U.S. SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB


   X             Annual report under Section 13 or 15(d) of the
---------        Securities Exchange Act of 1934 for the year
                 ended December 31, 1998

                 Transition report under section 13 or 15(d) of the
---------        Securities Act of 1934 for the transition period
                 from _____ to _____.

                         Commission File Number: 0-27554


                      PACE HEALTH MANAGEMENT SYSTEMS, INC.
           (Name of small business issuer as specified in its charter)

              Iowa                                     42-1297992
----------------------------------       -----------------------------------
  (State or other jurisdiction           (IRS Employer Identification Number)
of incorporation or organization)

                               1025 Ashworth Road
                            West Des Moines, IA 50265
--------------------------------------------------------------------------------
              (Address and zip code of principal executive offices)

                                 (515) 222-1717
                      -------------------------------------
                (Issuer's telephone number, including area code)


       Securities registered under Section 12(b) of the Exchange Act: None

         Securities registered under Section 12(g) of the Exchange Act:

                              Common Stock, no par
                                (Title of class)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject of the filing requirements for at least the past 90
days.  YES  X    NO __

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB.  [X]

Issuer's net revenues for its most recent fiscal year: $1,151,415

The aggregate market value of the voting and non-voting common stock held by
non-affiliates, based upon the closing sale price of the common stock on March
4, 1999 as reported by Reuters, Ltd., was approximately $93,426. Shares of
common stock held by each officer and director and by each person who owns 5% or
more of the outstanding common stock have been excluded in that such persons may
be deemed to be affiliates.

The number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date:

                                    Number of Shares Outstanding
            Class                          March 19, 1999
     Common Stock, no par                     5,321,784



Transitional Small Business Disclosure Format (Check one):  YES         NO  X
                                                               -----      -----



<PAGE>


                      PACE HEALTH MANAGEMENT SYSTEMS, INC.
                         1998 FORM 10-KSB ANNUAL REPORT

                                TABLE OF CONTENTS

                                     PART I.
                                                                            Page
                                                                            ----
ITEM 1.            Description of Business                                    1

ITEM 2.            Description of Property                                    3

ITEM 3.            Legal Proceedings.                                         3

ITEM 4.            Submission of Matters to a Vote of
                    Security Holders                                          3

                                    PART II.

ITEM 5.            Market for Common Equity and Related
                    Shareholder Matters                                       4

ITEM 6.            Management's Discussion and Analysis or
                    Plan of Operation                                         5

ITEM 7.            Financial Statements                                      11

ITEM 8.            Changes In and Disagreements With Accountants
                    on Accounting and Financial Disclosure                   28

                                    PART III.

ITEM 9.            Directors, Executive Officers, Promoters and
                    Control Person, Compliance With
                    Section 16(a) of the Exchange Act                        28

ITEM 10.           Executive Compensation                                    29

ITEM 11.           Security Ownership of Certain Beneficial
                    Owners and Management                                    32

ITEM 12.           Certain Relationships and Related Transactions            34

ITEM 13.           Exhibits and Reports on Form 8-K                          35






<PAGE>


                                     PART I.

ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

Prior to October 1998, PACE developed and marketed advanced patient care
management software systems that enabled healthcare providers to standardize the
delivery of care, maximize resource utilization and improve clinical outcomes.
The Company's enterprise-wide, client/server applications automated charting,
clinical workflow processes and clinical pathways. The Company's core system,
PACE CMS, was a modular suite of advanced software applications that provided
hospitals, physicians' offices, and integrated delivery systems a comprehensive
system for interdisciplinary documentation, nursing care planning, clinical
pathway management and enterprise-wide order management, all at the point of
care.

On October 7, 1998, the Company completed the sale of substantially all of its
assets to, and the assumption of certain of its liabilities by, Minnesota Mining
and Manufacturing Company ("3M") ("the Transaction"). The sale was made pursuant
to an Asset Purchase Agreement dated June 30, 1998, as amended, as described in
Company's definitive proxy statement dated September 14, 1998. The Transaction
was approved by the holders of both the common stock and the preferred stock at
a special meeting of shareholders held on October 7, 1998.

The purchase price of the Transaction was approximately $5.9 million, including
$4.75 million in cash (of which $750,000 was originally placed in escrow to be
held until July 1999 to secure the Company's indemnification obligations under
the Asset Purchase Agreement), plus the assumption of substantially all of the
Company's liabilities other than $2.1 million in line of credit balances, which
were paid off from proceeds at closing. 3M offered positions to most of the
Company's employees and has assumed full support of the Company's customers.
Subsequent to the closing of the Transaction, the Company agreed that $25,000 of
the amount in escrow could be paid to 3M as part of a purchase price adjustment
contemplated by the Asset Purchase Agreement, leaving an escrow balance of
$725,000.

Following the Transaction, the Company has no ongoing operations and no revenues
and has minimal operating expenses. The Company presently has only one part-time
employee. The Company's December 31, 1998 balance sheet reflects cash (including
the escrow balance pursuant to the Transaction) in excess of $2.0 million and
minimal debt.

The net proceeds from the sale will be retained by the Company pending a
determination of whether to engage in a follow-on transaction. The Company has
been seeking a business combination with another entity, before considering
possible liquidation and distribution of its assets. The Company believes that
with the cash on hand and net operating loss carryforwards, subject to the
limitation of such carryforwards under the Internal Revenue Code, such a
combination may be attractive to potential partners and would better serve the
interests of the Company's shareholders. As of the date of this Form 10-KSB, no
definitive agreement has been signed for a follow-on transaction. If no suitable
business combination is identified within a reasonable period of time, the
Company may elect to liquidate and distribute the remaining net proceeds to
shareholders. If the Company liquidated at the present time, all of the net
assets of the Company would be paid to holders of the Company's preferred stock.


                                      -1-
<PAGE>



THE COMPANY

PACE was organized in 1987 as a computer systems consulting firm. In 1989, the
Company began to develop and market a nursing management system built around an
artificial intelligence-based "Clinical Library." To that foundation, PACE added
point-of-care software applications in the early 1990's and introduced PACE
Clinical Information System ("PACE/CIS"). During fourth quarter of 1995, the
Company discontinued the marketing and sale of PACE/CIS; however, it was from
these core modules that PACE CMS complete care management system evolved. During
1996, PACE CMS, the system from which the Company derived substantially all of
its revenues, was further enhanced through the first release of a graphical user
interface (GUI) utilizing an object-oriented open three-tier, client/server
architecture ("Graphical PACE CMS"). The Company's open-systems architecture and
object orientation allowed PACE CMS to be integrated with a healthcare
provider's existing information systems, including financial management,
admissions, pharmacy, laboratory, and other ancillary systems. Graphical PACE
CMS had the user friendliness of Windows with significantly enhanced clinical
functionality.

In the second quarter of 1997, the Company expanded its product line into the
ambulatory market when it purchased substantially all of the assets of
Healthcare Software Solutions, L.C. (HSS), an affiliate of Wellmark, Inc.
(formerly IASD Health Services Corporation). The MR2000 product integrated
traditional paper charting activities into a system that improved practice
efficiency and quality of care.

As of December 31, 1997, PACE had 74 customers under contract and had completed
installation of the Graphical PACE CMS in six facilities. During 1997, the
Company signed new contracts valued at over $4,000,000; however, the lack of
substantial capital on the balance sheet seriously impacted end of year
operations. To reduce overhead, minimize negative cash flow, and try to attract
capital or secure strategic partners for operational growth, the Company
determined it necessary to terminate approximately 40 employees on February 18,
1998. These reductions were primarily targeted at legacy non-graphical product
cost centers, allowing the Company to continue directing resources into the
Graphical PACE CMS development and sales efforts and remain focused on current
implementation agreements.

In June 1998 the Company entered into the Asset Purchase Agreement with 3M
whereby the Company sold substantially all of its assets for cash and an
assumption of substantially all liabilities, except the Company's lines of
credit. The Transaction closed on October 7, 1998. See "The Company -- General."

EMPLOYEES

As of December 31, 1998, the Company employed 2 full-time personnel -- Mark J.
Emkjer, President and CEO, and Roger D. Huseman, Chief Financial Officer.
Effective January 1, 1999 Mr. Emkjer resigned from his position, and effective
March 1, 1999 Mr. Huseman became a part-time employee of the Company.

The Company is a party to a joint employer agreement with Merit Resources, Inc.,
a third-party provider of employee administration, benefits and personnel
services. Under this agreement, all personnel serving the Company are employees
of the provider (Merit) for the purposes of payroll administration and benefit
packages. A stipulation of this joint employer relationship is that all
employees owe all fiduciary and confidentiality obligations concerning the
Company's proprietary information to the Company and not Merit. In addition, the
Company's officers serve as officers of the Company only, and not of Merit.


                                      -2-
<PAGE>


ITEM 2.  DESCRIPTION OF PROPERTY

Prior to the Transaction, the Company leased office space in West Des Moines,
Iowa, Huntersville, North Carolina and Charlotte, North Carolina. The Charlotte,
North Carolina lease was terminated prior to closing the Transaction. As part of
the Transaction, 3M assumed the West Des Moines and Huntersville leases.
Pursuant to the Asset Purchase Agreement, 3M agreed to provide the Company with
office space in West Des Moines and Huntersville until the earlier of
termination of such office leases by 3M or six months after the closing date.
The Company discontinued use of the Huntersville space on January 1, 1999 and
will discontinue use of the West Des Moines space during March 1999. From that
date, the Company will not have any office facilities.

ITEM 3.  LEGAL PROCEEDINGS

None

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

A special meeting of the shareholders of PACE Health Management Systems, Inc.
was held on October 7, 1998.

At the meeting shareholders approved the Asset Purchase Agreement, dated June
30, 1998, as amended, by and between the Company and 3M. The vote was as
follows:

                              FOR               AGAINST          ABSTENTIONS
     Common Stock      8,428,277 - 76.1%     10,500 - 0.1%      4,000 - 0.0%
    Preferred Stock    2,875,000 - 100%          -0-                -0-


                                      -3-
<PAGE>


                                    PART II.

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.

Beginning May 19, 1998, PACE Common Stock has been quoted on the OTC Bulletin
Board under the symbol "PCES." From the Company's initial public offering on
April 27, 1995 through May 18, 1998, the Company's Common Stock was traded on
The Nasdaq SmallCap Market. The following table sets forth the range of high and
low bid prices as reported by The Nasdaq SmallCap Market from April 27, 1995
through May 18, 1998, and thereafter sets forth the high and low bid prices as
reported by Reuters, Ltd. These quotations reflect inter-dealer prices, without
retail markup, markdown, or commission and may not reflect actual transactions.

