance with Financial
Accounting Standard No. 115 (FAS 115), ACCOUNTING FOR CERTAIN INVESTMENTS IN
DEBT AND EQUITY SECURITIES. Under FAS 115, the Company's investment in Alteon,
which is classified as securities available-for-sale, is presented at its fair
value as of December 31, 1999, which is $67.6 million. The Company's investment
in Alteon increased $66.9 million from $700 thousand as of December 31, 1998. As
of December 31, 1999, the after tax unrealized gain in this investment is
$44.1 million with a current deferred tax liability of $22.8 million.

RISK CONCENTRATION

Financial instruments which potentially subject the Company to
concentrations of credit risk are primarily cash and cash-equivalents,
investments and accounts receivable. The Company places its investments in U.S.
government obligations, corporate securities and money market funds.
Substantially all of the Company's cash, cash equivalents and investments are
maintained with two major financial institutions.

The Company sells its products to customers in diversified industries
worldwide, primarily in North America, Europe, Asia and Latin America.
Fluctuations in currency exchange rates and adverse economic developments in
foreign countries could adversely effect the Company's operating results. The
Company performs ongoing credit evaluations of its customers' financial
condition and generally requires no collateral. The Company maintains reserves
for potential credit losses and such losses, in the aggregate, have not exceeded
management expectations.

While the Company believes that many of the materials used in the production
of its products are generally readily available from a variety of sources,
certain components are available from one or a limited number of suppliers. The
inability of any supplier or manufacturer to fulfill supply requirements of the
Company could impact future results.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost is computed
using standard cost, which approximates actual cost on a first-in, first-out
basis. Management estimates the allowance required to state inventory at the
lower of cost or market. There is a risk that the Company will forecast demand
for its products and market conditions incorrectly and produce excess
inventories. Therefore, there can be no assurance that the Company will not
produce excess inventory and incur inventory lower of cost or market charges in
the future.

F-7
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT

Property and equipment is stated at cost and depreciated on a straight-line
basis over the estimated useful lives of the assets. Such lives vary from 3 to
20 years. Leasehold improvements are amortized over the shorter of their useful
lives or the terms of the leases. Repair and maintenance costs are expensed as
incurred.

LONG-TERM INVESTMENTS

Long-term investments consist of U.S. government and corporate obligations
with maturities which range up to two years. Long-term investments are
classified as available for sale. These investments are valued at market value,
which approximates amortized cost. The difference between fair value and
amortized cost is not material.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess of purchase price and related direct costs
over the value assigned to the net tangible and specifically identifiable
intangible assets of businesses acquired. Goodwill is being amortized using the
straight-line method over 7 years. Intangibles generally relate to software and
developed technology acquired in a purchase business combination or an
acquisition of assets. Intangibles are being amortized over their estimated
useful lives, generally estimated at 7 years. Annual amortization expense
related to goodwill and other intangible assets for the years ended
December 31, 1999 and 1998 was $1.6 million and $1.0 million, respectively.

The Company assesses whether its goodwill and other intangible assets are
impaired as required by Statement of Financial Accounting Standard ("SFAS")
No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSET AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF, based on the evaluation of undiscounted projected cash
flows through the remaining amortization period. If an impairment exists, the
amount of such impairment is calculated based on the estimated fair value of the
asset.

FOREIGN CURRENCY TRANSLATION

The Company's international subsidiaries use their local currencies as their
functional currencies. Assets and liabilities are translated at the exchange
rate in effect at the balance sheet date, and income and expense accounts at
average exchange rates during the year. Resulting translation adjustments are
recorded directly to a separate component of stockholders' equity.

ACCOUNTING FOR STOCK OPTIONS

The Company has elected to continue to follow APB Opinion No. 25, ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES, (APB 25) and related interpretations in
accounting for its employee stock options. Under APB 25, if the exercise price
of an employee's stock option equals or exceeds the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
The Financial Accounting Standards Board (FASB) has issued SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION, which provides for either recognition
or disclosure of a hypothetical charge for stock options. The Company did not
recognize any charge in its income statement, but has provided the required
disclosure in Note 12.

F-8
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE

The Company reports two separate earnings per share numbers, basic EPS and
diluted EPS. Diluted EPS includes the dilutive impact of employee stock options
and warrants.

REVENUE RECOGNITION

The Company generally recognizes product revenue upon shipment of product.
The Company accrues for estimated warranty costs, sales returns and other
allowances at the time of shipment based on its experience. Revenue from
maintenance contracts is deferred and recognized over the contractual period the
services are performed. To date, warranty costs and sales returns have not been
material. There is a risk that technical issues on new products could result in
unexpected warranty costs and returns.

The Company has signed distribution agreements with distributors in the
United States, Europe and Asia. In general these relationships are
non-exclusive. Distributors typically maintain an inventory of ODS products.
Under these agreements, ODS provides certain protection to the distributors for
their inventory of ODS products for price reductions as well as products that
are slow-moving or have been discontinued by the Company. Recognition of sales
to distributors and related gross profits are deferred until the merchandise is
resold by the distributors.

As of January 1, 1998, the Company adopted the American Institute of
Certified Public Accountants Statement of Position ("SOP") No. 97-2, SOFTWARE
REVENUE RECOGNITION, which was effective for transactions that the Company
entered into after January 1, 1998. Prior years were not restated. The most
significant impact of SOP 97-2 on the Company's revenue recognition accounting
policies is that for software contracts with multiple elements, revenue will
generally be recognized later than under past practices under SOP 91-1. Adopting
SOP 97-2 had no effect on the Company's net loss for 1998 or 1999.

RESEARCH AND DEVELOPMENT COSTS

The Company incurs research and development costs that relate primarily to
the development of new security software, integrated solutions and networking
products and major enhancements to existing services and products. Research
development costs are comprised primarily of salaries and related benefits
expenses, contract labor and prototype and related expenses.

