<PAGE>

                          SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON, D.C.  20549
                                      FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934 [FEE REQUIRED]
    For the Fiscal Year Ended December 31, 1997

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
    For the transaction period from _______________ to ______________.

Commission File Number:  0-21992

                              FOURTH SHIFT CORPORATION
               (Exact name of registrant as specified in its charter)

     Minnesota                                 41-1437794
(State or other jurisdiction of    (I.R.S. Employer Identification Number)
incorporation or organization)

                                     Suite 450
                              7900 International Drive
                            Minneapolis, Minnesota 55425
                      (Address of principal executive office)
                                   (612) 851-1500
               (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common  Stock, $.01
par value

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

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

As of March 13, 1998, the aggregate market value of the registrant's
   Common Stock, $.01 par value, held by nonaffiliates of the registrant
   was $24,790,000 (based on the closing sale price of common stock as of
   March 13, 1998 as quoted on the Nasdaq National Market).

As of March 13, 1998, there were 9,900,653 shares of the registrant's
   Common Stock, $.01 par value, issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

The responses to items 10, 11, 12 and 13 herein are incorporated by reference to
  certain information in the Company's Definitive Proxy Statement for its Annual
  Meeting of Shareholders to be held May 6, 1998.


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                                       PART I
ITEM 1.  BUSINESS.

GENERAL

Fourth Shift Corporation (the "Company") is a developer and marketer of
client/server-based application software for industrial planning and
management processes.  The Company's principal product, the Fourth
Shift-Registered Trademark- Manufacturing Software System for OBJECTS
("MSS"), is a family of integrated manufacturing and financial management
applications for intermediate-sized sites of manufacturing and distribution
enterprises. The MSS system operates in a Windows NT and Novell open
computing environment.  Founded in 1982, the Company reincorporated in
Minnesota in 1984.  In 1985, the Company introduced the first modules of the
MSS product line.

The period from 1992 through 1997 was a period of steady growth for the Company.
The Company both expanded the range of services it offers with the MSS product
line and the geography it covers.  From 1992 to 1993, revenue increased 45%, as
the Company introduced six new modules of MSS, began selling third party
software that is compatible with MSS and established a new subsidiary in the
People's Republic of China.  Revenue increased approximately 15% in 1994 as the
Company worked to expand sales both domestically and internationally, instituted
new service programs, introduced CD-Rom based training aids, and introduced a
release that combined the domestic and international versions of the MSS product
into a single version with increased functionality.  Total revenue continued to
expand during 1995, increasing 24% over 1994, as the breadth of the MSS product
line continued to expand and the Company's sales continued to grow
internationally in Asia and the Pacific Rim.  The Company introduced a graphical
user interface providing Windows operability and released a version of MSS for
the Windows NT operating system in 1995, together with new modules designed to
provide sales order processing and cash management functions.  Revenues from the
Company's subsidiary in the People's Republic of China increased more than 175%
in 1995 as a result of increased market penetration in the People's Republic of
China and further expansion into Singapore and Malaysia.  In 1996, the Company
experienced another year of growth, both internationally and domestically with
total revenue increasing 32% over 1995.  In 1996, North American revenue growth
of 25% was accomplished through sales and marketing expansion and new product
offerings.  The Company continued to expand its international operations in 1996
experiencing total international revenue growth of 51%.  Revenue from the
Company's subsidiary in the People's Republic of China increased 70% over 1995
as a result of increased market penetration in China and expansion into
southeast Asia.  Revenue increases were also posted in Europe, growing 32% in
1996.

The Company's operations during the period from 1993 to 1995 were affected by
attention devoted to a product line, the Just In Time Enterprise System ("JIT"),
that was acquired in December 1992 and sold in December 1995.  JIT is a series
of information management software modules for industrial companies involved in
aerospace and defense and contract manufacturing which operate in the
UNIX/Oracle environment.  Acquired from a start-up company in Texas, the Company
devoted substantial resources, including some of the proceeds from the initial
public offering of its common stock completed in July 1993, to improving the JIT
code and instituting sales and development procedures designed to improve the
profitability of the product line.  Because of its drain on Company resources,
the product line (which was developed and marketed through a wholly-owned
subsidiary) was sold to the Interactive Group, Inc. ("IGI"). The JIT operations
are included in the Company's financial statements as discontinued operations.

In 1994, the Company began the development of its next generation technology
-Fourth Shift OBJECTS technology (OBJECTS). Starting mid-1995, the Company
has been investing significant resources in the development of OBJECTS.  In
July 1996 the Company completed a working model of software utilizing the
OBJECTS technology referred to as Fourth Shift OBJECTS Enterprise Software.
In early 1997, Fourth Shift OBJECTS Enterprise Software Release 1.0 was
distributed for beta testing with a general release in June 1997.  Absent the
broad functionality of the established MSS product, Fourth Shift OBJECTS
Enterprise Software did not meet market expectations.

In December 1997, in conjunction with a restructuring plan (See Note 4 to the
Consolidated Financial Statements), the Company reevaluated its OBJECTS
development activities and product strategy.  As a result of this evaluation,
the Company identified ways to combine some of the OBJECTS technology with the
functionality of the current MSS product, and redirected its development
activities accordingly.  Because of this, the decision was made that

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Fourth Shift OBJECTS Enterprise Software would not continue as a separate
product, but that portions of the OJBECTS technology would be incorporated
into future releases of MSS.  As of December 31, 1997, OBJECTS Release 1.0 is
no longer being marketed or licensed to customers.  Pursuant to the
restructuring plan, certain employees and contractors were severed from the
Company and North American development activities were combined from two
groups into a single operation.

Total revenue expanded during 1997 at a rate slower than the historical average,
increasing 6% over 1996.  North American revenue grew 10% over 1996 while
international revenue decreased by 3%.  The North American growth was achieved
through sales and marketing expansion and increased product and service
offerings.  New MSS product offerings included the development of an enhanced
graphical user interface, an engineering module, a screen customizer module, and
an enlarged database. The business in Europe showed continued growth in 1997,
with revenues increasing by 18% over 1996.  This was accomplished through
expanded sales and marketing efforts, particularly in Continental Europe.
Revenues from the Company's subsidiary in the People's Republic of China
decreased 19% in 1997 primarily as a result of economic problems in Asia,
particularly in the last half of the year.


PRODUCTS - MSS FOR OBJECTS

The Company's principal product, the Fourth Shift-Registered Trademark-
Manufacturing Software System for OBJECTS ("MSS"), provides client/server
computing in the DOS/Windows/Windows NT/NetWare open system environments and an
integrated approach to the industrial planning and control processes known as
MRP II.  A customer can combine any number of software modules within this
product line to provide on-line access to real-time information for MRP, bills
of material, capacity requirements planning, master production scheduling and
financial management.  Information is communicated consistently among the
various functional modules of MSS through a common database, facilitating the
automatic updating of common information used by all applications.  Using this
system, a customer can manage inventory to significantly reduce carrying costs,
manage material ordering to limit manufacturing shortages, manage manufacturing
to reduce finished goods surpluses or shortages, immediately access information
necessary to communicate customer order scheduling on-line, monitor overall
manufacturing and problem areas to maximize efficiency and quickly produce
financial reports that are consistent with manufacturing records.

