<PAGE>   1
                                                                Exhibit 13.1

                           selected financial data

The following table sets forth selected financial data of the Company for and
as of the five years ended September 30, 1996, 1995, 1994, 1993 and 1992. The
selected financial data has been derived from the Company's consolidated
financial statements. This financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto.

<TABLE>
<CAPTION>
                                                        Fiscal Years Ended September 30,
------------------------------------------------------------------------------------------------------------------------------------
  (In thousands, except per share amounts)      1996         1995         1994      1993(1)     1992(1)
------------------------------------------------------------------------------------------------------------------------------------
  <S>                                        <C>        <C>          <C>          <C>          <C>
  Statement of Operations Data:
     Total net revenues                      $22,307      $12,141      $ 4,667     $ 1,375     $   918 
     Gross profit                             20,277       10,380        3,580       1,152         763
     Income (loss) from operations             3,667        3,025          770        (388)       (484)
     Income (loss) before cumulative
        effect of change in accounting         3,460        2,176          584        (320)       (389)
     Net income (loss)                         3,460        2,176        1,384        (320)       (389)
     Net income (loss) available to
        common stockholders                  $ 3,460      $ 1,985      $ 1,127     $  (577)    $  (645)
  PER SHARE AND SHARE DATA:
     Earnings (loss) per common share
        and equivalents(2):
     Income (loss) before cumulative
        effect of change in accounting       $  0.27      $  0.23      $  0.08     $ (0.13)    $ (0.15)
     Net income (loss)                       $  0.27      $  0.23      $  0.18     $ (0.13)    $ (0.15)
     Net income (loss) available to
        common stockholders                  $  0.27      $  0.21      $  0.15     $ (0.23)    $ (0.26)
     Weighted average number of common
        shares and equivalents outstanding    12,838        9,423        7,685       2,514       2,520
  BALANCE SHEET DATA:
     Cash and cash equivalents               $16,490      $34,872      $ 1,606     $   757     $   239 
     Short-term investments                   17,593           --           --     $    --          --
     Working capital                          39,117       35,550        2,174         661       1,030
     Total assets                             48,769       43,509        5,871       1,167       1,416
     Redeemable convertible preferred stock       --           --        3,393       3,135       2,878
     Total stockholders' equity              $43,891      $37,614      $  (756)    $(2,227)    $(1,651)
</TABLE>


(1) Selected financial data for the years ended September 30, 1993 and 1992 do
    not include the results of Stonehand Inc., SurfWatch Software, Inc. or
    OS Technologies Corporation which were acquired in fiscal 1996 in
    transactions accounted for as pooling of interests. The selected financial
    data of such companies for these fiscal years do not materially affect the
    results shown above.

(2) On November 28, 1995, the Board of Directors declared a two-for-one common
    stock split, effected in the form of a 100% stock dividend, paid
    December 20, 1995, to stockholders of record as of December 6, 1995. All
    share and per share data have been restated to reflect the two-for-one
    common stock split for all periods presented.


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                                      12
<PAGE>   2

                           selected quarterly data

The following table sets forth certain quarterly financial information of the
Company for fiscal years 1996 and 1995. This information has been derived from
the quarterly consolidated financial statements of the Company which are
unaudited but which, in the opinion of management, have been prepared on the
same basis as the audited consolidated financial statements included herein and
include all adjustments (consisting only of normal recurring items) necessary
for a fair presentation of the financial results for such periods. This
information should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements and Notes thereto.

<TABLE>
<CAPTION>

                                                               Three Months Ended (Unaudited)
------------------------------------------------------------------------------------------------------------------------------------
                                          Sept. 30,   June 30,   March 31,   Dec. 31,   Sept. 30,     June 30,    March 31, Dec. 31,
(In thousands, except per share amounts)  1996        1996       1996        1995       1995(1)       1995        1995      1994
------------------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>         <C>        <C>         <C>        <C>           <C>         <C>       <C>
STATEMENT OF OPERATIONS DATA:                                                   
    Total net revenues                    $ 6,551     $ 6,003    $ 5,000     $ 4,753    $ 4,259       $ 3,154     $2,448    $2,280
    Gross profit                            5,961       5,484      4,562       4,270      3,708         2,789      2,094     1,789
    Income from operations                    921       1,008        876         862      1,490           560        577       398
    Net income                              1,004         862        752         842      1,176           356        400       244
    Net income available to                                                     
        common stockholders               $ 1,004     $   862    $   752     $   842    $ 1,176       $   294     $  335    $  180
PER SHARE AND SHARE DATA:                                                       
    Earnings per common share                                                   
        and equivalents(2):                                                     
    Net income                            $  0.08     $  0.07    $  0.06     $  0.07    $  0.09       $  0.04     $ 0.05    $ 0.03
    Net income available to                                                     
        common stockholders               $  0.08     $  0.07    $  0.06     $  0.07    $  0.09       $  0.03     $ 0.04    $ 0.02
    Weighted average number of                                                  
        common shares and                                                       
        equivalents outstanding            12,750      12,853     12,962      12,929     12,689         8,729      7,889     7,801
MARKET PRICE PER SHARE:                                                         
    High                                  $23 5/8     $34 7/8    $55 3/4     $    61    $    54       $29 1/4        N/A       N/A
    Low                                   $    12     $19 1/8    $    18     $16 1/2    $28 1/2       $26 1/2        N/A       N/A

</TABLE>

DIVIDEND POLICY:

The Company has never paid cash dividends on its capital stock. The Company
currently intends to retain earnings, if any, to support its growth strategy and
does not anticipate paying cash dividends in the foreseeable future.
        
(1) Includes a one-time pre-tax gain of $863 from the sale of the Company's
    data visualization product line in September 1995. The after-tax
    contribution to income is $0.06 per share.


(2) On November 28, 1995, the Board of Directors declared a two-for-one common
    stock split, effected in the form of a 100% stock dividend, paid
    December 20, 1995, to stockholders of record as of December 6, 1995. All
    share and per share data have been restated to reflect the two-for-one
    common stock split for all periods presented.

As of December 18, 1996, there were 651 stockholders of record.



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                                      13

<PAGE>   3

management's discussion and analysis of
financial condition and results of operations

OVERVIEW

Spyglass, Inc. ("Spyglass" or the "Company") was organized as an Illinois
corporation in February 1990 and reincorporated in Delaware in May 1995.
Spyglass entered the Internet market during fiscal 1994 and from fiscal 1994
through fiscal 1996, focused its efforts on developing, marketing and
distributing World Wide Web ("WWW" or "Web") client and server technologies for
incorporation into a variety of Internet-based products and services. In fiscal
1997, the Company will increasingly focus on the development, marketing and
distribution of its technologies to the Internet device market. This market
consists of non-PC devices and the underlying Internet infrastructure. Spyglass
will market Internet connectivity products to a variety of companies such as the
real time operating system (RTOS) vendors and consumer and industrial device
manufacturers in the device segment of this market, and will market Internet
infrastructure and application products to a variety of companies such as the
Regional Bell Operating Companies (RBOCs), Internet Service Providers (ISPs) and
internetworking hardware providers in the infrastructure segment of this market.
These technologies will be designed to be embedded within Internet devices,
software applications and on-line services to bring Web functionality to these
products and services. Spyglass technology offerings include the Spyglass Web
Client Software Development Kit, which was renamed Spyglass Mosaic in December
1996, ("Client SDK"), the Spyglass Web Server Software Development Kit, which
was renamed Spyglass Web Server in December 1996, ("Server SDK"), SurfWatch
ProServer, SurfWatch from Spyglass and WebNotes. Spyglass Web technology can be
found embedded inside various end-user products, including televisions, database
applications, set-top boxes, CAD-CAM software and consumer kiosks. Prior to
fiscal 1994, the Company focused its efforts on the scientific data
visualization tools market; this product line was sold in fiscal 1995.

In February 1996, the Company acquired Stonehand Inc. ("Stonehand"), a
privately-held company which was based in Cambridge, Massachusetts, for
approximately 230,000 shares of common stock in a transaction accounted for as
pooling of interests. As a result, all financial information prior to February
2, 1996, unless otherwise noted, includes the accounts and results of
operations of Stonehand for all periods presented. At the time of acquisition,
Stonehand was a leader in core Web technologies including text formatting and
internationalization technologies such as SGML, HTML, DSSSL and Unicode.

In April 1996, the Company acquired OS Technologies Corporation ("OS Tech") and
SurfWatch Software, Inc. ("SurfWatch") for approximately 87,000 and 470,000
shares of common stock, respectively, in transactions accounted for as pooling
of interests. As a result, all financial information prior to April 17, 1996
and April 24, 1996, unless otherwise noted, includes the accounts and results
of operations of OS Tech and SurfWatch, respectively, for all periods
presented. At the time of acquisition, OS Tech was located in Cambridge,
Massachusetts and developed and licensed WWW conferencing and forum technology.
At the time of acquisition, SurfWatch, a Los Altos, California vendor of
Internet filtering and parental control software, marketed Internet software
for blocking access to inappropriate material and licensed Internet filtering
technology to a variety of markets, including the on-line services industry,
personal computer manufacturers, and the educational market as well as
corporations.