         Quarter ended                High                      Low
       --------------------------------------------------------------------
         6/30/95                      5 3/8                     4 7/8
         9/30/95                      5 1/2                     4 7/8
         12/31/95                     5 3/8                     2 1/2
         3/31/96                      6                         2 3/4
         6/30/96                      9 5/8                     5 1/4
         9/30/96                      7 1/2                     3 1/8
         12/31/96                     4 7/8                     3
         3/31/97                      3 5/8                     2
         6/30/97                      4                         1 7/8
         9/30/97                      3                         1 1/4
         12/31/97                     1 7/8                     5/16
         3/31/98                      23/32                     1/4
         4/1 to 5/18/98               5/16                      1/8
         5/19 to 6/30/98              5/16                      1/8
         9/30/98                      0.10                      0.55
         12/31/98                     0.65                      0.01

The Company has declared no cash dividends since its inception with respect to
the Common Stock, and has no plan to declare a dividend in the near future. If
declared by the Board of Directors, the holders of Preferred Stock are entitled
to receive annual dividends at the rate of $0.175 per share. The Board has
declared no cash dividends with respect to the Preferred Stock and has no plan
to declare a dividend in the near future other than in connection with the
completion of a follow-on transaction or the liquidation of the Company. As of
March 4, 1999, there were 76 shareholders of record and approximately 1,000
beneficial shareholders of the Company's common stock.


                                      -4-
<PAGE>


ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

GENERAL

PACE was organized in 1987 as a computer systems consulting firm. In 1989, the
Company began to develop and market a nursing management system built around an
artificial intelligence-based "Clinical Library." To that foundation, PACE added
point-of-care software applications in the early 1990's and introduced PACE
Clinical Information System ("PACE/CIS"). During fourth quarter of 1995, the
Company discontinued the marketing and sale of PACE/CIS; however, it was from
these core modules that PACE CMS complete care management system evolved. During
1996, PACE CMS, the system from which the Company derived substantially all of
its revenues, was further enhanced through the first release of a graphical user
interface (GUI) utilizing an object-oriented open three-tier, client/server
architecture ("Graphical PACE CMS"). The Company's open-systems architecture and
object orientation allowed PACE CMS to be integrated with a healthcare
provider's existing information systems, including financial management,
admissions, pharmacy, laboratory, and other ancillary systems. Graphical PACE
CMS had the user friendliness of Windows with significantly enhanced clinical
functionality.

In the second quarter of 1997, the Company expanded its product line into the
ambulatory market when it purchased substantially all of the assets of
Healthcare Software Solutions, L.C. (HSS), an affiliate of Wellmark, Inc.
(formerly IASD Health Services Corporation). The MR2000 product integrated
traditional paper charting activities into a system that improved practice
efficiency and quality of care.

As of December 31, 1997, PACE had 74 customers under contract and had completed
installation of the Graphical PACE CMS in six facilities. During 1997, the
Company signed new contracts valued at over $4,000,000; however, the lack of
substantial capital on the balance sheet seriously impacted end of year
operations. To reduce overhead, minimize negative cash flow, and try to attract
capital or secure strategic partners for operational growth, the Company
determined it necessary to terminate approximately 40 employees on February 18,
1998. These reductions were primarily targeted at legacy non-graphical product
cost centers, allowing the Company to continue directing resources into the
Graphical PACE CMS development and sales efforts and remain focused on current
implementation agreements.

On October 7, 1998, the Company completed the sale of substantially all of its
assets to, and the assumption of certain of its liabilities by, 3M. The sale was
made pursuant to an Asset Purchase Agreement dated June 30, 1998, as amended, as
described in Company's definitive proxy statement dated September 14, 1998. The
Transaction was approved by the holders of both the common stock and the
preferred stock at a special meeting of shareholders held on October 7, 1998.

The purchase price of the Transaction was approximately $5.9 million, including
$4.75 million in cash (of which $750,000 was originally placed in escrow to be
held for nine months to secure the Company's indemnification obligations under
the Asset Purchase Agreement), plus the assumption of substantially all of the
Company's liabilities other than $2.1 million in line of credit balances, which
were paid off from proceeds at closing. 3M offered positions to most of the
Company's employees and has assumed full support of the Company's customers.
Subsequent to the closing of the Transaction, the Company agreed that $25,000 of
the amount in escrow could be paid to 3M as part of a purchase price adjustment
contemplated by the Asset Purchase Agreement, leaving an escrow balance of
$725,000.

Following the sale (beginning October 7, 1998) the Company has no ongoing
operations and no revenues and has minimal operating expenses. The Company
presently has only one part-time employee. The Company's December 31, 1998
balance sheet reflects cash (including the escrow balance pursuant to the
Transaction) in excess of $2.0 million and minimal debt.


                                      -5-
<PAGE>


The net proceeds from the sale will be retained by the Company pending a
determination of whether to engage in a follow-on transaction. The Company has
been seeking a business combination with another entity, before considering
possible liquidation and distribution of its assets. The Company believes that
with the cash on hand and net operating loss carryforwards, subject to the
limitation of such carryforwards under the Internal Revenue Code, such a
combination may be attractive to potential partners and would better serve the
interests of the Company's shareholders. As of the date of this Form 10-KSB, no
definitive agreement has been signed for a follow-on transaction. If no suitable
business combination is identified within a reasonable period of time, the
Company may elect to liquidate and distribute the remaining net proceeds to
shareholders. If the Company liquidated at the present time, all of the net
assets of the Company would be paid to holders of the Company's preferred stock.

Prior to the sale of assets to 3M, the Company derived substantially all of its
revenues from the sale of PACE systems including (a) software license fees, (b)
software implementation and installation services and (c) hardware sales.
Revenue from software license fees was recognized upon delivery of the software,
provided that collectibility was probable and the Company has no significant
obligations remaining under the software licensing agreement. The estimated
costs of any insignificant remaining obligations was accrued and charged to
costs and expenses at the time of revenue recognition. Revenue from software
license fee agreements that require significant customization was accounted for
over the length of the implementation period using the percentage-of-completion
method of accounting. Revenue from implementation and installation services was
accounted for separately from the software license fees and recognized when the
services were performed. Revenue from hardware sales was recognized upon
shipment or upon completion of significant staging and configuration
obligations. Customer support services, which include system updates, were
recognized over the period the services are performed.

Prior to the asset sale, the Company capitalized software development costs that
relate primarily to either the development of new software or significant
enhancements to existing software. Software costs were capitalized in accordance
with Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," which
required capitalization of expenses following determination of technical
feasibility and until the software was ready for general release. The
capitalized costs were amortized by the greater of (a) the ratio that current
gross revenues for software sales bear to the total of current and anticipated
future gross revenues for such software sales, or (b) the straight-line method
over the estimated economic life of the software, usually three to seven years.
At each balance sheet date, the unamortized capitalized costs of a computer
software product were compared to the net realizable value of the product and
the amount by which the unamortized capitalized costs exceed the net realizable
value was written off. The net realizable value was the estimated future gross
revenues from a product, reduced by the estimated future costs of completing and
disposing of that product.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1998 AND 1997

NET REVENUES: Net revenues include systems revenues (composed of software
license fees, hardware sales and implementation fees) and customer support
services. The Company's net revenues were $1,151,415 and $2,958,160 in 1998 and
1997, respectively, representing a decrease of 61%. Revenues from software
license fees decreased 59% to $206,998 in 1998 compared to $501,171 in 1997.
Revenues from hardware sales decreased 98% to $24,505 in 1998 compared to
$1,363,112 in 1997. Revenues from implementation services decreased 46% to
$238,830 in 1998 compared to $444,359 in 1997. Systems revenues decreased
throughout the year as implementation of older contracts were completed and no
new implementations were initiated. Revenues for 1997 were mainly attributable
to software licensing fees,


                                      -6-
<PAGE>


hardware sales and implementation services on 2 new customers initiated in the
first quarter of 1997. These two contracts accounted for 41% of net revenues in
1997. Customer support services revenues were $681,082 and $649,518 in 1998 and
1997, respectively, representing an increase of 5% as the Company's installed
client base stayed fairly constant.

COST OF SYSTEMS REVENUES: Costs of systems revenues include hardware purchases,
commissions, and royalties payable to third parties. The Company's cost of
systems revenues was $50,169 and $1,415,262 in 1998 and 1997, respectively,
representing a decrease of 97%, primarily as a result of reduced costs
associated with the decreased hardware sales.

CLIENT SERVICES: Client services expenses include salaries and expenses related
to implementation, installation and support. Client services expenses were
$812,243 and $1,469,993 in 1998 and 1997, respectively, representing a decrease
of 45%. This decrease was attributable to the corporate downsizing in February
1998, followed by the asset sale in October when all remaining client service
employees were terminated.

PRODUCT DEVELOPMENT: Product development expenses include salaries and expenses
related to development and documentation of software systems, net of capitalized
software development costs. Product development expenses were $1,030,853 and
$1,922,776 in 1998 and 1997 respectively, representing a decrease of 59%. This
decrease was attributable to the corporate downsizing in February 1998, followed
by the asset sale in October when all remaining technical services employees
were terminated. The Company capitalized $59,216 and $589,941 of product
development costs and amortized $167,451 and $215,365 in 1998 and 1997,
respectively.

PURCHASED RESEARCH AND DEVELOPMENT: As a result of the HSS acquisition on May
30, 1997, the Company expensed in-process research and development in the amount
of $588,502.

SALES AND MARKETING: Sales and marketing expenses include salaries, advertising,
trade show costs and travel expenses related to the sale and marketing of the
Company's systems. Sales and marketing expenses were $411,960 and $1,375,999 in
1998 and 1997, respectively, representing a decrease of 81%. This decrease was
attributable to the corporate downsizing in February 1998, followed by the asset
sale in October when all remaining sales and marketing personnel were
terminated.

GENERAL AND ADMINISTRATIVE: General and administrative expenses include salaries
and expenses for the corporate administration and finance, legal, insurance,
rent and depreciation expenses. General and administrative expenses were
$1,113,321 and $1,694,337 in 1998 and 1997, respectively, representing a
decrease of 40%. This decrease was attributable to the corporate downsizing in
February 1998, followed by the asset sale in October when all but two remaining
administrative personnel were terminated. Included in the 1998 expense is
$260,000 of compensation expense recognized from a 1996 stock option grant, as
compared to $96,750 in 1997. Also included in 1998 expense are $495,675 of
retention bonuses paid to employees on June 30 and in October to incentivize
employees to remain with the Company through closing of the Transaction and a
payment of $187,198 to the Company's former Chief Executive Officer under his
employment agreement upon completion of the Transaction.

OTHER INCOME (EXPENSE) NET: Other income (expense), net is comprised primarily
of interest income, interest expense and income from the gain on sale of assets.
Interest income and interest expense reflect minimal change from 1997 to 1998,
as debt and cash balances remained constant until after the asset sale to 3M in
October 1998.


                                      -7-
<PAGE>


YEARS ENDED DECEMBER 31, 1997 AND 1996

NET REVENUES: Net revenues include systems revenues and customer support
services. The Company's net revenues were $2,958,160 and $3,040,400 in 1997 and
1996, respectively, representing a decrease of 3%. Revenues from software
license fees decreased 206% to $501,171 in 1997 compared to $1,534,000 in 1996.
Revenues from hardware sales increased 68% to $1,363,112 in 1997 compared to
$810,864 in 1996. Revenues from implementation services increased 62% to
$444,359 in 1997 compared to $274,549 in 1996 as a result of increased
installations initiated during 1997. Revenues for 1997 were mainly attributable
to software licensing fees, hardware sales and implementation services on 2 new
customers initiated in the first quarter of 1997. These two contracts accounted
for 41% of net revenues in 1997. Revenues for 1996 were mainly attributable to
software licensing fees and hardware sales on a 20-site contract initiated in
the first quarter of 1996. In the fourth quarter of 1996, this client expanded
the contract to include an additional 8 sites which accounted for the majority
of the decrease in software license fees in 1997 compared to 1996. This contract
accounted for 10% and 64% of net revenues in 1997 and 1996, respectively.
Customer support services revenues were $649,518 and $420,987 in 1997 and 1996,
respectively, representing an increase of 54%. This increase was due to
additional maintenance contracts resulting from the continued growth in the
Company's installed client base.