MSS is a family of more than 40 integrated manufacturing, accounting, sales and
information management applications and third party products designed to support
decision-making in an industrial company.  MSS is designed for and primarily
licensed to intermediate-sized manufacturing and distribution companies and
"stand-alone" sites of larger companies, that are in need of a broadly
functional but easily implemented, off-the-shelf application system for up to
and beyond 100 concurrent users.  MSS is distributed with a shrink-wrap license
in standardized modules with extensive documentation and training aids.  MSS is
modular, so users can begin with fundamental applications and add more
specialized functionality as their requirements evolve and grow.

In 1994, the Company introduced Mentor-TM-, a self-paced interactive CD-ROM
training tool.  This product is a critical component of the Company's
performance support strategy, which supplements standard training classes while
serving as an update class for the occasional user.  Mentor-TM- provides users
with constant interaction through hands-on exercises and includes over 200 job
function-oriented lessons covering manufacturing, finance, order processing and
system administration.

The Company believes that the following features of MSS allow it to compete
successfully with other LAN-based products:  (i) MSS is an integrated and
flexible system designed to allow fast, multi-user access to data; (ii) MSS
includes over 40 integrated application modules and third party products that
have been refined to provide broad, deep functionality in MRP II applications,
including international features such as multiple currency and language
translation capabilities; (iii) MSS applications generally require fewer
keystrokes and screens per task than comparable products; (iv) MSS can be
rapidly and easily implemented through a standardized process using extensive
training aids, both interactive CD-ROM and classroom; (v) MSS is easy to use and
offers seamless integration with off-the-shelf word processing, electronic mail,
spreadsheet and other applications, (vi) MSS is offered with a comprehensive
support program with local, national and international support organizations,
and (vii) MSS is designed to encourage business process reengineering and
efficiency in its customers' manufacturing processes.

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MSS is designed for use with the DOS/Windows/Windows NT/NetWare operating
environments on both LANs and wide area networks and supports industry standard
networking protocols.  The integrated system of MSS modules allows a customer to
communicate consistent priorities through a common database and on-line
inquiries and updates, establishing a framework in which an entire organization
can work together.  MSS also provides a means to interface MSS with third-party
applications through the MSS connectivity modules.  The Company licenses a
number of third-party software products that have been designed to operate with
MSS.

The following is a list of current MSS product line offerings:

<TABLE>
<CAPTION>
<S>                                     <C>                                      <C>

MANUFACTURING MODULES                   FINANCIAL MODULES                        THIRD-PARTY PRODUCTS
Inventory Management                    Financial Management                     Data Net, data collection system VisiBar,
     -Inventory Control                      -Accounts Payable                     collection system
     -Shipping                               -Accounts Receivable & Invoicing    Integrated EDI System
     -Lot Trace/Serialization                -General Ledger                     Finite Capacity Planning
Manufacturing Operations                Payroll  Connection                      Rules-Based Configurator
     -Manufacturing Order Management    General Ledger Restructuring Package     Cash Collection & Management
     -Repetitive Manufacturing          Multi-Currency Management                Cycle Counting/Inventory
Product Definition                      Cash Management                            Management
     -Bill of Material                                                           Manufacturing Variance Analysis
     -Product Costing                   SYSTEM-WIDE MODULES                      Message Analysis & Reporting
Planning and Scheduling                 System Administration                    Formula Management
     -Materials Requirements Planning        -Configuration                      Remote Communications
Vendor Operations                            -System Control                     Customer Service System
     -Purchasing                             -CIM Data Import                    Paperless Document Management
     -Approved Vendor Sourcing               -CIM Data Export                    Electronic Business Forms
Custom Products Manufacturing                -Management Reports                 Automated Timekeeping
Co-Products Manufacturing                    -Framework for Windows              Quote Management
Material Management/Analysis            Executive Information System(EIS)        Engineering Change Order
Operations Performance                  CIM Customizer                             Management
Shop Floor Tracking and Reporting       Screen Customizer                        Forecast Management System
Engineering Module                                                               ISO9000 Implementation System
                                                                                 Bill of Material Analysis
SALES ACTIVITY MODULES                                                           Store Front Cash Collections System
Customer Operations
     -Order Entry
     -Advanced Price Book
Sales Analysis
Rules Based Pricing
Sales Order Processing

</TABLE>

The MANUFACTURING MODULES provide on-line information enabling users to solve
material shortage, excess inventory and manufacturing efficiency problems.  The
Inventory Management Module, which maintains and provides inventory status
information, is the basic building block for all other manufacturing
applications.  It works with the Planning and Scheduling Module, which
calculates the optimum manufacturing plan based on continual updates from other
modules; with the Product Definition Module, which maintains information
relating to the materials, resources, costs, and tools necessary to manufacture
each product; and with the Manufacturing Operations Module, which verifies
component availability, picks materials and calculates material usage variances.

The function of these modules can be further enhanced for use in specific
manufacturing environments with the Shop Floor Tracking and Reporting Module,
the Co-Products Manufacturing Module and the Custom Products Module.  In
addition, the Vendor Operations Module helps buyers manage vendor relationships
and the Material Management/Analysis Module allows for simulations and
engineering-change control.  The Engineering Module, new in 1997, permits
engineering information to be integrated with bill of material information.

The SALES ACTIVITY MODULES address customer service issues.  The Sales Order
Processing Module gives customer service representatives on-line support for
entering and tracking orders. Representatives can act on credit problems and
reschedule orders to meet changing delivery dates.  The Rules Based Pricing
Module further extends order entry


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functionality to allow the user to create pricing models for individual
customers or buying groups.  Sales Analysis tracks detailed and summarized
sales information by item, customer, and order.  Sales commissions are also
captured and tracked with the Sales Analysis Module.

The FINANCIAL MODULES are tightly integrated with the manufacturing and sales
activity modules so that financial transactions are automatically created as a
result of business activity.  The Financial Management Module provides
comprehensive management of a company's financial position and generates
financial reports through the module's general ledger function. This module also
controls the processing of supplier invoices from invoice entry to check
printing and reconciliation.   Similarly, customer invoicing, cash application,
and accounts receivable management is supported by the Financial Management
Module. The Multi-Currency Management Module offers exchange rate tracking and
allows transactions to be stated in the trading partners' currency.  The Cash
Management Module allows customers to track cash transactions and banking
activity while providing period-end reconciliations of cash activity.  The
Payroll Connection permits outside payroll services to download payroll
information into the general ledger portion of the Financial Management Module.

The SYSTEM-WIDE MODULES extend and enhance the manufacturing, sales activity and
financial modules.  The System Administration Module is used to tailor the MSS
modules to each customer's needs, and contains key features such as audit
trails, multi-language support, VAT tax, system-wide security and Novell or
Windows NT support.  The System Administration Module also provides CIM
connectivity to either commercial or user-developed third-party applications.
Open Database Connectivity (ODBC) is also provided under the System
Administration Module, this provides access to the MSS database via ODBC enabled
applications, i.e., MICROSOFT CORPORATION'S OFFICE SUITE OF PRODUCTS.
Additional system-wide modules such as Executive Information Systems (EIS), CIM
Customizer, and Screen Customizer complement the System Administration Module by
providing broader functionality.  The EIS Module provides decision makers a key
performance measurement tool that displays a quick overview of the state of the
entire business.  The CIM Customizer Module allows the user to extend the MSS
applications by embedding other application software into the processing flow of
the MSS system.  The Screen Customizer permits the customers to configure
certain screens to fit their business application.