These acquisitions significantly enhanced Spyglass core technologies as well as
increased its product offerings. Additionally, Stonehand and SurfWatch
operations have formed the core of new Spyglass research and development
facilities in Cambridge, Massachusetts and Los Altos, California, respectively.

The Company pays royalties to the University of Illinois with respect to
licenses of the Client SDK. Under its agreement with the University of
Illinois, the Company's royalty rate decreased effective January 1, 1995 from
the rate previously in effect. In addition, the Company pays royalties to RSA
Data Security, Inc. with respect to licenses of the Company's technologies
containing certain RSA code. These royalties are reflected in cost of revenues.

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                                      14
<PAGE>   4

                                         management's discussion and analysis of
                       financial condition and results of operations (continued)

RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of
revenues for the fiscal years ended September 30, 1996, 1995 and 1994:

<TABLE>
<CAPTION>
                                                                    Percentage of Revenues
                                                           For the Fiscal Years Ended September 30,

-------------------------------------------------------------------------------------------------------------
                                                            1996                    1995            1994    
-------------------------------------------------------------------------------------------------------------
<S>                                                          <C>                    <C>             <C>     
NET REVENUES:                                                                                               
World Wide Web technology revenues                           87.3%                   81.3%           56.1%  
Data visualization product revenues                             --                    12.5            42.3  
Service revenues                                              12.7                     6.2             1.6  
-------------------------------------------------------------------------------------------------------------
Total net revenues                                           100.0                   100.0           100.0  
-------------------------------------------------------------------------------------------------------------
COST OF REVENUES:                                                                                           
Cost of technology and product revenues                        8.6                    14.5            23.3  
Cost of service revenues                                       0.5                      --              --  
-------------------------------------------------------------------------------------------------------------
Total cost of revenues                                         9.1                    14.5            23.3  
-------------------------------------------------------------------------------------------------------------
Gross profit                                                  90.9                    85.5            76.7  
OPERATING EXPENSES AND OTHER:                                                                               
Sales and marketing                                           26.7                    27.2            22.9  
Research and development                                      30.6                    22.7            18.7  
General and administrative                                    17.2                    17.8            18.6  
Gain on sale of data visualization product line                 --                    (7.1)             --  
-------------------------------------------------------------------------------------------------------------
Income from operations                                        16.4                    24.9            16.5  
Other income                                                   7.8                     4.7             2.3  
-------------------------------------------------------------------------------------------------------------
Income before income taxes and                                                                              
   cumulative effect of change in accounting                  24.2                    29.6            18.8  
Provision for income taxes                                     8.7                    11.7             6.3  
-------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in accounting       15.5                    17.9            12.5  
Cumulative effect of change in accounting for income taxes      --                      --            17.1  
-------------------------------------------------------------------------------------------------------------
NET INCOME                                                    15.5%                   17.9%           29.6% 
=============================================================================================================
</TABLE>

FISCAL YEAR ENDED SEPTEMBER 30, 1996
COMPARED WITH FISCAL YEAR ENDED SEPTEMBER 30, 1995
Technology and product revenues for the year ended September 30, 1996
increased $8,082,000, or 71%, to $19,466,000 compared to $11,384,000 for the
year ended September 30, 1995. This increase in technology and product revenues
was due primarily to revenues from license agreements with new customers for
the Client SDK and, to a lesser extent, the Server SDK and SurfWatch
technologies. Approximately 12.1% of the Company's revenues for fiscal 1996
were attributable to a license from one customer. World Wide Web technology
revenues, as a percentage of revenues, increased to 87.3% during the 1996
fiscal year from 81.3% during the 1995 fiscal year. The Company sold its data
visualization product line in September 1995 and reported no revenues from this
product line for the year ended September 30, 1996 compared to $1,513,000 in
the year ended September 30, 1995. The Company expects its revenue growth to
slow during fiscal 1997 as the Company increasingly focuses its efforts on the
Internet device market.

Service revenues for the year ended September 30, 1996 increased $2,084,000, or
275%, to $2,841,000 compared to $757,000 for the year ended September 30, 1995.
During the third quarter of fiscal 1996, the Company formed a Partner Services
group to service the Internet device market. This group is comprised of
customer support and professional services. The increase in service revenues
was due primarily to the increase in the number of support agreements with new
customers for the Client SDK and the Server SDK in addition to continuing
support agreements with existing customers. Revenues from professional services
approximated $560,000 in fiscal 1996. The Company expects service revenues to
increase significantly as a percentage of revenues in fiscal 1997.

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                                      15

<PAGE>   5

management's discussion and analysis of 
financial condition and results of operations (continued)


Gross profit as a percentage of revenues was 90.9% for the year ended September
30, 1996 compared to 85.5% for the year ended September 30, 1995. This increase
in gross profit percentage resulted primarily from lower royalty costs
reflecting changes in product mix. This change in product mix resulted from the
sale of the data visualization product line in September 1995 (which had higher
royalty costs as a percentage of revenue than the Client SDK) and the
introduction of the Spyglass Server in July 1995, which has now been
incorporated into the Server SDK (which has lower royalty costs as a percentage
of revenue than the Client SDK).

Sales and marketing expenses for the year ended September 30, 1996 increased
$2,660,000, or 81%, to $5,963,000 from $3,303,000 for the year ended September
30, 1995, but decreased slightly as a percentage of revenues to 26.7% from
27.2%. The increased expenses reflected higher sales commission costs (which
increased to $785,000 in fiscal 1996 from $442,000 in fiscal 1995) due to
increased revenues in addition to staff additions in sales, marketing, and
customer support (which increased the cost of salary and related personnel
expenses to $2,725,000 in fiscal 1996 from $1,331,000 in fiscal 1995).
Additionally, certain marketing initiatives, which included a print campaign to
increase awareness of its products among the business and technology
communities, accounted for $530,000 of the increase in sales and marketing
expenses for the year ended September 30, 1996 as compared to the year ended
September 30, 1995. The Company expects to significantly increase its sales and
marketing expenses in fiscal 1997 as the Company increasingly focuses its
efforts on the Internet device market. The increased sales and marketing
expenses are expected to result from initiatives such as increased marketing
activities, an expanded sales organization, and the addition of new
distribution channels.

Research and development expenses for the year ended September 30, 1996
increased $4,045,000, or 147%, to $6,801,000 compared to $2,756,000 for the
year ended September 30, 1995, and increased as a percentage of revenues to
30.6% from 22.7%. The increase in research and development costs was due
primarily to costs associated with enhancements to existing technologies as
well as the development of the Software Development Kits, the SurfWatch
ProServer(TM) and other new technologies. The Company believes that it is
necessary to make significant investments in research and development and
acquisitions of new technologies to remain competitive in the Internet software
business and solidify a leadership position in the Internet device market. The
Company's current plans include significantly increasing the size of its
research and development staff during fiscal 1997, which will significantly
increase research and development expenses.

General and administrative expenses for the year ended September 30, 1996
increased $1,687,000, or 78%, to $3,846,000 from $2,159,000 for the year ended
September 30, 1995 but declined slightly as a percentage of revenues to 17.2%
from 17.8%. The increase in general and administrative expenses was due
primarily to increases in personnel (which increased salary and related
personnel expenses to $1,476,000 in fiscal 1996 from $679,000 in fiscal 1995)
as well as expenses incurred by the Company related to the acquisitions of
Stonehand, OS Tech and SurfWatch.

In fiscal 1995, the Company recorded a pre-tax gain, net of transaction
expenses, of $863,000 on the sale of its data visualization product line. The
approximate after-tax contribution to income was $523,000, or $0.06 per share.

Interest income, included in other income on the financial statements, for the
year ended September 30, 1996 increased $1,243,000, or 253%, to $1,734,000 from
$491,000 for the year ended September 30, 1995. This increase in interest
income is primarily due to an increase in cash and cash equivalents and
short-term investments as a result of the Company's initial public offering in
June 1995.

The provision for income taxes for the year ended September 30, 1996 increased
$536,000 to $1,951,000 from $1,415,000 for the year ended September 30, 1995.
The provision for income taxes as a percentage of income before income taxes
approximated 36% in fiscal 1996 as compared to 39% in fiscal 1995. This
decrease in the effective tax rate is due to increased research and development
tax credits for the current fiscal year.