Software development costs are included in research and development and are
expensed as incurred. Statement of Financial Accounting Standards No. 86,
ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE
MARKETED, requires that software development costs incurred subsequent to
reaching technological feasibility be capitalized, if material. If the process
of developing a new product or major enhancement does not include a detailed
program design, technological feasibility is determined only after completion of
a working model. To date, the period between achieving technological feasibility
and the general availability of such software has been short, and the software
development costs qualifying for capitalization have been insignificant.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during

F-9
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the reporting period. Estimates are used for, but not limited to, the accounting
for doubtful accounts, sales discounts, sales returns, distribution revenue,
warranty costs, inventory obsolescence, depreciation and taxes. Actual results
could differ from these estimates.

INCOME TAXES

The income tax provision is based on pretax financial accounting income or
loss. The Company accounts for income taxes pursuant to SFAS No. 109, ACCOUNTING
FOR INCOME TAXES, which uses the liability method to calculate deferred income
taxes. Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax basis of assets and
liabilities and their reported amounts. The realization of deferred tax assets
is based on historical tax positions and expectations about future taxable
income. The liability method also requires the recognition of future tax
benefits such as net operating loss carryforwards, to the extent that
realization of such benefits is more likely than not.

RECLASSIFICATION

Certain amounts in prior year financial statements have been reclassified to
conform with current year presentation.

3. BUSINESS COMBINATIONS AND ACQUISITION OF ASSETS

On May 7, 1998, the Company acquired Essential Communication Corporation
("Essential"), a privately-held company based in Albuquerque, New Mexico.
Essential designs and manufactures high-speed computer network equipment. The
Company exchanged a combination of $5.8 million of cash and approximately
306,000 shares of the Company's common stock for all outstanding shares of
Essential capital stock, and the Company issued approximately 104,000 stock
options in exchange for all unexpired and unexercised options to acquire
Essential capital stock. Essential's operations have been included in the
Company's consolidated financial statements since May 7, 1998, and the
acquisition was accounted for using the purchase method of accounting. The total
purchase price of $9.0 million was allocated to the net assets acquired based on
their estimated fair market value, which included approximately $7.4 million of
intangible assets to be amortized over seven years on a straight-line basis; and
approximately $2.3 million of in-process research and development. The
in-process research and development was expensed at the date of the acquisition
with the Company recognizing a one-time charge of $2.3 million, or $0.13 per
share. Pro forma financial information has not been presented.

On September 25, 1998, the Company completed an acquisition of certain
assets from Science Applications International Corporation ("SAIC"), a
privately-held company in San Diego, California. The Company acquired certain
assets of the Computer Misuse and Detection System ("CMDS") Division of SAIC and
certain other information security products under development. In exchange for
the CMDS assets, the information security products under development and
$1.5 million dollars in cash, ODS issued to SAIC 1.6 million shares of the
Company's common stock and warrants to purchase 1.5 million shares of its common
stock. Two separate warrants each grant SAIC the right to purchase 750,000
shares of ODS common stock. The first warrant has an exercise price of $8.00 per
share and a term of 18 months. The second warrant has an exercise price of
$10.50 per share and a term of 24 months. ODS' acquisition has been accounted
for as a purchase of software, in-process research and development and certain
other assets. The transaction value of approximately $6.9 million less the
$1.5 million cash received was allocated

F-10
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

3. BUSINESS COMBINATIONS AND ACQUISITION OF ASSETS (CONTINUED)
to the net assets acquired based on their estimated fair market value. Assets
acquired included approximately $1.1 million of in-process research and
development, $0.1 million of other intangible assets and approximately
$4.2 million of purchased software to be amortized over seven years on a
straight-line basis. During 1998 the Company recognized a one-time charge of
$0.7 million (net of taxes), or $0.04 per share, for write-off of the acquired
in-process research and development. The acquisition of certain assets of SAIC
does not meet the reporting requirements for pro forma financial information.

On September 30, 1999, the Company entered a technology licensing agreement
with RSA Security Inc. ("RSA") under which the Company is the exclusive licensee
of RSA's Kane Security Products in North America and Europe. The Kane Security
Products include the Kane Security Analyst, a vulnerability assessment tool, and
the Kane Security Monitor, a host based intrusion detection tool that
continuously reviews and analyzes NT security event logs for patterns of misuse
and alerts the security administrator in real-time. The Company is responsible
for marketing, sales, support, maintenance and development for Kane Security
software.

4. 1998 RESTRUCTURING

On December 31, 1998, the Company's management with the approval of the
Board of Directors committed to and implemented a series of measures to refocus
the Company's efforts on long term strategic objectives. The restructuring plans
are designed to focus the Company's efforts on high-performance network and data
security solutions while reducing the Company's cost structure and improving its
responsiveness to customers, operating efficiencies, and return on assets. The
necessity of restructuring to focus on key growth opportunities was required due
to the Company's performance levels resulting from declining markets for modular
shared media hubs and intense competition in the rapidly consolidating local
area network market.

The restructuring plan included (i) writing down the value of inventory
associated with older technologies, (ii) the write off of certain fixed assets,
(iii) preparation for closure of one of the two facilities in Richardson, Texas,
(iv) the reorganization and/or closure of certain sales offices,
(v) streamlining of research, product development and other functional
activities and (vi) workforce reductions. In connection with the change of the
Company's product focus under the Company's restructuring plan, the company
recorded a $6.7 million charge to cost of sales to write down the value of
inventory with reduced utility, generally associated with older technologies.

The Company also recorded a $3.5 million restructuring charge to write off
the value of certain fixed assets which are no longer in use and are to be
disposed of.

