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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
                            ------------------------
(MARK ONE)
 
     [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
        THE SECURITIES EXCHANGE ACT OF 1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
 
                                       OR
 
     [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
        THE SECURITIES EXCHANGE ACT OF 1934
           FOR THE TRANSITION PERIOD FROM __________ TO __________ .
 
                        COMMISSION FILE NUMBER: 0-27774
 
                             PRISM SOLUTIONS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      77-0282704
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
</TABLE>
 
                               1000 HAMLIN COURT
                              SUNNYVALE, CA 94089
          (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
 
                        TELEPHONE NUMBER (408) 752-1888
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                    COMMON STOCK, $.001 PAR VALUE PER SHARE
 
     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:  Yes [X]  No [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  [ ]
 
     The aggregate market value of voting Common Stock held by non-affiliates of
the Registrant as of January 31, 1999 was approximately $17,261,354. Shares of
Common Stock held by each executive, director and 5% or greater shareholder have
been excluded in that such persons may be deemed affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes. The Company has not issued any shares of non-voting common equity.
 
     As of January 31, 1999, there were approximately 18,769,149 shares of the
Registrant's Common Stock outstanding.
<PAGE>   2
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Portions of the Definitive Proxy Statement in connection with the
Registrant's 1998 Annual Meeting of Stockholders are incorporated by reference
in Part III.
 
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<PAGE>   3
 
                             PRISM SOLUTIONS, INC.
 
                                   FORM 10-K
 
                               TABLE OF CONTENTS
 
                                    PART I.
 
<TABLE>
<CAPTION>
                                                                         PAGE
                                                                         NO.
                                                                         ----
<S>        <C>                                                           <C>
Item 1.    Business....................................................    1
Item 2.    Properties..................................................    5
Item 3.    Legal Proceedings...........................................    5
Item 4.    Submission of Matters to a Vote of Security Holders.........    6
Item 4A.   Executive Officers of the Registrant........................    7
                                  PART II.
Item 5.    Market for Registrant's Common Equity and Related
             Stockholder Matters.......................................    8
Item 6.    Selected Consolidated Financial Data........................    9
Item 7.    Management's Discussion and Analysis of Financial Condition
             and Results of Operations.................................   10
Item 7A.   Quantitative and Qualitative Disclosures About Market
             Risk......................................................   15
Item 8.    Financial Statements and Supplementary Data.................   16
Item 9.    Changes in and Disagreements with Accountants on Accounting
             and Financial Disclosures.................................   36
                                  PART III.
Item 10.   Directors and Executive Officers of Registrant..............   37
Item 11.   Executive Compensation......................................   37
Item 12.   Security Ownership of Certain Beneficial Owners and
             Management................................................   37
Item 13.   Certain Relationships and Related Transactions..............   37
                                  PART IV.
Item 14.   Exhibits, Financial Statement Schedule and Reports on Form
             8-K.......................................................   38
Signatures.............................................................   41
</TABLE>
<PAGE>   4
 
                                     PART I
 
ITEM 1. BUSINESS
 
     Prism Solutions, Inc. pioneered the data warehouse market and today
provides a wide range of products and services to help companies understand,
manage and use information effectively. Through the end of 1992, Prism was
engaged primarily in research and development and the establishment of a sales
and marketing infrastructure. From 1992 to 1995, Prism began shipping the first
generation of its principal products, Prism(R) Warehouse Manager(TM) and Prism
Directory Manager(TM). In December 1996, Prism replaced those products with its
next generation software, Prism Warehouse Executive(TM) and Prism Warehouse
Directory(TM). Since then, Prism has introduced many new products and services.
With each new product and service offering Prism has enhanced its core products
and expanded its sales into new industry sectors.
 
PRODUCTS AND SERVICES
 
  THE PRISM EXECUTIVE SUITE
 
     The Prism Warehouse Executive is an integrated set of software tools which
allows users to manipulate the flow of data from multiple sources into a target
data warehouse through a simple to use point-and-click interface. With Prism
Warehouse Executive, the user can create reports and documents that provide an
overview of a project's structure and help the user to see the data warehouse or
data mart construction process. Prism Warehouse Executive extracts and
integrates data from mainframes and databases which are utilized in the UNIX
operating system. Built-in features allow users to convert and summarize data
and to develop a consistent historical perspective of their information.
 
     Prism Warehouse Executive has many unique features and is widely adaptable
to various uses. One feature of Prism Changed Data Capture(TM), allows users to
detect changes to information in various applications and to transform and load
these changes into the data warehouse. Another feature, Prism Schedule Manager,
provides support for planning, scheduling and managing the processes of
converting and loading data into the data warehouse. Two other features, Prism
FastLoad and FastUpdate(TM), allow the reproduction and movement of data between
databases to prevent an imbalance of data among various data sources and to
allow for the creation of data marts.
 
     Prism Warehouse Executive's components share common data, known as meta
data. Sharing this meta data enables users to move quickly and easily from
planning and design to actual warehouse implementation. Once the warehouse is
constructed, the meta data serves as the basis for generating programs to
integrate, transform and move particular data to the appropriate warehouse
database.
 
     The meta data collected by Prism Warehouse Executive is stored in the Prism
Warehouse Directory, which integrates and manages information about warehouse
changes across the computing enterprise. Developers use this meta data to manage
construction of data warehouses, while users rely on meta data to help them
navigate and access business information. Prism Warehouse Directory's meta data
can be read by a variety of software packages and industry-standard Web
browsers, giving users a choice as to how to access to warehoused information.
 
     Complementing Prism Warehouse Executive and Directory, Prism offers Prism
Quality Manager. This product allows customers to analyze and manage the
accuracy of data as it moves from one application to another and to monitor the
quality of data in the warehouse. Prism Quality Manager shortens the warehouse
development cycle and improves overall information accuracy. Prism Quality
Manager can also be used to improve quality in application conversions or
overhauls of existing operational systems.
 
  SUPPORT OF SAP PRODUCTS
 
     Prism offers a host of products and services targeted to the needs of
customers of SAP, a German software company that markets enterprise resource
information systems. One common problem SAP customers often face is the
difficulty of converting data from legacy databases for SAP R/3 applications. To
meet this need, Prism offers Prism Warehouse Executive Target Module. Prism also
offers Quality Manager,
 
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<PAGE>   5
 
a product that evaluates, cleans and prepares data for SAP R/3 implementations.
Prism offers its Warehouse Executive Source Module for R/3 that allows users to
move information from SAP R/3 systems into a data warehouse. Finally, Prism
offers its Warehouse Executive Target Module for SAP's Business Warehouse that
allows users to migrate legacy data into SAP's Business Warehouse.
 
CUSTOMER RELATIONSHIP MANAGEMENT SOLUTIONS FOR THE FINANCIAL SERVICES INDUSTRY
 
     Prism's Customer Relationship Management System is a product which allows
businesses to maintain complete customer profiles containing demographic,
product and service information. Customer Relationship Management System is the
only product in the industry which combines customer relationship management and
marketing automation applications. The system collects and standardizes
information which can then be analyzed or used to support customer service
functions. Ultimately, the system enables financial institutions to take
specific steps to improve customer service, sales performance, customer
retention and profitability. Campaign Advisor(TM) is a product which enables
financial institutions to implement appropriate product and service portfolios
for their customers. Campaign Advisor allows financial institutions to analyze
and predict future profitability.
 
IMPLEMENTATION AND CONSULTING SERVICES
 
     Prism designs and installs its products and offers long-term consulting
services to its customers. Product design and installation are a standard
component of the license and delivery process. This on-site contact enhances the
likelihood that customers will be satisfied with Prism's products. The design
and installation process lasts approximately two weeks and is delivered by a
systems engineering team familiar to the customer. The process includes an
on-site planning session, product training, a detailed design session and
implementation of a prototype or limited-scope data warehouse.
 
     Prism guides its users through the process of implementing and utilizing
its data warehouse products and services through Iterations(R), its consulting
methodology. Iterations shows customers the various steps and time required to
build effective data warehouses. Iterations guides users through all phases of
the process of implementing the data warehouse, from the startup phase to
analysis and design; to construction, testing and implementation; then returning
to evaluation and management of the subsequent version.
 
     Prism offers executive briefings, technical publications and seminars
worldwide to educate the market about the benefits and payback of data
warehousing. Additionally, Prism publishes a series of newsletters that provide
in-depth information on data warehousing strategy and implementation.
 
PRODUCT DEVELOPMENT
 
     Prism intends to expand its existing product offerings and to introduce new
data warehouse software products. To date, Prism has relied primarily on
internal development of its products, but expects that it will also license or
acquire technology or products from third parties or consultants. Prism intends
to continue to support industry standard operating environments, client-server
architectures and databases.
 
     Prism is currently rewriting its software code base and plans to
incrementally incorporate the new code into its products over the next two
years. The first product element to incorporate the new code base was the
point-and-click user interface, which was introduced as part of Prism Warehouse
Executive in the fourth quarter of 1996. Prism believes that the new code base
will add functionality and ease of use to its products.
 
     As of December 31, 1998, Prism's product development staff consisted of 61
full-time equivalent employees. Prism's total expenses for product development
for 1996, 1997 and 1998 were $6,974,000, $11,068,000 and $14,492,000,
respectively. Prism anticipates that it will continue to commit substantial
resources to product development in the future. To date, Prism has not
capitalized any software development costs as such costs required to be
capitalized have been immaterial.
 
     The market for data warehouse software products changes rapidly due to
constant improvements in computer hardware and software. Prism's success in the
future will depend upon its ability to deliver its new code base, maintain
competitive technologies, enhance its current products and develop new products
in a
 
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<PAGE>   6
 
timely and cost-effective manner. Prism may not be able to develop and market
product enhancements or new products. Even if Prism develops and markets those
products, they may not be accepted by customers. In the past, Prism has
experienced delays in the development and introduction of new products and
product enhancements. The length of these delays has varied depending upon the
size and scope of the project and the nature of the problems encountered. If
Prism fails to anticipate or to respond adequately to changing market
conditions, or if significant delays in product development or introduction
occur, customers could decide to delay or decide against purchases of Prism's
products. That could have a substantial negative impact on Prism's business,
operating results and financial condition.
 
SALES, MARKETING AND CUSTOMER SUPPORT
 
     Prism markets its software and services primarily through a direct sales
organization and, to a lesser extent, through third-party distributors and other
indirect sales channels. Prism employs skilled engineers and technically
proficient salespersons capable of serving the needs of its customers. In
addition to its direct sales efforts, Prism utilizes advertising, direct mail
and public relations programs, participates in numerous industry trade shows
and, individually or with others, organizes seminars and conferences to promote
the adoption of its products and methodologies. Prism currently has domestic
offices in the metropolitan areas of Atlanta, Boston, Chicago, Dallas, as well
as Orange, California, Little Falls, New Jersey and Washington, D.C. In
addition, Prism has offices in Reading, United Kingdom; Paris, France; Munich,
Germany; Madrid, Spain; Toronto, Canada; Hoofddorp, Netherlands; Auckland, New
Zealand; Melbourne, Australia; and Singapore. Field offices are staffed with
both sales and technical pre-sales representatives.
 
     Prism has also developed indirect distribution and marketing channels with
vendors whose products fit strategically with those of Prism. Prism believes
that in order to provide the most comprehensive and competitive data warehouse
management solutions, it will be necessary to develop, maintain and enhance
close associations with software and hardware vendors. Prism currently has
marketing relationships with over 20 software and hardware vendors and several
systems integrators. However, Prism may not be able to maintain these existing
relationships or enter into new relationships, which could adversely affect the
compatibility of Prism's products with other software and hardware. The failure
to maintain or enter into these relationships could also have a negative impact
on the timing of bringing new and enhanced products into the marketplace and
could affect Prism's ability to use third party distribution channels and
decrease its market presence.
 
     Prism engages distributors to serve international markets in which Prism
typically does not have a direct sales presence. Prism's current distributors
sublicense Prism's products in Belgium, Brazil, Denmark, Israel, Italy, Japan,
Korea, Luxembourg, the Netherlands, New Zealand, Portugal, South Africa, Spain,
Sweden and Venezuela. These distributors license Prism's products and relicense
them to third parties at a discount. These distributors may also provide
training and consulting services to users. Prism intends to expand its
operations in Europe, North America, Latin America and Asia, which will require
significant management attention and financial resources. Prism commits
significant resources to developing international sales and support channels and
opening international sales offices. The failure of those efforts could
substantially harm Prism's business, operating results and financial condition.
 
     Prism believes that its customer service and technical support are crucial
to its marketing efforts and to the establishment of long-term customer
relationships. Prism offers its licensees periodic product updates and
post-sales technical assistance via telephone hotline, Web and fax. Almost all
of Prism's licensees opt for annual maintenance contracts at the time they enter
into their initial license agreement. Annual maintenance fees generally account
for 15% of all fees for a given license agreement. Prism also offers
installation, consulting, education and training services on a fee basis to
assist customers implement their data warehouses. Prism's distributors offer
first-level customer support to their customers, while relying on Prism for any
additional support, as needed.
 
     Prism generally ships its products as orders are received. As a result,
Prism has relatively little backlog at any given time. Therefore, backlog is not
a meaningful indicator of future performance. Prism's sales cycle ranges from
three months to over a year, depending on the size of the transaction, the
length of the customer
 
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<PAGE>   7
 
relationship, the timing of new product releases, the level of sales management
activity and general economic conditions.
 
     Historically, a substantial majority of Prism's revenues in a given quarter
have been recorded in the third month of that quarter, with a concentration of
such revenues in the last two weeks of the third month. Because of the
relatively large dollar size of Prism's typical software license, any delay in
the closing of a transaction can have a significant impact on Prism's operating
results for a particular period.
 
     At December 31, 1998, Prism had more than 400 active customers, some with
multiple installations. No customer accounted for more than 10% of Prism's total
revenues in fiscal 1996, 1997 or 1998.
 