FISCAL YEAR ENDED SEPTEMBER 30, 1995
COMPARED WITH FISCAL YEAR ENDED SEPTEMBER 30, 1994
Technology and product revenues for the year ended September 30, 1995 increased
$6,790,000, or 148%, to $11,384,000 compared to $4,594,000 for the year ended
September 30, 1994. This increase in technology and product revenues was due
primarily to revenues from licenses of Spyglass Mosaic, which was introduced in
the third quarter of fiscal 1994 (and has now been incorporated into the Client
SDK). Approximately 17.3% of the Company's revenues for fiscal 1995 were
attributable to a license for Spyglass Mosaic granted in the first quarter of
fiscal 1995 to a single customer. World Wide Web technology revenues, as a
percentage of revenues, increased to 81.3% during the 1995 fiscal year from
56.1% during the 1994 fiscal year. Revenues from licenses of data visualization
products decreased $460,000, or 23%, to $1,513,000 for the year ended September
30, 1995 compared to $1,973,000 for the year ended September 30, 1994. In
September 1995, the Company sold its data visualization product line to a
stockholder for $910,000.

Service revenues for the year ended September 30, 1995 increased $684,000 to
$757,000 compared to $73,000 for 



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                                      16
<PAGE>   6
                                         management's discussion and analysis of
                       financial condition and results of operations (continued)


the year ended September 30, 1994. This increase in service revenues was due
to revenues from support agreements of Spyglass Mosaic.

Gross profit as a percentage of revenues was 85.5% for the year ended September
30, 1995 compared to 76.7% for the year ended September 30, 1994. This increase
in gross profit percentage resulted primarily from lower royalty costs
reflecting changes in product mix, as Spyglass Mosaic revenues (which had lower
royalty costs as a percentage of net revenues than data visualization products)
comprised a greater percentage of revenues during fiscal 1995 compared to
fiscal 1994, in addition to the effect of the acquisition of Stonehand (which
had a higher gross profit percentage in fiscal 1995 than in fiscal 1994).

Sales and marketing expenses for fiscal 1995 increased $2,234,000, or 209%, to
$3,303,000 from $1,069,000 for fiscal 1994, and increased as a percentage of
revenues to 27.2% from 22.9%. The increased expenses reflected higher sales
commission costs (which increased to $442,000 in fiscal 1995 from $112,000 in
fiscal 1994) due to increased revenues in addition to staff additions in sales,
marketing, and product support (which increased the cost of salary and related
personnel expenses to $1,331,000 in fiscal 1995 from $364,000 in fiscal 1994).

Research and development expenses for fiscal 1995 increased $1,885,000, or
216%, to $2,756,000, from $871,000 for fiscal 1994, and increased as a
percentage of revenues to 22.7% from 18.7%. The increase in research and
development costs was due primarily to costs associated with enhancements to
existing technologies and new product development of Spyglass Mosaic and the
Spyglass Server.

General and administrative expenses for fiscal 1995 increased $1,289,000, or
148%, to $2,159,000 from $870,000 for fiscal 1994, but declined as a percentage
of revenues to 17.8% from 18.6%. The increase in general and administrative
expenses in fiscal 1995 was due primarily to increases in personnel and
general corporate expenses required to support the growth of the Company's
operations.

In fiscal 1995, the Company recorded a pre-tax gain, net of transaction
expenses, of $863,000 on the sale of its data visualization product line. The
approximate after-tax contribution to income was $523,000 or $0.06 per share.

Interest income, included in other income on the financial statements, for the
year ended September 30, 1995 increased $468,000 to $491,000 from $23,000 for
the year ended September 30, 1994. This increase in interest income is
primarily due to the increase in the Company's cash balance and cash
equivalents as a result of its initial public offering in June 1995.

The provision for income taxes for the year ended September 30, 1995 increased
$1,090,000 to $1,415,000 from $325,000 for the year ended September 30, 1994.
The provision for income taxes as a percentage of income before income taxes
and cumulative effect of change in accounting approximated 39% in fiscal 1995
as compared to 38% in fiscal 1994. In the year ended September 30, 1994, the
Company recorded a tax benefit of $800,000 as a result of the change in its
method of accounting for income taxes. The cumulative effect of the change in
accounting for income taxes related primarily to the future tax benefits of net
operating loss carryforwards aggregating $1,655,000.

LIQUIDITY AND CAPITAL RESOURCES
On June 27, 1995, the Company completed an initial public offering of its
common stock which provided the Company with net proceeds of approximately
$32,145,000. As of September 30, 1996, the Company had no debt and had cash and
cash equivalents of $16,490,000, short-term investments of $17,593,000 and
working capital of $39,117,000. The Company's operating activities used cash of
$822,000 for the fiscal year ended September 30, 1996 and provided cash of
$715,000 and $879,000 for the fiscal years ended September 30, 1995 and 1994,
respectively.

The Company's net accounts receivable increased to $7,608,000 at September 30,
1996 from $4,180,000 at September 30, 1995. This increase was primarily due to
an increase in revenues.

The Company's capital expenditures totaled $2,905,000, $1,034,000, and $209,000
for the fiscal years ended September 30, 1996, 1995 and 1994, respectively, and
consisted primarily of computer hardware and software, office furniture and
equipment and leasehold improvements. The Company had no material commitments
for capital expenditures at September 30, 1996. Subsequent to year end, the
Company entered into agreements with various vendors to improve and enhance its
finance, human resources and customer support information systems.

The Company believes that its current cash and cash equivalents, together with
funds expected to be generated from operations, will be sufficient to finance
the Company's operations through at least the fiscal year ending September 30,
1997.

FUTURE OPERATING RESULTS
This Annual Report contains a number of forward-looking statements. Any
statements contained herein (including without limitation statements to the
effect that the Company or its management "believes", "expects", "anticipates",
"plans" and similar expressions) that are not statements of historical fact
should be considered forward-looking statements. There are a number of
important factors that could cause the Company's actual results 

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                                      17
<PAGE>   7
management's discussion and analysis of
financial condition and results of operations (continued)

to differ materially from those indicated by such forward-looking
statements. These factors include, without limitation, those set forth below.

The Company's future results of operations will be largely dependent upon a
number of factors relating to development and acceptance of the Internet device
market as a commercial market and the Company's ability to establish its
technologies as widely-accepted in the market. In particular, commercial use of
the Internet continues to be constrained by the need for reliable processes
such as security measures for electronic commerce as well as the need for
regularly available customer support and a supporting infrastructure providing
widespread Internet accessibility and high-speed communications capabilities.
In addition, the market for Internet software products is characterized by
rapidly changing technology, evolving industry standards and customer demands,
and frequent product introductions and enhancements, which make it difficult to
predict whether the initial commercial acceptance of the Company's products can
be sustained over a period of time.

The Company has recently announced an increased strategic focus on the Internet
device market. The Company is increasingly focusing on the development and
marketing of technologies that enable digital devices, such as business
productivity products, consumer electronic devices and office equipment, to
access the Web. Because this is a new and undeveloped market, there can be no
assurance as to the extent of the demand for product offerings similar to those
of the Company, or the extent to which the Company will be successful in
penetrating this market. Moreover, the Company expects its revenue growth to
slow during fiscal 1997 as the Company redirects its business strategy toward
vendors of Internet-enabled devices, rather than vendors of desk-top software
applications. In addition, the Company expects to significantly increase its
expenditures in product development, marketing and sales relating to the
Internet device market, which should negatively impact net income during fiscal
1997.

The market for Internet software products is extremely competitive, and
competition is likely to increase in the future due to the increasing
popularity of the Internet. The Company currently faces competition from other
Internet device technology and software vendors (such as Navio Communications
and Microsoft Corporation). In licensing its Internet technologies, the Company
considers a significant source of competition to be the prospect company's
internal software development resources. In addition, the increase in market
share of Netscape and Microsoft in the desktop browser and server market, as
well as the Microsoft corporate strategy for Windows, has increased the
competitive pressures on customers of Spyglass in the browser, server and
embedded technology markets. The Company has a license arrangement with
Microsoft Corporation which provides a worldwide license to distribute Spyglass
Mosaic on multiple platforms on a per copy basis with certain fixed fee
provisions.

The Company licenses its products to a variety of companies such as RTOS
vendors, consumer and industrial device manufacturers, RBOCs, ISPs and
internetworking hardware providers that incorporate the Company's technology
into their products and services. The success of the Company is therefore
dependent in large part on the performance of its customers, which is outside
of the Company's control.

The Company from time to time receives notices alleging that its products
infringe third party proprietary rights. For example, the Company has a pending
dispute with Unisys Corporation regarding the Graphics Interchange Format.
Spyglass has received a notice from Elk Industries Inc. alleging that one or
more products of Spyglass infringe a patent owned by Elk Industries Inc.
Spyglass has not concluded its examination of this claim. Patent and similar
litigation frequently is complex and expensive and its outcome can be difficult
to predict. If, as a result of proprietary rights infringements by any of the
Company's products, the Company is required to discontinue sales of certain
products, eliminate certain features on its products, or pay royalties to
another party, the Company's future operating results could be materially
adversely affected.