The typical customer licenses between $50,000 and $90,000 of MSS software.  MSS
license revenue totaled $21,883,000 for the year ended December 31, 1997, or
approximately 42% of the overall revenue of the Company.

THIRD-PARTY PRODUCTS.  The Company also licenses, implements and supports
third-party software and hardware products which are integrated to function
with the MSS software.  These products extend the functionality of Fourth
Shift's software and provide a broader solution to Fourth Shift clients.  At
December 31, 1997, the Company had 14 agreements with various third-party
software and hardware vendors to license third-party products.  Third-party
products revenue totaled $3,298,000 during the year ended December 31, 1997.

SERVICES

The Company offers a broad range of services for its MSS product line,
including a comprehensive customer support program, implementation
consulting, network-related technical consulting, custom software development
and extensive training programs.  Such services constituted 52%, 48%, and 49%
of the Company's revenue from continuing operations during 1997, 1996, and
1995, respectively.

CUSTOMER SUPPORT PROGRAM. The Company offers a standardized customer support
program ("CSP") for MSS.  CSP is a comprehensive, fee-based program designed to
help customers obtain the maximum benefit from their business management
software.  CSP subscribers pay an annual fee equal to approximately 15% of the
current list price of the modules licensed.  Approximately 75% of the currently
active users of MSS products subscribe to CSP.  The Company believes CSP is a
stable and reliable source of revenue, which the Company intends to continue to
emphasize to its new and existing customer base.

Included among the materials and services furnished through CSP are new product
releases, telephone technical and application support, a software tool kit, an
electronic bulletin board, and newsletter and application notes.  Updated and
enhanced versions of the Company's software products are provided to CSP
subscribers as part of the annual subscription fee.  Telephone support calls are
handled by manufacturing, financial and technical experts located in

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Fourth Shift offices in the United States, United Kingdom, People's Republic
of China, and Singapore.  Additionally, certain distributors handle support
calls in Eastern Europe and the Middle East.

PROFESSIONAL SERVICES.  The Company offers implementation consulting and
training for use of its MSS products, as well as custom software development
services.  Implementation consulting services, available on a fee basis, include
implementation planning, project management and specialized custom training.
The Company offers a special implementation workshop designed to ease the MSS
implementation process, a readiness audit to identify problems prior to using
the system, business reviews to maximize the utility of the system once
installed and several benchmarking tests to measure performance against
competitors.

The Company offers a series of classroom and individual on-site training
options.  Training includes classroom instruction at the Company's offices in
the United States, United Kingdom and People's Republic of China and at
authorized training centers or at customer sites.  Customers may also purchase
Mentor-TM-, the self-paced interactive CD-Rom training module, to supplement
standard training classes while serving as an update class for the occasional
user.

The Company also offers, on a limited basis, custom software development
services to meet specific customer requirements, and to integrate MSS with a
customer's existing computer systems and/or third-party software providers.

MARKETS

MSS is licensed primarily to mid-sized manufacturing companies, or business
units of larger manufacturing companies, that generate more than $5 million of
revenue annually and require up to approximately 100 concurrent users.  In
addition, MSS is licensed to manufacturing sites of Fortune 500 companies.  MSS
is used by discrete manufacturers (which assemble or machine parts into finished
products), and by process manufacturers (which mix, separate and otherwise
combine or control ingredients to create finished products).  It has broad
application and use in the electronics, industrial, machinery, medical device,
transportation, metal fabrication, food processing and chemical industries.

SALES AND MARKETING

The Company distributes its products and services through a direct sales force
and value-added resellers in major markets, and through sales agents in
secondary markets.  The Company maintains regional sales offices located in San
Diego, Los Angeles, and San Ramon, California; Atlanta, Georgia; Boston,
Massachusetts; Chicago, Illinois; Cleveland, Ohio; Dallas, Texas; and Phoenix,
Arizona; in addition to its headquarters located in Minneapolis, Minnesota.  The
Company sells directly through wholly owned subsidiaries in the United Kingdom,
Mexico, the People's Republic of China, South Africa, Malaysia, and Singapore,
and through distributors in the Americas, Europe, Africa, the Middle-East, and
Asia.  During 1997, approximately 94% of the Company's software license revenue
was generated through direct sales personnel and 6% was generated through
resellers and agents.  Of such software license revenues, approximately 65% was
generated in North America and 35% was generated abroad (see Note 10 to the
Consolidated Financial Statements).

The Company's direct sales personnel are compensated on a salary plus commission
basis with commissions paid monthly.  This monthly commission plan assists the
Company in managing the level of its sales activity throughout the quarter.  The
Company's reseller agreements generally provide that sales will be made by
authorized resellers on a nonexclusive basis from offices within a designated
territory.  The agreements obligate the Company to license to the end-user
through a value added reseller (VAR) at specified prices and to provide training
to each reseller.  The Company also maintains a staff of systems consultants who
offer pre- and post-sales support to the sales force and to customers.

The Company markets its products through advertising campaigns in national trade
periodicals, direct mail and telemarketing.  These efforts are supplemented by
listings in relevant directories and trade show and conference appearances.  The
Company also receives leads from its hardware and services vendors, customers
and various accounting and consulting firms.

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Sales cycles for the Company's products vary substantially based on the
degree of integration, consulting and training required and also on the
status of the customer's implementation of a hardware system.  The product
sales cycle is usually four to six months from the time an initial sales
presentation is made to a customer until the software is delivered and
licensed.  The Company's products are typically shipped within 48 hours of
receipt of order.  Generally 40-50% of the price is paid when the order is
made and the balance is due 30 days after delivery of the product.

STRATEGIC ARRANGEMENTS

Part of the Company's sales and marketing strategy is to build and develop
relationships with companies that will play an important role in the successful
marketing of the Company's products.  These companies include system software
suppliers (such as Microsoft Corporation) and database companies (such as Micro
Data Base Systems, Inc. and Microsoft Corporation).  The Company uses products
from system software suppliers to develop the Company's application software
products.  The suppliers also serve as technical references for future
prospects.  Arrangements with database companies allow the Company to sublicense
database management systems with its products and to provide fee-based support
for licensees.

PRODUCT DEVELOPMENT

Historically, the Company has invested heavily in research and development.
During the years ended December 31, 1997, 1996, and 1995, the Company recorded
research and development expenses from continuing operations of $9,271,000,
$8,674,000, and $5,732,000, respectively.  In addition, the Company capitalized
$3,819,000 in 1997 and $1,820,000 in 1996 of development costs related to the
development of OBJECTS functionality and related modules that had reached
technological feasibility.  In June 1997, the Company introduced Release 1.0 of
OBJECTS for general distribution.  In conjunction with this introduction, the
Company began amortizing all previously capitalized costs related to the
development of OBJECTS framework and Release 1.0 applications modules. The
amortization was based on a three-year economic life of the framework and
modules, and totaled $720,000 in 1997.