COMPETITION
 
     The data warehouse market is intensely competitive and subject to rapid
change. Competitors vary in size and scope of the products and services they
offer. Prism encounters competition from a number of sources, including internal
information systems departments of customers and potential customers. The most
active competitors to Prism's data warehouse products and services are
Evolutionary Technologies International, Apertus Carleton Corporation, and
PLATINUM technology, inc. The most active competitors to the Prism data mart
products and services are Informatica and several other small, private
companies. Prism expects to experience additional competition from other
established and emerging software companies, including some of Prism's current
marketing partners. Due to increased competition, Prism has had to lengthen
sales cycles and reduce prices. These circumstances could result in reduced
transaction sizes, fewer customer orders, reduced gross margins and loss of
market share. The end result could be a negative impact on Prism's business,
operations and financial condition.
 
     Prism believes that the principal competitive factors affecting the data
warehouse market include technical performance, company reputation, reliability
and compatibility of products, customer service and price. Prism may not be
successful in competing in the future with respect to these or other factors.
 
     Some of Prism's competitors have significantly greater financial,
technical, marketing and other resources than Prism. As a result, they may be
able to respond more quickly to new or emerging technologies and changes in
customer requirements or to devote greater resources to the development,
promotion, sale and support of their products than Prism. In addition, current
and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of Prism's prospective customers.
Accordingly, it is possible that new competitors or alliances among competitors
may emerge and rapidly gain significant market share. Prism may not be able to
compete successfully against these types of competitors. Competitive pressures
faced by Prism could have a negative impact on its business, operating results
and financial condition.
 
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
 
     Prism relies primarily on a combination of copyright and trademark laws,
trade secrets, confidentiality procedures and contractual provisions to protect
its proprietary technology. For example, Prism requires its customers to sign
license agreements which impose restrictions on the licensees' ability to
utilize the software. Prism also seeks to prevent disclosure of its trade
secrets by requiring those persons with access to Prism's proprietary
information to execute confidentiality agreements. These agreements restrict the
access to Prism's source code. Prism protects its software, documentation and
other written materials through trade secret and copyright laws. These laws,
however, afford only limited protection. Prism presently has no patents or
patent applications pending.
 
     Despite Prism's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of Prism's products or to obtain and use
information that Prism regards as proprietary. Policing unauthorized use of
Prism's products is difficult. Prism is unable to determine the extent to which
piracy of its software products exists, and software piracy is expected to be a
persistent problem in the future. In addition, the laws of many countries do not
protect Prism's proprietary rights to as great an extent as the laws of the
United
 
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States. Prism's means of protecting its proprietary rights may not be adequate,
and Prism's competitors may independently develop similar technology.
 
     To date, Prism has not been notified that its products infringe the
proprietary rights of third parties. However, third parties in the future could
claim infringement by Prism with respect to current or future products. Prism
expects that data warehouse software product developers will increasingly be
subject to infringement claims as the number of products and competitors in
Prism's industry segment grows and the functionality of products in different
industry segments overlaps. Any such claims, with or without merit, could be
time-consuming, result in costly litigation, cause product shipment delays or
require Prism to enter into royalty or licensing agreements. Such royalty or
licensing agreements may not be available on terms acceptable to Prism or at
all. This could substantially harm Prism's business, operating results and
financial condition.
 
EMPLOYEES
 
     As of December 31, 1998, Prism employed 285 full-time equivalent persons,
including 86 in sales, presales technical support, marketing and related
activities, 61 in product development and support, 114 in consulting services,
and 24 in management, administration and finance. Prism's success is highly
dependent on its ability to attract and retain qualified employees. Competition
for employees is intense in the software industry, and an inability to attract
and retain qualified development and sales personnel, in particular, could
postpone product release schedules and adversely affect Prism's ability to
generate revenue.
 
     None of Prism's employees is represented by a labor union or is the subject
of a collective bargaining agreement with respect to his or her employment by
Prism. Prism has never experienced a work stoppage and believes that its
employee relations are good.
 
ITEM 2. PROPERTIES
 
     Prism's sales, marketing, support and product development facility is
located in approximately 38,000 square feet of space in Sunnyvale, California.
The lease on this office space expires in April 2005. Prism also leases
approximately 7,200 square feet of space in the United Kingdom under two lease
agreements that expire in November 2000 and February 2003, respectively. Prism
currently leases small field offices in seven United States cities, as well as
in France, Germany, Spain, the Netherlands, Canada, Australia, New Zealand and
Singapore. Prism believes that suitable additional or alternative space will be
available in the future on commercially reasonable terms, as needed.
 
ITEM 3. LEGAL PROCEEDINGS
 
     On March 5, 1997, a class action complaint called Adler et al., v. Prism
Solutions, Inc. et al., Case No. CV764547, was filed by the law firm of Milberg
Weiss Bershad Hynes & Lerach LLP, in Superior Court of the State of California,
County of Santa Clara, against Prism, several of its current and former officers
and directors and the underwriters of its initial public offering. The complaint
was filed on behalf of those persons who purchased or otherwise acquired the
common stock of Prism from March 14 through October 14, 1996, and alleged that
the defendants artificially inflated the demand for the common stock prior to
and after the initial public offering. The complaint sought damages in an
unspecified amount.
 
     On August 6, 1997, the Court entered an order that agreed with the
defendants that the plaintiffs failed to present sufficient facts to proceed
with three claims under the corporation law of the State of California, one
claim under the civil code of the State of California, and two claims under the
federal securities laws. This order provided that the plaintiffs could amend the
state corporation law and civil code claims but not the federal securities law
claims. On December 12, 1997, the plaintiff filed a first amended complaint that
included a claim under the corporation law of the State of California and claims
under the federal securities laws against Prism and certain of its current and
former officers and directors. On March 2, 1998, the Court agreed with the
assertions of the individual officer and director defendants that the plaintiffs
failed to present sufficient facts to proceed with the claims against these
individuals, but provided that the plaintiffs could
 
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amend all of the claims. The Court disagreed with the assertions of Prism that
the plaintiffs failed to present sufficient facts to proceed with the claims
against the company.
 
     On December 24, 1997, Milberg Weiss filed an additional class action
complaint in the United States District Court for the Northern District of
California. This federal court action named Prism and several current and former
officers and directors as defendants, and was based on the same allegations as
the previously filed state court action. Like the state court action, this
complaint was filed on behalf of those persons who purchased or otherwise
acquired the common stock of Prism from March 14 through October 14, 1996. In
April 1998, the federal court action was dismissed.
 
     In March 1998, a new judge was assigned to the state court action. On March
12, 1998, the plaintiffs filed a second amended state court complaint against
Prism and certain of its officers and directors. In response, Prism filed a
motion that asked the Court to reconsider its prior assertion that the
plaintiffs had failed to present sufficient facts to proceed with the claims
against the company. The individual officer and director defendants also filed a
motion in response that argued that the plaintiffs had failed to present
sufficient facts to proceed with the claims against these individuals. On June
4, 1998, the Court agreed with the individual defendants that the plaintiffs had
failed to present sufficient facts to proceed with the claims, and provided the
plaintiffs the ability to amend the claims filed under federal securities laws
but not the claims filed under the corporation law of the State of California.
The Court also denied Prism's motion.
 
     On June 30, 1998, the plaintiffs filed a third amended complaint that
brought claims against Prism under the corporation law of the State of
California and the federal securities laws, and claims against all but one of
the same officer and director defendants under the federal securities laws. On
August 3, 1998, the individual defendants filed a motion that argued that the
plaintiffs had failed to present sufficient facts to proceed with the claims
against these individuals. The Court overruled this motion on September 29,
1998. On October 30, 1998, Prism and the four remaining individual defendants
filed a joint answer to the third amended complaint. Prism believes the third
amended complaint's claims have no merit and intends to vigorously defend the
state court action. Prism is also involved in other ongoing legal matters
incidental to its business.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     During the Fourth Quarter of 1998, no matter was submitted to a vote of
security holders through the solicitation of proxies or otherwise.
 
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ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The executive officers of the Company, and their respective ages as of
March 25, 1999, are as follows:
 
<TABLE>
<CAPTION>
                   NAME                      AGE                    POSITION
                   ----                      ---                    --------
<S>                                          <C>   <C>
Warren M. Weiss............................  42    President and Chief Executive Officer
Earl C. Charles............................  47    Chief Financial Officer and Secretary
Christopher Hyrne..........................  44    Vice President, Marketing,
Stacy Cooper...............................  48    Vice President, North America Sales
Mark Rankovic..............................  32    Vice President, Consulting Services
Michael Hunt...............................  57    Vice President, International Sales
</TABLE>
 
     Mr. Weiss has been President, Chief Executive Officer and a Director of the
Company since February 1997. From June 1996 to February 1997, he served as
President and Chief Operating Officer of SQRIBE Technologies, a provider of
server-based reporting solutions. From April 1995 to May 1996, Mr. Weiss served
as President and Chief Executive Officer of Strategic Mapping, Inc., a software
and geo-demographic information company. From 1993 to 1994, Mr. Weiss was
employed by NeXT Computer, Inc., a computer systems company, most recently as
Vice President, Worldwide Sales and Service. He has also held senior management
positions at Continuum and Management Science America. Mr. Weiss holds a
Bachelor of Science in Criminology from Western Illinois University.
 
     Mr. Charles has served as Chief Financial Officer and Secretary of the
Company since April 1997. From June 1996 to April 1997, he was Chief Financial
Officer of R2 Technology, Inc., a medical imaging software company. From
September 1993 to June 1996, he was Senior Vice President of Operations and
Chief Financial Officer of Strategic Mapping, Inc., a software and
geo-demographic information company. Prior to that, from 1983 to 1993, he was a
partner at Deloitte & Touche LLP, a public accounting firm. Mr. Charles received
his B.B.A. degree from the University of Notre Dame.
 
     Mr. Hyrne has served as Vice President of Marketing for Prism Solutions
since September 1997. From August 1994 to December 1996, he was Director of
Market Development for Taligent, responsible for defining new market
opportunities, early adopter and partner relationships. From June 1977 to July
1994, he was at IBM, holding positions in marketing, large enterprise sales and
new market development. Mr. Hyrne received his B.S. degree in Economics from the
University of Santa Clara.
 
     Mr. Cooper has served as Vice President, North American Sales of the
Company since July 1998. From September 1997 to June 1998, he was Vice President
of Western Region Sales. Prior to that, Mr. Cooper was Vice President of North
American Sales for AnswerSoft from August 1996 to August 1997. Prior to that, he
spent one year as acting Vice President of Sales for Software AG of North
America. Previous, Mr. Cooper spent 13 years at Dun and Bradstreet Software
where he was Southwest area Vice President. Mr. Cooper received his bachelors
degree in business administration from the University of North Texas.
 
     Mr. Rankovic has served as Vice President of Asia Pacific Sales since July
1997. From January 1991 to July 1997, Mr. Rankovic was the President and founder
of Object Software Pty Ltd., which the Company acquired in July. From 1986
through 1990, Mr. Rankovic was the Director of Professional Services for
Information Builders, Inc. (and its prior distributor in Australia). Mr.
Rankovic received his Bachelor of Science in Applied Mathematics and Computer
Science with Honours from the University of Adelaide, Australia in 1985.
 
     Mr. Hunt has served as Vice President, International Sales since October
1998. From October 1997 to September 1998, Mr. Hunt was Vice President,
International for Intrepid Systems. From January 1996 to June 1997, Mr. Hunt
served as Vice President for Oracle Corporation. From January 1994 to December
1995, Mr. Hunt was President of Ross Systems International. Mr. Hunt received
his BSC degree in Mathematics from University of Manitoba.
 
                                        7
<PAGE>   11
 
                                    PART II
 
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
 
PRICE RANGE OF COMMON STOCK
 
     The Company's common stock is traded on the Nasdaq National Market under
the symbol PRZM. The following table sets forth the range of high and low sales
prices for each of the quarterly periods included in the fiscal years ended
December 31, 1997 and 1998:
 
<TABLE>
<CAPTION>
                           FISCAL                              HIGH      LOW
                           ------                             ------    -----
<S>                                                           <C>       <C>
1997
First Quarter...............................................  $10.38    $4.88
Second Quarter..............................................  $ 7.88    $4.38
Third Quarter...............................................  $ 7.50    $4.38
Fourth Quarter..............................................  $ 7.06    $3.50
</TABLE>
 
<TABLE>
<CAPTION>
                           FISCAL                              HIGH      LOW
                           ------                             ------    -----
<S>                                                           <C>       <C>
1998
First Quarter...............................................  $ 6.25    $3.75
Second Quarter..............................................  $ 9.00    $4.50
Third Quarter...............................................  $ 5.50    $1.50
Fourth Quarter..............................................  $ 3.88    $0.75
</TABLE>
 
     On January 31, 1999, there were approximately 115 record holders and more
than 2,000 beneficial holders of Prism Solutions, Inc. common stock.
 
DIVIDEND POLICY
 
     The Company has never declared or paid any cash dividends on its capital
stock. The Company currently anticipates that it will retain any future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future.
 
                                        8
<PAGE>   12
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
     The following selected consolidated financial data of Prism as of and for
each of the five fiscal years ended December 31, 1998 are derived from the
consolidated financial statements of Prism. The financial statements for the
five fiscal years ended December 31, 1998 have been audited by
PricewaterhouseCoopers LLP, independent accountants. This data is qualified in
its entirety by, and should be read in conjunction with, the Prism Financial
Statements and related notes thereto appearing elsewhere herein. See "Financial
Statements and Supplementary Data" and "Prism Management's Discussion and
Analysis of Financial Condition and Results of Operations".
 