The Company's quarterly operating results have varied and they may continue to
vary significantly depending on factors such as the timing of significant
license agreements, the terms of the Company's licensing arrangements with its
customers and the timing of new product introductions and upgrades by the
Company and its competitors. The Company typically structures its license
agreements with customers to require commitments for a significant minimum
number of licenses, and license revenues are recognized as the committed
licenses are purchased. The Company typically experiences the greatest
proportion of net revenues in the first quarter of a license arrangement. The
Company's net revenue often declines after the first quarter of a contract as
the number of copies purchased by the customer declines. Additional revenues
from a customer will not be earned unless and until the initial committed
levels are exceeded. The Company's revenues in any quarter will therefore
depend in significant part on its ability to sell licenses to new customers in
that quarter. The Company's expense levels are based in part in expectations of
future revenue levels and any shortfall in expected revenue could therefore
result in a disproportionate decrease in the Company's net income.

INFLATION
The Company does not believe that inflation has had a material impact on its
operations to date.

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                                      18
<PAGE>   8

                    consolidated statements of operations


<TABLE>
<CAPTION>
                                                                 For the Years Ended September 30,
---------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)                     1996               1995               1994
<S>                                                         <C>                <C>                <C>
---------------------------------------------------------------------------------------------------------
NET REVENUES:
  World Wide Web technology revenues                        $19,466            $ 9,871            $ 2,621
  Data visualization product revenues                            --              1,513              1,973
  Service revenues                                            2,841                757                 73
---------------------------------------------------------------------------------------------------------
  Total net revenues                                         22,307             12,141              4,667
COST OF REVENUES:
  Cost of technology and product revenues                     1,912              1,761              1,087
  Cost of service revenues (Note 1)                             118                 --                 --
---------------------------------------------------------------------------------------------------------
  Total cost of revenues                                      2,030              1,761              1,087
---------------------------------------------------------------------------------------------------------
Gross profit                                                 20,277             10,380              3,580
OPERATING EXPENSES AND OTHER:
  Sales and marketing                                         5,963              3,303              1,069
  Research and development                                    6,801              2,756                871
  General and administrative                                  3,846              2,159                870
  Gain on sale of data visualization product line                --              (863)                 --
---------------------------------------------------------------------------------------------------------
Income from operations                                        3,667              3,025                770
Other income                                                  1,744                566                139
---------------------------------------------------------------------------------------------------------
Income before income taxes and
   cumulative effect of change in accounting                  5,411              3,591                909
Provision for income taxes                                    1,951              1,415                325
---------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in accounting       3,460              2,176                584
Cumulative effect of change in accounting for income taxes       --                 --                800
---------------------------------------------------------------------------------------------------------
NET INCOME                                                    3,460               2,176             1,384
Accretion of preferred stock dividends                           --                (191)             (257)
---------------------------------------------------------------------------------------------------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS                 $ 3,460             $ 1,985           $ 1,127
=========================================================================================================
Earnings per common share and equivalents:
   Income before cumulative effect of change in accounting  $  0.27             $  0.23           $  0.08
   Net income                                               $  0.27             $  0.23           $  0.18
   Net income available to common stockholders              $  0.27             $  0.21           $  0.15
   WEIGHTED AVERAGE NUMBER OF COMMON SHARES
      AND EQUIVALENTS OUTSTANDING                            12,838               9,423             7,685
==========================================================================================================
</TABLE>



See accompanying Notes to the Consolidated Financial Statements.

                                    [LOGO]

                                      19

<PAGE>   9




                         consolidated balance sheets

<TABLE>
<CAPTION>
                                                                September 30,
--------------------------------------------------------------------------------
(In thousands)                                                 1996    1995     
--------------------------------------------------------------------------------
 <S>                                                           <C>      <C>     
 ASSETS                                                                         
    CURRENT ASSETS:                                                             
       Cash and cash equivalents                               $16,490  $34,872 
       Short-term investments                                   17,593       -- 
       Accounts receivable, net of allowance for                                
          doubtful accounts of $470 and $180, respectively       7,608    4,180 
       Prepaid expenses and other assets                         2,094      489 
       Deferred income taxes                                        --      199 
--------------------------------------------------------------------------------
          Total current assets                                  43,785   39,740 
    Properties, net                                              3,377    1,187 
    Long-term accounts receivable                                  618    1,281 
    Other assets                                                   989    1,301 
--------------------------------------------------------------------------------
          TOTAL ASSETS                                         $48,769  $43,509 
================================================================================
 LIABILITIES AND STOCKHOLDERS' EQUITY                                           
    CURRENT LIABILITIES:                                                        
       Accounts payable                                        $ 2,160  $ 1,466 
       Deferred revenues                                         1,453    1,634 
       Accrued compensation and related benefits                   952      604 
       Accrued expenses and other liabilities                      103      486 
--------------------------------------------------------------------------------
          Total current liabilities                              4,668    4,190 
    Long-term deferred revenues                                    210    1,100 
    Deferred income taxes                                           --      605 
--------------------------------------------------------------------------------
          Total liabilities                                      4,878    5,895 
--------------------------------------------------------------------------------
 COMMITMENTS AND CONTINGENCIES (NOTE 11)                                        
 STOCKHOLDERS' EQUITY:                                                          
    Preferred stock, $.01 par value,                                            
       2,000,000 shares authorized, none issued                     --       -- 
    Common stock, $.01 par value, 50,000,000 and                                
       15,000,000 shares authorized, 11,819,545 and                             
       11,406,645 shares issued and outstanding, respectively      118      114 
    Additional paid-in capital                                  39,341   36,528 
    Retained earnings                                            4,432      972 
--------------------------------------------------------------------------------
          Total stockholders' equity                            43,891   37,614 
--------------------------------------------------------------------------------
          TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY           $48,769  $43,509 
================================================================================
                                                                                
</TABLE>



See accompanying Notes to the Consolidated Financial Statements.


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                                      20
                                      
<PAGE>   10



                consolidated statements of changes in redeemable
             convertible preferred stock and stockholders' equity

<TABLE>
<CAPTION>
                                        Redeemable convertible preferred stock                          
                                        at net issuance plus dividend accretion       Common Stock       Additional     
                                        ---------------------------------------     -----------------     Paid-in     Retained
(In thousands, except share amounts)       Series A       Series B         Total    Shares     Amount     Capital     Earnings
----------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>           <C>            <C>         <C>        <C>       <C>         <C>
BALANCE AT SEPTEMBER 30, 1993               $ 1,063       $  2,073       $  3,136    1,658,969  $  213    $  --       $(2,140)
    Exercise of stock options                                                              875
     Capital contribution                                                                           24 
     Net income                                                                                                         1,384
   Accretion of preferred                                                                   
      stock dividends                            85            172            257                                        (257)
----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1994                 1,148          2,245          3,393    1,659,844     237       --        (1,013)
   Exercise of stock options                                                            46,602       1       45
   Exercise of stock warrants                                                          202,778       2       18
   Issuance of incentive
      stock options                                                                                         146
   Exchange of common stock
      from no par to $0.01 par                                                                    (221)     221
   Conversion of preferred stock
      into common stock                      (1,211)        (2,373)        (3,584)   1,724,099      17    3,567
   Net proceeds from
      initial public offering                                                        2,070,000      21   32,124
   Tax benefit from exercise
      of stock options                                                                                      464
   Issuance of common stock
      to effect for two-for-one
      common stock split                                                             5,703,322      57      (57)
   Net income                                                                                                           2,176
   Accretion of preferred
      stock dividends                            63            128            191                                        (191)
------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1995                    --            --              --    11,406,645     114   36,528          972
   Exercise of stock options                                                            412,900       4      797
   Issuance of incentive
      stock options                                                                                           80
   Tax benefit from exercise
      of stock options                                                                                      1,936
   Net income                                                                                                           3,460
------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1996               $    --       $    --        $     --    11,819,545  $  118   $39,341     $ 4,432
====================================================================================================================================
</TABLE>


See accompanying Notes to the Consolidated Financial Statements.