In December 1997 the Company evaluated its existing cost structure and the
future marketability of its products.  As a result of this consideration, a
restructuring plan was implemented.  In connection with this restructuring plan,
the Company recognized a restructuring charge totaling $2,566,000.
Approximately $936,000 was related to employee severance costs, costs to exit
office space that was no longer needed due to staff reductions, and prepaid
royalties relating to the OBJECTS product that had no future value.
Additionally, $1,630,000 of previously capitalized development costs were
expensed as a result of the change in product strategy (see Note 2 to the
Consolidated Financial Statements).  As of December 31, 1997, OBJECTS Release
1.0 is no longer being marketed or licensed to customers.  As such, the
remaining capitalized asset of $3,289,000 will not be amortized until the
underlying technology is incorporated into a product that is available for
general release.  At that time, the remaining capitalized costs will be
amortized to expense over the product's estimated life.

In 1997, in addition to investing significant resources in the development of
OBJECTS, the Company continued to develop and enhance its MSS Product.  New
modules, an expanded database, and additional third party product offerings were
added.

In 1998, the Company's product strategy will be focused on providing solutions
for the Company's primary customer base.  Future releases will incorporate much
of the OBJECTS technology including the message bus, support for both Micro Data
Base Systems Inc. (MDBS) and Microsoft SQL Server databases, and multi-company,
multi-plant application functionality.  Releases in early 1998 will provide the
only Internet ready application software release targeted for small to mid-size
manufacturers.

The computer industry is characterized by rapid technological advances, changes
in customer requirements and frequent new product introductions and
enhancements.  The Company's future success will depend upon its ability to
enhance its current products and to develop and introduce new products that keep
pace with technological developments, respond to evolving customer requirements
and achieve market acceptance.  In particular, the Company believes it must
continue to respond quickly to users' needs for broad functionality and
multiplatform support and to advances in hardware and operating systems.
Failure to anticipate or respond adequately to

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technological developments and customer requirements, or any significant
delays in product development or introduction, could result in a loss of
competitiveness and revenues.  In the past, the Company has experienced
delays in the introduction of new products and product enhancements.  These
development efforts are dependent upon the availability of adequate cash to
fund them.  See "Item 7. Management's Discussion of Financial Condition and
Results of Operations."  There can be no assurance that the Company will be
successful in developing and marketing new products or product enhancements
on a timely basis or that the Company will not experience significant delays
in the future, which could have a material adverse effect on the Company's
results of operations.  In addition, there can be no assurance that new
products or product enhancements developed by the Company will achieve market
acceptance.

COMPETITION

The computer industry is intensely competitive and rapidly changing.  Due to the
flexibility of the Company's products, the Company's competitors range from
providers of high-end industrial application software for use on mainframes and
minicomputers to providers of low-end application software for use on PCs and
LANs.  Because of the wide functionality of the Company's product line,
competitors include providers of financial and business application software as
well as industrial and manufacturing resource planning software.  The Company
competes generally on the basis of product features and functions, product
architecture, the ability to run on a variety of industry standard platforms,
technical support and other related services, ease of product integration with
third-party application software and price/performance.  The ability to address
thoroughly the requirements for various forms of manufacturing (discrete,
process, etc.), efficiency of the user interfaces and commands, computational
speed and responsiveness, ease of implementation, support for application
integration, extensive training materials, and established local support and
training are key competitive factors with respect to MSS.

MSS currently competes primarily in the market for PC-based MRP II software.
The Company's primary competitors in this market include Micro MRP, Inc.,
Macola, Inc., Symix Systems, Inc., Dataworks Corporation, and QAD, Inc.  In
addition, there are a number of smaller, regional companies that produce MRP II
software for PCs.  The Company believes that purchases in this market are based
primarily on hardware platform and operating system (DOS/Windows/Windows
NT/NetWare for LANs versus UNIX systems), functionality, ease of implementation,
application integration and industry reviews.  The Company believes that the MSS
product line competes favorably in the portion of this market intended for
DOS/Windows/Windows NT/NetWare operating systems and LANs.

The Company's products compete indirectly with providers of financial and
accounting software for PCs and other specialized applications in the markets it
serves.  Competition from this market arises primarily when a customer is
seeking only a very narrow solution and the Company believes its products
compete favorably with such products on the basis of broad functionality and
complete vertical integration.

Many of the Company's competitors have greater financial, marketing and
technological resources than the Company.  There can be no assurance that other
companies have not developed or marketed or will not develop or market software
products that are superior to those of the Company, that are offered at
substantially lower prices than those of the Company or that have achieved or
will achieve greater market acceptance than those of the Company.

INTELLECTUAL PROPERTY

The Company has registered its "FOURTH SHIFT", "FOURTH SHIFT OBJECTS ENTERPRISE
SOFTWARE", and "MENTOR" trademark for software services and products with the
United States Patent and Trademark Office and with the equivalent offices of
most foreign countries in which it does business.  The Company also registers
the copyright on its MSS software products.

The Company regards its software as proprietary in that title to and ownership
of the software reside exclusively with the Company.  The Company attempts to
protect its rights with a combination of trademark, copyright, employee and
third-party nondisclosure agreements.  Despite these precautions, it may be
possible for unauthorized parties to copy or reverse-engineer portions of the
Company's products.  While the Company's competitive position could conceivably
be threatened by its inability to protect its proprietary information, the
Company believes that

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copyright and trademark protection are less important to the Company's
success than other factors such as the knowledge, ability and experience of
the Company's personnel, name recognition and ongoing product development and
support.

The Company's software products are licensed to end users under a perpetual,
nontransferable, nonexclusive license that stipulates which modules can be used
and how many concurrent users may use them.  The Company relies primarily on
"shrink wrap" licenses for the protection of MSS.  A "shrink wrap" license
agreement is a printed license agreement included in the packaged MSS software
that sets forth the terms and conditions under which the licensee can use the
product, and binds the licensee by its acceptance and license of MSS to such
terms and conditions.  Shrink wrap licenses typically are not signed by the
licensee and therefore may be unenforceable under the laws of certain
jurisdictions.

As the number of software products in the industry increases and the
functionality of these products further overlaps, the Company believes that
software programs could become increasingly the subject of infringement claims.
Although the Company's products have never been the subject of an infringement
claim, there can be no assurance that third parties will not assert infringement
claims against the Company in the future or that any such assertion will not
require the Company to enter into royalty arrangements or result in costly
litigation.

PRODUCTION

The principal materials and components used in the Company's software products
include computer media, user manuals and training guides.  The Company prepares
master software disks, user manuals and packaging.  In some cases, the Company
uses third party vendors to duplicate disks containing its software and to print
the Company's user manuals, packaging and related materials.  To date, the
Company has not experienced any material difficulties or delays in the
manufacture and assembly of its products, or material returns due to product
defects.

EMPLOYEES

As of December 31, 1997, the Company had 433 full-time employees, including 128
in sales and marketing, 101 in software programming and documentation, 131 in
customer support services and 73 in finance and administration.  The Company's
employees are not represented by any collective bargaining organization and the
Company has never experienced a work stoppage.  The Company believes that its
relations with its employees are good.