COST OF SYSTEMS REVENUES: Costs of systems revenues include hardware purchases,
commissions, and royalties payable to third parties. The Company's cost of
systems revenues was $1,415,262 and $853,777 in 1997 and 1996, respectively,
representing an increase of 66%, primarily as a result of costs associated with
increased hardware sales. Cost of systems revenues as a percentage of net
revenues was 48% and 28% in 1997 and 1996, respectively. Total cost of systems
revenues as a percentage of total net revenues in future periods could reflect
considerable variations depending on the product mixes of revenues.

CLIENT SERVICES: Client services expenses include salaries and expenses related
to implementation, installation and support. Client services expenses were
$1,469,993 and $890,287 in 1997 and 1996, respectively, representing an increase
of 65%. This increase was primarily due to increases in personnel and payroll
related expenses needed to support the new sales and growth in the installed
client base.

PRODUCT DEVELOPMENT: Product development expenses include salaries and expenses
related to development and documentation of software systems, net of capitalized
software development costs. Product development expenses were $1,922,776 and
$1,748,645 in 1997 and 1996 respectively, representing an increase of 10%. The
Company capitalized $589,941 and $495,399 of product development costs and
amortized $215,365 and $213,175 in 1997 and 1996, respectively.

WRITE-OFF OF CAPITALIZED SOFTWARE: Write-off of capitalized software development
costs reflects a one-time adjustment of $1,270,835 during 1996. This write-off
reflects the unamortized costs of developing the Company's original text-based
version of CMS. This version of the product will no longer be offered for sale
and, as a result, any net realizable value to the Company for that product is
minimal. This adjustment was made following the Company's delivery and
implementation of its new three-tier Graphical User Interface Solution (GUI)
during the third quarter of 1996.

PURCHASED RESEARCH AND DEVELOPMENT: As a result of the HSS acquisition on May
30, 1997, the Company expensed in-process research and development in the amount
of $588,502.

SALES AND MARKETING: Sales and marketing expenses include salaries, advertising,
trade show costs and travel expenses related to the sale and marketing of the
Company's systems. Sales and marketing expenses were $1,375,999 and $1,364,727
in 1997 and 1996, respectively, representing an increase of less than 1%.


                                      -8-
<PAGE>


GENERAL AND ADMINISTRATIVE: General and administrative expenses include salaries
and expenses for the corporate administration and finance, legal, insurance,
rent and depreciation expenses. General and administrative expenses were
$1,694,337 and $1,790,130 in 1997 and 1996, respectively, representing a
decrease of 5%.

OTHER INCOME (EXPENSE), NET: Other income (expense) net is comprised primarily
of interest income and expenses: Other income (expense) net was ($169,506) and
$97,810 in 1997 and 1996, representing a decrease of $267,316. This decrease was
a result of decreased interest income caused by reduced cash balances and
increased interest expense caused by additional borrowing on the line of credit.

LIQUIDITY AND CAPITAL RESOURCES

Since inception in 1987 through 1994, the Company's primary source of funding
for working capital needs, capital expenditures and its operating losses was
from the sale of common and convertible preferred stock. During this time, the
Company completed numerous private placements, receiving approximately $7.8
million in aggregate net proceeds. In 1995, the Company completed its initial
public offering by selling 1,300,000 shares of common stock at $5.00 per share
for net proceeds to the Company of approximately $5.5 million. Additionally, in
September 1996, PACE sold 900,000 shares of common stock at $3.25 per share
providing net proceeds of approximately $2.8 million. In the third and fourth
quarters of 1997, the Company sold 2,250,000 shares of convertible preferred
stock at $1.00 per share representing total proceeds of $2,250,000. In the first
quarter of 1998, the Company sold an additional 625,000 shares of convertible
participating preferred stock at $1.00 per share representing proceeds of
$625,000. Each share of preferred stock is convertible into 2 shares of common
stock.

For 1998 the Company reflected net income of $951,670, as a result of the
$3,374,354 gain on sale of assets to 3M, and cash used in operations of
$948,197. Net of this gain on sale the Company's net loss would have been
$2,422,684. For the two years ended December 31, 1997 and 1996 the Company
reflected net losses of $5,678,215 and $4,780,191, respectively, resulting in
net cash used in operations for each of the years of $3,821,955 and $2,969,718,
respectively. For each of the years presented, the Company incurred depreciation
and amortization expenses totaling $509,252, $658,342 and $423,103,
respectively.

Customer deposits, accounts payable and accrued liabilities decreased $1,639,743
to $12,096 at December 31, 1998 from $1,651,839 at December 31, 1997. Of this
decrease, $513,390 was attributable to the reduction in operations during the
year and $1,126,353 of liabilities were assumed by 3M following the asset sale
in October 1998. Accounts receivable decreased $1,372,687 to $2,798 at December
31, 1998 from $1,375,485 at December 31, 1997. Of this decrease $1,201,159 was
attributable to the reduction in operations during the year and the balance of
approximately $163,000 was sold to 3M in the asset sale.

Net cash used in investing activities for the three years ended December 31,
1998, 1997, and 1996 was $71,088, $949,733, and $853,898, respectively. Cash
used in investing activities was primarily for the purchase of computer and
office equipment and capitalized software costs.

Net cash provided by financing activities for the three years ended December 31,
1998, 1997, and 1996 was $2,531,913, $3,610,000, and $2,679,002, respectively.
Net cash provided by financing activities during 1998 was primarily related to
net proceeds of $4,015,262 from the sale of assets to 3M. During 1997 and 1996
net cash provided by financing activities was primarily related to proceeds from
the sale of common and convertible preferred stock. For the twelve months ended
December 31, 1997, the Company also received net cash of $1,500,000 from the
Company's line of credit.


                                      -9-
<PAGE>


As of December 31, 1998, the Company had total liabilities of only $12,096 and a
cash balance of $2,037,984, of which $725,000 is held in escrow until July 1999
to secure the Company's indemnification obligations under the asset sale to 3M.
As of March 1, 1999 the Company has no ongoing operations and no revenues and
has minimal operating expenses. The Company presently has only one part-time
employee.

The net proceeds from the sale will be retained by the Company pending a
determination of whether to engage in a follow-on transaction. The Company has
been seeking a business combination with another entity, before considering
possible liquidation and distribution of its assets. The Company believes that
with the cash on hand and net operating loss carryforwards, subject to the
limitation of such carryforwards under the Internal Revenue Code, such a
combination may be attractive to potential partners and would better serve the
interests of the Company's shareholders. As of the date of this Form 10-KSB, no
definitive agreement has been signed for a follow-on transaction. If no suitable
business combination is identified within a reasonable period of time, the
Company may elect to liquidate and distribute the remaining net proceeds to
shareholders. If the Company liquidated at the present time, all of the net
assets of the Company would be paid to holders of the Company's preferred stock.

YEAR 2000 CONVERSION

As of December 31, 1998 the Company has no operations and as such management
believes that the year 2000 conversion should have no adverse effect on the
Company.


                                      -10-
<PAGE>


ITEM 7.  FINANCIAL STATEMENTS


                                    CONTENTS



--------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT                                                 12
--------------------------------------------------------------------------------

FINANCIAL STATEMENTS
       Balance sheets                                                        13
       Statements of operations                                              14
       Statements of shareholders' equity                                    15
       Statements of cash flows                                              16
       Notes to financial statements                                         18

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



                                      -11-
<PAGE>










                          INDEPENDENT AUDITOR'S REPORT



To the Board of Directors
PACE Health Management Systems, Inc.
West Des Moines, Iowa

We have audited the accompanying balance sheets of PACE Health Management
Systems, Inc. as of December 31, 1998 and 1997, and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of PACE Health Management Systems,
Inc. as of December 31, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.

McGladrey & Pullen, LLP
Des Moines, Iowa
January 28, 1999


                                      -12-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

BALANCE SHEETS
DECEMBER 31, 1998 AND 1997

<TABLE>
<CAPTION>
ASSETS                                                                             1998                 1997
--------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                  <C>
CURRENT ASSETS
   Cash and cash equivalents (Note 5)                                     $        1,312,984   $          525,356
   Restricted escrow account (Note 11)                                               725,000                    -
   Accounts receivable (Notes 6 and 9)                                                 2,798            1,087,485
   Inventories, primarily computer equipment                                               -               70,157
   Prepaid expenses                                                                   29,366               28,417
                                                                          ------------------------------------------
             TOTAL CURRENT ASSETS                                                  2,070,148            1,711,415
                                                                          ------------------------------------------

NON-CURRENT ACCOUNTS RECEIVABLE (Notes 6 and 9)                                            -              288,000
                                                                          ------------------------------------------

FURNITURE AND EQUIPMENT,  net of accumulated
   depreciation in 1997 of $492,777                                                        -              636,992
                                                                          ------------------------------------------

COMPUTER SOFTWARE DEVELOPMENT COSTS, net of
   accumulated amortization in 1997 of $321,084                                            -            1,179,082
                                                                          ------------------------------------------

OTHER ASSETS, net                                                                          -               57,730
                                                                          ------------------------------------------
                                                                          $        2,070,148   $        3,873,219
                                                                          ==========================================

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES
   Notes payable, bank                                                    $                -   $        2,000,000
   Current maturities of long-term obligations                                             -               79,252
   Accounts payable                                                                    2,096              386,565
   Accrued expenses                                                                   10,000              300,534
   Customer deposits                                                                       -              964,740
                                                                          ------------------------------------------
             TOTAL CURRENT LIABILITIES                                                12,096            3,731,091
                                                                          ------------------------------------------

LONG-TERM OBLIGATIONS, less current maturities                                             -               53,888
                                                                          ------------------------------------------

SHAREHOLDERS' EQUITY
   Serial preferred stock, no par value, authorized 1,000,000 shares;
       issued none                                                                         -                    -
   Convertible participating preferred stock, Series A, no par
       value; authorized 4,000,000 shares; issued and outstanding
       1998 2,875,000 shares; 1997 2,250,000 shares                                2,875,000            2,250,000
   Common stock, no par value; authorized 20,000,000 shares;
       issued and outstanding 1998 and 1997 5,321,784 shares;                     16,910,544           16,910,544
   Additional paid-in capital                                                        673,486              413,486
   Accumulated deficit                                                           (18,400,978)         (19,352,648)
   Unearned debt guarantee fees                                                            -             (133,142)
                                                                          ------------------------------------------
                                                                                   2,058,052               88,240
                                                                          ------------------------------------------
                                                                          $        2,070,148   $        3,873,219
                                                                          ==========================================
</TABLE>