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                                      21

<PAGE>   11


                    consolidated statements of cash flows

<TABLE>
<CAPTION>
                                                                    For the Years Ended September 30,
--------------------------------------------------------------------------------------------------------

             (In thousands)                                               1996     1995     1994
--------------------------------------------------------------------------------------------------------
<S>                                                                    <C>         <C>      <C>
CASH FLOWS FROM OPERATING ACTIVITIES:                                            
   Net income                                                          $   3,460   $ 2,176  $ 1,384
   Cumulative effect of change in accounting for income taxes                 --        --     (800)
   Adjustments to reconcile net income to net cash                               
         provided by (used in) operating activities:                             
      Depreciation and amortization                                          694       218        68
      Loss on disposal of fixed assets                                        21        --        --
      Deferred income taxes                                                 (406)      888       318
      Incentive stock option compensation                                     80       146        --
      Interest income from related party receivables                          --        --        (4)
      Gain on sale of data visualization product line                         --      (863)       --
      Other                                                                 (201)      (17)       --
   Changes in operating assets and liabilities:                                  
      Accounts and long-term receivables                                  (2,765)   (2,368)   (2,754)
      Prepaid expenses and other assets                                   (1,293)   (1,530)      (53)
      Accounts payable                                                       694       940       267
      Deferred revenues                                                   (1,071)      210     2,487
      Accrued compensation and related benefits                              348       463       141
      Accrued expenses and other liabilities                                (383)      452      (175)
---------------------------------------------------------------------------------------------------------
      Net cash provided by (used in) operating activities                   (822)      715       879
---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:                                            
   Proceeds from sale of data visualization product line                      --       910        --
   Purchase of short-term investments                                    (17,593)       --        --
   Capital expenditures                                                   (2,905)   (1,034)     (209)
---------------------------------------------------------------------------------------------------------
      Net cash (used in) investing activities                            (20,498)     (124)     (209)
---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:                                            
   Proceeds from exercise of stock options,                                      
      including tax related benefits                                       2,938       510        --
   Capital contribution                                                       --        --        24
   Net proceeds from initial public offering                                  --    32,145        --
   Proceeds from exercise of warrants                                         --        20        --
----------------------------------------------------------------------------------------------------------
      Net cash provided by financing activities                            2,938    32,675        24
---------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents                     (18,382)   33,266       694
Cash and cash equivalents at beginning of period                          34,872     1,606       912
---------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD                             $  16,490   $34,872  $  1,606
=========================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                
   Cash paid for income taxes                                            $   169  $     80    $   --
                                                                                 
</TABLE>


See accompanying Notes to the Consolidated Financial Statements.

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                                      22


<PAGE>   12

                                notes to the consolidated financial statements

NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES 
Operations 

Spyglass, Inc. ("Spyglass" or the "Company") develops, markets and distributes
World Wide Web  ("WWW" or "Web") technologies designed to be embedded within
Internet devices, software applications and on-line services. Spyglass
technology offerings include the Spyglass Web Client Software Development Kit,
which was renamed Spyglass Mosaic in December 1996, ("Client SDK"), the Spyglass
Web Server Software Development Kit, which was renamed Spyglass Web Server in
December 1996, ("Server SDK"), SurfWatch ProServer, SurfWatch  from Spyglass and
WebNotes. These technologies are used to bring Web functionality to customers'
products and services.

In May 1996, the Company formed Spyglass International, Inc., a wholly-owned
subsidiary. Spyglass International, Inc. is a U.S. subsidiary that has one
branch office in Hong Kong.

In April 1996, the Company acquired OS Technologies Corporation ("OS Tech") and
SurfWatch Software, Inc. ("SurfWatch") in transactions accounted for as pooling
of interests. As a result, all financial information prior to April 17, 1996
and April 24, 1996 includes the accounts and results of operations of OS Tech
and SurfWatch, respectively, for all periods presented. (See Note 14.)

In February 1996, the Company acquired Stonehand Inc. ("Stonehand"), in a
transaction accounted for as pooling of interests. As a result, all financial
information prior to February 2, 1996 includes the accounts and results of
operations of Stonehand for all periods presented. (See Note 14.)

On November 28, 1995, the Board of Directors declared a two-for-one common
stock split effected in the form of a 100% stock dividend paid on December 20,
1995 to stockholders of record as of December 6, 1995. All share and per share
information in the accompanying consolidated financial statements and related
notes thereto have been restated to reflect the two-for-one common stock split
for all periods presented.

On June 27, 1995, the Company completed an initial public offering of
its common stock in which it sold 4,140,000 shares of common stock at a public
offering price of $8.50 per share. Proceeds to the Company totaled approximately
$32,145,000, net of expenses associated with the offering. Upon the closing of
the initial public offering, 1,724,099 shares of redeemable convertible
preferred stock were converted into 3,448,198 shares of common stock.

Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary. All intercompany transactions and balances between
the companies have been eliminated.

University of Illinois Agreement
The Company's principal product, the Client SDK, is a commercial derivative
version of NCSA Mosaic(TM). NCSA Mosaic was developed by the National Center
for Supercomputing Applications at the University of Illinois at
Urbana-Champaign. In May 1994, the Company and the University entered into an
agreement (as amended to date, the "University Agreement") granting the Company
the exclusive (subject to approximately 10 previously granted licenses),
worldwide right to develop, distribute and sublicense commercial client
browsers based on NCSA Mosaic. The University Agreement provides for royalties
based on Spyglass' net revenues from the Client SDK, and includes cumulative
minimum quarterly royalties. The University Agreement has an initial term of
five years, with automatic one-year renewals, and is terminable in the event of
a material breach by the Company of its obligations thereunder. Under the
University Agreement, the Company was required to provide the University with
source code versions of Spyglass Mosaic through Release 2.5. The University
will have the right (subject to certain restrictions) to incorporate these
releases of the Spyglass Mosaic into new releases of NCSA Mosaic, which will
continue to be available on a free-with-copyright basis to organizations for
non-commercial academic and research use only. However, the University is not
permitted to make NCSA Mosaic available for distribution by resellers other
than the Company. The University Agreement gives the Company the exclusive
right (with certain limited exceptions) to use the University's trademarks
"Mosaic(TM)" and "NCSA Mosaic(TM)" and its spinning globe logo in connection
with Mosaic on a royalty-free basis (with certain limited exceptions). In
addition, the Company has the exclusive right (with certain limited exceptions)
to use these marks in connection with the sale of other products for a royalty
payment based on net revenues derived from such products.

Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.

                                    [LOGO]

                                      23
<PAGE>   13

notes to the consolidated financial statements (continued)

Cash and Cash Equivalents
For the purposes of the balance sheet and statement of cash flows, all highly
liquid investments with original maturities of three months or less are
considered cash equivalents.

Investments
The Company accounts for its investments in debt and equity securities in
accordance with Statement of Financial Accounting Standards No. 115, Accounting
for Certain Investments in Debt and Equity Securities. Accordingly, the Company
has classified its marketable debt securities in the held-to-maturity category.
Securities classified as held-to-maturity are reported at amortized cost.
Realized gains and losses and declines in value of securities judged to be
other-than-temporary are included in other income. The appropriate
classification of debt securities is determined at the time of purchase and is
re-evaluated as of each balance sheet date.

Investments with original maturities between three and twelve months are
considered short-term investments. Short-term investments consist of debt
securities such as commercial paper, time deposits, certificates of deposit,
bankers' acceptances, and marketable direct obligations of the United States
Treasury.

Other Assets
The Company licenses certain technology from third parties and records prepaid
royalty costs associated with these licenses. These expenses are deferred and
realized based upon revenues. It is the Company's policy to periodically review
and evaluate whether the benefits associated with these expenses are expected
to be realized and, therefore, deferral and amortization is appropriate.
Approximately $550,000 and $200,000 of these deferred expenses are included in
prepaid expenses and other assets and approximately $989,000 and $1,301,000 are
included in other assets at September 30, 1996 and September 30, 1995,
respectively.

Properties
Properties are stated at cost less accumulated depreciation. Depreciation is
determined for financial reporting purposes using the straight line method over
the estimated useful lives of the assets, which range from 3 to 7 years.
Depreciation for income tax reporting purposes is determined using accelerated
depreciation methods.

Revenue Recognition
The Company recognizes revenue in accordance with the provisions of Statement
of Position 91-1, Software Revenue Recognition, issued by the American
Institute of Certified Public Accountants. World Wide Web technology revenues
are generally recognized as the licenses are purchased, provided the license
agreement does not allow for extended payment terms, and there are no
significant remaining obligations under the contract. Data visualization
product revenue was recognized upon shipment. Service revenues are comprised of
revenues from customer support and professional services agreements. Revenue
from the sale of support agreements is recognized over the term of the
agreement using the straight-line method and related costs are included in
operating expenses under the sales and marketing classification. Revenue from
professional services agreements is recognized on the percentage of completion
method and related costs are reported as a cost of sales.