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                                        YEAR ENDED DECEMBER 31,
                                                           -------------------------------------------------
                                                             1998       1997      1996      1995      1994
                                                           --------   --------   -------   -------   -------
<S>                                                        <C>        <C>        <C>       <C>       <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
  License................................................  $ 22,166   $ 23,823   $19,586   $12,868   $ 6,295
  Services and other.....................................    29,924     27,568    16,581     8,533     1,932
                                                           --------   --------   -------   -------   -------
    Total revenue........................................    52,090     51,391    36,167    21,401     8,227
                                                           --------   --------   -------   -------   -------
Costs and expenses:
  Cost of license........................................     1,031      1,338       847       402       113
  Cost of services and other.............................    21,410     16,046     9,684     5,159     1,654
  Selling and marketing..................................    27,355     24,712    18,462    11,604     5,632
  Research and development...............................    14,492     11,068     6,974     3,987     2,436
  General and administrative.............................     6,587      7,114     4,048     3,206       889
  Purchased in process technology........................        --      8,558        --        --        --
                                                           --------   --------   -------   -------   -------
    Total costs and expenses.............................    70,875     68,836    40,015    24,358    10,724
                                                           --------   --------   -------   -------   -------
Loss from operations.....................................   (18,785)   (17,445)   (3,848)   (2,957)   (2,497)
                                                           --------   --------   -------   -------   -------
Other income (expenses):
Other income (expense)-net...............................        13         --       (21)      (67)      (21)
Interest income-net......................................       370      1,352     1,453       119        43
                                                           --------   --------   -------   -------   -------
    Total other income...................................       383      1,352     1,432        52        22
                                                           --------   --------   -------   -------   -------
Loss before provision for income taxes...................   (18,402)   (16,093)   (2,416)   (2,905)   (2,475)
Provision for income taxes...............................       249         91        21         9        63
                                                           --------   --------   -------   -------   -------
Net loss.................................................  $(18,651)  $(16,184)  $(2,437)  $(2,914)  $(2,538)
                                                           ========   ========   =======   =======   =======
Basic net loss per common share:.........................  $  (1.01)  $  (0.94)  $ (0.17)  $ (0.45)  $ (0.90)
Diluted net loss per common share:.......................  $  (1.01)  $  (0.94)  $ (0.17)  $ (0.45)  $ (0.90)
Basic weighted average number of common shares
  outstanding............................................    18,485     17,291    14,640     6,467     2,814
                                                           ========   ========   =======   =======   =======
Diluted weighted average number of common and common
  equivalent shares outstanding..........................    18,485     17,291    14,640     6,467     2,814
                                                           ========   ========   =======   =======   =======
 
CONSOLIDATED BALANCE SHEET DATA:
Cash and equivalents and short-term investments..........  $  5,069   $ 21,706   $34,915   $ 2,068   $ 3,205
Working capital..........................................     5,420     22,252    35,562     1,355     3,247
 
Total assets.............................................    21,512     43,185    48,894    12,487     7,257
Long term debt, less current portion.....................       329        364       179       438        --
Stockholders' equity.....................................    10,566     27,604    38,022     2,767     3,623
</TABLE>
 
                                        9
<PAGE>   13
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
     In addition to historical information contained herein, Management's
Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended, and Section 27A of the Securities
Act of 1933, as amended. The forward-looking statements contained herein are
subject to certain risks and uncertainties including those discussed below that
could cause actual results to differ materially from those reflected herein.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's analysis only as of the date hereof. The
Company undertakes no obligation to publicly revise any forward-looking
statements in order to reflect events or circumstances after the date hereof.
 
OVERVIEW
 
     Incorporated in California in March 1991 and reincorporated in Delaware in
January 1996, Prism Solutions, Inc. pioneered the data warehouse market to help
companies understand, manage and use information effectively. Today, Prism
provides comprehensive solutions to deliver data warehouse applications. Through
the end of 1992, Prism was in the development stage and was engaged primarily in
research and development and the establishment of a sales and marketing
infrastructure. Prism began shipping its principal products, Prism Warehouse
Manager and Prism Directory Manager in December 1992 and April 1995,
respectively. In December 1996, Prism Warehouse Manager and Prism Directory
Manager were replaced with Prism Warehouse Executive and Prism Warehouse
Directory, respectively, as Prism's next generation software. In the fourth
quarter of 1996, Prism also completed the first transactions for Iterations, its
consulting methodology. Over the course of 1997 Prism introduced additional
components to its core products. These included Prism Schedule Manager for
operational planning and deployment, Prism Quality Manager for auditing and
improving data quality, Prism FastLoad for replication offerings and Prism Web
Access for warehouse navigation and data delivery. In the first quarter of 1998,
Prism complemented its Warehouse development solutions by offering its Customer
Relationship Management System (through the acquisition of Customer Focus
International). This offering consists of comprehensive data models and
analytical and sales development applications for customer relationship
management in the financial services industry. In April 1998, Prism introduced
the Prism Executive Suite which consists of Prism Warehouse Executive, Prism
Warehouse Directory and Prism Quality Manager. Most recently, through the
acquisition of Systems Techniques, Inc., Prism enhanced its ability to deliver
greater business value to customers through vertical data warehouse solutions by
establishing a data warehouse Center of Excellence for the healthcare industry.
Prism's total revenues to date have been derived from software license revenues
and consulting services revenues. Software license revenue accounted for 54%,
46% and 43% of total revenues in 1996, 1997 and 1998, respectively. Services and
other revenues accounted for the remaining revenues in 1996, 1997 and 1998.
Prism's core data warehouse products are primarily enterprise related and they
require a significant amount of consulting and implementation time from
qualified personnel. Because many companies are experiencing increased demands
for other information technology projects, most companies are outsourcing the
implementation of data warehouse projects. Accordingly, Prism believes that the
consulting services component of its business will continue to be a significant
portion of total revenues, with the balance derived from license fees and the
related maintenance revenue.
 
                                       10
<PAGE>   14
 
RESULTS OF OPERATIONS
 
     The following table sets forth selected consolidated statement of
operations data as a percentage of total revenues for the periods indicated:
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                              -----------------------
                                                              1998     1997     1996
                                                              -----    -----    -----
<S>                                                           <C>      <C>      <C>
Revenues:
  License...................................................   42.6%    46.4%    54.2%
  Services and other........................................   57.4     53.6     45.8
                                                              -----    -----    -----
     Total revenues.........................................  100.0    100.0    100.0
                                                              -----    -----    -----
Cost of revenues:
  License...................................................    2.0      2.6      2.3
  Services and other........................................   41.1     31.2     26.8
                                                              -----    -----    -----
     Total cost of revenues.................................   43.1     33.8     29.1
                                                              -----    -----    -----
     Gross margin...........................................   56.9     66.2     70.9
                                                              -----    -----    -----
Costs and expenses:
  Sales and marketing.......................................   52.5     48.1     51.0
  Research and development..................................   27.8     21.5     19.3
  General and administrative................................   12.6     13.8     11.2
  Purchased-in-process technology...........................     --     16.7       --
                                                              -----    -----    -----
     Total operating expenses...............................   92.9    100.1     81.5
                                                              -----    -----    -----
  Loss from operations......................................  (36.0)   (33.9)   (10.6)
Interest income, net........................................    0.7      2.6      4.0
Other expense, net..........................................     --       --     (0.1)
                                                              -----    -----    -----
  Loss before income taxes..................................  (35.3)   (31.3)    (6.7)
                                                              -----    -----    -----
Provision for income taxes..................................    0.5      0.2       --
                                                              -----    -----    -----
  Net loss..................................................  (35.8)%  (31.5)%   (6.7)%
                                                              =====    =====    =====
</TABLE>
 
REVENUES
 
     Total revenues were $52,090,000, $51,391,000 and $36,167,000 in 1998, 1997
and 1996, respectively, representing increases of 42.1% from 1996 to 1997 and
1.4% from 1997 to 1998. Prism's revenues are derived from license fees for its
software products and fees for services complementing its products, including
software maintenance and support, implementation, consulting and training.
 
     License Revenues.  License revenues decreased $1,657,000, or 7.0%, for the
year ended December 31, 1998 compared to the same period of 1997. Sales to new
customers accounted for 70% of revenues during 1998 compared to 73% for 1997.
The lower sales volume in 1998 compared to the same period of 1997 is primarily
the result of lower than expected new product sales, and, to a lesser extent,
lower than expected sales in the Pacific Rim territory due to the economic
downturn in that region.
 
     Revenues from software licenses were $22,166,000, $23,823,000 and
$19,586,000 in 1998, 1997 and 1996, respectively, representing an increase of
21.6% from 1996 to 1997 and a decrease of 7.0% from 1997 to 1998. The increase
in license revenues from 1996 to 1997 was primarily attributable to growing
acceptance of Prism's products and an increase in the number and tenure of
direct sales personnel, which led to increases in the number of units licensed.
The decrease in license revenues from 1997 to 1998 was primarily the result of
lower than expected sales in the North American and Asian Pacific market places.
License revenues in 1997 and 1998 were favorably affected by Prism's
acquisitions completed during fiscal 1997 and 1998, in addition to the expansion
and development of the sales force into the European and Asia Pacific regions.
 
                                       11
<PAGE>   15
 
     Services and Other Revenues.  Services and other revenues increased
$2,356,000, or 8.5%, for the year ended December 31, 1998 compared to the same
period of 1997. The growth in service and other revenue during 1998 compared to
1997 was primarily the result of an increase in the number and scope of
consulting engagements. Additionally, Prism's consulting organization has
continued to grow to meet customer demand. The majority of services and other
revenues in both periods came from consulting revenues.
 
     Services and other revenues were $29,924,000, $27,568,000 and $16,581,000
in 1998, 1997 and 1996, respectively, representing increases of 66.3% from 1996
to 1997 and 8.5% from 1997 to 1998. The growth from 1996 to 1998 was primarily
due to an increase in the number and size of consulting engagements and, to a
lesser extent, licensing activity and maintenance renewals. As a percentage of
total revenues, services and other revenue comprised 57.4%, 53.6% and 45.8% in
1998, 1997 and 1996, respectively. A majority of services and other revenues in
1998, 1997 and 1997 came from consulting revenues.
 
COST OF REVENUES
 
     Cost of License Revenues.  Cost of license revenues consists primarily of
the costs of royalties paid to third-party vendors, product media and
duplication, shipping expenses, manuals and packaging materials. Cost of license
revenues decreased $307,000, or 23.0%, for the year ended December 31, 1998
compared to the same period of 1997. Approximately 72% of the decrease in cost
of license revenue for the year was the result of decreases in royalty payments
with the remainder due to decreases in distribution costs. Prism expects that
the cost of license revenues will increase in absolute dollars as Prism licenses
technology and products from third parties for which royalties are owed.
 
     Cost of license revenues was $1,031,000, $1,338,000 and $847,000 in 1998,
1997 and 1996, respectively, representing 2.0%, 2.6% and 2.3% of total revenues
for those years. The increase both in absolute dollars and as a percentage of
revenues from 1996 to 1997 was primarily attributable to increased royalties and
commissions paid to third party vendors as license revenues continued to
increase. The decrease both in absolute dollars and as a percentage of revenues
from 1997 to 1998 was primarily attributable to decreased royalties and
commissions payable to third parties as license revenues continued to decrease.
 
     Cost of Services and Other Revenues.  Cost of services and other revenues
consists primarily of personnel-related costs incurred in providing consulting
and implementation services, telephone support and training to customers. Cost
of services and other revenues increased $5,364,000, or 33.4%, for the year
ended December 31, 1998 compared to the same period of 1997. The increase in
cost of service and other revenues was primarily due to increased costs related
to growth of the consulting organization and the use of contractors in Prism's
consulting, customer support and training organizations. Prism expects that the
cost of services and other revenues will increase in absolute dollars as Prism
continues to add customers.
 
     Cost of services and other revenues was $21,410,000, $16,046,000 and
$9,684,000 in 1998, 1997 and 1996, respectively, representing 41.1%, 31.2% and
26.8% of total revenues for those years. The dollar amount of cost of services
and other revenues increased significantly from 1996 to 1998 primarily because
of increases in the infrastructure required to expand the consulting
organization both domestically and worldwide.
 
OPERATING EXPENSES
 
     The growth in operating expenses during the years ended December 31, 1998
and 1997, when compared to the earlier periods presented, occurred primarily as
a result of increases in salaries and benefits resulting from higher staffing
levels and the expansion of facilities. Prism has recently conducted a reduction
in force which should result in lower operating expenses in subsequent periods.
However, should Prism's revenues grow substantially, staff levels may be higher
and operating expenses may increase.
 
     Prism's operating expenses were $48,434,000, $51,452,000 and $29,484,000,
or 93.0%, 100.1% and 81.5% of total revenues, in 1998, 1997 and 1996,
respectively. The growth in operating expenses in absolute dollars from 1996 to
1997 occurred primarily as a result of increases in salaries and benefits,
resulting from higher staffing levels, and the expansion of facilities. The
decrease in operating expenses as a percentage of revenues from 1997 to 1998
resulted from economies of scale associated with Prism's growing revenues. The
increase in operating expenses as a percentage of revenues from 1996 to 1997 was
primarily the result of the one time
 
                                       12
<PAGE>   16
 
charge of $8,558,000 associated with the write-off of the purchased in-process
technology related to acquisitions made during the 1997 fiscal year.
 
     Sales and Marketing.  Sales and marketing expenses consist primarily of
salaries, commissions and bonuses paid to sales and marketing personnel and
promotional expenses. Sales and marketing expenses increased $2,643,000, or
11.0%, for the year ended December 31, 1998 compared to the same period of 1997.
The percentage increase from 1997 to 1998 in sales and marketing expenses
resulted primarily as a result of increases in salaries and benefits, resulting
from higher staffing levels and the expansion of sales office facilities.
 
     Sales and marketing expenses were $27,355,000, $24,712,000 and $18,462,000,
or 52.5%, 48.1% and 51.0% of total revenues, in 1998, 1997 and 1996,
respectively. The increases in dollar amounts in sales and marketing expenses
were primarily due to the expansion of Prism's sales operations and increased
marketing activities, including trade shows and promotional expenses. The
decrease in sales and marketing expenses as a percentage of total revenues from
1996 to 1997 resulted primarily from increases in productivity as newly hired
sales personnel and system engineers became more experienced, and was also due
to the benefits of economies of scale associated with the increase in total
revenues.
 