See Notes to Financial Statements


                                      -13-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996

<TABLE>
<CAPTION>
                                                               1998                1997                 1996
--------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>                 <C>                  <C>
Net revenues:  (Note 9)
   Systems revenues                                   $         470,333   $        2,308,642   $        2,619,413
   Customer support services                                    681,082              649,518              420,987
                                                      --------------------------------------------------------------
                                                              1,151,415            2,958,160            3,040,400
                                                      --------------------------------------------------------------

Costs and expenses:
   Cost of systems revenues                                      50,169            1,415,262              853,777
   Client services                                              812,243            1,469,993              890,287
   Product development (Note 7)                               1,030,853            1,922,776            1,748,645
   Write-off of capitalized software                                  -                    -            1,270,835
   Purchased research and development                                 -              588,502                    -
   Sales and marketing                                          411,960            1,375,999            1,364,727
   General and administrative                                 1,113,321            1,694,337            1,790,130
                                                      --------------------------------------------------------------
                                                              3,418,546            8,466,869            7,918,401
                                                      --------------------------------------------------------------
          LOSS FROM OPERATIONS                               (2,267,131)          (5,508,709)          (4,878,001)
                                                      --------------------------------------------------------------

Other income (expense):
   Interest income                                               24,711               13,796               67,290
   Interest expense                                            (269,050)            (227,567)              (5,222)
   Gain on asset sale (Note 11)                               3,374,354                    -                    -
   Other                                                         88,786               44,265               35,742
                                                      --------------------------------------------------------------
                                                              3,218,801             (169,506)              97,810
                                                      --------------------------------------------------------------
          INCOME (LOSS) BEFORE INCOME TAXES                     951,670           (5,678,215)          (4,780,191)

Provision for income taxes (Note 4)                                   -                    -                    -
                                                      --------------------------------------------------------------
          NET INCOME (LOSS)                           $         951,670   $       (5,678,215)  $       (4,780,191)
                                                      ==============================================================

Earnings (loss) per share (Note 3)
   Basic                                              $            0.13   $            (1.06)  $            (1.06)
                                                      ==============================================================
   Fully diluted                                      $             .09   $            (1.06)  $            (1.06)
                                                      ==============================================================
</TABLE>

See Notes to Financial Statements


                                      -14-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996

<TABLE>
<CAPTION>
                                                                                                   Unearned
                                                                     Additional                      Debt
                                         Preferred      Common        Paid-In      Accumulated     Guarantee
                                           Stock         Stock        Capital        Deficit          Fees          Total
-----------------------------------------------------------------------------------------------------------------------------

<S>                                    <C>             <C>              <C>            <C>                <C>            <C>
Balance, December 31, 1995             $         -   $  13,300,481  $        -   $   (8,894,242)  $        -   $   4,406,239
  Exercise of 37,985 stock options
    (Note 2)                                     -         140,117           -                -            -         140,117
  Issuance of 900,000 shares of
    common stock                                 -       2,800,846           -                -            -       2,800,846
  Compensation expense recognized
    upon grant of stock options
    (Note 2)                                     -               -     116,000                -            -         116,000
  Net loss                                       -               -           -       (4,780,191)           -      (4,780,191)
                                       --------------------------------------------------------------------------------------
Balance, December 31, 1996                       -      16,241,444     116,000      (13,674,433)           -       2,683,011
  Exercise of 1,600 stock options
    (Note 2)                                     -           4,400           -                -            -           4,400
  Issuance of 230,000 shares of
    common stock (Note 8)                        -         664,700           -                -            -         664,700
  Compensation expense recognized
    upon grant of stock options
    (Note 2)                                     -               -      96,750                -            -          96,750
  Unearned debt guarantee fees
    recognized upon grant of stock
    warrants                                     -               -     283,142                -     (283,142)              -
  Issuance of 2,250,000 shares of
    Series A convertible
    participating preferred stock        2,250,000               -           -                -            -       2,250,000
  Offering costs associated with the
    issuance of Series A preferred
    stock                                        -               -     (82,406)               -            -         (82,406)
  Net loss                                       -               -           -       (5,678,215)           -      (5,678,215)
  Amortization of unearned debt
    guarantee fees (Note 2)                      -               -           -                -      150,000         150,000
                                       --------------------------------------------------------------------------------------
Balance, December 31, 1997               2,250,000      16,910,544     413,486      (19,352,648)    (133,142)         88,240
  Issuance of 625,000 shares of
    Series A preferred stock               625,000               -           -                -            -         625,000
  Amortization of unearned debt
    guarantee fees (Note 2)                      -               -           -                -      133,142         133,142
  Compensation expense recognized
    upon grant of stock options
    (Note 2)                                     -               -     260,000                -            -         260,000
  Net income                                     -               -           -          951,670            -         951,670
                                       --------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998             $ 2,875,000   $  16,910,544  $  673,486   $  (18,400,978)  $        -   $   2,058,052
                                       ======================================================================================
</TABLE>


See Notes to Financial Statements


                                      -15-
<PAGE>

PACE HEALTH MANAGEMENT SYSTEMS, INC.

STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
                                                                       1998              1997               1996
--------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>                <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Net income (loss)                                              $      951,670   $  (5,678,215)      $  (4,780,191)
   Adjustments to reconcile net income (loss) to net cash
         provided by (used in) operating activities
       Depreciation                                                      208,659         292,977             209,838
       Amortization                                                      300,593         365,365             213,175
       Purchased research and development                                      -         588,502                   -
       Write-off of capitalized software                                       -               -           1,270,835
       Compensation expense recognized upon grant
         of stock options                                                260,000          96,750             116,000
       Gain on sale of assets to 3M (Note 11)                         (3,374,354)
       Other                                                                   -          49,822              26,807
   Change in assets and liabilities:
       (Increase) decrease in accounts receivable                      1,209,259         (39,482)           (699,240)
       Increase (decrease) in accounts payable
          And accrued expenses                                          (390,849)       (240,435)            485,493
       Increase (decrease) in customer deposits                         (101,815)        679,115             223,752
       Increase (decrease) in other                                      (11,360)         63,646             (36,187)
                                                                  --------------------------------------------------
          NET CASH (USED IN) OPERATING ACTIVITIES                       (948,197)     (3,821,955)         (2,969,718)
                                                                  --------------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES
   Cash paid for net assets of Healthcare
       Software Solutions                                                      -         (50,000)                  -
   Capitalized computer software development costs                       (59,216)       (589,941)           (495,399)
   Purchase of furniture and equipment                                   (11,872)       (309,792)           (358,499)
                                                                  --------------------------------------------------
          NET CASH (USED IN) INVESTING ACTIVITIES                        (71,088)       (949,733)           (853,898)
                                                                  --------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES
   Payments for expenses of issuing capital stock                              -         (82,406)           (124,154)
   Proceeds from exercise of stock options                                     -           4,400             140,117
   Proceeds from notes payable                                           100,000       2,980,000             950,000
   Proceeds from sale of preferred stock                                 625,000       2,250,000                   -
   Proceeds from the sale of assets                                       24,791               -                   -
   Net Proceeds from sale to 3M (Note 11)                              3,290,262               -                   -
   Proceeds from sale of common stock                                          -               -           2,925,000
   Payments on long-term obligations and
       notes payable                                                  (2,233,140)     (1,541,994)         (1,211,961)
                                                                  --------------------------------------------------
          NET CASH PROVIDED BY FINANCING ACTIVITIES                    1,806,913       3,610,000           2,679,002
                                                                  --------------------------------------------------
          NET INCREASE (DECREASE) IN CASH AND CASH
             EQUIVALENTS                                                 787,628      (1,161,688)         (1,144,614)

CASH AND CASH EQUIVALENTS
   Beginning                                                             525,356       1,687,044           2,831,658
                                                                  --------------------------------------------------
   Ending                                                         $    1,312,984      $  525,356       $   1,687,044
                                                                  ==================================================
</TABLE>


                                      -16-
<PAGE>




PACE HEALTH MANAGEMENT SYSTEMS, INC.

STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
                                                                            1998              1997              1996
------------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                <C>               <C>
SUPPLEMENTAL DISCLOSURES OF CASH
  FLOWS INFORMATION
   Cash payments for interest                                       $       283,571    $       77,567    $         5,221


 SUPPLEMENTAL SCHEDULE OF NONCASH
  INVESTING AND FINANCING ACTIVITIES
   Purchase of inventory on account                                               -            40,000                  -
   Purchase of net assets of Healthcare Software Solutions
     Assets acquired (Note 10):
        In-process research and development                                       -           588,502                  -
        Accounts receivable                                                       -            23,177                  -
        Furniture and equipment, primarily computer
           Equipment                                                              -            92,637                  -
        Intangible assets                                                         -            70,384                  -
     Liabilities assumed                                                          -           (60,000)                 -
                                                                    ----------------------------------------------------
                                                                                  -           714,700                  -
      Issuance of common stock                                                    -          (664,700)                 -
                                                                    ----------------------------------------------------
     Cash paid                                                      $             -    $       50,000    $             -
                                                                    ====================================================

    Gross cash received                                             $     4,025,000    $            -    $             -
    Expenses of sale                                                       (734,738)                -                  -
                                                                    ----------------------------------------------------
          PROCEEDS FROM SALE TO 3M (NOTE 11)                              3,290,262                 -                  -
    Liabilities assumed
      Deferred revenue                                                      862,925                 -                  -
      Accrued liabilities                                                   104,117                 -                  -
      Accounts payable                                                      159,311                 -                  -
    Restricted escrow on sale                                               725,000                 -                  -
    Assets sold
      Furniture, equipment and computer software
        development costs                                                (1,523,265)                -                  -
      Inventory                                                             (74,113)                -                  -
      Accounts receivable                                                  (163,428)                -                  -
      Other assets                                                           (6,455)                -                  -
                                                                    ----------------------------------------------------
          GAIN ON SALE OF ASSETS TO 3M                              $     3,374,354   $             -   $              -
                                                                    ====================================================
</TABLE>

 See Notes to Financial Statements.


                                      -17-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 1.    NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of business: Prior to the sale of the majority of its assets, the Company
was in the business of developing, marketing and supporting advanced clinical
software that automates the recording, storage and management of patient care
information. The software provided complete care management solutions to
physicians, nurses and other clinicians in multiple settings at the point of
care.

A summary of the Company's significant accounting policies is as follows:

   Cash equivalents: The Company considers all highly liquid debt instruments
   purchased with a maturity of three months or less to be cash equivalents.

   Inventories: Inventories are stated at the lower of cost (first-in, first-out
   method) or market.

   Furniture and equipment: Furniture and equipment are stated at cost.
   Depreciation of furniture and equipment is computed by straight-line and 200%
   declining-balance methods over five to seven-year lives.

   Computer software development costs: Computer software development costs are
   capitalized and amortized by the greater of (a) the ratio that current gross
   revenues for software sales bear to the total of current and anticipated
   future gross revenues for such software sales, or (b) the straight-line
   method over the estimated economic life, usually three to seven years, of the
   software. Amortization expense was $167,451, $202,711, and $213,175 in 1998,
   1997 and 1996, respectively.

   At each balance sheet date, the unamortized capitalized costs of a computer
   software product is compared to the net realizable value of that product and
   the amount by which the unamortized capitalized costs exceed the net
   realizable value is written off.