Implementation of the plan in the fourth quarter of 1998 resulted in
workforce reductions of approximately 45 professional staff positions and
approximately 72 manufacturing operations positions. Overall employment at the
Company has decreased, predominately due to the restructuring, from
approximately 415 employees in September 1998 to approximately 265 employees as
of December 31, 1998, a decrease of 150 employees. In connection with these cost
reduction actions, the Company incurred approximately $0.4 million of severance
costs. The Company recognized a liability and expense for the cost of the
involuntary termination benefits in fiscal 1998 as the Company's management
approved the plan of termination during fiscal 1998 and terminations were
complete as of December 31, 1998.

F-11
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4. 1998 RESTRUCTURING (CONTINUED)
The closure of certain facilities was initiated in 1998 and was
substantially completed in the second quarter of 1999. The sale of the Company's
excess facility in Richardson, Texas occurred in December 1999, generating net
proceeds of $2.6 million which approximated the assets' carrying value.

There were no significant accrued liabilities at December 31, 1999 related
to severance or other direct and incremental exit costs.

5. IMPAIRMENT OF EQUITY INVESTMENT

In March 1998, the Company invested $1.25 million in convertible preferred
stock in Blue Ridge Networks, Inc. ("Blue Ridge") which shares are convertible
into common voting stock of Blue Ridge in an amount, if converted, equal to a
minimum of 25% of the then outstanding voting interests of Blue Ridge. Blue
Ridge is a privately held company which provides secure remote access products
for local and wide area networks. This investment was accounted for using the
equity method of accounting with the Company's share of losses of Blue Ridge
reported in the income statement of the Company.

Due to ongoing operating losses and the uncertainty of Blue Ridge obtaining
additional outside financing, all remaining unamortized capitalized costs
related to the Company's investments in Blue Ridge were written off as of
December 31, 1998, resulting in a total charge to expense of approximately
$1 million. The loss in value of the investment was determined to be other than
temporary based on a review of Blue Ridge's current and expected operating
performance and the Company's refocused efforts under the strategic
restructuring plan which did not provide for additional Company investments into
Blue Ridge.

6. BALANCE SHEET DETAIL (IN THOUSANDS)

INVENTORIES

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Raw materials.............................................. $ 2,113 $1,845
Work in process............................................ 1,016 401
Finished products.......................................... 5,729 5,669
Demonstration systems...................................... 1,834 1,347
------- ------
$10,692 $9,262
======= ======
</TABLE>

F-12
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6. BALANCE SHEET DETAIL (IN THOUSANDS) (CONTINUED)

INTANGIBLE ASSETS, NET

<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
CMDS purchased software................................... $ 4,136 $ 4,136
CMDS intangible asset..................................... 135 135
Essential goodwill........................................ 3,971 3,971
Essential intangible asset................................ 3,340 3,340
------- -------
11,582 11,582
Accumulated amortization.................................. (2,559) (968)
------- -------
$ 9,023 $10,614
======= =======
</TABLE>

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Trade accounts payable..................................... $ 8,229 $3,345
Accrued sales commissions.................................. 527 768
Accrued incentive bonus.................................... 108 406
Accrued vacation........................................... 863 776
Accrued property taxes..................................... 222 494
Accrued warranty expense................................... 475 475
Other (individually less than 5% of current liabilities)... 1,477 1,436
------- ------
$11,901 $7,700
======= ======
</TABLE>

7. NOTE RECEIVABLE FROM STOCKHOLDER

Note receivable from stockholder of $1.2 million at December 31, 1999
represents amounts loaned to an officer during the third quarter of 1998 secured
by the Company's common stock. These amounts were classified as contra-equity
because in the event the officer failed to remit payment, the Company would have
received shares of the Company's common stock. On February 28, 2000, the officer
repaid the Company in full including principal of $1.2 million and interest of
approximately $98,000.

8. LEASES

The Company leases office space for its corporate headquarters in
Richardson, Texas under an operating lease, the base term of which expires in
February 2005, with two seven-year options to extend the term of the lease,
subject to compliance with certain conditions. The Company also leases a
separate warehouse facility adjacent to its headquarters under a lease which
expires in June 2000. The Company leases office space in Albuquerque, New Mexico
for Essential under an operating lease which expires in February 2009. The
Company leases office space in San Diego, California for its security software
research and development staff under an operating lease which expires in
August 2002. In addition, the Company leases office space for its U.S. and
international sales and engineering offices. Total rental expense of
$1.8 million, $2.3 million and $2.1 million was charged to operations during
1999, 1998, and 1997, respectively.

F-13
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. LEASES (CONTINUED)
Future minimum lease payments consisted of the following at December 31,
1999 (in thousands):

<TABLE>
<S> <C>
2000........................................................ $1,722
2001........................................................ 1,544
2002........................................................ 1,400
2003........................................................ 1,244
2004........................................................ 1,063
Thereafter.................................................. 732
------
$7,705
======
</TABLE>

9. SEGMENTS

In the fourth quarter of 1999, the Company adopted SFAS No. 131, DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131
establishes standards for the way that companies report information about
operating segments, geographic areas and major customers in annual financial
statements and requires those companies to report selected information about
operating segments in interim financial statements. The adoption of SFAS
No. 131 had no effect on the Company's consolidated financial position,
consolidated results of operations or liquidity.

The Company has two business segments: Security and Networking. The Security
segment focuses on security software and integrated solutions and the Networking
segment focuses on high performance network solutions.

FACTORS USED TO IDENTIFY SEGMENTS

The Company's reportable segments were identified by looking at both the
product types and the type of customer using the product. Where it may seem the
same customer is purchasing both products, in fact the purchasing decision is
generally made independent and often by two separate decision making bodies
within a corporate or governmental entity. Security segment products include
software and integrated products to assess vulnerability, detect and monitor
intrusion, and to provide secure platforms to perform a full array of security
applications including third-party applications. Networking segment products
include primarily switches that provide for a managed approach to moving data
within a network.