As of September 30, 1995, long-term receivables of $1,100,000 resulted from a
non-refundable Spyglass Mosaic software licensing contract with installment
payments totaling $2,812,500 over a five year contract term commencing July 27,
1994. The Company's license contract required a payment of $562,500 upon
execution of the agreement and four equal payments of $500,000 on July 27,
1995, 1996, 1997 and 1998. The Company had no significant post-contract
obligations under this agreement. In addition to the license contract, the
Company entered into a contract to provide support for a period of five years.
This contract required payment of $50,000 upon execution and four equal annual
payments of $50,000 on the first four anniversary dates of the contract. During
fiscal 1996, the Company completed an amendment to this contract which provided
for a discounted prepayment of the remaining license fee installments and the
cancellation of all future support obligations of the Company and related
support fee installments. As of September 30, 1996, there were no long-term
receivables or deferred revenues relating to this contract.

Accounting for Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation, which will be effective for the Company in fiscal year 1997. SFAS
No. 123 allows companies which have stock-based compensation arrangements with
employees to adopt a new fair-value basis of accounting for stock options and
other equity instruments, or to continue to apply the existing accounting rules


                                    [LOGO]


                                      24
<PAGE>   14
                      notes to the consolidated financial statements (continued)

under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees, but with additional financial statement disclosure. The Company
plans to adopt the disclosure provisions of this statement and does not
anticipate that SFAS No. 123 will have a material impact on its financial
position, results of operations or cash flows.

Per Share Information
Earnings per share are based on the weighted average number of shares of common
stock and common stock equivalents outstanding during periods presented,
computed using the treasury stock method for stock options and warrants in
accordance with Staff Accounting Bulletin No. 83 of the Securities and Exchange
Commission.

Reclassification
Certain balance sheet accounts as of September 30, 1995 and certain income
statement accounts as of September 30, 1995 and 1994 have been reclassified to
conform with the current year's presentation.

NOTE 2. ACCOUNTING CHANGE
Effective October 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 109, Accounting For Income Taxes. The cumulative
effect of the change in accounting for income taxes, recorded in fiscal 1994,
was $800,000.

NOTE 3. SHORT-TERM INVESTMENTS
The following is a summary of short-term investments at
amortized cost as of September 30, 1996:


<TABLE>
<CAPTION>

(In thousands)
------------------------------------------
<S>                              <C>
Commercial paper                  $ 4,776
Corporate debt securities           1,973
Money market                        9,513
------------------------------------------
    Cash equivalents               16,262
Cash                                  228
------------------------------------------
TOTAL CASH AND CASH EQUIVALENTS   $16,490
==========================================
Commercial paper                 $    997
Corporate debt securities          10,740
U.S. treasury notes                 5,856
------------------------------------------
TOTAL SHORT-TERM INVESTMENTS      $17,593
==========================================
</TABLE>

Since these securities are short-term in nature, changes in market interest
rates would not have a significant impact on the fair value of these
securities. These securities are carried at amortized cost which approximates
fair value. It is the intent of the Company to hold its investments until
maturity.

NOTE 4. PROPERTIES
Properties and related accumulated depreciation were as follows:


<TABLE>
<CAPTION>
                                        September 30,
----------------------------------------------------------
(In thousands)                         1996       1995
----------------------------------------------------------
<S>                                 <C>        <C>
Computer equipment                  $  2,545   $ 1,102
Furniture and fixtures                 1,571       468
Leasehold improvements and other         420       148
----------------------------------------------------------
                                       4,536     1,718
Less: Accumulated depreciation        (1,159)     (531)
---------------------------------------------------------
PROPERTIES, NET                     $  3,377   $ 1,187
=========================================================
</TABLE>


NOTE 5. INCOME TAXES
The components of the provision for income taxes were as follows:


<TABLE>
<CAPTION>
                                      For the Years Ended September 30,
---------------------------------------------------------------------------
(In thousands)                             1996        1995         1994
---------------------------------------------------------------------------
<S>                                  <C>         <C>           <C>
Current:
         Federal                       $    --     $       3     $      8
         Foreign                            152           60           --
         State                               --           --           --
----------------------------------------------------------------------------
           Total current                    152           63            8
----------------------------------------------------------------------------
Deferred:
         Federal                          1,444        1,100          263
         State                              355          252           54
----------------------------------------------------------------------------
           Total deferred                 1,799        1,352          317
----------------------------------------------------------------------------
PROVISION FOR
INCOME TAXES                            $ 1,951      $ 1,415     $    325
============================================================================
</TABLE>

                                    [LOGO]


                                      25


<PAGE>   15

notes to the consolidated financial statements (continued)

A reconciliation of income tax expense to the statutory federal income tax rate
follows:

<TABLE>
<CAPTION>
                                 For the Years Ended September 30,
------------------------------------------------------------------
                                      1996     1995     1994      
------------------------------------------------------------------
<S>                                   <C>      <C>      <C>       
Federal income taxes at                                           
   statutory rate                     34.0%    34.0%    34.0%     
State income taxes, net                                           
   of federal income tax benefit       4.3%     4.6%     4.2%     
Other                                 (2.2%)    0.8%    (0.3%)    
------------------------------------------------------------------
EFFECTIVE TAX RATE                    36.1%    39.4%    37.9%     
==================================================================
</TABLE>                                                          
                                                                  

The current provision is the amount of income taxes reported or expected to be
reported on the Company's tax returns. Differences between accounting rules and
tax laws cause differences between the basis of certain assets and liabilities
for financial reporting and tax purposes. The tax effect of these differences,
to the extent that they are temporary, are recorded as deferred tax assets and
liabilities under Statement of Financial Accounting Standards ("SFAS") No. 109,
Accounting for Income Taxes.

Significant components of the Company's net deferred tax assets
(liabilities) were as follows:

<TABLE>
<CAPTION>                                                             
                                                                                    September 30,
--------------------------------------------------------------------------------------------------------------------
(In thousands)                                                       1996                              1995
--------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                               <C>
DEFERRED TAX ASSETS:
   Accounts payable                                                $    836                         $     540
   Deferred revenue                                                     282                               320
   Accrued expenses and other liabilities                               410                               272
--------------------------------------------------------------------------------------------------------------------
      Deferred tax assets                                             1,528                             1,132
--------------------------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
   Depreciation                                                        (103)                              (31)
   Accounts and notes receivable                                     (2,840)                           (1,375)
   Prepaid expenses and other assets                                 (1,070)                             (685)
---------------------------------------------------------------------------------------------------------------------
      Deferred tax liabilities                                       (4,013)                           (2,091)
---------------------------------------------------------------------------------------------------------------------
Net operating loss carryforwards                                      3,459                               289
Research and development tax
   credit carryforwards                                                 341                               194
Foreign tax credit carryforwards                                        152                                60
Alternative minimum tax
   credit carryforwards                                                  10                                10
---------------------------------------------------------------------------------------------------------------------
Gross deferred tax assets (liabilities)                            $  1,477                         $    (406)
Deferred tax asset valuation allowance                               (1,477)                               --
----------------------------------------------------------------------------------------------------------------------
NET DEFERRED TAX ASSETS (LIABILITIES)                              $     --                         $    (406)
======================================================================================================================
</TABLE>


As of September 30, 1996, the Company had net operating loss carryforwards for
income tax purposes of approximately $8,939,000 which expire in the years
2006-2011. The net operating loss carryforward balances at September 30, 1995
and 1994 were approximately $748,000 and $845,000, respectively. The net
operating losses arise primarily as a result of the deductions relating to the
exercise of incentive stock options.

As of September 30, 1996, the Company had research and development credit
carryforwards of approximately $341,000 which are available to offset future
income tax liabilities in the years 2006-2011. The research and development
credit carryforward balances at September 30, 1995 and 1994 were approximately
$194,000 and $80,000, respectively.

In fiscal 1996, the Company realized approximately $3,682,000 of tax benefit
from the exercise of stock options by employees. Of this amount, $2,205,000 has
been recorded as a reduction of the Company's deferred tax liability and an
increase in additional paid-in capital. The remaining $1,477,000 of tax benefit
has been recorded as a valuation allowance and is available to reduce future
deferred tax liabilities. In fiscal 1995, the Company realized approximately
$464,000 of tax benefit from the exercise of stock options by employees. This
amount was recorded as a reduction of the Company's deferred tax liability and
an increase in additional paid-in capital.

NOTE 6. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On June 27, 1995, the Company completed an initial public offering of its
common stock in which 1,724,099 shares of redeemable convertible preferred
stock were converted into 3,448,198 shares of common stock.

As of September 30, 1994, the Company was authorized to issue 2,000,000 shares
of no par value redeemable convertible preferred stock ("preferred stock"), of
which 765,766 shares were outstanding as Series A preferred stock, and 958,334
shares were outstanding as Series B preferred stock and 275,900 shares were not
outstanding. The Series A and B preferred stock had certain conversion, voting,
redemption, liquidation and dividend rights prior to the conversion of the
preferred stock on June 27, 1995.