    Revenue recognition:

    Systems revenues: Systems revenues consist of software license fees,
    software implementation and installation services and hardware sales.

        Revenue from software license fees is recognized upon delivery of the
        software provided that collectibility is probable and the Company has no
        significant obligations remaining under the software licensing
        agreement. The estimated costs of any insignificant remaining
        obligations are accrued and charged to costs and expenses at the time of
        revenue recognition. Revenue from software license fee agreements that
        require significant obligations is accounted for over the length of the
        implementation period using the percentage-of-completion method of
        accounting.


                                      -18-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

        Revenue from implementation and installation services is accounted for
        separately from the software license fees and recognized when the
        services are performed.

        Revenue from hardware sales is recognized upon shipment or upon
        completion of significant staging and configuration obligations.

    Customer support services: Revenue from customer support services, including
    system updates, is recognized over the period the services are provided.

Income taxes: Deferred taxes are provided on a liability method whereby deferred
tax assets are recognized for deductible temporary differences and operating
loss carryforwards and deferred tax liabilities are recognized for taxable
temporary differences. Temporary differences are the differences between the
reported amounts of assets and liabilities and their tax bases. Deferred tax
assets are reduced by a valuation allowance when, in the opinion of management,
it is more likely than not that some portion or all of the deferred tax assets
will not be realized.

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

Basic and diluted loss per share: In February 1997, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 128, Earnings per Share, which requires the Company to present basic and
diluted income (loss) per share amounts. Basic loss per share is based on the
weighted average number of common shares outstanding during the period. Diluted
income (loss) per share is based on the weighted average number of common shares
and dilutive potential common shares outstanding during the period. Dilutive
potential common shares consist of stock options and warrants (using the
treasury stock method) and convertible preferred stock (using the if-converted
method).

Stock-based compensation: In October 1995, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation, which establishes a fair value based
method for financial accounting and reporting for stock-based employee
compensation plans and for transactions in which an entity issues its equity
instruments to acquire goods and services from non-employees. However, the new
standard allows employee compensation to continue to be measured by using the
intrinsic value based method of accounting prescribed by Accounting Principles
Board Opinion (APBO) No. 25, Accounting for Stock Issued to Employees, but
requires expanded disclosures. The Company has elected to continue to apply the
intrinsic value based method of accounting for stock-based employee
compensation. Accordingly, compensation cost for stock options issued to
employees is measured as the excess, if any, of the quoted market price of the
Company's stock at the date of grant over the amount an employee must pay to
acquire the stock.


                                      -19-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Unearned debt guarantee fees: The estimated fair value of the stock warrants
granted to non-employees is determined by using the Black-Scholes option-pricing
model with the following weighted-average assumptions: dividend rates of 0%,
price volatility of 64%, risk-free interest rates of 6.0% and expected lives of
5 years. The unearned debt guarantee fees are being amortized to interest
expense by the interest method over the period of the related debt.

NOTE 2.    COMMON STOCK WARRANTS AND OPTIONS

Common stock warrants

The Company has issued common stock purchase warrants to various shareholders,
directors, employees, and certain accredited investors. One group of warrants
expires ten years after the date of issuance. The second group of warrants
expires five years after the date of issuance. At December 31, 1998, warrants to
purchase 256,464 shares were outstanding and exercisable. The warrants provide
for reductions in the exercise price under certain terms and conditions and are
exercisable at prices ranging from $.37 to $4.58 per share with an average price
per share of approximately $1.45.

The Company has issued Class A and Class B warrants to former serial preferred
shareholders and certain accredited investors. The warrants were exercisable
beginning in April 1995 and expire in January 2000. The exercise price of the
warrants is $3.75. The Class A and Class B warrant holders were granted certain
limited piggyback and Form S-3 registration rights with respect to the shares
issuable upon exercise of the warrants. At December 31, 1998, Class A warrants
to purchase 114,052 shares and Class B warrants to purchase 59,105 shares were
outstanding and exercisable.

The Company has issued Series A warrants to convertible, participating Series A
preferred stock shareholders. In addition, the Company has issued Series A
warrants to certain shareholders for their unconditional promise to guarantee
repayment of the Company's revolving line of credit. The warrants were
exercisable beginning in July 1997 and expire beginning in July 2002 through
December 2002. The exercise price of the warrants is $0.50. The Series A warrant
holders were granted certain limited piggyback and Form S-3 registration rights
with respect to the shares issuable upon exercise of the warrants. At December
31, 1998, Series A warrants to purchase 2,830,360 shares were outstanding and
exercisable.

For nominal consideration, the Company has issued a warrant to the underwriter
of the initial public offering to purchase 115,445 shares of common stock at an
exercise price of $6.00 per share. The warrant was exercisable beginning April
1996 and expires in April 2000.

Common stock options

In December 1994, the Board of Directors adopted the Company's 1995 Stock
Compensation Plan (the "stock compensation plan"). The stock compensation plan
provides for the grant of incentive stock options, nonqualified stock options,
restricted stock, stock bonuses and stock appreciation rights. The stock
compensation plan is administered by the Board of Directors which has the
authority and discretion to determine: the persons to whom the options will be
granted; when the options will be granted; number of shares subject to each
option; the price at which the shares subject to each option may be purchased;
and when each option will become exercisable. Options under the stock
compensation plan expire on the tenth anniversary of the date the options were
granted.


                                      -20-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Stock option activity under the stock compensation plan is summarized as
follows:

<TABLE>
<CAPTION>
                                                      Option price                           Available for
                                                        per share          Outstanding           grant
                                                     ----------------    ----------------    ---------------
       <S>                                            <C>                      <C>                <C>
       Balance, December 31, 1995                     $2.75 - 3.00             218,421            327,073
            Granted                                   $3.25 - 3.88             261,000           (261,000)
            Exercised                                 $2.75 - 3.00              (5,073)                 -
            Canceled                                  $3.00 - 3.25             (13,347)            13,347
                                                                         ----------------    ---------------
       Balance, December 31, 1996                     $2.75 - 3.88             461,001             79,420
            Granted                                       $1.75                  5,000             (5,000)
            Canceled                                  $1.75 - 3.25            (210,881)           210,881
                                                                         ----------------    ---------------
       Balance, December 31, 1997                      $.50 - 3.88             255,120            285,301
            Granted                                       $.50                 121,731           (121,731)
            Canceled                                  $1.75 - 3.88            (126,180)           126,180
                                                                         ----------------    ---------------
       BALANCE, DECEMBER 1998                             $.50                 220,671            319,750
                                                                         ================    ===============
</TABLE>


On January 5, 1998 by Board action, the exercise price for all current employee
options was changed to $0.50. At December 31, 1998, options to purchase all
shares were exercisable.

In March 1996, the Board of Directors adopted the Nonqualified Executive Stock
Option Plan (the "stock option plan"). The stock option plan provides for the
grant of nonqualified stock options to executive officers of the Company. The
Company has reserved 800,000 shares for issuance pursuant to the stock option
plan. Options may be granted at prices determined by the Board of Directors,
which may not be less than 85% of the fair market value of the shares subject to
the options as of the date of grant. Options vest at the rate of 20% on the
first anniversary date of the grant and 20% on each of the next four anniversary
dates of the grant. On January 5, 1998, by Board action, the exercise price for
all current, non-qualified stock options to executive officers was $0.50.
Options expire on the tenth anniversary of the date the options were granted.
Options to purchase 1,600 shares with an exercise price of $2.75 were exercised
during 1997. As of December 31, 1998, the Company had granted options to
purchase 507,986 shares, all of which were exercisable.

In March 1996, the Company granted a nonqualified stock option to an officer of
the Company to purchase 100,000 shares of common stock which vests 20% on the
first anniversary date of the grant and 20% on each on the next four anniversary
dates of the grant, all of which are exercisable at the price of $0.50 per
share. In addition, the officer received another nonqualified stock option to
purchase 110,000 shares at an exercise price of $0.50 per share. At the date of
grant, 35,000 shares under the option were eligible for purchase with the
balance vesting at the rate of 15,000 shares per year for five years beginning
one year from the date of grant. The options expire on the tenth anniversary of
the date the options were granted.


                                      -21-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Compensation cost charged to income for the grant of stock options for 1998,
1997 and 1996, was $260,000, $96,750 and $116,000, respectively. Had
compensation cost for all of the stock-based compensation plans been determined
based on the grant date fair values of awards (the method described in SFAS No.
123), approximate reported net loss and loss per common and common equivalent
share would have been increased to the pro forma amounts shown below:

<TABLE>
<CAPTION>
                                                    1998                1997                1996
                                              ----------------    ----------------    ----------------
<S>                                            <C>                <C>                 <C>
Net Income (loss):
             As reported                       $      952,000     $    (5,678,000)    $    (4,780,000)
             Pro forma                                776,000          (5,958,000)         (5,488,000)
Basic and diluted income (loss) per
   common share
             As reported                       $          .13     $         (1.06)    $         (1.06)
             Pro forma                                    .10               (1.14)              (1.22)
</TABLE>

The fair value of each grant is estimated at the grant date using the
Black-Scholes option-pricing model with the following weighted-average
assumptions for grants after December 31, 1994: dividend rate of 0%, price
volatility ranging from 77% to 79%, risk-free interest rates ranging from 5.74%
to 7.40%, and expected lives ranging from 5 to 10 years.

Amortization expense of unearned debt guarantee fees charged to income for the
grant of Series A warrants for 1998 and 1997 was $133,142 and $150,000,
respectively. (None for the year ended December 31, 1996).

The effects of applying SFAS No. 123 are not indicative of future amounts since,
among other reasons, options vest over several years and additional awards
generally are made each year.