MEASUREMENT OF SEGMENT PROFIT OR LOSS

The accounting policies of each business segment are the same as described
in the summary of significant accounting policies. All corporate and centrally
incurred costs are allocated to the business segments based principally on
revenue, assets, employees or usage. Corporate assets are principally cash, cash
equivalents and investments.

F-14
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. SEGMENTS (CONTINUED)
A summary of the Company's operations by business segment for 1999, 1998 and
1997 is presented below (in thousands of dollars):

<TABLE>
<CAPTION>
TOTAL CORPORATE SECURITY NETWORKING
-------- --------- -------- ----------
<S> <C> <C> <C> <C>
1999
Total revenue........................................ $ 57,951 $ -- $ 7,963 $49,988
Operating income (loss).............................. (13,151) (128) (19,206) 6,183
Depreciation and amortization........................ 3,839 128 1,460 2,251
Interest income, net................................. 1,104 1,104 -- --
Total assets......................................... 120,502 89,085 14,356 17,061

1998
Total revenue........................................ $ 74,610 $ -- $ 1,920 $72,690
Operating income (loss).............................. (30,371) -- (21,751) (8,620)
Depreciation and amortization........................ 4,601 -- 1,006 3,595
Interest income, net................................. 1,398 1,398 -- --
Total assets......................................... 61,710 27,000 7,635 27,075

1997
Total revenue........................................ $ 92,327 $ -- $ -- $92,327
Operating income (loss).............................. (9,580) -- -- (9,580)
Depreciation and amortization........................ 3,285 -- -- 3,285
Interest income, net................................. 1,639 1,639 -- --
Total assets......................................... 77,178 38,905 -- 38,273
</TABLE>

10. EMPLOYEE BENEFIT PLANS

EMPLOYEE STOCK PURCHASE PLAN

On April 24, 1997, the Company adopted an Employee Stock Purchase Plan (the
"Purchase Plan") under which 0.5 million shares of common stock have been
reserved for issuance. Eligible employees may designate not more than 10% of
their compensation to be deducted each pay period for the purchase of common
stock under the Purchase Plan. The Purchase Plan was amended January 19, 2000 to
increase the maximum number of shares that can be purchased per participant from
250 shares to 500 shares per offering. Each participant may purchase up to 1,000
shares in any one calendar year. On January 31 and July 31 of each calendar
year, shares of common stock are purchased with the employees' payroll
deductions over the immediately preceding six months at a price per share of 85%
of the lesser of the market price of the common stock on the purchase date or
the market price on the first day of the six-month period. The Purchase Plan
will terminate no later than April 24, 2007. A total of 39,458 shares have been
issued under the Purchase Plan as of December 31, 1999. Subsequent to
December 31, 1999, 11,492 shares of stock were issued under the Purchase Plan
for an aggregate purchase price of $56,195.88 related to the purchase period
which commenced on August 1, 1999 and ended on January 31, 2000.

EMPLOYEE 401(K) PLAN

The Company has adopted a plan known as the ODS 401(k) Savings Plan (the
"Plan") to provide retirement and incidental benefits for its employees. The
Plan covers substantially all employees who meet

F-15
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10. EMPLOYEE BENEFIT PLANS (CONTINUED)
minimum age and service requirements. As allowed under Section 401(k) of the
Internal Revenue Code, the Plan provides tax deferred salary deductions for
eligible employees.

Employees may contribute from 1% to 19% of their annual compensation to the
Plan, limited to a maximum amount as set by the Internal Revenue Service. The
Company matches employee contributions at the rate of $0.25 per each $1.00 of
contribution on the first 4% of deferred compensation. Company matching
contributions to the Plan were approximately $112,000, $119,000, and $121,000 in
1999, 1998 and 1997, respectively.

11. INCOME TAXES

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31, 1999 and
December 31, 1998 are as follows (in thousands):

<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Deferred tax assets:
Foreign subsidiaries net operating loss carryforward...... $ 382 $ 404
Net operating loss carryover.............................. 6,135 1,622
Minimum tax credit........................................ 410 410
Book over tax depreciation................................ 273 268
Intangibles............................................... 501 442
Equity investments........................................ 459 471
Vacation accrual.......................................... 348 292
Allowance for doubtful accounts and returns............... 430 202
Warranty accrual.......................................... 174 179
Inventory................................................. 2,575 2,667
Deferred revenue.......................................... 34 179
Other..................................................... 215 252
-------- --------
Deferred tax assets..................................... 11,936 7,388
Valuation allowance for deferred tax assets............... (11,936) (7,388)
-------- --------
Deferred tax assets, net of allowance................... -- --
-------- --------

Deferred tax liabilities:
Intangibles............................................... 938 1,361
Unrealized gain on securities held for sale............... 22,850 --
Other..................................................... 1,186 --
-------- --------
Total deferred tax liabilities.......................... 24,974 1,361
-------- --------
Net deferred tax assets (liabilities)....................... $(24,974) $ (1,361)
======== ========

Current deferred assets (liabilities)....................... $(23,305) $ --
Noncurrent deferred assets (liabilities).................... $ (1,669) (1,361)
-------- --------
Net deferred tax assets (liabilities)....................... $(24,974) $ (1,361)
======== ========
</TABLE>

F-16
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

11. INCOME TAXES (CONTINUED)
Deferred tax assets are required to be reduced by a valuation allowance if
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. Realization of the future benefits related to the deferred
tax assets is dependent on many factors, including the Company's ability to
generate taxable income within the near to medium term. Management has
considered these factors in determining the valuation allowance in 1999.