     Research and Development.  Research and development expenses consist
primarily of salaries paid to the engineering staff. Research and development
expenses increased $3,424,000, or 31.0%, for the year ended December 31, 1998
compared to the same period of 1997. The increase in research and development
expenses in absolute dollars and as a percentage of revenues from 1997 to 1998
was primarily attributable to increased staffing and associated support for
software engineers required to expand and develop Prism's most recent product
offerings. Software development costs have been expensed in accordance with
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed." To date, costs
incurred after establishment of technological feasibility have been immaterial
and, as a result, all research and development costs have been expensed as
incurred. Prism believes that a significant level of investment for research and
development is required to remain competitive.
 
     Research and development expenses were $14,492,000, $11,068,000 and
$6,974,000, or 27.8%, 21.5% and 19.3% of total revenues, in 1998, 1997 and 1996,
respectively. The increases in dollar amounts in research and development
expenses since 1996 were primarily attributable to increased staffing and
associated support for software engineers required to expand and enhance Prism's
product line.
 
     General and Administrative.  General and administrative expenses consist
primarily of salary expenses for administrative and executive staff. General and
administrative expenses decreased $527,000, or 7.4%, for the year ended December
31, 1998 compared to the same period of 1997. These expenses decreased due to
workforce reductions undertaken by Prism during 1998. Prism expects that its
general and administrative expenses will be lower in absolute dollars and
decrease as a percentage of revenues if Prism's total revenues increase.
 
     General and administrative expenses were $6,587,000, $7,114,000, and
$4,048,000 or 12.6%, 13.8% and 11.2% of total revenues, in 1998, 1997 and 1996,
respectively. These expenses increased in absolute dollars from 1996 to 1997
primarily as a result of increases in staffing and an expansion of facilities.
The decrease in absolute dollars from 1997 to 1998 was primarily the result of
decreases in headcount as part of Prism's workforce reduction undertaken during
the third quarter of 1998.
 
     Purchased-in-process technology.  During the third quarter of 1997, Prism
incurred a one time charge of $8,558,000 for the write-off of
purchased-in-process technology.
 
     In connection with its acquisition of QDB Solutions, Inc. and the purchase
of technology from Peregrine/Bridge Transfer Corporation, as further discussed
below, Prism acquired certain in-process technology which was expensed in
accordance with Interpretation 4 to Statement of Financial Accounting Standards
No. 2 "Accounting for Research and Development Costs." Such in-process
technologies along with other acquired net assets were valued at fair value.
 
                                       13
<PAGE>   17
 
     In July 1997, Prism acquired QDB Solutions, Inc. for 1,143,613 shares of
Prism common stock and cash of $1.25 million. The acquisition was treated as a
purchase transaction for financial accounting purposes. The allocation of the
purchase price was based on appraised values, of which $7.2 million was
identified as purchased in-process technology for three projects that were
completed in 1998 and which had no alternative future use. The development
activities of QDB Solutions, Inc. were planned to be integrated to existing
Prism in-process development projects. The same core in-process technology of
QDB Solutions, Inc. would be integrated into all three planned Prism products.
The nature of the technology acquired allows analysis and management of data,
monitors data quality and shortens the data warehouse development cycle. The
three products were:
 
<TABLE>
<CAPTION>
                                                                      %
PRODUCT                       DESCRIPTION                         COMPLETE     VALUE ASSIGNED
-------                       -----------                         --------     --------------
<S>      <C>                                                      <C>          <C>
PQM 1.0  Data quality, 16 bit architecture....................       90%        $3.4 million
PQM 2.0  Data quality, 32 bit architecture, additional data
         filters and user interface enhancements..............       75%        $2.8 million
PWE/PQM  Integrated product to use data quality filters in
         data transformations and in the metadata model.......       40%        $1.0 million
</TABLE>
 
     Working models of the products were not complete at the date of
acquisition. The working models were completed subsequent to the acquisition
date. Completeness was confirmed through product testing and quality assurance
processes. At the time of acquisition, additional development activities were
required to be performed to develop the in-process technology for use in the
three Prism products. Approximately $1,000,000 was anticipated to complete the
work on the existing in-process QDB Solutions, Inc. technology by mid-1998. All
projects were successfully completed. Estimated costs to complete the projects
and the completion dates for the projects did not differ materially from the
assumptions used in the appraisal, although revenues were below those expected.
Revenue from these projects was approximately 6% of total revenue for 1998.
Although revenues from these products were lower than those expected for 1998,
Prism believes that there is customer demand for the products and that the
expected return on the acquired technology will be realized. Prism used the
income approach in appraising the technology. The significant assumptions used
in such approach include estimates for revenue and expenses. The discount rate
of 27% was based on an analysis of the cost of capital to Prism. Prism assumed a
long-term increase in revenue from this business in the appraisal, with profit
margins trending upward over time. There were no cost reductions expected from
this acquisition.
 
     In July 1997, Prism purchased certain in-process technology from
Peregrine/Bridge Transfer Corporation for $1.3 million in pre-paid royalties.
Prism expensed this prepayment at the time of purchase as purchased in-process
technology because it had not reached technological feasibility and had no
alternative future use to Prism. The nature of the technology acquired allows
high performance batch and incremental data replication to leverage the
investment and reduce cost in the deployment of data warehouses. The two
products that Prism developed from the technology, FastLoad and FastUpdate, have
ultimately only generated revenue of $86,000 since January 1998, when the
products were released. The same core in-process technology was used in both
Prism products. The technology underlying the FastLoad and FastUpdate products
was approximately 90% complete at the acquisition date. The value assigned to
this technology was $1.3 million, the amount of the pre-paid royalties. This
technology has also been subsequently deployed by Prism in the roll out of its
change data capture products for Oracle and DB2 databases. Working models of
these products were not complete at the date of acquisition. The working models
were completed subsequent to the acquisition date. Completeness was confirmed
through product testing and quality assurance processes. Future revenue from
these products is difficult to estimate. Actual estimated costs to complete the
projects and the completion dates for the projects did not differ materially
from Prism's assumptions, however revenue results were below expectations.
Although revenues from these products have been lower than those expected, the
products allow Prism to offer a more robust data warehouse solution. Prism
believes that the value of the technology will help Prism to deliver more
enterprise solution customers, even though demand for the individual products is
difficult to predict.
 
                                       14
<PAGE>   18
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Prism's cash and cash equivalents decreased from $6,351,000 at December 31,
1997 to $5,069,000 as of December 31, 1998. The decrease was attributable
primarily to Prism's loss of $18,651,000 during the year ended December 31,
1998, which was offset by collections of accounts receivable of $4,192,000 and
depreciation and amortization expense of $3,455,000. The increase in cash used
in operating activities was offset by net sales and maturities of short-term
investments which provided cash of $15,384,000 from investing activities. As of
December 31, 1998, Prism had $5,069,000 in cash and cash equivalents.
 
     In recognition of the operating losses experienced by Prism in 1998, Prism
implemented cost reduction measures which began in the third quarter of 1998.
These measures consisted primarily of reductions in headcount and were intended
to align operating expenses with projected revenues. To the extent Prism
experiences continuing losses in the future as it has in the previous year,
Prism will need to obtain additional debt or equity financing which may not be
available or, if available, may not be on favorable terms or may be dilutive. In
recognition of these factors, the company entered into a merger agreement with
Ardent Software, Inc.
 
     As of December 31, 1998, Prism had no material commitments to make capital
expenditures. Prism's principal commitments consisted of non-cancelable
operating leases on its facilities.
 
     To date, Prism has not invested in derivative securities or any other
financial instruments that involve a high level of complexity or risk.
Management expects that, in the future, cash in excess of current requirements
will be invested in short-term, interest-bearing, investment grade securities.
 
     Prism has planned, based on its current operating levels and cost reduction
and containment efforts, to use existing cash resources at December 31, 1998 for
operating activities through fiscal 1999. However, if Prism is unable to turn
around its financial performance of previous quarters it will require additional
resources. There can be no assurance, however, that Prism will obtain additional
resources or achieve sufficient cost reductions. In the event that management is
unable to achieve its planned revenue levels or complete its merger with Ardent
Software, Inc. in a timely manner, operating activities may be significantly
curtailed.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     Not applicable.
 
                                       15
<PAGE>   19
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<S>                                                           <C>
Report of Independent Accountants...........................    17
Consolidated Balance Sheets as of December 31, 1998 and
  1997......................................................    18
Consolidated Statements of Operations for the three years
  ended December 31, 1998, 1997 and 1996....................    19
Consolidated Statements of Stockholders' Equity for the
  three years ended December 31, 1998, 1997 and 1996........    20
Consolidated Statements of Cash Flows for the three years
  ended December 31, 1998, 1997 and 1996....................    21
Notes to Consolidated Financial Statements..................    23
Supplemental Schedule II -- Valuation and Qualifying
  Accounts..................................................    41
</TABLE>
 
                                       16
<PAGE>   20
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Stockholders
Prism Solutions, Inc. and Subsidiaries:
 
     In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Prism Solutions, Inc. and its subsidiaries at December 31, 1998 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. In addition, in our opinion, the financial
statement schedule listed in the accompanying index presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
 
     The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 12 to the
financial statements, the Company has suffered recurring losses from operations
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters, which include the proposed merger
with Ardent Software, Inc., are also described in Note 12. The financial
statements do not include any adjustments that might result from this
uncertainty.
 
PRICEWATERHOUSECOOPERS LLP
 
San Jose, California
March 1, 1999
 
                                       17
<PAGE>   21
 
                             PRISM SOLUTIONS, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1998        1997
                                                              --------    --------
<S>                                                           <C>         <C>
ASSETS
Current assets:
  Cash and cash equivalents.................................  $  5,069    $  6,351
  Short-term investments....................................        --      15,355
  Accounts receivable, net of allowance for doubtful
     accounts of $481 and $649 in 1998 and 1997,
     respectively...........................................     9,994      14,186
  Other receivables.........................................       510         650
  Prepaid expenses and other current assets.................       464         927
                                                              --------    --------
     Total current assets...................................    16,037      37,469
Property and equipment, net.................................     3,620       3,517
Other assets................................................     1,855       2,199
                                                              --------    --------
     Total assets...........................................  $ 21,512    $ 43,185
                                                              ========    ========
LIABILITIES
Current liabilities:
  Notes payable, current portion of long-term debt and
     capital leases.........................................  $    214    $    262
  Accounts payable..........................................     2,214       2,813
  Accrued commissions.......................................       657       1,169
  Accrued payroll and related...............................     2,384       2,335
  Deferred revenue..........................................     3,980       5,221
  Other accrued liabilities.................................     1,168       3,417
                                                              --------    --------
     Total current liabilities..............................    10,617      15,217
Notes payable, long-term debt and capital leases............       329         364
                                                              --------    --------
     Total liabilities......................................    10,946      15,581
                                                              --------    --------
Commitments and contingencies (Note 5)
 
STOCKHOLDERS' EQUITY
Convertible preferred stock, par value $0.001 per share:
  Authorized 1,000,000; none issued or outstanding..........        --          --
Common stock, par value $0.001 per share:
  Authorized: 50,000,000 shares issued and outstanding:
     18,716,661 in 1998 and 18,182,251 in 1997..............        19          18
Additional paid-in capital..................................    59,822      57,253
Accumulated comprehensive loss..............................        --         (29)
Receivable from stockholder.................................        --         (90)
Accumulated deficit.........................................   (49,275)    (29,548)
                                                              --------    --------
     Total stockholders' equity.............................    10,566      27,604
                                                              --------    --------
     Total liabilities and stockholders' equity.............  $ 21,512    $ 43,185
                                                              ========    ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       18
<PAGE>   22
 
                             PRISM SOLUTIONS, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                              -------------------------------
                                                                1998        1997       1996
                                                              --------    --------    -------
<S>                                                           <C>         <C>         <C>
Revenues:
  License...................................................  $ 22,166    $ 23,823    $19,586
  Services and other........................................    29,924      27,568     16,581
                                                              --------    --------    -------
     Total revenues.........................................    52,090      51,391     36,167
                                                              --------    --------    -------
Cost of revenues:
  License...................................................     1,031       1,338        847
  Services and other........................................    21,410      16,046      9,684
                                                              --------    --------    -------
     Total cost of revenues.................................    22,441      17,384     10,531
                                                              --------    --------    -------
  Gross margin..............................................    29,649      34,007     25,636
                                                              --------    --------    -------
Costs and expenses:
  Sales and marketing.......................................    27,355      24,712     18,462
  Research and development..................................    14,492      11,068      6,974
  General and administrative................................     6,587       7,114      4,048
  Purchased-in-process technology...........................        --       8,558         --
                                                              --------    --------    -------
     Total costs and expenses...............................    48,434      51,452     29,484
                                                              --------    --------    -------
  Loss from operations......................................   (18,785)    (17,445)    (3,848)
                                                              --------    --------    -------
Interest income, net........................................       370       1,352      1,453
Other income (expense), net.................................        13          --        (21)
                                                              --------    --------    -------
  Loss before income taxes..................................   (18,402)    (16,093)    (2,416)
Provision for income taxes..................................       249          91         21
                                                              --------    --------    -------
  Net loss..................................................   (18,651)    (16,184)    (2,437)
                                                              --------    --------    -------
Unrealized holding gain (loss)..............................        29         (29)        --
                                                              --------    --------    -------
  Comprehensive loss........................................  $(18,622)   $(16,213)   $(2,437)
                                                              ========    ========    =======
  Basic and dilutive loss per share.........................  $  (1.01)   $  (0.94)   $ (0.17)
                                                              ========    ========    =======
  Shares used in per share calculation......................    18,485      17,291     14,640
                                                              ========    ========    =======
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       19
<PAGE>   23
 