ITEM 2.  PROPERTIES

The Company's corporate headquarters is located in Minneapolis, Minnesota, in
a leased facility consisting of roughly 58,000 square feet, occupied under a
lease expiring December 31, 1998.  In conjunction with the expiration of the
lease, the Company will relocate its corporate headquarters in December 1998.
 A 10-year lease has been signed for a new facility in Minneapolis, Minnesota
that consists of approximately 57,000 square feet. The Company also leases
15,400 square feet, approximately 8,700 square feet of which is subleased to
a third-party, of space for a second principal office in San Ramon,
California pursuant to leases expiring in August 1999.  The Company leases
additional facilities for domestic operations in San Diego, Anaheim and San
Jose, California; Atlanta, Georgia; Boston, Massachusetts; Chicago, Illinois;
Cleveland, Ohio; Dallas, Texas; and Nashua, New Hampshire.  In conjunction
with the December 1997 restructuring plan, the Company's San Jose office,
which encompasses 4,561 square feet, has been vacated and the Company is
actively seeking a sub-lessee. (See Note 4 of Notes to Consolidated Financial
Statements for information on the Company's restructuring plan).  The Company
also leases facilities and offices for its international operations in
London, Paris, Mexico City, Johannesburg, Port Elizabeth, Malaysia,
Taiwan, Singapore and in Beijing, Tianjin, Guangzhou, Nanjing, and
Shanghai of the People's Republic of China. The Company believes that its
existing facilities are adequate to meet its current needs and that suitable
additional or alternative space will be available as needed to accommodate
expansion of corporate operations and for additional sales offices.  See Note
8 of Notes to Consolidated Financial Statements for information regarding the
Company's lease obligations.

                                       9

<PAGE>

ITEM 3.  LEGAL PROCEEDINGS

From time to time the Company is involved in litigation relating to claims
arising from its operations in the normal course of business.    As of the date
of this filing, neither the Company nor any of its subsidiaries is a party to
any legal proceedings, the adverse outcome of which, in management's opinion,
would have a material adverse effect on the Company's results of operations or
financial position.

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

Not applicable

EXECUTIVE OFFICERS

Marion Melvin Stuckey, age 59, is the founder of the Company and has been the
Chief Executive Officer and Chairman of the Company since 1982.  Prior to
forming the Company, Mr. Stuckey was an executive officer of Control Data
Corporation ("CDC"), a multinational computer hardware, peripherals and services
company, from 1975 to 1982.  Prior to that Mr. Stuckey served in various sales,
marketing and management positions at IBM from 1960 to 1975.

Jimmie H. Caldwell, age 58, has been President, Chief Operating Officer and a
Director of the Company since 1984.  Prior to that time, Mr. Caldwell served in
various positions at CDC from 1964 to 1984 and held the position of Vice
President of Operations for CDC's Peripheral Products Company when he left to
join the Company.

David G. Latzke, age 38, has been Vice President and Chief Financial Officer
since April 1994.  Mr. Latzke joined the Company as director of special projects
in April 1993.  From 1982 until April 1993, Mr. Latzke was a manager with the
Audit and Business Advisory Division of Arthur Andersen LLP

                                       10

<PAGE>

                                      PART II


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

   NASDAQ Symbol

     The Company's common stock trades on the NASDAQ National Market tier of The
     NASDAQ Stock Market under the symbol FSFT.

   Price Range of Common Stock

     The following table sets forth the high and low sales price of
     the Common Stock as quoted by the NASDAQ National Market System for
     the periods indicated. Such prices include inter-dealer prices, and
     may not include retail markup, markdown or commissions.

<TABLE>
<CAPTION>

                                                        High           Low
                                                        ----           ---
<S>                                                   <C>             <C>

      FISCAL 1996:
               First Quarter                           5 3/4          3 5/8
               Second Quarter                         10 1/2          4 1/2
               Third Quarter                           8 1/2          5 1/8
               Fourth Quarter                          8 1/8          5 1/8
      FISCAL 1997:
               First Quarter                           6 1/8          3 5/8
               Second Quarter                              5          2 3/4
               Third Quarter                           5 3/4              4
               Fourth Quarter                          4 5/8          2 5/8
</TABLE>

As of December 31, 1997, there were 278 shareholders of record and, based on the
best available information, approximately 2,583 beneficial holders of the
Company's Common Stock.  The Company has never paid cash dividends on its Common
Stock and currently intends to retain earnings for use in operations.

                                       11

<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA


<TABLE>
<CAPTION>

Selected Consolidated Financial Data
(In Thousands, Except Per Share Data)
STATEMENT OF OPERATIONS DATA-                         1997           1996           1995           1994           1993
                                                   -------        -------        -------        -------        -------
<S>                                                <C>            <C>            <C>            <C>            <C>
REVENUE:
  Software license                                 $21,883        $22,947        $17,128        $13,956        $11,615
  Service                                           27,137         23,822         18,097         13,937         11,316
  Third-party software and other                     3,298          2,541          1,999          2,183          3,186
                                                   -------        -------        -------        -------        -------
        Total revenue                               52,318         49,310         37,224         30,076         26,117
                                                   -------        -------        -------        -------        -------
OPERATING EXPENSES:
  Cost of licenses                                   2,767          2,601          1,708          1,455          1,577
  Cost of services                                  13,209         11,747          8,868          6,356          5,357
  Cost of third-party software and other             2,341          2,008          1,386          1,853          2,576
  Selling, general and administrative               27,505         23,046         18,720         15,394         10,628
  Product development                                9,271          8,674          5,732          2,817          2,021
  Restructuring charge                               2,566              -            149              -              -
                                                   -------        -------        -------        -------        -------
        Total operating expenses                    57,659         48,076         36,563         27,875         22,159
                                                   -------        -------        -------        -------        -------

        Operating profit (loss)                     (5,341)         1,234            661          2,201          3,958

Other income (expense), net                           (432)           (36)          (158)           213            (23)
                                                   -------        -------        -------        -------        -------
  Income (loss) from continuing operations
    before provision for income taxes               (5,773)         1,198            503          2,414          3,935
Provision for income taxes                             328            189            298            159            190
                                                   -------        -------        -------        -------        -------
Income (loss) from continuing operations            (6,101)         1,009            205          2,255          3,745
                                                   -------        -------        -------        -------        -------
Discontinued operations:
  Loss from discontinued operations                      -              -         (7,642)        (4,977)          (228)
  Net gain on sale of discontinued operations        2,311            761          2,037              -              -
                                                   -------        -------        -------        -------        -------
        Total discontinued operations                2,311            761         (5,605)        (4,977)          (228)
                                                   -------        -------        -------        -------        -------
Net income (loss)                                  $(3,790)       $ 1,770       $ (5,400)       $(2,722)       $ 3,517
                                                   -------        -------        -------        -------        -------
                                                   -------        -------        -------        -------        -------

Basic income (loss) per common share (1):
  Continuing operations                            $  (.63)       $   .11       $    .02        $   .24        $   .86
  Discontinued operations                              .24            .08           (.60)          (.54)          (.05)
                                                   -------        -------        -------        -------        -------
        Basic income (loss) per share              $  (.39)       $   .19       $  (0.58)       $ (0.30)       $  0.81
                                                   -------        -------        -------        -------        -------
                                                   -------        -------        -------        -------        -------

Diluted income (loss) per common share (1):
  Continuing operations                            $  (.63)       $   .10       $    .02        $   .24        $   .51
  Discontinued operations                              .24            .08           (.59)          (.53)          (.03)
                                                   -------        -------        -------        -------        -------
        Diluted income (loss) per share            $  (.39)       $   .18       $   (.57)       $  (.29)       $   .48
                                                   -------        -------        -------        -------        -------
                                                   -------        -------        -------        -------        -------

BALANCE SHEET DATA -
  Working capital surplus (deficit)                $(4,161)       $   847       $  1,810        $ 5,055        $ 8,995
  Total assets                                      31,429         31,172         24,494         23,066         20,740
  Long-term obligations                              1,299          2,304            275            269              -
  Shareholders' equity                               4,047          7,087          4,700          9,632         12,162
</TABLE>

(1)  See Note 2 of notes to the Company's consolidated financial statements for
     an explanation of the determination of shares used in the per common share
     computation.