                                      -22-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 3.    EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings
(loss) per-share:

<TABLE>
<CAPTION>
                                                                                                      Per-Share
                                                                                                       Amount
                                                                                                -------------------
                                                                                                     Net income
                                                            Numerator           Denominator            (loss)
                                                       ------------------- -------------------  -------------------
                                                                      YEAR ENDED DECEMBER 31, 1998
                                                       ------------------------------------------------------------
<S>                                                    <C>                 <C>                  <C>
Net income                                             $        951,670
Dividends in arrears included in the calculation               (273,500)
                                                       -------------------
Basic earnings per share, available to
   common stockholders                                                     $      5,321,784     $           0.13
                                                                                                ===================
Effect of dilutitive securities:
   convertable preferred stock                                  273,500           5,750,000
                                                       ------------------- -------------------
Diluted earnings per share, available to
   common stockholders plus assumed
   conversion of preferred shares                      $        951,670    $     11,071,784     $           0.09
                                                       =================== ===================  ===================

                                                                      Year Ended December 31, 1997
                                                       ------------------------------------------------------------

Net (loss)                                             $     (5,678,215)
Dividends in arrears included in the calculation                (26,000)
                                                       -------------------
Basic earnings (loss) per share, available to
   common stockholders                                       (5,704,715)   $      5,402,895     $          (1.06)
                                                                                                ===================
Effect of dilutitive securities:
   convertable preferred stock                                        -                   -
                                                       ------------------- -------------------
Diluted earnings (loss) per share, available to
   common stockholders plus assumed
   conversion of preferred shares                      $     (5,704,715)   $      5,402,895     $          (1.06)
                                                       =================== ===================  ===================

                                                                      Year Ended December 31, 1996
                                                       ------------------------------------------------------------

Net (loss)                                             $     (4,780,191)
Dividends in arrears included in the calculation                      -
                                                       -------------------
Basic earnings (loss) per share, available to
   common stockholders                                       (4,780,191)    $     4,506,166     $          (1.06)
                                                                                                ===================
Effect of dilutitive securities:
   convertable preferred stock                                        -                   -
                                                       -------------------  ------------------
Diluted earnings (loss) per share, available to
   common stockholders plus assumed
   conversion of preferred shares                      $     (4,780,191)    $     4,506,166     $          (1.06)
                                                       ===================  ==================  ===================
</TABLE>


                                      -23-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 4.    INCOME TAX MATTERS

Approximate deferred taxes consist of the following components as of December
31, 1998 and 1997:

<TABLE>
<CAPTION>
Deferred tax assets:                                                               1998                1997
                                                                             ----------------    ----------------
     <S>                                                                     <C>                   <C>
     Net operating loss carryforwards                                        $      6,502,000    $      6,511,000
     Computer software development costs                                                    -             225,000
     Deferred revenue                                                                       -             400,000
     Research and development credit carryforwards                                    338,000             338,000
     Allowance for doubtful accounts                                                        -              15,000
     Compensation expense on stock options                                            189,000              82,000
     Amortization expense on unearned debt guarantee fees                             113,000              59,000
     Accrued expenses                                                                       -              87,000
     Other                                                                                  -               2,000
                                                                             ----------------    ----------------
                                                                                    7,142,000           7,719,000
     Less valuation allowance                                                       7,142,000           7,504,000
                                                                             ----------------    ----------------
                                                                                            -             215,000
     Deferred tax liabilities, computer software
         development costs                                                                  -            (215,000)
                                                                             ----------------    ----------------
                                                                             $              -    $              -
                                                                             ================    ================
</TABLE>


The Company recorded a valuation allowance of $7,142,000 and $7,504,000, against
deferred tax assets at December 31, 1998 and 1997, respectively, to reduce the
total to an amount that management believes will ultimately be realized.
Realization of deferred tax assets is dependent upon sufficient future taxable
income during the period that deductible temporary differences and carryforwards
are expected to be available to reduce taxable income. The net change in the
valuation allowance for deferred tax assets was an increase (decrease) of
($362,000), $2,304,000 and $1,888,000, during 1998, 1997 and 1996, respectively.

The provision for income taxes differs from the approximate amount of income tax
benefit determined by applying the U.S. Federal income tax rate to pretax loss
for the years ended December 31, 1998, 1997 and 1996, due to the following:

<TABLE>
<CAPTION>
                                                              1998                 1997                  1996
                                                         ----------------    -----------------     -----------------
<S>                                                      <C>                 <C>                   <C>
Computed federal income tax (benefit)                    $        385,000    $     (2,214,000)     $      (1,673,000)
Other, primarily computed state income tax
  benefit                                                         (23,000)            (90,000)              (215,000)
Accounting losses (income) for which deferred
  deferred federal and state income tax benefits
  benefits could not be recognized (reduced
  the valuation allowance)                                       (362,000)          2,304,000              1,888,000
                                                         ----------------    -----------------     -----------------
                                                         $              -    $              -      $               -
                                                         ================    =================     =================
</TABLE>


At December 31, 1998, the Company has approximately $16,708,000 of net operating
loss carryforwards to offset future federal taxable income. This net operating
loss carryforward will, if unused, expire in the years 2006 through 2013.


                                      -24-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 5. CONCENTRATION OF CREDIT RISK The Company maintains cash in bank deposit
accounts that, at times, may exceed federally insured limits. The Company has
not experienced any losses in such accounts.

NOTE 6.  ACCOUNTS RECEIVABLE

                                                  1998               1997
                                              --------------     --------------
 Current

     Billed                                   $        4,241     $      752,491
     Accrued revenue                                       -            373,301
                                              --------------     --------------
                                                       4,241          1,125,792
 Less:  Allowance for doubtful accounts               (1,443)           (38,307)
                                              --------------     --------------
                                              $        2,798     $    1,087,485
                                              ==============     ==============

 Non-Current
     Accrued revenue                          $            -     $      288,000
                                              ==============     ==============

Accrued revenue receivable represents revenue recognized on site license
agreements for which the Company has delivered and installed the first of
multiple copies of a software product to be installed at various customer sites
in exchange for a fixed fee. Under these site license agreements, license fees
payments are due at specified dates or, if earlier, upon the installation and
system set-up at each site.

NOTE 7.  RESEARCH AND DEVELOPMENT COSTS

Total research and development costs charged to product development were
approximately $790,944, $2,296,000 and $1,535,500 for 1998, 1997 and 1996,
respectively.

NOTE 8.  PURCHASE OF HEALTHCARE SOFTWARE SOLUTIONS, L.C.

On May 30, 1997, the Company acquired substantially all of the assets, net of
certain liabilities, of Healthcare Software Solutions, L.C. (HSS), a developer
of ambulatory clinical information systems, for a purchase price of $715,000,
which included cash in the amount of $50,000 and 230,000 shares of the Company's
common stock.


                                      -25-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 9.  MAJOR CUSTOMERS

Current and non-current accounts receivable at December 31, 1998 and 1997,
include amounts concentrated with the following customer:

                                       1998             1997
                                    -----------     -------------
         Customer A                          -             40.0%
                                    ===========     =============


Net revenues for the years ended December 31, 1998, 1997, and 1996, include the
following approximate amounts concentrated with the following customers:

                                       1998             1997            1996
                                    -----------     -------------    -----------
         Customer A                        13%               10%            63%
         Customer B                        19%               21%              -
         Customer C                          -               20%              -
                                    -----------     -------------    -----------
                                           32%               51%            63%
                                    ===========     =============    ===========


NOTE 10. CONVERTIBLE PARTICIPATING PREFERRED STOCK AND VOTING RIGHTS

The Convertible Participating Preferred Stock must be converted into fully paid
and non-assessable shares of Common Stock by the Company upon the earlier of (i)
the closing of a Qualified Public Offering, or (ii) the affirmative vote of the
holders of a majority of the outstanding Convertible Participating Preferred
Stock for a mandatory conversion. A "Qualified Public Offering" is a public
offering of the shares of the Company in which (a) a minimum of $10 million is
raised in such offering by the Company, or (b) the per share purchase price is
at least $4.00 and (c) the offering is underwritten on a firm basis by a
recognized underwriter.

Each share of Convertible Participating Preferred Stock shall be convertible
into fully paid and nonassessable shares of Common Stock at a rate of two shares
of Common Stock for each share of Convertible Participating Preferred Stock,
subject to adjustment when Common Stock has been proportionately adjusted. The
initial "Conversion Price" shall be equal to $1.00 per share divided by the
Conversion Rate. Upon conversion, all accumulated and unpaid dividends to the
conversion date on the Convertible Participating Preferred Stock so converted
shall also be converted into fully paid and nonassessable shares of Common Stock
at the rate of $0.50 of accumulated and unpaid dividends for each share of
Common Stock.

The holders of the Convertible Participating Preferred Stock are entitled to an
annual $0.10 cumulative dividend per share payable in cash and shall become due
and payable when, as and if declared by the Board of Directors or the conversion
of the Convertible Preferred Stock. Accumulated undeclared dividends in arrears
were approximately $300,000 and $26,500 at December 31, 1998 and 1997.

Convertible Participating Preferred Stock and Common Stock are entitled to one
vote per share.


                                      -26-
<PAGE>


PACE HEALTH MANAGEMENT SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 11. SALE OF ASSETS

On October 7, 1998, the Company completed the sale of substantially all of its
assets to, and the assumption of certain of its liabilities by, Minnesota Mining
and Manufacturing Company ("3M").

The purchase price of the Transaction was approximately $5.9 million, including
$4.75 million in cash (of which $750,000 was originally placed in escrow to be
held until July 1999, to secure the Company's indemnification obligations under
the Asset Purchase Agreement), plus the assumption of substantially all of the
Company's liabilities other than $2.1 million in line of credit balances, which
were paid off from proceeds at closing.

The net proceeds from the sale will be retained by the Company pending a
determination of whether to engage in a follow-on transaction. The Company has
been seeking a business combination with another entity, before considering
possible liquidation and distribution of its assets. If no suitable business
combination is identified within a reasonable period of time, the Company may
elect to liquidate and distribute the remaining net proceeds to shareholders. If
the Company liquidated at the present time, all of the net assets of the Company
would be paid to holders of the Company's preferred stock.


                                      -27-
<PAGE>


ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

None

                                    PART III.

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
         COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

The Company's Articles of Incorporation provide that the Board of Directors will
consist of no less than three and no more than seven members and that the Board
is divided into three classes, each class to be as nearly equal in number as
possible. Presently the Company has two Directors -- John Pappajohn and Bill W.
Childs -- and five vacancies. Following the closing of the Transaction, board
members Mark J. Emkjer, Carl S. Witonsky, R. David Spreng and Gordon M. Derzon
resigned. None of the resigning directors has furnished the Company with any
letter describing any disagreement with the Company on any matter relating to
the Company's operations, policies or practices. The term of Director John
Pappajohn expired in 1998, and the term of Director Bill W. Childs will expire
at the 2000 annual meeting of shareholders. Mr. Pappajohn is continuing his
position until such time as the next annual meeting of shareholders. The Company
does not intend to incur the expense of convening such a meeting because it will
either complete a follow-on transaction or dissolve and does not intend to
engage in any further business activities.

DIRECTORS OF THE COMPANY

The following paragraphs set forth information concerning each of the current
Directors of the Company:

Bill W. Childs, age 59, has been a director of the Company since February 1990.
He is the Chief Executive Officer of MC Informatics, an outsourcing and
facilities management company based in Fountain Valley, California. From April
1995 to September 1996 was a Senior Vice President of CyCare, an information
systems company providing physicians' office software. Prior to that, he was the
President and CEO of Health Data Analysis, Inc. from 1984 until May 1995. Mr.
Childs was the founder and Editor-in-Chief of Healthcare Informatics, a leading
hospital information systems magazine published by Health Data Analysis, Inc. He
also is the founder or co-founder of several other magazines, including
Computers in Healthcare, Healthcare Computing & Communications Canada, and r.f.
design. He was also one of the founders of Continental Healthcare Systems and
TDS Healthcare Systems Corp.

John Pappajohn, age 70, has been a Director of the Company since January 1994.
Since 1969, Mr. Pappajohn has been the sole owner of Pappajohn Capital
Resources, a venture capital fund, and President of Equity Dynamics, Inc., a
financial consulting firm, both located in Des Moines, Iowa. Mr. Pappajohn also
serves as a director of the following public companies: American Physician
Partners, Inc.; Health Desk Corporation; and Patient Infosystems, Inc.