Significant components of the provision for income taxes for the years ended
1999, 1998 and 1997 are as follows (in thousands):

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Income tax provision

Federal:
Current................................................. $ -- $(5,630) $(2,671)
Deferred................................................ -- 1,478 (176)

State:
Current................................................. -- 200 (249)
Deferred................................................ -- (433) (19)

Foreign:
Current................................................. -- 40 111
------- ------- -------
$ -- $(4,345) $(3,004)
======= ======= =======
</TABLE>

The differences between the provision for income taxes and income taxes
computed using the federal statutory rate for the years ended 1999, 1998 and
1997 are as follows (in thousands):

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Reconciliation of income tax provision to statutory rate:
Income tax benefit at statutory rate...................... $(4,131) $(10,513) $(2,779)
State taxes, less federal benefit......................... -- (151) (174)
Increase in valuation allowance........................... 4,075 5,136 --
In process research and development....................... -- 805 --
Goodwill amortization..................................... 193 132 --
Other..................................................... (137) 246 (51)
------- -------- -------
$ -- $ (4,345) $(3,004)
======= ======== =======
</TABLE>

At December 31, 1999, the Company had federal net operating loss
carryforwards of $15.8 million for income tax purposes that begin to expire in
2018, and net operating loss carryforwards of approximately $4.2 million subject
to the ownership change limitations under Internal Revenue Code Section 382,
which begin to expire in 2008. The Company also has $29.3 million of state net
operating loss carryforwards. Net operating loss carryforwards of the foreign
subsidiaries of $0.8 million at December 31, 1999 are available indefinitely for
offset only against taxable income generated by the foreign subsidiaries. In
addition, the Company has tentative minimum tax credit carryovers of
approximately $0.4 million which may be carried forward indefinitely.

The Company has made income tax payments of $0.1 million, $0.1 million and
$0.4 million during 1999, 1998 and 1997, respectively.

F-17
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12. STOCK, STOCK OPTIONS AND WARRANTS

On May 7, 1998, in connection with the Company's acquisition of Essential
the Company issued approximately 306,000 shares of the Company's Common Stock
for all outstanding shares of Essential capital stock, and the Company issued
approximately 104,000 stock options in exchange for all unexpired and
unexercised options to acquire Essential capital stock. Currently, there are
44,716 options outstanding from the Essential assumed options.

On September 25, 1998, in connection with the Company's acquisition of
certain assets from Science Applications International Corporation ("SAIC"), the
Company issued to SAIC 1.6 million shares of the Company's common stock and
warrants to purchase 1.5 million shares of its common stock. Two separate
warrants each grant SAIC the right to purchase 750,000 shares of its common
stock. The first warrant has an exercise price of $8.00 per share and a term of
18 months. The second warrant has an exercise price of $10.50 per share and a
term of 24 months.

At December 31, 1999, the Company has four stock-based compensation plans,
which are described below. These plans were developed to retain and attract key
employees and directors.

The Company established an Incentive Stock Option Plan in 1983, which
provides for the issuance of options to key employees of the Company to purchase
common stock of the Company. The 1983 Incentive Stock Option Plan was terminated
on November 10, 1993.

In 1987, an additional Incentive Stock Option Plan was established with
similar provisions to allow for further issuance of options. The 1987 Incentive
Stock Option Plan was terminated on January 26, 1997. The 1983 and 1987 plans
each provided for the issuance of up to 1.2 million shares of common stock upon
exercise of options granted pursuant to the plans.

In 1995, the Company adopted the 1995 Stock Option Plan (the "1995 Plan")
which provides for the issuance of up to 1.6 million shares of common stock upon
exercise of options granted pursuant to the 1995 Plan. The 1995 Plan provides
for the issuance of both non-qualified and incentive stock options to employees,
officers, and employee-directors of the Company.

In 1995, the Company adopted the 1995 Non-employee Director Stock Option
Plan (the "1995 Non-employee Director Plan") which provides for the issuance of
up to 160,000 shares of common stock upon exercise of options granted pursuant
to the 1995 Non-employee Director Plan. The Plan provides for the issuance of
non-qualified stock options to non-employee directors.

In 1995 and 1994, options to purchase 60,000 shares, and 12,000 shares,
respectively, were granted to directors. The terms and exercise prices of these
options are similar to the incentive stock options.

Common shares reserved for future issuance under all of the stock option
plans, warrants and employee stock purchase plans total approximately 4 million
shares at December 31, 1999.

The Compensation Committee of the Board of Directors determines the term of
each option, option exercise price within limits set forth in the plans, number
of shares for which each option is granted and the rate at which each option is
exercisable (generally ratably over three or five years from grant date).
However, the exercise price of any incentive stock option may not be less than
the fair market value of the shares on the date granted (or less than 110% of
the fair market value in the case of optionees holding more than 10% of the
voting stock of the Company), and the term cannot exceed ten years (five years
for incentive stock options granted to holders of more than 10% of the Company's
voting stock).

F-18
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12. STOCK, STOCK OPTIONS AND WARRANTS (CONTINUED)
A summary of the Company's stock option activity and related information for
the years ended December 31, 1999, 1998 and 1997, is as follows:

<TABLE>
<CAPTION>
1999 1998 1997
---------------------- ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE
OPTIONS (IN EXERCISE OPTIONS (IN EXERCISE OPTIONS (IN EXERCISE
THOUSANDS) PRICE THOUSANDS) PRICE THOUSANDS) PRICE
----------- -------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year......... 1,683 $7.53 1,572 $14.34 1,200 $13.88
Granted.................................. 479 4.95 2,358 4.36 605 13.78
Exercised................................ (91) 3.26 (101) 2.69 (99) 2.93
Cancelled................................ (617) 6.77 (2,146) 9.76 (134) 16.15
----- ------ -----
Outstanding at end of year............... 1,454 7.83 1,683 7.53 1,572 14.34
===== ====== =====
Operations exercisable at end of year.... 551 535 562
</TABLE>