                                       12

<PAGE>



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

1997 Management's Discussion & Analysis of Financial Condition and Results of
Operations

The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's
consolidated results of operations and financial condition and should be read in
conjunction with the consolidated financial statements and notes thereto.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.  The following Management's Discussion
and Analysis contains various "forward looking statements" within the meaning of
federal securities laws which represent management's expectations or beliefs
concerning future events, including statements regarding anticipated sales,
marketing and research and development expenditures, growth in revenue, capital
requirements and the sufficiency of cash to meet operating expenses.  These, and
other forward looking statements made by the Company, must be evaluated in the
context of a number of factors that may affect the Company's financial condition
and results of operations, including the following:

-    The ability of the Company to continually enhance the Manufacturing
     Software System for OBJECTS (MSS) product to meet ever changing market
     demands for both functionality and new technology;

-    Fluctuations in quarterly operating results caused by changes in the
     computer industry, buying patterns and general economic conditions;

-    The ability of the Company to successfully develop its MSS product to meet
     European Monetary Union requirements;

-    The dependence of the Company on revenue from licensing of its MSS product;

-    The effects of changes in technology and standards in the computer
     industry;

-    The significant competition among developers and marketers of industrial
     software;

-    The ability of the Company to retain key employees;

-    The increasing size of the Company's international operations, particularly
     in Asia;

-    The ability of the Company to manage expansion of international
     distribution channels;

-    The dependence of the MSS product line on a third-party database management
     system; and

-    Evolving standards regarding intellectual property protection for software
     products in general.


SALE OF JUST IN TIME ENTERPRISE SYSTEMS, INC.

Effective December 31, 1995, the Company sold all of the capital stock of Just
In Time Enterprise Systems, Inc. (JIT), a wholly owned subsidiary of the
Company, along with certain net assets related to the operations of JIT in the
United Kingdom, to Interactive Group, Inc. (IGI). The Company received cash
proceeds of $1.5 million and a $2.5 million note that was collateralized by the
common stock of JIT, all receivables generated by JIT or from the JIT Enterprise
System and by the intellectual property rights in the JIT Enterprise System.  In
addition, IGI agreed to pay an additional amount equal to 4% of the revenues
generated from the JIT Enterprise System after December 31, 1995, up to a total
of $1.2 million.  This amount is also collateralized by JIT's common stock,
receivables, and intellectual property rights.

In connection with the sale of JIT, the Company recorded a 1995 gain on the sale
of $2,037,000, equal to the excess of the cash proceeds received over the
deficit book value of JIT, net of transaction costs. The Company deferred

                                       13

<PAGE>

recognition of the gain associated with the note received in connection with the
sale and is recognizing the gain associated with this note, as well as the
additional amounts receivable based on revenues generated from the JIT
Enterprise System, as such amounts are deemed collectible.  In 1996 the Company
recognized a gain totaling $761,000 related to cash received in 1996 and January
1997.  In 1997 the Company recognized a gain of $2,311,000 relating to cash
received in 1997 and January 1998 (See Note 3).  All income taxes related to
these transactions have been offset through the utilization of net operating
losses previously generated by JIT.

The operating results of JIT have been presented as discontinued operations in
the Company's consolidated financial statements. Accordingly, the discussion
contained herein relates to the continuing operations of the Company, unless
otherwise noted.

RESULTS OF OPERATIONS

REVENUE:

TOTAL REVENUE for the year ended December 31, 1997 increased 6% to $52,318,000
from $49,310,000 in 1996 and increased 32% to $49,310,000 from $37,224,000 in
1995. The overall growth in total revenue over the three-year period was
achieved through increased market penetration in North America and geographic
expansion internationally.  North American total revenue increased 10% from 1996
to 1997 and increased 25% from 1995 to 1996.  Total revenue from the Company's
subsidiary in Asia decreased 19% in 1997 following a 70% increase in 1996.  The
1997 decrease in revenue was primarily a result of economic problems in Asia,
particularly in the last half of the year.  Total revenue from the Company's
European subsidiary grew 18% in 1997 and 32% in 1996.  The growth was the result
of continued market penetration in continental Europe. As a percentage of total
revenue, sales outside of North America accounted for 29% in 1997, 32% in 1996
and 28% in 1995.

SOFTWARE LICENSE REVENUE are fees paid by customers for the right to use the
Company's software system. Software license revenue decreased 5% to $21,883,000
in 1997 from $22,947,000 in 1996 and increased 34% to $22,947,000 in 1996 from
$17,128,000 in 1995. The decrease in license revenue in 1997 is attributable to
reduced license revenues in Asia.  In North America, license revenues were
virtually even with 1996 results, and license revenue in Europe grew by 17%.  As
stated above, economic problems in Asia resulted in reduced customer demand,
particularly in new system licenses, as fewer new manufacturing enterprises
opened, and those in place delayed capital expenditures.  In North America,
competitive pressure and a shortage of experienced sales professionals depressed
license revenue in the first half of 1997.  The new sales management effected a
strong second half of revenues and finished the year even with 1996.  Growth in
1996 resulted from increased penetration in foreign markets, an increase in the
direct sales force, increased marketing and lead-generating activities and
increased acceptance of PC LAN-based manufacturing information systems.

SERVICE REVENUE includes customer support fees, training, consulting,
installation and project management. Service revenue increased 14% to
$27,138,000 in 1997 from  $23,822,000 in 1996 and increased 32% to $23,822,000
in 1996 from $18,097,000 in 1995. The demand for services and support has
increased proportionately with the increase in the installed software license
base. In addition, the Company is strengthening its efforts to standardize and
promote its consulting and training offerings, as well as developing additional
value-added products and services for our customers. The Company believes that
services are an important component to the overall product line offering and
should grow in a manner consistent with the growth in the installed software
license base.

THIRD-PARTY SOFTWARE AND OTHER REVENUE are derived principally from the resale
of third-party software licenses (complementary applications) along with limited
hardware sales. These complementary applications have been integrated to
function with the MSS software and extend the functionality of MSS.  Third-party
software and other revenue increased 30% to $3,298,000 in 1997 from $2,541,000
in 1996 and increased 27% to $2,541,000 in 1996 from $1,999,000 in 1995.  The
increase in 1997 resulted from increased customer demand for broad ERP
functionality, both among new customers and in the Company's previously
installed base.  The increase in 1996 was directly related to increases in MSS
license revenue, since third-party software is often licensed in conjunction
with the licensing of the MSS product.

                                       14

<PAGE>

OPERATING EXPENSES:

COST OF LICENSES increased to $2,767,000 in 1997 from $2,601,000 in 1996 and
increased as a percentage of total license revenue to 13% in 1997 from 11% in
1996 and 10% 1995. The increase in these costs as a percent of license revenue
from 1996 to 1997 is due to increases in royalty costs paid to third-party
software suppliers whose products are embedded in and distributed with the MSS
product.