EXECUTIVE OFFICERS

All of the Company's executive officers other than Mark J. Emkjer, President and
Chief Executive Officer, and Roger D. Huseman, Chief Financial Officer, resigned
as employees of the Company following the closing of the Transaction in October
1998. Mr. Emkjer terminated his employment with the Company effective January 1,
1999. Mr. Huseman became a part-time employee of the Company, effective March 1,
1999. Mr. Huseman has accepted other full-time employment and will devote only
as much of his time to the Company as is needed to carry out the Company's
limited activities.


                                      -28-
<PAGE>


Mr. Huseman, age 46, joined the Company as Chief Financial Officer in July 1994
and was appointed Secretary and Treasurer of the Company on January 31, 1995.
From 1990 through June 1994, Mr. Huseman operated a financial consulting firm
specializing in assisting businesses with financial restructuring and financing
needs. For four years prior to that he served initially as Vice President and
CFO, then as President and a Director of Non-Invasive Monitoring Systems, Inc.,
a public company located in Sarasota, Florida. He is licensed as a certified
public accountant in Iowa.

ORGANIZATION OF THE BOARD OF DIRECTORS

The Board of Directors has established an Audit Committee to advise the Board of
Directors on questions, policies and general matters of accounting, financing
and operating controls, to review the audit of the Company's financial
statements, and to select auditors subject to the approval of the full Board and
ratification by the shareholders. From January 1, 1998 through the dates of
resignation of Messrs. Spreng and Witonsky, the Audit Committee consisted of Mr.
Pappajohn, Mr. Spreng and Mr. Witonsky. The Audit Committee held 2 meetings in
1998.

The Board of Directors as a whole acts as a nominating committee for candidates
for the Board of Directors. Directors are selected without regard to race,
creed, color, sex or national origin, and must have demonstrated outstanding
business and civic accomplishments. The Board of Directors will consider all
candidates recommended by shareholders in accordance with the procedure to be
established in the Company's Bylaws which require recommendations to be
submitted in writing ninety days in advance of the annual meeting of
shareholders. Such recommendations should include the name and address of the
shareholder and the candidate pursuant to which the recommendation is being
made, such other information about the candidate pursuant to which the
recommendation is being made, such other information about the candidate as
required to be included in the Company's proxy statement and the consent of the
candidate to serve as a director if elected. Recommendations should be sent to
the Secretary, PACE Health Management Systems, Inc., 1025 Ashworth Road, Suite
200, West Des Moines, Iowa 50265.

The Board of Directors of the Company held 6 meetings in 1998. All Directors
attended at least 75% of the aggregate number of meetings of the Board of
Directors and Board Committees on which they served.

ITEM 10. EXECUTIVE COMPENSATION

DIRECTOR COMPENSATION

Directors receive no compensation for serving on the Board of Directors other
than reimbursement of reasonable expenses incurred in attending meetings.
Nonemployee directors who are not affiliated with principal shareholders and who
began service as directors prior to February 1995 (only Mr. Childs and Mr.
Witonsky) have received nonqualified warrants to purchase Common Stock. Mr.
Childs and Mr. Witonsky were each granted warrants to purchase 27,274 shares of
Common Stock of the Company as consideration for serving on the Board of
Directors. The warrants have an exercise price of at least 85% of the fair
market value of the Common Stock, as determined by the Board of Directors, on
the date of grant.

Subsequent to February 10, 1995, under the 1995 Stock Compensation Plan, new
non-employee directors receive a nondiscretionary grant of nonqualified stock
options for 21,820 shares upon their election or appointment to the Board. The
Plan provides for automatic grants of nonqualified stock options to new
non-employee directors at an exercise price equal to 100% of the fair market
value of the shares on the date of grant. One-fifth of such options vest over
each of five years from the date of election or appointment of the new
non-employee director. The non-employee director options are exercisable for


                                      -29-
<PAGE>


ten years from the date of grant. The Compensation Committee has no discretion
regarding the grant or terms of non-employee director options. Mr. Derzon
received a nonqualified option to purchase 21,820 shares under the Plan upon his
appointment as a director in 1995. During 1998 no options were granted to any
board members.

EXECUTIVE COMPENSATION

The following table sets forth information concerning the compensation of the
persons who served as Chief Executive Officer of the Company at any time during
the year ended December 31, 1998 and all other persons who served as executive
officers of the Company at December 31, 1998 and whose total annual salary and
bonus for the year exceeded $100,000 for services in all capacities to the
Company during such fiscal year.

                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
                                                                                      Long Term
                                                                                     Compensation
                                                                                        Awards
                                                                 Annual               -----------
                                       Fiscal                 Compensation            Securities
                                        Year            -----------------------       Underlying
Name and Principal Position         Compensation (1)    Salary (1)       Bonus        Options (3)       All Other
---------------------------         ----------------    ----------       ------       ------------      ---------
<S>                                      <C>            <C>             <C>             <C>             <C>
Mark J. Emkjer, President                1998           $203,886        $421,250              0          $      0
   and Chief Executive Officer (2)       1997           $175,000        $ 25,000        195,500          $ 86,000 (4)
                                         1996           $130,625        $      0        260,000          $135,147 (5)

Roger D. Huseman, Chief Financial        1998           $104,481        $ 55,000          8,900          $      0
   Officer, Secretary and Treasurer (6)

Alan C. Wittmer, Vice President          1998           $ 85,134        $ 55,000         20,000          $      0
   of Sales and Marketing (6)

Josh E. Wisham, Vice President           1998           $ 98,083        $ 55,000         12,400          $      0
   of Client Services (6)

Gary L. Feierstein, Vice President       1998           $ 76,788        $ 55,000         65,000          $      0
   of Technology (6)
</TABLE>

---------------------------
(1) Excludes certain perquisites and other benefits which did not exceed the
    lesser of $50,000 or 10% of salary and bonus for any named executive in any
    of the years shown.

(2) Mr. Emkjer became President and Chief Executive Officer of the Company in
    March 1996 and was not employed by the Company prior to that time.

(3) For additional information, see "Stock Options/SARs/LTIPs."

(4) Consists of moving expense reimbursements.

(5) Consists of the signing bonus and moving expense reimbursements required by
    Mr. Emkjer's employment agreement. See "Employment Agreement."

(6) Total annual compensation and bonus for years other than 1998 did not exceed
    $100,000.


                                      -30-
<PAGE>


STOCK OPTIONS/SARS/LTIPS

The following table provides certain information concerning stock options
granted during the year ended December 31, 1998 to the persons named in the
Summary Compensation Table set forth above.

<TABLE>
<CAPTION>
                                    Option Grants in Fiscal 1998
                                          Individual Grants
---------------------------------------------------------------------------------------------------------
                                                     % of Total
                                                   Options Granted      Exercise or
                              Number of             to Employees        Base Price         Expiration
       Name                Options Granted          in Fiscal 1998      ($/Share)              Date
---------------            ---------------          --------------      ---------        ----------------
<S>                               <C>                    <C>             <C>                    <C>
Roger D. Huseman                  8,900                  5.7%            $0.50          January 26, 2008
Alan C. Wittmer                  20,000                 12.7%            $0.50          January 26, 2008
Josh E. Wisham                   12,400                  7.9%            $0.50          January 26, 2008
Gary L. Feierstein               65,000                 41.3%            $0.50          January 26, 2008
</TABLE>

----------------------
(1)  Nonqualified stock options.


In addition, in January 1998, all other outstanding stock options were amended
to reduce the exercise price to $.50 per share. See Note 3 of Notes to Financial
Statements. No stock appreciation rights (SARs) were granted to any named
executive officer during the fiscal year ended December 31, 1998. No stock
options or SARs were exercised during 1998 by any named executive officer. No
long term incentive plan awards (LTIPs) were made during 1998 to any named
executive officer.

EMPLOYMENT AGREEMENT

Effective as of March 15, 1996, Mark J. Emkjer was appointed President and Chief
Executive Officer and was appointed to the Board of Directors of the Company.
The employment agreement between the Company and Mr. Emkjer provides for base
compensation of $165,000 per year, a signing bonus of $10,000, and an annual
bonus of up to 50% of base compensation based on attainment of goals determined
by the Board of Directors with respect to financial performance, stock price
appreciation and operating objectives. Pursuant to the agreement Mr. Emkjer
received a nonqualified option to purchase 100,000 shares of common stock of the
Company which vest 20% on the first anniversary date of the grant and 20% on
each of the next four anniversary dates of grant, and are exercisable at the
price of $2.50 per share. He also received a nonqualified option for 110,000
shares of common stock of the Company with an exercise price of $1.00 per share,
of which 35,000 vested upon purchase by Mr. Emkjer of a house and relocation of
his family to the Des Moines area, and the balance vest at the rate of 15,000
per year for five years. In addition, Mr. Emkjer's employment agreement provided
for payment of the selling commission with respect to his home in California and
moving expenses. The Agreement also contains severance, change of control and
noncompete provisions.

On October 17, 1997, the Company and Mr. Emkjer amended the Employment Agreement
to provide certain benefits to Mr. Emkjer in the event of a "Trigger Event"
which is defined in the Amendment to mean (A) Mr. Emkjer is terminated without
Cause (as defined in the Amendment), (B) the Company is liquidated, or (C) any
person becomes the owner of more than 50 percent of the Company's outstanding


                                      -31-
<PAGE>


common stock as result of a tender offer, merger, acquisition of substantially
all of the Company's assets or other similar transaction (but not including an
investment by a third party in stock newly issued by the Company or the
conversion into common stock of convertible securities by a person holding such
securities on October 17, 1997, or the conversion into common stock of
convertible securities issued by the Company as part of an investment in the
Company by a third party.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

SHARE OWNERSHIP

The following tables set forth, as of March 1, 1999, based on the information
available to the Company, the number and percentages of shares of the Common
Stock and Preferred Stock beneficially owned by each current director, by the
chief executive officer of the Company and all other executive officers whose
total cash compensation in the year ended December 31, 1998 exceeded $100,000,
by all directors and such executive officers as a group, and by each person
known to the Company to be the beneficial owner of more than 5% of the
outstanding shares of the Company's Common Stock and Preferred Stock. The table
setting forth information with respect to holders of Common Stock includes (i)
shares of Common Stock issuable upon the exercise of options and warrants
exercisable within 60 days and (ii) ownership of Preferred Stock, which is
convertible into Common Stock on a 2 for 1 basis. The Company is aware of no
stockholder, other than those listed below, claiming to hold more than five
percent of any class of the Company's outstanding voting securities.