                                    [LOGO]


                                      26
<PAGE>   16

                      notes to the consolidated financial statements (continued)

At September 30, 1994, the liquidation value of the Series A and Series B
preferred stock was $1,147,500 and $2,245,382, respectively. As of June 27,
1995, the liquidation value of the Series A and Series B preferred stock was
$1,210,540 and $2,373,322, respectively.

The difference between the preferred stock issuance price and the redemption
value was accreted periodically through June 27, 1995, by a charge to
accumulated deficit in the amount equal to the annual accruing dividend. The
Company charged $190,980 and $257,500, respectively, to the accumulated deficit
in recognition of the accruing dividends applicable to the Series A and Series
B preferred stock issued and outstanding during the years ended September 30,
1995 and 1994.

NOTE 7. PREFERRED STOCK
Pursuant to the Company's Amended and Restated Certificate of Incorporation,
the Company is authorized to issue up to 2,000,000 shares of $.01 par value
preferred stock at terms and conditions to be designated by the Board of
Directors. As of September 30, 1996 and 1995, there were no shares of
preferred stock designated or outstanding.

NOTE 8. STOCKHOLDERS' EQUITY
In May 1995, the Company reincorporated as a Delaware corporation and exchanged
each share of no par value common stock for one share of common stock, $.01 par
value. Holders of common stock are entitled to one vote per share.

NOTE 9. STOCK INCENTIVE PLANS
The Company has a 1995 Director Stock Option Plan ("1995 Director Option Plan")
and a 1995 Stock Incentive Plan ("1995 Incentive Plan") which replaced the
Company's 1991 Stock Option Plan ("1991 Option Plan") and the 1991 Employee
Stock Bonus Plan ("1991 Bonus Plan") effective June 27, 1995, when the Company
completed its initial public offering.

The above plans enable the Company to grant options to purchase common stock,
to make awards of restricted common stock and to issue certain other
equity-related securities of the Company to any full or part-time employees,
officers, directors, consultants or independent contractors of the Company.
Stock options entitle the optionee to purchase common stock from the Company
for a specified exercise price during a period specified in the applicable
option agreement. Restricted stock awards entitle the recipient to purchase
common stock from the Company under terms which provide for vesting over a
period of time and a right of repurchase in favor of the Company of the
unvested portion of the common stock subject to the award upon the termination
of the recipient's employment or other relationship with the Company. The
plans, except for the 1995 Director Option Plan, are administered by the
Compensation Committee of the Board of Directors, which selects the persons to
whom stock options and restricted stock awards are granted and determines the
number of shares of common stock covered by the option or award, its exercise
price or purchase price, its vesting schedule and, in the case of stock
options, its expiration date.

Furthermore, the above plans stipulate that the exercise price of any incentive
stock option shall not be less than 100% of the fair market value of the common
stock at the date of the grant or less than 110% of the fair market value in
the case of optionees holding more than 10% of the total combined voting power
of all classes of stock of the Company. The exercise periods of incentive stock
options cannot exceed 10 years from the date of grant, except for incentive
stock options granted to optionees holding more than 10% of the total combined
voting power of all classes of stock, which must be exercised within 5 years.
Non-qualified stock options, if any, must be exercised within the time period
set forth in the option agreement. Any portion not exercised within the terms
as stipulated in the option agreement shall be forfeited.

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                                      27


<PAGE>   17


notes to the consolidated financial statements (continued)

The Company records as compensation expense the excess, if any, of the
estimated fair market value of the common stock at the date of option grant
over the option exercise price. Any compensation expense is recognized ratably
over the vesting period of the options. The Company recorded compensation
expense of $80,148 and $146,013 for the years ended September 30, 1996 and
1995, respectively, relating to options granted with an exercise price below
the estimated fair market value of the common stock. No compensation expense
was recorded in fiscal 1994. Options granted prior to October 1994 and
subsequent to the Company's initial public offering have an exercise price
approximating the fair market value of the common stock as of their grant date.

1995 Stock Incentive Plan
The maximum number of shares of common stock which may be issued pursuant to
the 1995 Incentive Plan is 1,800,000 shares, subject to certain anti-dilution
adjustments. Options generally become exercisable over four years, commencing
on the one-year anniversary of the date of grant and accumulate if not
exercised. Options to purchase 967,099 and 72,000 shares of common stock, at
prices ranging from $0.43 to $28.375 per share and from $18.75 to $21.75 per
share, had been granted as of September 30, 1996 and 1995, respectively.

The 1995 Incentive Plan further provides for the granting of stock appreciation
rights ("SARs") subject to certain conditions and limitations to holders of
options under the 1995 Incentive Plan. SARs permit optionees to surrender an
exercisable option for any amount equal to the excess of the market price of
the common stock over the option price when the right is exercised. There were
no SARs issued or exercised during fiscal 1996 or 1995.

Furthermore, the 1995 Incentive Plan provides for the granting of performance
share awards entitling recipients to acquire shares of common stock upon the
attainment of specified performance goals, as determined by the Board of
Directors. No performance share awards were issued during fiscal 1996 or fiscal
1995.


1991 Stock Option Plan
At September 30, 1996, the maximum number of shares of common stock which may
be issued pursuant to the 1991 Option Plan is 1,574,448 shares subject to
certain anti-dilution adjustments. The 1991 Option Plan was terminated
effective June 27, 1995, when the Company completed its initial public
offering, and was replaced by the 1995 Stock Incentive Plan. Options granted
under the 1991 Option Plan generally become exercisable in four equal annual
installments, commencing on the date of grant and continuing through the third
anniversary of the date of grant and accumulate if not exercised. At September
30, 1996, options to purchase 1,520,132 shares of common stock, at prices
ranging from $0.08 to $4.125 per share, had been granted.

The 1991 Option Plan further provides for the granting of SARs subject to
certain conditions and limitations to holders of options under the 1991 Option
Plan. SARs permit optionees to surrender an exercisable option for any amount
equal to the excess of the market price of the common stock over the option
price when the right is exercised. There were no SARs issued or exercised
during fiscal 1996, 1995 or 1994.

A summary of the 1995 Stock Incentive Plan and the 1991 Stock Option Plan
transactions follows:


<TABLE>
<CAPTION>

                                    September 30,
---------------------------------------------------------
                                   1996       1995
---------------------------------------------------------
<S>                              <C>        <C>
Options outstanding at
   beginning of year             1,433,004    872,438
Granted (prices ranging
   from $0.43 to $28.375)          895,099    671,922
Exercised (prices ranging
   from $0.08 to $17.4375)        (412,900)   (94,454)
Canceled                           (19,014)   (16,902)
---------------------------------------------------------
Options outstanding at end
   of year (prices ranging from
   $0.08 to $28.375)             1,896,189  1,433,004

=========================================================
</TABLE>



Options to purchase 670,535 and 602,488 shares of common stock were exercisable
under the Plans at September 30, 1996 and 1995, respectively.

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                                      28
<PAGE>   18


                      notes to the consolidated financial statements (continued)


1995 Director Stock Option Plan
Under the Company's 1995 Director Stock Option Plan, the maximum number of
shares of common stock which may be issued is 200,000 shares, subject to
certain anti-dilution adjustments. Options become exercisable over four years,
commencing on the one-year anniversary of the date of grant and accumulate if
not exercised. As of September 30, 1996, 24,000 shares were exercisable. There
were no shares exercisable as of September 30, 1995.

In January 1996 and March 1995, the Company granted options to purchase 5,000
and 20,000 shares of common stock, respectively, to each of its non-employee
directors at an exercise price of $42.50 and $3.75 per share, respectively. In
addition, each non-employee director initially elected to the Board of
Directors in the future will be granted an option, upon initial election as a
director, to purchase 20,000 shares of common stock. Each non-employee director
will also receive a subsequent grant of an option for 5,000 shares on the date
of each Annual Meeting of Stockholders.

Common Stock Warrants
The Company issued common stock purchase warrants for 30,000 shares of common
stock during fiscal 1995 pursuant to the terms of an agreement with a third
party under which the Company purchased certain trademark rights. The common
stock warrants permit the holder to purchase shares of common stock at a price
of $20.625 per share. The common stock warrants expire in August, 2002.

The Company issued common stock purchase warrants for 455,556 shares of common
stock during fiscal 1991 pursuant to the terms of the investment agreement with
Greylock Limited Partnership and Venrock Associates. The common stock warrants
permitted the holders to purchase shares of common stock at a price of $0.05
per share, subject to certain anti-dilution adjustments. The common stock
warrants were scheduled to expire at various dates through fiscal 1996. There
were stock warrants for 50,000 shares canceled during fiscal 1993. The
remaining common stock purchase warrants for 405,556 shares were exercised in
full in May 1995.