                             PRISM SOLUTIONS, INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                       (IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
                                             CONVERTIBLE
                                           PREFERRED STOCK         COMMON STOCK       ADDITIONAL     ACCUMULATED    RECEIVABLES
                                         -------------------   --------------------     PAID-IN     COMPREHENSIVE       FROM
                                           SHARES     AMOUNT     SHARES      AMOUNT     CAPITAL     GAINS (LOSS)    STOCKHOLDERS
                                         ----------   ------   -----------   ------   -----------   -------------   ------------
<S>                                      <C>          <C>      <C>           <C>      <C>           <C>             <C>
BALANCE AT JANUARY 1, 1996.............   7,990,817    $  8      6,011,493    $ 6       $14,946           --          $   (129)
Conversion of preferred stock..........  (7,990,817)     (8)     7,990,817      8
Issuance of common stock in initial
  public offering......................                          2,325,500      3        35,610
Issuance of common stock under stock
  option plan..........................                            116,324                   78
Issuance of common stock under stock
  purchase plan........................                             42,751                  491
Issuance of common stock for consulting
  purposes.............................                             11,472                  106
Repurchase of common stock.............                            (63,822)                 (20)
Payment received on receivables from
  stockholder..........................                                                                                     25
Net loss...............................
                                         ----------    ----    -----------    ---       -------         ----          --------
BALANCE AT DECEMBER 31, 1996...........          --      --     16,434,535     17        51,211           --              (104)
Issuance of common stock under stock
  option plan..........................                            267,669                  286
Issuance of common stock under stock
  purchase plan........................                            164,016                  869
Repurchase of common stock.............                           (348,536)              (2,021)
Issuance of common stock related to
  acquisitions.........................                          1,664,567      1         6,908
Payment received on receivables from
  stockholder..........................                                                                                     14
Unrealized holding losses..............                                                                 $(29)
Net loss...............................
                                         ----------    ----    -----------    ---       -------         ----          --------
BALANCE AT DECEMBER 31, 1997...........          --      --     18,182,251     18        57,253          (29)              (90)
Termination of S-corp election for
  CFI..................................                                                   1,053
Issuance of common stock under stock
  option plan..........................                            221,129      1           544
Issuance of common stock under stock
  purchase plan........................                            328,084                  976
Payment received on receivable from
  stockholder..........................                                                                                     90
Realized holding gain..................                                                                   29
Repurchase of common stock.............                            (14,803)                  (4)
Payment of preferred stock dividends of
  acquired companies...................
Net loss...............................
                                         ----------    ----    -----------    ---       -------         ----          --------
BALANCE AT DECEMBER 31, 1998...........          --    $ --     18,716,661    $19       $59,822         $ --          $     --
                                         ==========    ====    ===========    ===       =======         ====          ========
 
<CAPTION>
 
                                         ACCUMULATED
                                           DEFICIT      TOTAL
                                         -----------   --------
<S>                                      <C>           <C>
BALANCE AT JANUARY 1, 1996.............   $(10,927)    $  3,904
Conversion of preferred stock..........                      --
Issuance of common stock in initial
  public offering......................                  35,613
Issuance of common stock under stock
  option plan..........................                      78
Issuance of common stock under stock
  purchase plan........................                     491
Issuance of common stock for consulting
  purposes.............................                     106
Repurchase of common stock.............                     (20)
Payment received on receivables from
  stockholder..........................                      25
Net loss...............................     (2,437)      (2,437)
                                          --------     --------
BALANCE AT DECEMBER 31, 1996...........    (13,364)      37,760
Issuance of common stock under stock
  option plan..........................                     286
Issuance of common stock under stock
  purchase plan........................                     869
Repurchase of common stock.............                  (2,021)
Issuance of common stock related to
  acquisitions.........................                   6,909
Payment received on receivables from
  stockholder..........................                      14
Unrealized holding losses..............                     (29)
Net loss...............................    (16,184)     (16,184)
                                          --------     --------
BALANCE AT DECEMBER 31, 1997...........    (29,548)      27,604
Termination of S-corp election for
  CFI..................................     (1,053)          --
Issuance of common stock under stock
  option plan..........................                     545
Issuance of common stock under stock
  purchase plan........................                     976
Payment received on receivable from
  stockholder..........................                      90
Realized holding gain..................                      29
Repurchase of common stock.............                      (4)
Payment of preferred stock dividends of
  acquired companies...................        (23)         (23)
Net loss...............................    (18,651)     (18,651)
                                          --------     --------
BALANCE AT DECEMBER 31, 1998...........   $(49,275)    $ 10,566
                                          ========     ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       20
<PAGE>   24
 
                             PRISM SOLUTIONS, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                               -----------------------------
                                                                 1998       1997      1996
                                                               --------   --------   -------
<S>                                                            <C>        <C>        <C>
  Cash flows from operating activities:
  Net loss..................................................   $(18,651)  $(16,184)  $(2,437)
  Adjustment to reconcile net loss to net cash used in
    operating activities:
    Depreciation and amortization...........................      3,455      2,207     1,836
    Provision for doubtful accounts.........................        168        248        44
    Loss on disposal of property and equipment..............         --         41        14
    Purchase of in-process technology.......................         --      8,558        --
    Stock issued for consulting services....................         --        125       106
    Changes in operating assets and liabilities:
       Accounts receivable..................................      4,024     (3,989)   (2,041)
       Other receivables....................................        140       (479)     (250)
       Prepaid expenses and other current assets............        463         42      (687)
       Other assets.........................................         92       (896)      188
       Accounts payable.....................................       (599)     1,386       832
       Accrued commissions..................................       (512)       466       180
       Accrued payroll and related..........................         49      1,112       877
       Deferred revenue.....................................     (1,241)       295      (682)
       Other accrued liabilities............................     (2,249)       320       355
                                                               --------   --------   -------
  Net cash used in operating activities.....................    (14,861)    (6,748)   (1,665)
                                                               --------   --------   -------
  Cash flows from investing activities:
    Purchase of in-process technology and assets, net of
       cash received........................................         --     (2,466)       --
    Purchases of property and equipment.....................     (3,306)    (3,095)   (1,860)
    Purchases of short-term investments.....................     (5,093)        --   (20,052)
    Sale of short-term investments..........................     20,477      4,668        --
                                                               --------   --------   -------
    Net cash provided by (used in) investing activities.....     12,078       (893)  (21,912)
                                                               --------   --------   -------
  Cash flows from financing activities:
  Repayment of equipment lines of credit....................         --         --    (1,238)
    Proceeds from debt......................................         --      3,085        --
    Repayment of debt.......................................        (83)    (3,104)       --
    Proceeds from sale of common stock......................         --         --    35,613
    Proceeds from sale of stock of acquired companies.......         --         --     1,500
    Dividend paid on stock of acquired companies............         --         --       (77)
    Payments received on receivable from stockholder........         90         14        25
    Proceeds from employee stock purchase plan..............        976        869       491
    Proceeds from the exercise of employee stock options....        545        286        78
    Payment of preferred stock dividend of acquired
       company..............................................        (23)        --        --
    Repurchase of common stock..............................         (4)    (2,021)      (20)
                                                               --------   --------   -------
    Net cash provided by (used in) financing activities.....      1,501       (871)   36,372
                                                               --------   --------   -------
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       21
<PAGE>   25
                             PRISM SOLUTIONS, INC.
 
              CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                               -----------------------------
                                                                 1998       1997      1996
                                                               --------   --------   -------
<S>                                                            <C>        <C>        <C>
Net increase (decrease) in cash and cash equivalents........     (1,282)    (8,512)   12,795
Cash and cash equivalents at beginning of year..............      6,351     14,863     2,068
                                                               --------   --------   -------
Cash and cash equivalents at end of year....................   $  5,069   $  6,351   $14,863
                                                               ========   ========   =======
Supplemental cash flow information:
  Cash paid for income taxes................................   $     89   $     82   $    81
  Cash paid for interest....................................   $     56   $      9   $    22
Supplemental disclosure of noncash transactions:
  Property and equipment included in accounts payable.......   $     --   $     24   $    69
  Issuance of common stock for consulting services..........   $     --   $     --   $   106
  Conversion of preferred stock into common stock in initial
    public offering.........................................   $     --   $     --   $     8
  Effect of acquisitions:
    Termination of S-Corp election for Customer Focus
       International........................................   $  1,053         --        --
    Fair value of assets acquired (see note 11).............   $     --   $  7,374   $    --
    Goodwill................................................   $     --   $  1,275   $    --
    Issuance of common stock................................   $     --   $  6,908   $    --
    Assets acquired, net of $244 cash received..............   $     --   $  2,466   $    --
    Liabilities assumed including expenses incurred.........   $     --   $    464   $    --
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       22
<PAGE>   26
 
                             PRISM SOLUTIONS, INC.
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
1.  NATURE OF BUSINESS
 
     Nature of Business -- Prism Solutions, Inc. (the "Company") designs,
develops, markets and supports data warehouse management software that assists
its customers in developing, managing and maintaining data warehouses. The
Company currently markets its software products to a wide variety of businesses
and other organizations in North and South America, Europe, South Africa, the
Middle East, Asia Pacific and Australia. Substantially all of the Company's
revenues to date have been attributable to licenses of two of the Company's
products and related services.
 
     On January 30, 1998, the Company completed the acquisition of Customer
Focus International, Inc. ("CFI"), which was accounted for as a pooling of
interests. All financial data of the Company, including the Company's previously
issued financial statements for the periods presented have been restated to
include the historical financial information of CFI in accordance with generally
accepted accounting principles and pursuant to Securities and Exchange
Commission Regulation S-X.
 
     On May 13, 1998, the Company completed the acquisition of Systems
Techniques, Inc. ("STI"), which was accounted for as a pooling of interests. All
financial data of the Company, including the Company's previously issued
financial statements for the periods presented have been restated to include the
historical financial information of STI in accordance with generally accepted
accounting principles and pursuant to Securities and Exchange Commission
Regulation S-X.
 
2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     Consolidation
 
     The Company has established wholly-owned subsidiaries in Mexico, Canada,
the United Kingdom, Germany, France and Spain. In 1997, the Company established
wholly-owned subsidiaries in the Netherlands, Hong Kong and Singapore, and
acquired Object Software in Melbourne, Australia and QDB Solutions, Inc. in
Cambridge, Massachusetts. The consolidated financial statements include the
financial statements of Prism Solutions, Inc. and its wholly-owned subsidiaries
after elimination of intercompany accounts and transactions.
 
     Use of Estimates
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that reflect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
     Cash, Cash Equivalents and Short-Term Investments
 
     The Company considers all highly liquid investments purchased with an
original or remaining maturity of three months or less to be cash equivalents.
Highly liquid investments with an original or remaining maturity beyond three
months, but less than one year, are classified as short-term investments and
carried at fair value, which approximates cost.
 
     Concentration of Credit Risk and Fair Value of Financial Instruments
 
     The Company's cash and cash equivalents are held in various interest
bearing deposit accounts at local and foreign banks. Through December 31, 1998,
no material losses had been experienced on such investments.
 
     As of December 31, 1997, the Company had short-term investments totaling
$15,355, which were classified as available for sale. There were no short-term
investments as of December 31, 1998. Short-term
 
                                       23
<PAGE>   27
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
investments principally consist of municipal securities and corporate bonds.
Through December 31, 1998, no material losses had been experienced on such
investments. The amortized cost of debt securities is adjusted for amortization
of premiums and accretion of discounts to maturity, both of which are included
in interest income. Realized gains and losses are recorded on the specific
identification method.
 
     The Company markets its software products directly and through resellers,
and generally does not require collateral. The Company performs ongoing credit
evaluations of its customers and maintains an allowance for doubtful accounts.
As of December 31, 1998 and 1997 no one customer accounted for more than 10% of
accounts receivable.
 
     For financial instruments consisting of cash and cash equivalents, accounts
receivable, other receivables, deposits, long-term debt, accounts payable, and
accrued liabilities included in the Company's consolidated financial statements,
the carrying amounts are reasonable estimates of fair value.
 
     Property and Equipment
 
     Property and equipment are stated at cost and depreciated on a
straight-line basis over their estimated useful lives of two to three years.
Leasehold improvements are amortized on a straight-line basis over their
estimated useful lives or their lease terms, whichever is less.
 
     Goodwill
 
     Goodwill related to the Company's acquisitions (see Note 11 in the notes to
the Consolidated Financial Statements) is included in other assets and is being
amortized over 5 years on a straight-line basis.
 
     Revenue Recognition
 
     The Company has adopted the provisions of Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-4, "Deferral
of the Effective Date of Certain Provisions of SOP 97-2", effective January 1,
1998. SOP 97-2 supercedes Statement of Position 91-1 and delineates the
accounting for software product and maintenance revenues. Under SOP 97-2, the
Company recognizes product revenues and license fees upon shipment if a signed
contract exists, the fee is fixed and determinable, collection of resulting
receivables is probable and product returns are reasonably estimable. In
addition, for contracts with multiple obligations (e.g. deliverable and
undeliverable products, services and maintenance), revenue must be allocated to
each component of the contract based on evidence of its fair value which is
specific to the Company, or for products not yet being sold separately, the
price established by management.
 
     Revenue allocated to undelivered products is recognized when criteria for
product and license revenue set forth above are met. Revenue allocated to
maintenance fees for ongoing customer support and product updates is recognized
ratably over the period of the maintenance contract. Payments for maintenance
fees are generally made in advance and are non-refundable. Revenue allocated to
other services is recognized as the related services are performed.
 
     Prior to January 1, 1998, product revenues were generally recognized after
execution of a licensing agreement, a valid purchase order for resellers, and
shipment of the product, if no significant vendor obligations remained and
collection of the resulting receivables was deemed probable. The Company's
license agreements generally did not provide a right of return.
 
     Service revenues from customer maintenance fees for ongoing customer
support and product updates were recognized ratably over the term of the
service. Payments for maintenance fees were generally received in advance and
were generally nonrefundable. Consulting, implementation and training revenues
were
 
                                       24
<PAGE>   28
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
generally recognized following execution of a contract, performance of the
related services and if collection of the resulting receivables was deemed
probable.
 
     Advertising Costs
 
     Advertising costs, included in sales and marketing expenses, are expensed
as incurred and were $251, $260 and $380 in 1998, 1997 and 1996, respectively.
 