Information related to stock options outstanding at December 31, 1999, is
summarized below:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
OUTSTANDING AT AVERAGE AVERAGE EXERCISABLE AT AVERAGE
12/31/99 (IN REMAINING EXERCISE 12/31/99 (IN EXERCISE
RANGE OF EXERCISE PRICES THOUSANDS) CONTRACTUAL LIFE PRICE THOUSANDS) PRICE
- ------------------------ -------------- ---------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$1.88 -$4.69....................... 733 8.61 years $2.98 219 $ 2.62
5.13--15.27........................ 473 7.22 years 7.72 148 8.72
18.25--36.25....................... 248 4.39 years 22.41 184 22.21
----- ---
1,454 7.43 years 7.83 551 10.81
===== ===
</TABLE>

SFAS No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION, requires the
disclosure of pro forma net income and earnings per share information computed
as if the Company had accounted for its employee stock options granted
subsequent to December 31, 1994, under the fair value method set forth in
SFAS 123. The fair value for these options was estimated using a Black-Scholes
option pricing model with the following weighted-average assumptions:

<TABLE>
<CAPTION>
EMPLOYEE STOCK OPTIONS
------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Expected dividend yield............................ 0.0% 0.0% 0.0%
Risk-free interest rate............................ 5.5% 4.8% 6.0%
Expected volatility................................ 70.0% 70.0% 67.0%
Expected life (in years)........................... 2.0 2.0 2.0
</TABLE>

The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. In addition, because
SFAS 123 is applicable only to options granted

F-19
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12. STOCK, STOCK OPTIONS AND WARRANTS (CONTINUED)
subsequent to December 31, 1994, the pro forma information does not reflect the
pro forma effect of all previous stock option grants of the Company, and thus
the pro forma information is not necessarily indicative of future amounts until
SFAS 123 is applied to outstanding stock options.

Information relating to the fair value of option grants made during 1999,
1998 and 1997 is as follows:

<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Options granted with exercise price equal to fair value of
common stock:
Number of options (in thousands).......................... 479 2,358 550
Weighted average exercise price per share................. $4.95 $4.36 $13.62
Weighted average fair value of stock options grants per
Black-Sholes option valuation model..................... $2.44 $2.24 $ 5.65
Options granted with exercise price greater than fair Value
of common stock:
Number of options (in thousands).......................... -0- -0- 55
Weighted average exercise price per share................. -0- -0- $15.27
Weighted average fair value of stock options grants per
Black-Sholes option valuation model..................... -0- -0- $ 5.17
</TABLE>

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. For purposes
of pro forma disclosure, the Company assumed that it would not receive a tax
deduction or tax benefit for financial reporting purposes related to incentive
stock options. In management's opinion, the pro forma disclosure is not
necessarily indicative of the net financial effect assuming the Company was
required to expense the fair value of employee stock options because an
incentive stock option often generates a tax deduction for the Company because
the stock option holder does not comply with the holding period requirements
under applicable tax laws. The Company's pro forma information follows (in
thousands, except earnings per share information):

<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Pro forma net loss.......................................... $(12,884) $(27,201) $(7,535)
Pro forma earnings per share................................ $ (0.69) $ (1.58) $ (0.46)
</TABLE>

EXCHANGE OF STOCK OPTIONS IN 1998

On January 21, 1998, the Compensation Committee of the Board of Directors
approved a stock option exchange program (the "Initial Exchange Program"),
pursuant to which certain employees and officers holding stock options
(i) awarded under the Company's 1987 Incentive Stock Option Plan (the "1987
Plan") in 1997 and (ii) awarded prior to December 31, 1997, under the 1995 Plan,
were given the opportunity to exchange such options (the "Existing Options") for
new options (the "Initial New Options"), based on the fair market value of the
Company's Common Stock at the close of business on January 30, 1998. All outside
directors of the Company, the President and Chief Executive Officer, and one
Executive Vice President were ineligible to participate in the Exchange Program.

Pursuant to the Initial Exchange Program, holders of the Existing Options
were offered the opportunity to exchange, on a share-for-share basis, such
options for Initial New Options having an exercise price of $7.50 per share, the
fair market value of the Company's Common Stock on the exchange date of
January 30, 1998 (the "Exchange Date"). Each Initial New Option was awarded
under the 1995 Plan and vests and is exercisable with respect to 20% of the
shares covered thereby on each anniversary date of the

F-20
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12. STOCK, STOCK OPTIONS AND WARRANTS (CONTINUED)
Exchange Date. Eligible employees holding Existing Options for an aggregate of
646,800 shares of Common Stock with an average per share exercise price of
approximately $15.87 elected to participate in the Initial Exchange Program and
were issued Initial New Options covering the same aggregate number of underlying
shares as they had held pursuant to their respective Existing Options. Other
than the new exercise price and the commencement of a new vesting schedule, the
option agreements relating to the Initial New Options are substantially
identical to the option agreements of the Existing Options they replaced.

On December 11, 1998, the Compensation Committee of the Board of Directors
approved a second stock option exchange program (the "Exchange Program"),
pursuant to which certain employees and officers holding incentive stock options
(i) awarded under the Initial Exchange Program, (ii) awarded under the 1995 Plan
during 1998 (1998 Options) and (iii) assumed in connection with the Company's
assumption of the Essential stock option plan in conjunction with the Company's
acquisition of Essential ("Essential Options"), were given the opportunity,
within certain limitations, to exchange such options (Initial New Options, 1998
Options and Essential Options, together the "Old Options") for new options (the
"New Options"), based on the fair market value of the Company's Common Stock at
the close of business on December 14, 1998. All outside directors of the
Company, the President and Chief Executive Officer, and one Executive Vice
President were ineligible to participate in the Exchange Program.