<TABLE>
<CAPTION>
NAME AND ADDRESS                                             NO. OF SHARES                  PERCENT OF CLASS
OF BENEFICIAL OWNER (3)                                BENEFICIALLY OWNED (1) (13)            OUTSTANDING(15)
<S>                                                            <C>                                <C>
COMMON STOCK:

DIRECTORS AND OFFICERS:

   Mark J. Emkjer                                              455,500  (10)                      7.9
   John G. Pappajohn                                         2,531,686   (2)                     34.5
   Bill W. Childs                                               37,474   (8)                        *
   Roger D. Huseman                                            100,000  (20)                      1.8
   Josh E. Wisham                                              106,000  (14)                      2.0
   Gary L. Feierstein                                          105,000   (9)                      1.9
   Alan Wittmer                                                 98,909  (19)                      1.8
   All present directors and
     named executive officers
     as a group (7 persons)                                  3,434,569  (15)                     41.7

OTHER FIVE PERCENT OR MORE
   SHAREHOLDERS:

   Simon Casady (5)                                            314,428  (16)                      5.9
   IAI Investment Funds (6)                                  4,172,038   (4)                     48.7
   FBL Investment Advisory Services, Inc. (7)                1,264,237  (17)                     19.2
   Edgewater Private Equity Fund, L.P. (11)                  2,227,757  (18)                     31.7
   The Dreyfus Corporation (12)                                380,000                            7.1


                                      -32-
<PAGE>


PREFERRED STOCK:

DIRECTORS AND OFFICERS:

John G. Pappajohn                                              625,000                           21.7

OTHER FIVE PERCENT OR MORE
   SHAREHOLDERS:

IAI Investment Funds                                         1,250,000                           43.5
FBL Investment Advisory Services, Inc.                         500,000                           17.4
Edgewater Private Equity Fund, L.P.                            500,000                           17.4
</TABLE>

------------
*  Less than 1%.

1)  Unless otherwise noted, each person has sole investment and voting power
    with respect to the shares indicated. Preferred stock is entitled to two
    votes per share and is convertible into common stock on a two for one basis.

2)  Includes 100,000 common stock shares held by Halkis, Ltd., an affiliate of
    Mr. Pappajohn, 408,519 common stock shares, 625,000 preferred stock shares
    and presently exercisable warrants to purchase 773,167 shares held by Mr.
    Pappajohn.

3)  Except as noted, the address of each officer and director of the Company is
    1025 Ashworth Road, Suite 200, Suite 200, West Des Moines, Iowa 50265.

4)  Includes 471,473 common stock shares and presently exercisable warrants to
    purchase 56,820 shares held by IAI Investment Fund IV; 340,705 common stock
    shares, 1,250,000 preferred stock shares and presently exercisable warrants
    to purchase 681,820 shares held by IAI Investment Fund VI; and 121,220
    common stock shares held by IAI Investment Fund VII.

5)  Address: 1238 Fulton, Indianola, Iowa 50125.

6)  The address for each of the IAI Funds is 3700 First Bank Place, P.O. Box
    357, Minneapolis, Minnesota 55402.

7)  Address: 5400 University Avenue, West Des Moines, Iowa 50266.

8)  Includes 37,474 shares issuable upon the exercise of presently exercisable
    options.

9)  Includes 5,000 shares and 100,000 shares issuable upon the exercise of
    presently exercisable options.

10) Includes 455,500 shares issuable upon the exercise of presently exercisable
    options.

11) Address: 666 Grand Avenue, Suite 200, Des Moines, Iowa 50309.

12) Address: c/o Mellon Bank Corporation, One Mellon Bank Center, Pittsburgh,
    Pennsylvania 15258. The shares are beneficially owned by The Dreyfus
    Corporation, which is a subsidiary of Mellon Bank Corporation, the trustee
    of the Company's employee benefit plan (the "Trustee"). The shares include
    all shares held of record by the Trustee which have not been allocated to
    the individual accounts of employee participants in the plan. The Trustee
    disclaims beneficial ownership of all shares that have been allocated to the
    individual accounts of employee participants in the plan for which
    directions have been received and followed.

13) Assumes exercise of options or warrants exercisable on or before December
    31, 1998 by the named person or group, but by no other person.


                                      -33-
<PAGE>


14) Includes 6,000 shares and 100,000 shares issuable upon the exercise of
    presently exercisable options.

15) Includes shares, options and warrants held by Messrs. Emkjer, Pappajohn,
    Childs, Huseman, Wisham, Feierstein and Wittmer, as described in the notes
    above.

16) Includes 302,465 shares and presently exercisable warrants to purchase
    11,963 shares.

17) Includes 500,000 preferred stock shares and presently exercisable warrants
    to purchase 264,237 shares, held on behalf of Mutual Ventures of South
    Dakota, Inc., a South Dakota corporation, which is an investment advisory
    client of FBL Investment Advisory Services, Inc. Does not include shares
    which may be deemed to be owned indirectly by Mutual Ventures of South
    Dakota as a 7.51% shareholder of Iowa Business Development Finance Corp.,
    which owns approximately 4.3% of the outstanding shares of the Company.

18) Includes 517,090 common stock shares, 500,000 preferred stock shares and
    presently exercisable warrants to purchase 710,667 shares.

19) Includes 98,909 shares issuable upon the exercise of presently exercisable
    options.

20) Includes 100,000 shares issuable upon the exercise of presently exercisable
    options.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

During 1997 and the first quarter of 1998, John Pappajohn, who is a Director of
the Company and who beneficially owns 34.5% of the Company's Common Stock; IAI
Investment Funds, which beneficially owns 48.7% of the Company's Common Stock
and which was at that time an affiliate of R. David Spreng, who was then a
Director of the Company; Edgewater Private Equity Fund, L.P., which beneficially
owns 31.7% of the Company's Common Stock; and an affiliate of EquiTrust
Investment Management Services, Inc. (formerly FBL Investment Advisory Services,
Inc.), which [beneficially owns] 26.4% of the Company's Common Stock, purchased
an aggregate of 2,875,000 shares of the Company's Preferred Stock at a price of
$1.00 per share. Each share of Preferred Stock is convertible into two shares of
Common Stock. For additional information, see "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Liquidity and
Capital Resources" and "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT."

In August 1997, the Company's Board of Directors reduced the exercise price of
all outstanding stock options of the Company to $1.75 per share. In January
1998, the Board of Directors reduced the exercise price of all outstanding stock
options to $.50 per share. In adopting each resolution, the Board determined
that, prior to the amendment, the options no longer provided an incentive for
the holders of such options because the market price of the Company's stock had
declined to substantially below the then-effective exercise price of the
options. In each case, the Board also determined that the amended exercise price
was equal to the fair market value of the Company's common stock, within the
meaning of the stock option plans, as of the date of the amendment. These
amendments applied to options held by officers and directors of the Company, as
well as to options held by employees who were not officers or directors. The
number of such options held by each officer and director is set forth under
"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT."


                                      -34-
<PAGE>


ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a)  The following exhibits are filed as a part of this report.

       3.        Articles of Incorporation and Bylaws
       3.1           Restated Articles of Incorporation, as amended (1)
       3.2           Restated Bylaws (1)
       4.        Instruments defining the rights of shareholders
       4.1           Form of Common Stock Certificate (2)
       4.9           Form of Class A Warrant Certificate (2)
       4.12          Form of Class B Warrant Certificate (2)
       4.13          Form of Agent's Warrant (2)
       4.14          Restated Articles of Incorporation, as amended
                       (Incorporated by reference to Exhibit 3.1)
       4.15          Restated Bylaws (Incorporated by reference to Exhibit 3.2)
      10.        Material Contracts
      10.1           Employment Agreement for Michael Vasquez, as amended
                       December 16, 1994 (2)
      10.2           Employment Agreement for Simon Casady, as amended
                       December 16, 1994 (2)
      10.3           1995 Stock Compensation Plan, effective
                       February 10, 1995 (2)
      10.4           Form of Incentive Stock Option Agreement (2)
      10.5           Form of Non-Qualified Stock Option Agreement (2)
      10.6           Form of Non-Employee Director Non-Qualified Stock Option
                        Agreement (2)
      10.7           Incentive Stock Option Agreement for Michael J. Vasquez
                        dated December 16, 1994 (2)
      10.8           Form of Five-year Employee Warrants (2)
      10.9           Form of Three-year Employee Warrants (2)
      10.10          Compensatory Warrants issued to Director Carl S. Witonsky
                        dated April 22, 1994 and December 16, 1994 (2)
      10.11          Compensatory Warrants issued to Director Bill W. Childs
                        dated February 26, 1990 and December 16, 1994 (2)
      10.12          Form of Lockup Agreements with Executive Officers,
                        Directors and Shareholders (2)
      10.13          Consulting Services Agreement with Steven Evans
                        dated December 31, 1993 (2)
      10.14          Consulting Services Agreement with Carl S. Witonsky
                        dated January 1, 1995 (2)
      10.15          Software Purchase Agreement with JRS Clinical
                        Technologies, Inc. dated October 18, 1989 (2)
      10.16          COMMES Purchase Agreement between the Company and Creighton
                        University dated December 18, 1989 (2)
      10.17          Office Lease and Amendments thereto between the Company and
                        Ashworth Plaza Ltd. (2)
      10.18          Merit Client Agreement with Customer dated
                        January 1, 1995 (2)
      10.19          Master Agreement with Customer dated September 30, 1994 (2)
      10.20          Nonqualified Executive Stock Option Plan adopted
                        March 25, 1996 (3)
      10.21          Employment Agreement with Mark J. Emkjer dated
                        February 15, 1996 (4)
      10.22          Amendment to Employment Agreement with Mark J. Emkjer dated
                       October 17, 1997 (5)
      10.23          Form of Employee Retention Agreement (5)


                                      -35-
<PAGE>


      10.24          Asset Purchase Agreement dated June 30, 1998,
                        as amended, with Minnesota
                        Mining and Manufacturing Company (6)
      11             Earnings Per Share Calculation (included herein)
      27             Financial Data Schedule


    1)  Incorporated by reference to the Company's Form 8-K dated May 3, 1996.

    2)  Incorporated by reference to the Company's Registration Statement on
        Form SB-2, Registration No. 33-90408-C, effective April 27, 1995.

    3)  Incorporated by reference to the Company's Form 10-QSB for the quarter
        ended March 31, 1996.

    4)  Incorporated by reference to the Company's Registration Statement on
        Form S-1, Registration No. 333-7487, effective August 9, 1996.

    5)  Incorporated by reference to the Company's Form 10-KSB for the year
        ended December 31, 1997.

    6)  Incorporated by reference from the Company's definitive Proxy Statement
        dated September 14, 1998.


(b)  Reports on Form 8-K

     Reports on Form 8-K were filed on October 16, 1998 and September 9, 1998.


                                      -36-
<PAGE>



                                   SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.


                                 PACE HEALTH MANAGEMENT SYSTEMS, INC.
                                 ------------------------------------
                                 (Registrant)

                                 By  /s/  Roger D. Huseman
                                     --------------------------------
                                 Roger D. Huseman, Chief Executive Officer

                                 March 29, 1998
                                 --------------
                                 Dated

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.


March 29, 1998                 By  /s/ Roger D. Huseman
------------------                 ----------------------------------------
Dated                                  Roger D. Huseman, Vice President, 
                                       Chief Executive Officer, Secretary 
                                       and Treasurer, Chief Financial
                                       Officer and Principal Accounting Officer

March 29, 1998                 By  /s/ John G. Pappajohn
------------------                 ----------------------------------------
Dated                                  John G. Pappajohn, Director

March 29, 1998                 By  /s/ Bill W. Childs
------------------                 ----------------------------------------
Dated                                  Bill W. Childs, Director




                                      -37-
<PAGE>


                      PACE HEALTH MANAGEMENT SYSTEMS, INC.

                                INDEX TO EXHIBITS


EXHIBIT
NUMBER                                ITEM                             PAGE
------           -----------------------------------------------       ----
27               Financial Data Schedule                                39





                                      -38-