     Research and Development
 
     Research and development expenditures are expensed as incurred.
 
     Software Development Costs
 
     Software development costs have been expensed in accordance with Statement
of Financial Accounting Standards No. 86 ("SFAS 86"), "Accounting for the Costs
of Computer Software to be Sold, Leased or Otherwise Marketed." Under SFAS 86,
capitalization of software development costs begins upon the establishment of
technological feasibility and ends when a product is available for general
release to customers. Such costs have been immaterial to date.
 
     Income Taxes
 
     The Company determines its income tax liability in accordance with
Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting
for Income Taxes." Under SFAS 109, the liability method is used to account for
income taxes. Under this method, deferred tax assets and liabilities are
determined based on differences between the financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amounts more likely than not to be realized.
 
     Foreign Currency Translation
 
     All subsidiaries located outside the United States operate with the U.S.
dollar as the functional currency. Net nonmonetary assets are translated at
historical exchange rates, and net monetary assets are translated at current
exchange rates. Transaction and translation gains and losses are included in the
determination of the results of operations and were not material.
 
     Basic and Diluted Loss Per Share
 
     Basic and diluted net loss per share is computed in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share."
Common equivalent shares are excluded from basic and diluted loss per share as
their effect is antidilutive. Common equivalent shares that could potentially
dilute earnings per share in the future and that were not included in the
computation of diluted loss per share because of
 
                                       25
<PAGE>   29
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
antidilution were 1,297,508, 868,262 and 1,113,919 for the years ended December
31, 1998, 1997 and 1996, respectively.
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED
                                                                DECEMBER 31,
                                                   --------------------------------------
                                                      1998          1997         1996
                                                   -----------   ----------   -----------
<S>                                                <C>           <C>          <C>
BASIC EPS:
Net loss.........................................  $   (18,651)  $  (16,184)  $    (2,437)
Denominator: Average common shares outstanding...   18,485,000   17,291,000    14,640,000
                                                   -----------   ----------   -----------
Basic net loss per share.........................  $     (1.01)  $    (0.94)  $     (0.17)
                                                   ===========   ==========   ===========
DILUTED EPS:
Denominator: Average common shares outstanding...   18,485,000   17,291,000    14,640,000
Common equivalent shares outstanding (options)...           --           --            --
                                                   -----------   ----------   -----------
          Total shares...........................   18,485,000   17,291,000    14,640,000
                                                   -----------   ----------   -----------
Dilutive net loss per share......................  $     (1.01)  $    (0.94)  $     (0.17)
                                                   ===========   ==========   ===========
</TABLE>
 
     Recent Pronouncements
 
     In March 1998, the Accounting Standards Executive Committee, or AcSEC,
released Statement of Position 98-1, or SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 requires
companies to capitalize certain costs of computer software developed or obtained
for internal use, provided that those costs are not research and development.
SOP 98-1 is effective for fiscal years beginning after December 15, 1998. The
Company is evaluating the requirements of SOP 98-1 and the effects, if any, on
the Company's current policies on accounting for software costs.
 
     In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, or SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS 133 establishes new standards of accounting and reporting for
derivative instruments and hedging activities. SFAS 133 requires that all
derivatives be recognized at fair value in the statement of financial position,
and that the corresponding gains or losses be reported either in the statement
of operations or as a component of comprehensive income, depending on the type
of hedging relationship that exists. SFAS 133 will be effective for fiscal years
beginning after June 15, 1999. The Company does not currently hold derivative
instruments or engage in hedging activities.
 
     In December 1998, AcSEC released Statement of Position 98-9, or SOP 98-9,
"Modification of SOP 97-2, "Software Revenue Recognition," with Respect to
Certain Transactions". SOP 98-9 amends SOP 97-2 to require that an entity
recognize revenue for multiple element arrangements by means of the "residual
method" when (1) there is vendor-specific objective evidence (VSOE) of the fair
values of all the undelivered elements that are not accounted for by means of
long-term contract accounting, (2) VSOE of fair value does not exist for one or
more of the delivered elements, and (3) all revenue recognition criteria of SOP
97-2 (other than the requirement for VSOE of the fair value of each delivered
element) are satisfied.
 
     The provisions of SOP 98-9 that extend the deferral of certain paragraphs
of SOP 97-2 became effective December 15, 1998. These paragraphs of SOP 97-2 and
SOP 98-9 will be effective for transactions that are entered into in fiscal
years beginning after March 15, 1999. Retroactive application is prohibited. The
Company does not expect the adoption of SOP 98-9 to have a material effect on
its consolidated financial position or results of operations.
 
                                       26
<PAGE>   30
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     Reclassifications
 
     Certain prior year balances have been reclassified to conform with the
current year financial statement presentation.
 
3.  PROPERTY AND EQUIPMENT
 
     Property and equipment consist of the following:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
<S>                                                           <C>        <C>
Computers and equipment.....................................  $ 5,973    $ 4,566
Furniture and fixtures......................................    2,100      1,480
Software....................................................    2,015      1,186
Leasehold improvements......................................      984        326
                                                              -------    -------
                                                               11,072      7,558
Less accumulated depreciation and amortization..............   (7,452)    (4,041)
                                                              -------    -------
                                                              $ 3,620    $ 3,517
                                                              =======    =======
</TABLE>
 
4.  NOTES PAYABLE, LONG-TERM DEBT AND CAPITAL LEASES
 
     Notes payable, long-term debt and capital leases consist of the following
at December 31, 1998:
 
<TABLE>
<S>                                                           <C>
  Notes payable, due March 31, 1999; interest at 7.77%......  $  83
  Advances under line of credit, due through August 2000;
     interest at 5.285%.....................................    220
  Equipment leases, due through 2002, varying rates of
     interest...............................................    240
                                                              -----
                                                                543
          Less: current position............................   (214)
                                                              -----
                                                              $ 329
                                                              =====
</TABLE>
 
     Scheduled repayments are as follows:
 
<TABLE>
<CAPTION>
                                                            CAPITAL    NOTES AND
                                                            LEASES     ADVANCES     TOTAL
                YEARS ENDING DECEMBER 31,                   -------    ---------    -----
<S>                                                         <C>        <C>          <C>
1999......................................................   $122        $131       $253
2000......................................................     74          96        170
2001......................................................     49          65        114
2002......................................................     21          40         61
2003......................................................     --          10         10
                                                             ----        ----       ----
                                                              266         342        608
Less: amounts representing interest.......................    (26)        (39)       (65)
                                                             ----        ----       ----
                                                             $240        $303       $543
                                                             ====        ====       ====
</TABLE>
 
                                       27
<PAGE>   31
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
5.  COMMITMENTS AND CONTINGENCIES
 
     Operating Leases
 
     The Company leases its facilities under noncancelable operating leases that
expire in February 2002 with renewal options at fair market value for additional
periods. The Company is generally responsible for maintenance, property taxes,
liability and personal property insurance and utilities relating to its facility
leases.
 
     Rent expense under the operating leases amounted to approximately $2,722,
$1,821 and $1,122 in 1998, 1997 and 1996, respectively.
 
     Future minimum payments to be made under noncancelable operating leases and
future payments to be received under a sublease agreement are as follows:
 
<TABLE>
<CAPTION>
                                                               LEASE      SUBLEASE
                 YEARS ENDING DECEMBER 31,                    PAYMENTS     INCOME
                 -------------------------                    --------    --------
<S>                                                           <C>         <C>
1999........................................................   $1,943        $7
2000........................................................    1,864        --
2001........................................................    1,623        --
2002........................................................    1,514        --
2003........................................................    1,422
Thereafter..................................................    1,477        --
                                                               ------        --
                                                               $9,843        $7
                                                               ======        ==
</TABLE>
 
     Royalty Agreements
 
     The Company is obligated to pay royalties based on sales from other
specified products under certain continuing license agreements. Royalty expense
was $141, $351 and $140 for 1998, 1997 and 1996, respectively.
 
     Contingencies
 
     On March 5, 1997, a class action complaint was filed by the law firm of
Milberg Weiss Bershad Hynes & Lerach LLP in Superior Court of the State of
California, County of Santa Clara, against the Company and several of its
current and former officers and directors and the underwriters of its initial
public offering. The complaint was filed on behalf of those persons who
purchased or otherwise acquired the common stock of the Company from March 14
through October 14, 1996 and alleges that the defendants artificially inflated
the demand for the common stock prior to and after the initial public offering.
The complaint seeks damages in an unspecified amount. The Company believes the
complaint has no merit and will vigorously defend itself. At December 31, 1998,
no range of loss could be estimated and accordingly, no accrual has been made in
the financial statements. The Company is also involved in other ongoing legal
matters incidental to its business.
 
6.  STOCKHOLDERS' EQUITY
 
     Reincorporation
 
     On February 2, 1996, the reincorporation of the Company as a Delaware
corporation was consummated. The certificate of incorporation provides for
8,990,817 authorized shares of preferred stock with a $0.001 par value per share
and for 50,000,000 authorized shares of common stock with a $0.001 par value per
share. The consolidated financial statements have been retroactively restated to
give effect to the reincorporation.
 
                                       28
<PAGE>   32
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     Common and Convertible Preferred Stock
 
     On March 15, 1996, the Company sold 2,325,500 shares of common stock in its
initial public offering. Net proceeds to the Company, after deducting the
underwriting discount and offering expenses, were approximately $35,613. In
connection with such offering, all outstanding shares of preferred stock were
converted into 7,990,817 shares of common stock and the authorized shares of
preferred stock was reduced to 1,000,000 shares of preferred stock with a $0.001
par value.
 
     Employee Stock Purchase Plan
 
     In 1996, the Company's stockholders approved the adoption of the Employee
Stock Purchase Plan (the "Purchase Plan") wherein 500,000 shares were reserved
for issuance pursuant to such plan. In 1998, the Purchase Plan was increased by
600,000 shares, bringing the total shares reserved for issuance pursuant to the
Purchase Plan to 1,100,000 shares. The Purchase Plan is administered over
offering periods of 24 months each, with each offering period divided into four
consecutive six-month purchase periods beginning August 1 and February 1 of each
year. Eligible employees may designate not more than 10 percent of their cash
compensation to be deducted each pay period for the purchase of common stock
under the Purchase Plan. In addition, in an offering period, no employee may
purchase more than the number of shares specified by the Board of Directors for
any single purchase date or twice the number of shares an employee would be
eligible to purchase at 85 percent of the market price of a share on the first
business day of the offering period if the market price of a share on the last
business day of the purchase period drops to less than one-half of the market
price of a share on the first business day of the offering period. On the last
business day of each purchase period, shares of common stock are purchased with
the employee's payroll deductions accumulated during the six months, generally
at a price per share of 85 percent of the market price of the common stock on
the employee's entry date of the applicable offering period or the last day of
the applicable offering period, whichever is lower. The Purchase Plan will
terminate no later than 2006. A total of 164,016 and 42,751 shares were issued
under the Purchase Plan in 1997 and 1996, respectively. During 1998, a total of
328,084 additional shares were issued pursuant to the Purchase Plan.
 
     Stock Option Plan
 
     In 1996, the Company's stockholders approved an increase in the number of
common shares reserved under the 1992 Stock Option Plan (the "1992 Plan") by
400,000 shares. In addition, the Company's stockholders approved the adoption of
the 1996 Equity Incentive Plan and the 1996 Directors Stock Option Plan
(together known as the "1996 Plans") wherein 2,000,000 and 300,000 shares,
respectively, were reserved for issuance pursuant to these plans. The 1992 Plan
and the 1996 Plans together are known as "the Plans". In 1997, the 1996 plan was
amended to reflect an increase of 5,500,000 shares issuable under the plan. In
1998, the Company's stockholders approved an increase in the number of common
shares reserved under the 1996 Plans by 4,000,000 shares.
 
     The Plans provide for the grant of incentive stock options and nonqualified
stock options to employees, directors and consultants of the Company at prices
ranging from 85% to 110% (depending on the type of grant and the individual
receiving the grant) of the fair market value of the common stock on the date of
grant as determined by the Board of Directors.
 
     The vesting and exercise provisions of the option grants under the Plans
are determined by the Board of Directors. Options granted under the Plans are
generally immediately exercisable, but any shares acquired pursuant to exercises
are subject to repurchase by the Company until they have vested. Options
generally vest ratably over a four-year period commencing from the date of
grant, subject to one year of employment and expire ten years from date of
grant.
 
                                       29
<PAGE>   33
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     Information with respect to the Plans is summarized as follows:
 
<TABLE>
<CAPTION>
                                                                OUTSTANDING OPTIONS
                                              -------------------------------------------------------
                                                                              WEIGHTED
                                 AVAILABLE      NUMBER         PRICE        AVERAGE PRICE   AGGREGATE
                                 FOR GRANT    OF SHARES      PER SHARE        PER SHARE       PRICE
                                 ----------   ----------   --------------   -------------   ---------
<S>                              <C>          <C>          <C>              <C>             <C>
Balance at December 31, 1995...       8,359    1,138,758   $0.20 - $5.50       $ 1.74       $  1,985
  Additional shares reserved...   2,700,000           --               --          --             --
  Granted......................  (1,830,323)   1,830,323    4.88 - 36.00         9.76         17,738
  Canceled.....................     886,641     (886,641)   0.20 - 36.00        12.63        (11,033)
  Exercised....................          --     (116,324)   0.20 - 7.50          0.67            (78)
                                 ----------   ----------                                    --------
Balance at December 31, 1996...   1,764,677    1,966,116                         4.38          8,612
  Additional shares reserved...   5,500,000           --               --          --             --
  Granted......................  (3,417,931)   3,417,931    0.20 - 8.25          5.58         18,774
  Canceled.....................     748,870     (748,870)   0.20 - 8.25          0.96         (3,831)
  Exercised....................          --     (267,669)   0.10 - 5.63          5.12           (286)
                                 ----------   ----------                                    --------
Balance at December 31, 1997...   4,595,616    4,367,508                         5.38         23,269
  Additional shares reserved...   4,000,000           --               --          --             --
  Granted......................  (6,466,969)   6,466,969    0.87 - 7.75          1.12         15,841
  Canceled.....................   5,565,124   (5,565,124)   0.25 - 8.52          5.49        (31,126)
  Exercised....................          --     (221,129)   0.20 - 7.50          2.49           (544)
                                 ----------   ----------                                    --------
Balance at December 31, 1998...   7,693,771    5,048,224                         1.47       $  7,440
                                 ==========   ==========                                    ========
</TABLE>
 
     As of December 31, 1998, the Company had reserved 12,741,995 shares of
common stock for future issuance under the Plans. As of December 31, 1998,
776,371 options outstanding under the Plans had vested and 7,619 shares of
common stock acquired under the Plans were subject to the Company's right of
repurchase.
 