Pursuant to the Exchange Program, holders of the Old Options were offered
the opportunity to exchange, on a share-for-share basis, such options for New
Options having an exercise price of $2.50 per share, the fair market value of
the Company's Common Stock on the exchange date of December 14, 1998 (the "New
Exchange Date"). In accordance with the 1995 Plan, each employee, unless
otherwise ineligible, could exchange options to purchase up to 50,000 shares of
the Company's Common Stock less all other option grants provided to the employee
during 1998. Each New Option was awarded under the 1995 Plan and vests and is
exercisable with respect to 33.3% of the shares covered thereby on each
anniversary date of the New Exchange Date. Eligible employees holding Old
Options for an aggregate of 859,524 shares of Common Stock with an average per
share exercise price of approximately $7.40 per share elected to participate in
the Exchange Program and were issued New Options covering the same aggregate
number of underlying shares as they had held pursuant to their respective Old
Options. Other than the new exercise price and the commencement of a new vesting
schedule, the option agreements relating to the New Options are substantially
identical to the option agreements of the Old Options they replaced.

Both option exchange programs resulted from the significant declines in the
market value of the Company's Common Stock since issuance of the Existing
Options and Old Options, causing the Existing Options and Old Options to be
exercisable at prices which substantially exceeded the market value of the
Common Stock. In approving both exchange programs and in keeping with the
Company's philosophy of utilizing equity incentives to motivate and retain
qualified employees, the Compensation Committee acknowledged that retention and
attraction of qualified employees are critical to the Company's success and its
ability to continue to meet its performance objectives. Additionally,
Recognizing that stock options constitute a significant component of the
Company's compensation structure, the Compensation Committee deemed it important
to regain the incentive intended to be provided by the Existing Options and Old
Options to purchase shares of the Company's Common Stock and therefore serve as
a significant factor in the Company's ability to continue to attract and retain
the services of superior quality personnel.

F-21
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

13. EARNINGS PER SHARE

<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
NUMERATOR: 1999 1998 1997
- ---------- --------- --------- ---------
<S> <C> <C> <C>
Net loss.................................................... $(12,040) $(25,750) $(4,937)
-------- -------- -------
Numerator for basic and diluted earnings per share.......... $(12,040) $(25,750) $(4,937)
Denominator:
Denominator for basic earnings per share--weighted average
common shares outstanding................................. 18,565 17,190 16,437
Effect of dilutive securities:
Stock options and warrants................................ 0 0 0
-------- -------- -------
Denominator for diluted earnings per share--adjusted
weighted average common shares outstanding................ 18,565 17,190 16,437
======== ======== =======
Basic and dilutive loss per share........................... $ (0.65) $ (1.50) $ (.30)
======== ======== =======
</TABLE>

Total stock options and warrants outstanding in 1999, 1998 and 1997 that are
not included in the diluted earnings per share computation due to the
antidilutive effect are 3 million, 3.2 million, and 1.6 million, respectively.
Such options are excluded due to the Company incurring a net loss per share in
that year or due to exercise prices exceeding the average market value of the
Company's common stock in the applicable period.

14. MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION

The Company's operations were concentrated in two segments--Security and
Networking (see Note 9 above). Sales to customers exceeding 10% of total sales
were as follows: 1999--$6.3 million SGI, Inc. and $6.8 million to Microage
Federal; 1998--$9.8 million to various agencies of the U.S. Government
(aggregated as one); 1997--$14.9 million to EDS and $10.8 million to various
agencies of the U.S. Government (aggregated as one).

Export sales, primarily to Europe, Asia, Latin America and Canada, were
$7.2 million in 1999, $14.9 million in 1998, and $25.1 million in 1997. No
significant long-lived assets are deployed outside of the United States.

15. IMPACT OF YEAR 2000

In prior years, the Company discussed the nature and progress of its plans
to become Year 2000 ready. In late 1999, the Company completed its remediation
and testing of systems. As a result of those planning and implementation
efforts, the Company experienced no significant disruptions in mission critical
information technology and non-information technology systems and believes those
systems successfully responded to the Year 2000 date change. The costs
associated with the Company's Year 2000 project were expensed as incurred, were
not significant and were funded through operating cash flows and working
capital. The Company is not aware of any material problems resulting from Year
2000 issues, either with its products, its internal systems, or the products and
services of third parties. The Company will continue to monitor its mission
critical computer applications and those of its suppliers and vendors throughout
2000 to ensure that any latent Year 2000 matters that may arise are addressed
promptly.

F-22
<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

16. SUBSEQUENT EVENT

On March 2, 2000, the Company sold its investment of 770,745 shares of the
common stock of Alteon WebSystems, Inc. ("Alteon") (Nasdaq:ATON) for $87.00 per
share generating cash of approximately $67.1 million. The disposition of this
stock generated a pre-tax gain of approximately $66.4 million which will be
reported by the Company in the quarter ending March 31, 2000.

SUPPLEMENTAL FINANCIAL DATA

SUMMARIZED QUARTERLY DATA (UNAUDITED)
(In thousands, except per share amounts)

<TABLE>
<CAPTION>
1999
----------------------------------------------------
Q1 Q2 Q3 Q4 TOTAL
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Revenue........................................ $14,065 $18,505 $13,184 $12,197 $57,951
Gross profit................................... 6,175 9,353 5,758 4,561 25,847
Net loss....................................... (2,249) 146 (3,857) (6,080) (12,040)
Net loss per share............................. (0.12) 0.01 (0.21) (0.33) (0.65)
</TABLE>

<TABLE>
<CAPTION>
1998
----------------------------------------------------
Q1 Q2(1) Q3(2) Q4(3) TOTAL
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Revenue........................................ $18,213 $25,215 $18,397 $12,785 $74,610
Gross profit................................... 8,015 10,826 7,727 (2,188) 24,380
Net loss....................................... (1,974) (3,209) (3,525) (17,042) (25,750)
Net loss per share............................. (0.12) (0.19) (0.21) (0.92) (1.50)
</TABLE>

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

(1) The results for the second quarter of 1998 include a $2.3 million write-off
of acquired in-process research and development related to the Company's
acquisition of Essential Communication Corporation.