NOTE 10. EMPLOYEE BENEFITS
401(k) Savings Plan
The Company has a salary reduction 401(k) retirement savings plan (the "Plan")
covering substantially all of the Company's employees. Participating employees
may contribute an amount up to 15% of their eligible compensation, subject to
an annual limit. The Company, at the discretion of the Board of Directors, may
make contributions to the Plan. The Company contributed $118,300 and $31,600 to
the Plan in fiscal 1996 and 1995, respectively. No contributions were made to
the Plan by the Company in fiscal 1994. Expenses of the Plan were approximately
$6,400, $2,600 and $2,400 in fiscal 1996, 1995 and 1994, respectively.

1995 Employee Stock Purchase Plan
Under the Company's 1995 Employee Stock Purchase Plan ("Stock Purchase Plan"),
employees are granted the opportunity to purchase the Company's common stock.
The first offering under the Plan commenced on August 16, 1995 and concluded
February 15, 1996. Subsequent offerings begin on February 16 and August 16 of
each year and conclude on August 15 and February 15, respectively. The price at
which the employees may purchase the common stock is 85% of the closing price
of the Company's common stock on the Nasdaq National Market on the date the
offering period commences or terminates, whichever is lower. A total of 600,000
shares of common stock have been reserved under this plan. In fiscal 1996,
18,401 shares were issued under the Stock Purchase Plan. No shares were issued
under the Stock Purchase Plan in fiscal 1995.

NOTE 11. COMMITMENTS AND CONTINGENCIES
The Company leases office facilities under non-cancelable operating lease
agreements expiring at various dates through fiscal 2001. At September 30,
1996, approximate future minimum lease commitments under these leases were as
follows:


<TABLE>
<CAPTION>


(In thousands)
-----------------------
<S>             <C>
1997            $1,162
1998               716
1999               511
2000               257
2001                29
-----------------------
                $2,675
=======================
</TABLE>

Total rent expense under non-cancelable operating leases was approximately
$689,000, $269,000 and $97,000 for the years ended September 30, 1996, 1995 and
1994, respectively.

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                                      29
<PAGE>   19

                                                                          
                                                                          
notes to the consolidated financial statements (continued)

NOTE 12. SIGNIFICANT CUSTOMERS AND FOREIGN REVENUES
Sales to Microsoft Corporation represented 12.1% and 17.3% of revenues in
fiscal 1996 and 1995, respectively. In fiscal 1994, sales to FTP Software, Inc.
and Sumitomo Metal Industries, Ltd., a foreign customer, represented 12.3% and
11.0% of revenues, respectively.

The Company exports products to diverse geographic areas. Net revenues by
geographic area were as follows:


<TABLE>
<CAPTION>
                                        For the Years Ended September 30,
--------------------------------------------------------------------------------
(In thousands)                             1996         1995         1994
--------------------------------------------------------------------------------
    <S>                                   <C>          <C>          <C>
    United States                         $18,619      $10,095      $ 3,817
    Japan                                   2,094          708          819
    Other international                     1,594        1,338           31
--------------------------------------------------------------------------------
    TOTAL NET REVENUES                    $22,307      $12,141      $ 4,667
================================================================================
</TABLE>


NOTE 13. SALE OF DATA VISUALIZATION PRODUCT LINE
In September 1995, the Company sold its data visualization product line to a
stockholder for $910,000. The Company recorded a pre-tax gain, net of
transaction expenses, of $863,000. As of September 30, 1995, accounts
receivable of approximately $109,000 related to the data visualization product
line were included in current assets.

NOTE 14. ACQUISITIONS
On February 2, 1996, the Company issued approximately 230,000 shares of its
common stock in exchange for all of the outstanding common stock of Stonehand.
At the time of acquisition, Stonehand was located in Cambridge, Massachusetts,
and was a leader in core Web technologies including text formatting and
internationalization technologies such as SGML, HTML, DSSSL and Unicode.

On April 17, 1996, the Company issued approximately 87,000 shares of
its common stock in exchange for all of the outstanding common stock of OS
Tech. At the time of acquisition, OS Tech was located in Townsend,
Massachusetts, and developed and licensed WWW conferencing and forum
technology.

On April 24, 1996, the Company issued approximately 470,000 shares of its
common stock in exchange for all of the outstanding common stock of SurfWatch.
At the time of acquisition, SurfWatch, a Los Altos, California vendor of
Internet filtering and parental control software, marketed Internet software
for blocking access to inappropriate material, and licensed Internet filtering
technology to a variety of markets including the on-line services industry,
personal computer manufacturers and the educational market as well as
corporations.

These acquisitions have been accounted for as pooling of interests and,
accordingly, the Company's consolidated financial statements reflect the
accounts and operations of Stonehand, OS Tech and SurfWatch for all periods
prior to the acquisitions. Separate results of operations for the periods prior
to the acquisition of Stonehand, OS Tech and SurfWatch by the Company are
summarized as follows:


<TABLE>
<CAPTION>
                                      For the Years Ended September 30,
--------------------------------------------------------------------------------
(In thousands)                           1996         1995         1994
--------------------------------------------------------------------------------
      <S>                              <C>          <C>          <C>
      NET REVENUES:
        Spyglass                        $20,391      $10,350      $ 3,629
        Stonehand                           540        1,479          921
        OS Tech                              31            3          117
        Surf/Watch                        1,345          309           --
--------------------------------------------------------------------------------
           COMBINED                     $22,307      $12,141      $ 4,667
================================================================================
      NET INCOME:
        Spyglass                        $ 3,355      $2,177       $ 1,331
        Stonehand                            67         199            (5)
        OS Tech                              --         (63)           58
        Surf/Watch                           38        (137)           --
--------------------------------------------------------------------------------
           COMBINED                     $ 3,460      $2,176       $ 1,384

================================================================================

</TABLE>

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                                      30
<PAGE>   20


                                              report of independent accountants


To the Board of Directors
and Stockholders of Spyglass, Inc.
Naperville, Illinois

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in redeemable convertible
preferred stock and stockholders' equity and of cash flows, present fairly, in
all material respects, the financial position of Spyglass, Inc. and its
subsidiary at September 30, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended September
30, 1996, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatements. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.




/s/ Price Waterhouse LLP
    -----------------------
    Price Waterhouse LLP

Chicago, Illinois
October 25, 1996


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                                      31


<PAGE>   21
                                   DIRECTORY

SPYGLASS WORLDWIDE HEADQUARTERS
Spyglass, Inc.
1240 E. Diehl Road
Naperville, IL60563

SPYGLASS U.S. OPERATIONS
Cambridge, MA
Champaign, IL
Los Altos, CA
Marina del Rey, CA
Morristown, NJ
San Ramon, CA

SPYGLASS INTERNATIONAL OPERATIONS
Spyglass Asia Pacific
Central, Hong Kong

SPYGLASS EUROPE
Berkshire, United Kingdom

INTERNET ADDRESSES
World Wide Web, www.spyglass.com
Electronic mail, investor@spyglass.com

TRANSFER AGENT
Inquiries regarding shareholder-related
services, such as transfers or changes
of address, should be directed to:
American Stock Transfer & Trust Company
40 Wall Street
New York, NY 10005
800-937-5449

10-K FILING
A copy of Spyglass' Annual Report on Form 10-K,
filed with the Securities and Exchange Commission,
is available to stockholders by written request to
Thomas S. Lewicki, Controller, at the Spyglass
Worldwide Headquarter address.

SHARES LISTED
Spyglass common stock is traded on the Nasdaq
Stock Market under the ticker symbol SPYG.

INDEPENDENT AUDITORS
Price Waterhouse LLP
Chicago, IL

LEGAL COUNSEL
Hale and Dorr
Boston, MA

ANNUAL MEETING
Spyglass shareholders are invited to attend
our annual shareholder meeting, to be held on
February 12, 1997 at 10:00 AM, at the Holiday Inn
in Naperville, IL.

SPYGLASS DIRECTORS
Douglas P. Colbeth, President and
Chief Executive Officer, Spyglass, Inc.
William S. Kaiser, General Partner,
Greylock Management Corporation
Timothy K. Krauskopf, Chief Technical Officer,
Spyglass, Inc.
Ray Rothrock, General Partner, Venrock Associates
Steven R. Vana-Paxhia, President and
Chief Executive Officer, INSOCorporation

SPYGLASS EXECUTIVE OFFICERS
Douglas P. Colbeth, President and
Chief Executive Officer
Gary L. Vilchick, Executive Vice President
Finance, Administration and Operations
and Chief Financial Officer
Thomas S. Lewicki, Controller,
Treasurer and Secretary
Timothy K. Krauskopf,
Chief Technical Officer
Richard M. Houle, Executive Vice President
of Development and Services
Michael F. Tyrrell, Executive Vice President
of Business Development
Randall T. Littleson,
Vice President of Marketing


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