     In October 1998, the Board of Directors approved a plan for repricing of
stock options under which each employee-holder of outstanding options with an
exercise price above the closing price of the Company's stock on October 15,
1998 was permitted to elect to exchange the existing options for new options
which would vest monthly over a four year period and the exercise price of which
was equal to the closing price of the Company's common stock on October 15,
1998. Sale of shares purchased through exercise of these options was prohibited
until April 1, 1999.
 
                                       30
<PAGE>   34
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     The following information concerning the Company's stock option and
employee stock purchase plans is provided in accordance with Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation." The Company accounts for such plans in accordance with APB No. 25
and related interpretations.
 
<TABLE>
<CAPTION>
                                   OPTIONS OUTSTANDING                      VESTED OPTIONS
                         ---------------------------------------        -----------------------
                                          WEIGHTED
                                          AVERAGE       WEIGHTED                       WEIGHTED
                           NUMBER        REMAINING      AVERAGE           NUMBER       AVERAGE
RANGE OF                 OUTSTANDING    CONTRACTUAL     EXERCISE        EXERCISABLE    EXERCISE
EXERCISE PRICES          AT 12/31/98    LIFE (YEARS)     PRICE          AT 12/31/98     PRICE
---------------          -----------    ------------    --------        -----------    --------
<S>                      <C>            <C>             <C>             <C>            <C>
     $0.20 - $0.87        4,458,543         9.79         $ .87            308,650       $ 0.38
      1.00 -  5.00          252,173         6.80          1.81            227,302         2.95
      5.12 - 17.00          337,508         8.73          8.52            240,419        10.03
                          ---------         ----         -----            -------       ------
      0.20 - 17.00        5,048,224         9.35          1.47            776,371         4.18
                          =========                                       =======
</TABLE>
 
     The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1998, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                                               1998       1997       1996
                                                              -------    -------    -------
<S>                                                           <C>        <C>        <C>
Risk-free interest rates....................................     5.2%       5.5%      5.18%
Expected life...............................................  4 years    4 years    4 years
Volatility..................................................      40%        93%        44%
Dividend yield..............................................       0%         0%         0%
</TABLE>
 
     The weighted average expected life was based on the exercise behavior. The
weighted average fair value of those options granted in 1998, 1997 and 1996 was
$0.65, $5.29 and $10.65 per share, respectively.
 
     Under SFAS 123, proforma compensation cost is calculated for the fair value
of employee's purchase rights under the Company's Employee Stock Purchase Plan,
which was estimated using the following assumptions for 1998, 1997 and 1996,
respectively:
 
<TABLE>
<CAPTION>
                                                               1998      1997      1996
                                                              -------   -------   -------
<S>                                                           <C>       <C>       <C>
Volatility..................................................      40%       93%       44%
Risk-free interest rates....................................    4.33%     3.57%     3.75%
Expected life...............................................  2 years   2 years   2 years
Dividend yield..............................................       0%        0%        0%
</TABLE>
 
     Based on the above assumptions, the weighted average fair value per share
of those purchase rights granted in 1998, 1997 and 1996 was $1.05, $2.03 and
$3.36, respectively.
 
     At December 31, 1998, the Company had two stock-based compensation plans,
which are described above. As the Company applies APB Opinion 25 and related
interpretations in accounting for its plans, no compensation cost has been
recognized for its fixed stock option plans and its stock purchase plan.
 
                                       31
<PAGE>   35
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     Had compensation cost for the Company's two stock-based compensation plans
been determined consistent with SFAS 123, the Company's net loss and loss per
share would have been increased to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                        1998        1997       1996
                                                      --------    --------    -------
<S>                       <C>                         <C>         <C>         <C>
Net loss                  as reported.............    $(18,651)   $(16,184)   $(2,437)
                          pro forma...............     (19,105)    (17,004)    (2,670)
Basic and dilutive loss
  per share               as reported.............    $  (1.01)   $  (0.94)   $ (0.17)
                          pro forma...............       (1.03)      (0.98)     (0.18)
</TABLE>
 
     The above pro forma effects on net loss may not be representative of the
effects in future years as option grants typically vest over several years and
are generally granted each year.
 
7.  INCOME TAXES
 
     The components of the provision for income taxes for 1998, 1997 and 1996
were as follows:
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED DECEMBER 31,
                                                              -------------------------
                                                              1998      1997      1996
                                                              -----    ------    ------
<S>                                                           <C>      <C>       <C>
Current:
  Federal, state and Other..................................  $ 50     $   5     $(116)
  Foreign...................................................   199        86        95
                                                              ----     -----     -----
                                                              $249     $  91     $  21
                                                              ====     =====     =====
</TABLE>
 
     The principal items accounting for the difference between income taxes
computed at the United States statutory rate and the provision for income taxes
is as follows:
 
<TABLE>
<CAPTION>
                                                           YEARS ENDED DECEMBER 31,
                                                          ---------------------------
                                                           1998       1997      1996
                                                          -------    -------    -----
<S>                                                       <C>        <C>        <C>
U.S. federal statutory benefit at 34%...................  $(7,110)   $(5,460)   $(821)
State benefit, net of U.S. federal income tax effect....     (201)       (77)     (51)
Tax credits.............................................   (1,090)      (648)      (6)
Foreign withholding taxes...............................      164         57       95
In-process research and development.....................       --      2,328       --
Other...................................................      287        171       43
Unbenefited net operating loss and credits..............    8,199      3,720      761
                                                          -------    -------    -----
                                                          $   249    $    91    $  21
                                                          =======    =======    =====
</TABLE>
 
                                       32
<PAGE>   36
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Significant components of
deferred tax assets for federal and state income taxes are as follows:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              -------------------
                                                                1998       1997
                                                              --------    -------
<S>                                                           <C>         <C>
Net operating loss carryforwards............................  $ 13,000    $ 6,449
Research credits............................................     2,592      1,277
Capitalized research and development........................     1,558        368
Other temporary differences.................................      (128)       727
                                                              --------    -------
  Total deferred tax assets.................................    17,022      8,821
Valuation allowance for deferred tax assets.................   (17,022)    (8,821)
                                                              --------    -------
  Net deferred tax assets...................................  $     --    $    --
                                                              ========    =======
</TABLE>
 
     The Company has established a valuation allowance to the extent of its
deferred tax assets due to the uncertainty of utilization against future
operating income. During the years ended December 31, 1998 and 1997, the
Company's valuation allowance increased by $8,201 and $4,483, respectively.
 
     As of December 31, 1998, the Company, including certain pooled entities,
had federal and California net operating loss carryforwards of approximately
$37,981 and $3,013, respectively. The Company also had Federal and California
research and development tax credit carryforwards of $1,635 and $957,
respectively. The net operating loss and credit carryforwards will expire at
various dates from 1999 through 2013, if not utilized.
 
     Utilization of the net operating losses and credits may be subject to an
annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization. Approximately $1,500 of such operating losses are already
subject to such limitations.
 
8.  EMPLOYEE BENEFIT PLAN
 
     During 1994, the Company adopted a qualified profit sharing plan and trust
under Internal Revenue Service Code 401(k) (the "401(k) Plan"). The 401(k) Plan
provides for tax deferred salary deductions. Employees can elect to contribute
to the 401(k) Plan up to 20% of their salary, subject to current statutory
limits. The Company is not required to contribute to the 401(k) Plan and has
made no contributions since the inception of the 401(k) Plan.
 
9.  RELATED PARTY TRANSACTIONS
 
     At December 31, 1997, the Company held a note receivable of $90, with
interest at 8.0% per annum, from an executive officer issued in connection with
the purchase of common stock under incentive and non-qualified stock option
plans. The note was repaid during 1998.
 
10.  INDUSTRY AND GEOGRAPHIC SEGMENT INFORMATION
 
     The Company has adopted Statement of Financial Accounting Standards No.
131, ("SFAS 131"), "Disclosure about Segments of an Enterprise and Related
Information". SFAS 131 supercedes Statement of Financial Accounting Standards
No. 14, or SFAS 14, Financial Reporting for Segments of a Business Enterprise.
SFAS 131 changes current practice under SFAS 14 by establishing a new framework
on which to base segment reporting and also requires interim reporting of
segment information.
 
                                       33
<PAGE>   37
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     Management uses one measurement of profitability for its business. The
Company's software products and related services are developed and marketed to
support data warehouses. The Company markets its products and related services
to customers in the United States, Canada, Latin America, Europe and Asia
Pacific.
 
     Revenues and long-lived-asset information by geographic area as of and for
the year ended:
 
<TABLE>
<CAPTION>
                                                                          LONG-LIVED
                                                              REVENUES      ASSETS
                                                              --------    ----------
                                                                  (IN THOUSANDS)
<S>                                                           <C>         <C>
December 31, 1998:
  United States.............................................  $33,404       $4,751
  International.............................................   18,686          724
                                                              -------       ------
  Total.....................................................  $52,090       $5,475
                                                              =======       ======
December 31, 1997:
  United States.............................................  $38,503       $5,013
  International.............................................   12,888          703
                                                              -------       ------
  Total.....................................................  $51,391       $5,716
                                                              =======       ======
December 31, 1996:
  United States.............................................  $26,801       $1,652
  International.............................................    9,366          372
                                                              -------       ------
  Total.....................................................  $36,167       $2,024
                                                              =======       ======
</TABLE>
 
     No customer accounted for more than 10 percent of the Company's total
revenues in the years ended December 31, 1998, 1997 and 1996.
 
11.  ACQUISITIONS
 
     On July 1, 1997, the Company completed the acquisition of Object Software
Pty. Limited ("Object") by issuing an aggregate of 258,621 shares of its Common
Stock and $160 in cash. The transaction was completed in connection with the
acquisition by a wholly-owned Australian subsidiary of the Company of certain of
Object's assets pursuant to an Asset Purchase Agreement entered into on July 1,
1997 between the Company, the Company's wholly-owned Australian subsidiary,
Object and Object's major shareholder. The transaction has been accounted for as
a purchase and results of operations subsequent to the acquisition date have
been consolidated with the Company. At December 31, 1998 and 1997, accumulated
amortization of the purchased intangibles, including goodwill was $323, and
$108, respectively.
 
     Consideration for the acquisition was allocated as follows:
 
<TABLE>
<S>                                                           <C>
Total consideration paid....................................  $    1,240
Fair value of assets acquired (principally cash)............         164
                                                              ----------
Goodwill....................................................  $    1,076
                                                              ==========
</TABLE>
 
     On July 21, 1997, the Company issued an aggregate of 1,143,613 shares of
its Common Stock and paid an aggregate of $1,250 in cash in connection with the
acquisition by the Company of QDB Solutions, Inc., a Massachusetts corporation
("QDB"). The acquisition was accounted for as a purchase through the merger of a
wholly-owned subsidiary of the Company with and into QDB pursuant to an
Agreement and Plan of Reorganization entered into on July 21, 1997 between the
Company, the Company's wholly-owned subsidiary,
 
                                       34
<PAGE>   38
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
QDB and the shareholders of QDB. The results of operations subsequent to the
acquisition date have been consolidated with the Company. At December 31, 1998
and 1997, accumulated amortization of the purchased goodwill was $74, and $37,
respectively.
 
     Consideration for the acquisition was allocated as follows:
 
<TABLE>
<S>                                                           <C>
Total consideration paid....................................  $    7,409
Fair value of assets acquired...............................       7,210
                                                              ----------
Goodwill....................................................  $      199
                                                              ==========
</TABLE>
 
     Net assets acquired consisted primarily of in-process technology ($7,200),
existing technology and furniture and fixtures, less liabilities assumed.
 
     Pro-forma results of operations from both acquisitions would not have been
material to the Company's 1997 loss.
 
     On July 22, 1997, the Company purchased certain technology from the
Peregrine/Bridge Transfer Corporation for $1,300 in pre-paid royalties.
Additionally, the Company may be obligated to make an additional $2,700 in
royalty payments not to exceed $4,000 in the aggregate. The royalty payments are
payable 45 days after the end of each of the Company's fiscal quarters. Under
the terms and conditions of this agreement, the Company has not paid any
royalties as of December 31, 1998. Assets acquired consisted almost exclusively
of purchased in-process technology.
 
     On January 30, 1998, the Company completed the acquisition of CFI by
issuing approximately 2,877,500 shares of common stock in exchange for all
outstanding common stock of CFI. The transaction was accounted for as a pooling
of interests. CFI designs, markets, integrates, and supports enterprise customer
relationship management software for the financial services industry, primarily
banking. All financial data of the Company has been restated to include the
historical financial information of CFI. Accumulated earnings for CFI at the
time of revocation of its S corporation were reclassified to additional
paid-in-capital in accordance with SEC Topic 4-B. Pro-forma tax expense for the
year ended December 31, 1997 has not been presented as it was not material.
 
     Costs associated with the merger were charged to expense as incurred and
were not significant.
 
                                       35
<PAGE>   39
                             PRISM SOLUTIONS, INC.
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
     On May 13, 1998, the Company completed the acquisition of STI by issuing
approximately 544,000 shares of common stock in exchange for all outstanding
common stock of STI. The transaction was accounted for as a pooling of
interests. STI, a specialist in data warehousing solutions for the healthcare
industry, offers application-specific bundled solutions and methodology and
consulting services for the healthcare industry. All financial data of the
Company has been restated to include the historical financial information of
STI.
 