(2) The results for the third quarter of 1998 includes a $0.7 million write-off,
net of taxes, of acquired in-process research and development related to the
Company's acquisition of Computer Misuse Detection System assets from
Science Application International Corporation.

(3) The results for the fourth quarter of 1998 includes a $3.9 million
restructuring charge and a related writedown of inventory of $6.7 million.

F-23
<PAGE>
SCHEDULE II
ODS NETWORKS, INC, AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE CHARGED TO BALANCE
AT BEG. COSTS AND (ADDITIONS) AT END OF
OF PERIOD EXPENSE TRANSFERS DEDUCTIONS PERIOD
--------- ---------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997
Deducted from asset accounts:
Allowance for doubtful accounts and
returns............................. $ 822 $ 86 $ -- $ 150 (1) $ 758
Inventory obsolescence reserve........ $1,985 $7,693 $ -- $7,484 (2) $2,194

Year ended December 31, 1998
Deducted from asset accounts:
Allowance for doubtful accounts and
returns............................. $ 758 $ 146 $ 74(3) $ 98 (1) $ 880
Inventory obsolescence reserve........ $2,194 $5,777 $230(3) $1,627 (2) $6,574

Year ended December 31, 1999
Deducted from asset accounts:
Allowance for doubtful accounts And
returns............................. $ 880 $ 85 $ -- $ (206)(4) $1,171
Inventory obsolescence reserve........ $6,574 $1,001 $ -- $ 554 (2) $7,021
</TABLE>

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

(1) Uncollectible accounts written off.

(2) Obsolete inventory written off.

(3) Reserves related to acquisition of Essential Communication Corporation.

(4) Unapplied cash, net of write-offs.

S-1

<PAGE>
EXHIBIT 21

ODS NETWORKS, INC. AND SUBSIDIARIES
SUBSIDIARIES OF THE REGISTRANT

The following table lists the subsidiaries of the Registrant as of March 1,
2000, the state or other jurisdiction of incorporation and the names under which
such subsidiaries do business. The Registrant owns all of the outstanding voting
securities of each subsidiary.

<TABLE>
<CAPTION>
JURISDICTION NAME UNDER
OF WHICH SUBSIDIARY
NAME OF SUBSIDIARY ORGANIZATION IS DOING BUSINESS
- ------------------ -------------- ----------------------------------------
<S> <C> <C>
ODS Networks, Inc. Delaware ODS Networks, Inc.

Intrusion.com, Inc. Delaware Intrusion.com, Inc.

Optical Data Systems, Inc. Nevada Optical Data Systems, Inc.

ODS, Inc. Nevada ODS, Inc.

Optical Data Systems--Texas, Inc. Texas Optical Data Systems--Texas, Inc.

ODS Networks GmbH Germany ODS Networks GmbH

ODS Networks Ltd. United Kingdom ODS Networks Ltd.

ODS Ltd. United Kingdom ODS Ltd.

ODS Networks SARL France ODS Networks SARL

Optical Data Systems, Ltda Brazil Optical Data Systems, Ltda

Optical Data Systems (Barbados) Ltd. Barbados Optical Data Systems (Barbados) Ltd.

ODS Networks Sdn. Bhd. Malaysia ODS Networks Sdn. Bhd.

ODS Investments, Inc. Nevada ODS Investments, Inc.
</TABLE>

<PAGE>
EXHIBIT 23

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statement
(Form S-8, No. 33-58570) pertaining to the 1983 Incentive Stock Option Plan of
ODS Networks, Inc. and the 1987 Incentive Stock Option Plan of ODS
Networks, Inc., the Registration Statement (Form S-8, No. 33-34476) pertaining
to the 1995 Stock Option Plan of ODS Networks, Inc., the Registration Statement
(Form S-8, No. 33-34484) pertaining to the 1995 Non-employee Director Stock
Option Plan of ODS Networks, Inc., the Registration Statement (Form S-8,
No. 33-42927) pertaining to the 1997 Employee Stock Purchase Plan of ODS
Networks, Inc., the Registration Statement (Form S-8, No. 33-80898) pertaining
to the ODS 401(k) Savings Plan of ODS Networks, Inc. and the Registration
Statement (Form S-8, No. 333-53813) pertaining to the Essential Communication
Corporation 1996 Stock Option Plan of our report dated January 19, 2000, of ODS
Networks, Inc. included in the Annual Report (Form 10-K) for the year ended
December 31, 1999.

Our audits also included the financial statement schedule of ODS
Networks, Inc. listed in Item 14(a)2. This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

[LOGO]

Dallas, Texas
March 10, 2000

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATMENTS OF INCOME FOUND ON PAGES
F-2 AND F-3 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<CIK> 0000736012
<NAME> ODS NETWORKS, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1
<CASH> 12,602
<SECURITIES> 73,733
<RECEIVABLES> 6,575
<ALLOWANCES> 1,171
<INVENTORY> 10,692
<CURRENT-ASSETS> 103,823
<PP&E> 12,851
<DEPRECIATION> 8,630
<TOTAL-ASSETS> 120,502
<CURRENT-LIABILITIES> 37,245
<BONDS> 0
0
0
<COMMON> 186
<OTHER-SE> 81,391
<TOTAL-LIABILITY-AND-EQUITY> 81,577
<SALES> 57,951
<TOTAL-REVENUES> 57,951
<CGS> 32,104
<TOTAL-COSTS> 32,104
<OTHER-EXPENSES> 38,913
<LOSS-PROVISION> 85
<INTEREST-EXPENSE> 5
<INCOME-PRETAX> (12,040)
<INCOME-TAX> 0
<INCOME-CONTINUING> (12,040)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,040)
<EPS-BASIC> (.65)
<EPS-DILUTED> (.65)

</TABLE>