COST OF SERVICES increased to $13,209,000 in 1997 from $11,747,000 in 1996 and
$8,868,000 in 1995 and held flat as a percentage of service revenue at 49% for
all three years.  Margins were favorably impacted in 1997 by improved customer
support margins due to productivity improvements and high customer support
renewal rates.  This was offset by lower margins in consulting and training
services due to pricing pressures.

COST OF THIRD-PARTY PRODUCTS as a percentage of third-party products revenue was
71% in 1997, 79% in 1996, and 69% in 1995.   The decrease from 1996 to 1997
resulted from the mix of products sold.  The increase from 1995 to 1996 is due
to the mix of products sold combined with increases in fixed personnel costs and
increased costs associated with writing, supporting and maintaining the
interface between certain companion products and MSS.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE increased to $27,505,000 in 1997
from $23,046,000 in 1996 and $18,720,000 in 1995. As a percentage of total
revenue, selling, general and administrative expense was 53% of total revenue in
1997, 47% in 1996 and 50% in 1995.  The increase in spending in 1997 and 1996 is
due to the addition of sales and marketing personnel, and related commissions
earned, in connection with the Company's expanded market penetration in North
America and international markets.  The rate of spending as a percent of revenue
decreased by three percentage points from 1995 to 1996 and increased by six
percentage points from 1996 to 1997.  The decrease in the spending rate from
1995 to 1996 is due to the 32% growth in total revenue combined with an
increased emphasis on expense control particularly in the general and
administrative areas.  The increase in the spending rate from 1996 to 1997 is
due primarily to growth in selling and marketing expenses in the second half of
1997.  During the second half of 1997, the Company incurred additional costs to
reorganize and grow the sales organization, particularly in North America.  Due
to the leadtime required to deploy additional sales personnel and resources, the
full benefits of this additional spending have not yet been realized through
increased revenue.

PRODUCT DEVELOPMENT EXPENSE was $9,271,000 or 18% of total revenue during 1997,
compared to $8,674,000 or 18% of total revenue in 1996 and $5,732,000 or 15% of
total revenue in 1995.  The increased expense in 1996 and 1997 is a direct
result of increased headcount and support resources associated with the
development of the Company's object-oriented, communications-centric technology
(OBJECTS).  The Company also completed several significant user enhancements
associated with the MSS product Release 6.0, including enhanced graphical user
interface features, an engineering module, a screen customizer module, and an
enlarged database.   The Company's research and development activities are
conducted internally and consist primarily of software development--the writing
of code. The Company does not have any material fixed commitments for capital
expenditures in research and development.  The Company believes that product
development spending is critical to the continuing success of the Company's
products and intends to continue to invest heavily in research and development.

Under Statement of Financial Accounting Standards No. 86 ("SFAS No. 86"),
"Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed," capitalization of computer software development costs is to begin
upon the establishment of technological feasibility, limited to the net
realizable value of the software product, and cease when the software is
available for general release to customers.

Since mid-1995, the Company has been investing significant resources in the
development of OBJECTS and completed a working model of OBJECTS in July 1996.
The Company believes that the object-oriented framework under development is
highly reusable and that its economic life will be in excess of five years.
Costs associated with its development were therefore capitalized.  The Company
also capitalized the development costs associated with certain "core" OBJECTS
modules that were anticipated to have an economic life in excess of three years.
In 1997 and 1996, the Company capitalized $3,819,000 and $1,820,000 of
development costs, respectively.

                                       15

<PAGE>

In June 1997, the Company introduced Release 1.0 of OBJECTS for general
distribution.  As such, the Company initiated amortization of all previously
capitalized costs related to the development of OBJECTS framework and Release
1.0 application modules.  These costs were amortized assuming a three-year
economic life for the framework and modules.  Amortization expense for 1997
totaled $720,000 and is presented as a component of product development expense.

In December 1997, in conjunction with the restructuring plan discussed below,
the Company reevaluated its OBJECTS development activities and product strategy.
As a result of this evaluation, the Company identified ways to combine some the
OBJECTS technology with the functionality of the current MSS product, and
redirected its development activities accordingly.  Because of this redirection,
it was determined that components of the previously developed OBJECTS product,
particularly the application modules, would not be incorporated into planned
future product releases.  As such, $1,630,000 of previously capitalized costs
related to these components, net of accumulated amortization, were charged to
restructuring expense in December 1997.

RESTRUCTURING CHARGE is the result of an evaluation of the Company's structure
and organization, primarily in the product development area.  In December 1997,
the Company's development operations were restructured in conjunction with a
change in product strategy.  Specifically, all North American development
activities were combined into a single operation - previously the Company
maintained two development groups.  The restructuring charge totaled $2,566,000
and included $394,000 of severance costs for employees and contractors, $392,000
to provide for the cost to exit office space that was no longer needed as a
result of the staff reductions, and $150,000 of prepaid royalties relating to
the OBJECTS product that had no future value.  In addition, $1,630,000 of
previously capitalized development costs were expensed as a result of the change
in product strategy.

A restructuring charge was also incurred during the second quarter of 1995.
Substantially all of this charge was associated with the JIT operations and
included in the loss reported from discontinued operations; however, a
restructuring charge of $149,000 was also provided related to the Company's
continuing operations. This charge was primarily related to employee severance
costs paid during 1995 and to provide for costs to be incurred under existing
contracts to exit office space that were no longer providing an economic benefit
to the Company.

OTHER INCOME (EXPENSE), NET is comprised principally of interest expense on
line-of-credit borrowings, equipment loans, and leases, net of interest income.

PROVISION FOR INCOME TAXES totaled $328,000 in 1997 versus $189,000 in 1996 and
$298,000 in 1995. The effective tax rate in 1995 and 1996 was reduced as a
result of the utilization of net operating loss carryforwards. The tax provision
for all years is comprised exclusively of state and foreign income taxes.  The
Company has not recognized any benefits related to deferred taxes or net
operating loss carryforwards.

OPERATING PROFIT:

The Company reported an operating loss of $5,341,000 for 1997 compared to
operating profits of $1,234,000 for 1996 and $661,000 for 1995. The change in
operating results in 1997 compared with 1996 is a result of the restructuring
charge and other increases in operating expenses that were not entirely offset
by increased revenue.

The Company has historically experienced higher revenue and gross margin in its
fourth quarter compared to the other quarters.  The Company attributes these
increases to customers' increased spending at the end of their calendar year
budgetary periods. The Company believes this pattern will continue.

FOREIGN CURRENCY EXCHANGE

Approximately 16% of the Company's total revenue in 1997, 14% in 1996 and 16% in
1995, was derived from sales denominated in foreign currencies. These sales were
made through certain foreign subsidiaries and were denominated in the
subsidiaries' functional currencies. The effect of foreign currency exchange
rate fluctuations versus the U.S. Dollar on these revenues is largely offset to
the extent expenses of the foreign subsidiary are incurred and paid for in that
same currency. None of these foreign operations have significant receivables,
obligations or commitments denominated in currencies other than these
operations' functional currencies.

                                       16

<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

Cash provided by continuing operating activities was $1,775,000 in 1997 compared
to $3,163,000 in 1996 and $4,270,000 in 1995.  In 1997, the net loss adjusted
for discontinued operations and noncash items resulted in a cash use of
$186,000.  An additional cash use was the result of an increase in accounts
receivable of $994,000.  These uses were offset by increases in accrued expenses
and deferred revenue of $1,730,000 and $1,455,000, respectively.  The increase
in accounts receivable is a direct result of an increase in fourth quarter
sales. The increased accrued expenses results from reserves established for
restructuring charges, increased accrued commissions resulting from a change in
when commissions earned are paid, and costs of third-party software associated
with fourth quarter growth. The increase in deferred revenue results from the
continued growth of the business and increases in the number of annual customer
support contracts.