     The following data includes the revenues and net loss of each of the
companies for the years ended December 31, 1997 and 1996.
 
<TABLE>
<CAPTION>
                                                  YEAR ENDED          YEAR ENDED
                                               DECEMBER 31, 1997   DECEMBER 31, 1996
                                               -----------------   -----------------
<S>                                            <C>                 <C>
Revenues:
  Prism......................................      $ 43,433             $30,424
  CFI........................................         3,514               2,082
  STI........................................         4,444               3,661
                                                   --------             -------
  Combined...................................      $ 51,391             $36,167
                                                   ========             =======
Net Income (loss):
  Prism......................................      $(16,152)            $(1,839)
  CFI........................................            49                 539
  STI........................................           (81)             (1,137)
                                                   --------             -------
  Combined...................................      $(16,184)            $(2,437)
                                                   ========             =======
</TABLE>
 
     Costs associated with the merger were charged to expense as incurred and
were not significant.
 
NOTE 12.  PROPOSED ACQUISITION AND LIQUIDITY
 
     During the year ended December 31, 1998, the Company utilized cash flows
from operations and incurred a net operating loss. In recognition of these
matters, the Company undertook a plan in the third quarter to reduce its
headcount to balance its expenses with projected revenues. In addition, the
Company entered into a merger agreement with Ardent Software, Inc., the closing
of which is subject to certain conditions. The accompanying financial statements
have been prepared on the basis of a going concern and do not include any
adjustments that might result if the Company's plans, consisting principally of
the merger with Ardent Software, Inc., are not completed.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
 
     None
 
                                       36
<PAGE>   40
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     Information required by this Item regarding the Company's directors is
incorporated herein by reference from the section entitled "Election of
Directors" of the Company's proxy statement to be delivered to stockholders with
the Company's Annual Report to Stockholders. Information regarding the Company's
executive officers may be found in Part I of this Form 10-K in the section
entitled "Executive Officers of the Company" and is incorporated by reference
herein. Information required by this Item concerning compliance with Section
16(a) of the Exchange Act is incorporated herein by reference from the section
entitled "Section 16(a) Beneficial Ownership Reporting Compliance" contained in
the Company's proxy statement to be delivered to stockholders with the Company's
Annual Report to Stockholders.
 
ITEM 11. EXECUTIVE COMPENSATION
 
     Information required by this Item is incorporated herein by reference from
the section entitled "Executive Compensation" of the Company's proxy statement
to be delivered to stockholders with the Company's Annual Report to
Stockholders.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     Information required by this Item is incorporated herein by reference from
the section entitled "Stock Ownership of Certain Beneficial Owners and
Management" of the Company's proxy statement to be delivered to stockholders
with the Company's Annual Report to Stockholders.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Information required by this Item is incorporated herein by reference from
the section entitled "Certain Transactions" of the Company's proxy statement to
be delivered to stockholders with the Company's Annual Report to Stockholders.
 
                                       37
<PAGE>   41
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
(a) The following documents are filed as part of this report:
 
     1. Financial Statements -- see Index to Consolidated Financial Statements
        at Item 8 on page 16 of this Report.
 
     2. Financial Statement Schedule:
 
        Schedule II -- Valuation and Qualifying Accounts is filed on page 40 of
        this Report on Form 10-K.
 
        All other schedules for which provision is made in the applicable
        accounting regulations of the Securities and Exchange Commission are
        omitted because they are not required under the related instructions or
        are inapplicable.
 
        The independent accountant's report with respect to the above listed
        financial statements and financial statement schedule listed in Items
        14(a) is filed on page 17 of this Report on Form 10-K.
 
     3. Exhibits -- The following exhibits are filed as part of, or incorporated
        by reference into, this Report:
 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                               EXHIBIT
-------                             -------
<S>       <C>
 2.01     Agreement and Plan of Merger by and between Prism Solutions,
          Inc., a Delaware corporation, and Prism Solutions, Inc., a
          California corporation, and material exhibits thereto.(1)
 3.01     Company's Certificate of Incorporation(1)
 3.02     Company's Amendment of Certificate of Incorporation(1)
 3.03     Company's Certificate of Designation(1)
 3.04     Company's Certificate of Retirement(1)
 3.05     Company's Bylaws(1)
 4.01     Amended and Restated Investor Rights Agreement dated
          December 19, 1994(1)
10.01     Company's 1992 Stock Option Plan(1)(2)
10.02     Company's 1996 Equity Incentive Plan, as amended
          (incorporated by reference to Exhibit 4.01 to the Company's
          Registration Statement on Form S-8 filed August 11,
          1997(1)(2)
10.03     Company's 1996 Directors Stock Option Plan(1)(2)
10.04     Company's 1996 Employee Stock Purchase Plan(1)(2)
10.05     Company's 401(k) Plan(1)(2)
10.06     Employment Agreement dated as of March 27, 1992 between
          Registrant and James W. Ashbrook(1)(2)
10.7      Form of Indemnity Agreement to be entered into by Registrant
          with each of its directors and executive officers
          (incorporated by reference to Exhibit 10.18 to the Form
          SB-2)
10.8      Lease Agreement between Francisco Berrueta and Registrant,
          dated as of February 1995(1)
</TABLE>
 
                                       38
<PAGE>   42
 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                               EXHIBIT
-------                             -------
<S>       <C>
10.9      Lease from Smallbone & Co. (Devizes) Limited to Registrant,
          dated as of February 1996(1)
10.10     Modification to Lease Agreement between Francisco Berrueta
          and Registrant, dated as of March 1996 (incorporated by
          reference to Exhibit 10.24 to the Company's Annual Report on
          Form 10-K for the year ended December 31, 1996 ("the 1996
          10-K"))
10.11     Employment Agreement dated as of January 22, 1997 between
          Registrant and Warren M. Weiss, incorporated by reference to
          Exhibit 10.25 to the 1996 10-K (2)
10.12     Employment Agreement dated as of April 14, 1997 between
          Registrant and Earl C. Charles(2), incorporated by reference
          to Exhibit 10.16 to the Company's Annual Report on Form 10-K
          for the year ended December 31, 1997
10.13     Employment Agreement dated as of September 29, 1998 between
          Registrant and Michael O. Hunt (incorporated by reference to
          Exhibit 10.19 to the Company's quarterly report on Form 10-Q
          for the quarter ended September 30, 1998(2)
10.14     Agreement and Plan of Merger and Reorganization dated as of
          November 19, 1998 by and among Ardent Software, Inc.,
          Aquarius Acquisition Corp. and Prism Solutions, Inc.
          (incorporated by reference to Exhibit 2.1 to Ardent
          Software, Inc.'s Form S-4/A, filed on March 23, 1999. File
          Number 333-73267).
16.01     Letter on change in independent auditors(1)
21.01     List of Registrant's subsidiaries
23.01     Consent of PricewaterhouseCoopers LLP, Independent
          Accountants
27.01     Financial Data Schedule
</TABLE>
 
---------------
(1) Incorporated by reference to the exhibit with the same number in the
    Company's Registration Statement on Form SB-2 (File No. 33-1180-LA),
    declared effective March 14, 1996.
 
(2) Management contract or compensatory plan
 
(b) Reports on Form 8-K -- No current reports on Form 8-K were filed in the
    fiscal quarter ended December 31, 1998
 
(c) Exhibits: the Company hereby files as part of this Report the exhibits
    listed in Item 14(a)(3) as set forth above
 
                                       39
<PAGE>   43
 
                                  SCHEDULE II
 
                       VALUATION AND QUALIFYING ACCOUNTS
 
<TABLE>
<CAPTION>
                                           BALANCE AT   CHARGED TO   CHARGED                     BALANCE
                                           BEGINNING    COSTS AND    TO OTHER                    AT END
                                           OF PERIOD     EXPENSES    ACCOUNTS   DEDUCTIONS(1)   OF PERIOD
                                           ----------   ----------   --------   -------------   ---------
<S>                                        <C>          <C>          <C>        <C>             <C>
Year ended December 31, 1996
  Allowance for doubtful accounts........   $356,000     $140,031          --     $ 95,707      $400,324
Year ended December 31, 1997
  Allowance for doubtful accounts........   $400,324     $353,527          --     $105,098      $648,753
Year ended December 31, 1998
  Allowance for doubtful accounts........   $649,000     $253,000          --     $ 85,000      $481,000
</TABLE>
 
------------------------
(1) Deductions represent accounts receivables written off during 1996, 1997, and
1998.
 
                                       40
<PAGE>   44
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
 
                                          PRISM SOLUTIONS, INC.
                                          (Registrant)
 
Date: March 25, 1999
                                          By:      /s/ WARREN M. WEISS
                                            ------------------------------------
                                                      Warren M. Weiss
                                             President, Chief Executive Officer
                                                         and Director
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated:
 
<TABLE>
<CAPTION>
                        NAME                                        TITLE                    DATE
                        ----                                        -----                    ----
<C>                                                    <C>                              <S>
 
                 /s/ WARREN M. WEISS                          President, Chief          March 25, 1999
-----------------------------------------------------  Executive Officer and Director
                   Warren M. Weiss                      (Principal Executive Officer)
 
                 /s/ EARL C. CHARLES                     Vice President, Finance and    March 25, 1999
-----------------------------------------------------  Administration, Chief Financial
                   Earl C. Charles                          Officer and Secretary
                                                          (Principal Financial and
                                                             Accounting Officer)
 
                /s/ JAMES W. ASHBROOK                       Chairman of the Board       March 25, 1999
-----------------------------------------------------
                  James W. Ashbrook
 
                  /s/ KEVIN A. FONG                               Director              March 25, 1999
-----------------------------------------------------
                    Kevin A. Fong
 
                 /s/ FLOYD E. KVAMME                              Director              March 25, 1999
-----------------------------------------------------
                   E. Floyd Kvamme
 
                  /s/ PROMOD HAQUE                                Director              March 25, 1999
-----------------------------------------------------
                    Promod Haque
 
               /s/ NANCY J. SCHOENDORF                            Director              March 25, 1999
-----------------------------------------------------
                 Nancy J. Schoendorf
 
               /s/ NORRIS VAN DEN BERG                            Director              March 25, 1999
-----------------------------------------------------
                 Norris van den Berg
</TABLE>
 
                                       41
<PAGE>   45
                                EXHIBIT INDEX

 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                               EXHIBIT
-------                             -------
<S>       <C>
 2.01     Agreement and Plan of Merger by and between Prism Solutions,
          Inc., a Delaware corporation, and Prism Solutions, Inc., a
          California corporation, and material exhibits thereto.(1)
 3.01     Company's Certificate of Incorporation(1)
 3.02     Company's Amendment of Certificate of Incorporation(1)
 3.03     Company's Certificate of Designation(1)
 3.04     Company's Certificate of Retirement(1)
 3.05     Company's Bylaws(1)
 4.01     Amended and Restated Investor Rights Agreement dated
          December 19, 1994(1)
10.01     Company's 1992 Stock Option Plan(1)(2)
10.02     Company's 1996 Equity Incentive Plan, as amended
          (incorporated by reference to Exhibit 4.01 to the Company's
          Registration Statement on Form S-8 filed August 11,
          1997(1)(2)
10.03     Company's 1996 Directors Stock Option Plan(1)(2)
10.04     Company's 1996 Employee Stock Purchase Plan(1)(2)
10.05     Company's 401(k) Plan(1)(2)
10.06     Employment Agreement dated as of March 27, 1992 between
          Registrant and James W. Ashbrook(1)(2)
10.7      Form of Indemnity Agreement to be entered into by Registrant
          with each of its directors and executive officers
          (incorporated by reference to Exhibit 10.18 to the Form
          SB-2)
10.8      Lease Agreement between Francisco Berrueta and Registrant,
          dated as of February 1995(1)
</TABLE>
 
                                       
<PAGE>   46
 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                               EXHIBIT
-------                             -------
<S>       <C>
10.9      Lease from Smallbone & Co. (Devizes) Limited to Registrant,
          dated as of February 1996(1)
10.10     Modification to Lease Agreement between Francisco Berrueta
          and Registrant, dated as of March 1996 (incorporated by
          reference to Exhibit 10.24 to the Company's Annual Report on
          Form 10-K for the year ended December 31, 1996 ("the 1996
          10-K"))
10.11     Employment Agreement dated as of January 22, 1997 between
          Registrant and Warren M. Weiss, incorporated by reference to
          Exhibit 10.25 to the 1996 10-K (2)
10.12     Employment Agreement dated as of April 14, 1997 between
          Registrant and Earl C. Charles(2), incorporated by reference
          to Exhibit 10.16 to the Company's Annual Report on Form 10-K
          for the year ended December 31, 1997
10.13     Employment Agreement dated as of September 29, 1998 between
          Registrant and Michael O. Hunt (incorporated by reference to
          Exhibit 10.19 to the Company's quarterly report on Form 10-Q
          for the quarter ended September 30, 1998(2)
10.14     Agreement and Plan of Merger and Reorganization dated as of
          November 19, 1998 by and among Ardent Software, Inc.,
          Aquarius Acquisition Corp. and Prism Solutions, Inc.
          (incorporated by reference to Exhibit 2.1 to Ardent
          Software, Inc.'s Form S-4/A, filed on March 23, 1999. File
          Number 333-73267).
16.01     Letter on change in independent auditors(1)
21.01     List of Registrant's subsidiaries
23.01     Consent of PricewaterhouseCoopers LLP, Independent
          Accountants
27.01     Financial Data Schedule
</TABLE>
 
---------------
(1) Incorporated by reference to the exhibit with the same number in the
    Company's Registration Statement on Form SB-2 (File No. 33-1180-LA),
    declared effective March 14, 1996.
 
(2) Management contract or compensatory plan
 
(b) Reports on Form 8-K -- No current reports on Form 8-K were filed in the
    fiscal quarter ended December 31, 1998
 
(c) Exhibits: the Company hereby files as part of this Report the exhibits
    listed in Item 14(a)(3) as set forth above