Cash used for investing activities was $3,377,000 in 1997 compared to $5,916,000
in 1996 and  $201,000 in 1995.  The decrease from 1996 to 1997 relates primarily
to decreased capital spending offset by increased capitalized software
development costs.  Specifically, 1997 cash used for investing activities
includes $3,819,000 of capitalized software development costs and $1,200,000 for
purchases of furniture, fixtures and equipment.  This is offset by the receipt
of $1,857,000 related to the sale of JIT.

Cash provided by financing activities was $1,445,000 in 1997 compared to
$1,665,000 in 1996 and $499,000 in 1995.  The Company's financing activities
related primarily to line of credit borrowings in 1997 and net proceeds from the
Company's capital lease and equipment financing arrangements in 1996.

As discussed in Note 5 of Notes to Consolidated Financial Statements, in
November 1995, the Company entered into a $3,000,000 line-of-credit agreement
with a bank. Borrowings under the credit agreement were limited to the lesser of
the committed line or a borrowing base equal to 75% of eligible accounts
receivable, as defined. Borrowings were collateralized by the Company's accounts
receivable and all other assets of the Company and bear interest at prime plus
1.25%. In November 1996 the agreement was extended to November 1997 and the line
was increased to $5,000,000.  The agreement was subsequently extended to
February 1998.  The agreement contains restrictive covenants, which include the
maintenance of minimum tangible net worth and profitability levels as well as
certain financial ratios, as defined. At December 31, 1997 there were $2,000,000
in borrowings on the line.  Although the Company was not in compliance with
certain financial covenants on December 31, 1997, the Company restored
compliance through restructuring this credit facility on March 2, 1998.

Under the new agreement, all outstanding balances under the old facility were
repaid and financed with borrowings under the new agreement.  The new agreement
provides a credit line not to exceed $5,000,000 and expires in March 1999.
Actual borrowings are limited to a percentage of eligible accounts receivable
reduced by amounts outstanding under the Company's long term equipment facility
(see Note 6 to the Consolidated Financial Statements).  Borrowings are
collaterized by the Company's accounts receivable and all other assets of the
Company and bear interest at prime plus 2%.  The agreement contains restrictive
covenants that include the maintenance of minimum net worth.  As of March 2,
1998, approximately $3,400,000 of borrowings were available to the Company under
the new agreement.

The Company does not have any material scheduled commitments for capital
expenditures during 1998. The Company believes that the $5,758,000 of cash and
cash equivalents on hand at December 31, 1997 together with anticipated cash
flows from operations and the Company's available line of credit will be
sufficient to fund operating cash needs for 1998. Beyond 1998, the Company plans
to consistently generate positive cash flows from operations; however, if this
does not occur, then the Company may need to seek additional funds through
equity or debt financing.

The Company has available net operating loss carryforwards of approximately
$19,400,000 and tax credit carryforwards of approximately $1,504,000 at December
31, 1997.  The Company has not recognized any of these benefits in the related
financial statements.

                                       17

<PAGE>

NEW ACCOUNTING PRONOUNCEMENTS

The Company adopted Financial Accounting Standards Board (SFAS) No. 128,
"Earnings Per Share," in 1998.  This statement requires presentation of basic
and diluted Earnings Per Share (EPS).  Basic EPS is computed by dividing net
income by the number of weighted average common shares outstanding.  Diluted EPS
reflects dilution of ownership from outstanding stock options, using the
treasury stock method.  The Company has restated results for all prior years
presented.

Statement of Position (SOP) 97-2, "Software Revenue Recognition," issued in
October 1997, is effective for transactions entered into beginning January 1998.
This statement supersedes SOP 91-1 and provides guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions.
The Company is currently analyzing the implementation of SOP 97-2 and does not
believe it will have a material impact on the Company's financial condition or
results of operations.

The Financial Accounting Standards Board has released SFAS No. 130, "Reporting
Comprehensive Income," effective for fiscal years beginning after December 15,
1997.  SFAS No. 130 establishes standards for reporting and display in the
financial statements of total net income and the components of all other
nonowner changes in equity, referred to as comprehensive income.  The Company
will adopt SFAS No. 130 in 1998 and is currently analyzing the impact it will
have on the disclosures in the financials statements.

The Financial Accounting Standards Board also has released SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," effective
for fiscal years beginning after December 15, 1997.  SFAS No. 131 requires
disclosure of business and geographic segments in the consolidated financial
statements of the Company.  The Company will adopt SFAS No. 131 in 1998 and is
currently analyzing the impact it will have on the disclosures in its financial
statements.

OTHER

The Company has analyzed the potential affect of the year 2000 issue on both the
application software that the Company licenses through sales cycles and
application software it uses in its internal operations.  The Company has tested
all of the system software included in its products and determined that it will
not be affected.  The Fourth Shift development environment has always supported
the use of century-compliant dates.  The Information Technology Association of
America (ITAA) has certified that Fourth Shift enterprise software solutions are
year 2000 compliant.  Additionally, the Company has requested and received
documentation from vendors currently supplying third party products addressing
year 2000 compliance.  In most cases, vendors responses indicated that their
applications were either currently year 2000 compliant or that they would be
compliant by the end of 1998.  In certain instances, vendors have not made a
commitment to become year 2000 compliant by the end of 1998.  The Company is
evaluating alternative courses of action relating to these certain vendors and
anticipates resolution by the end of 1998.  Based on this review, the Company
does not anticipate any material negative effect on the future operating results
or financial condition of the Company.

                                       18

<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                     FOURTH SHIFT CORPORATION AND SUBSIDIARIES

                            Consolidated Balance Sheets

                                 As of December 31

                  (In Thousands, Except Share and Per Share Data)


<TABLE>
<CAPTION>

                             ASSETS

                                                                      1997          1996
                                                                    --------      ---------
<S>                                                                 <C>           <C>
CURRENT ASSETS:
  Cash and cash equivalents                                         $ 5,758       $  5,935
  Accounts receivable, net                                           14,001         13,007
  Inventories                                                           482            596
  Prepaid expenses                                                    1,031          1,156
  Current portion of note and other receivable                          650            813
                                                                    --------      ---------
        Total current assets                                         21,922         21,507
                                                                    --------      ---------

FURNITURE, FIXTURES AND EQUIPMENT, at cost:
  Furniture and fixtures                                              2,644          2,309
  Computer equipment                                                  7,553          6,734
  Leasehold improvements                                              1,150          1,080
  Assets held under capital lease                                     2,784          2,110
  Less- Accumulated depreciation and amortization                    (8,628)        (6,093)
                                                                    --------      ---------
        Net furniture, fixtures and equipment                         5,503          6,140

RESTRICTED CASH                                                         715            500

NOTE RECEIVABLE                                                           -          1,121

SOFTWARE DEVELOPMENT COSTS, net                                       3,289          1,820

GOODWILL, net                                                             -             84
                                                                    --------      ---------
        Total assets                                                $31,429        $31,172
                                                                    --------      ---------
                                                                    --------      ---------
</TABLE>

                                       19

<PAGE>

                     FOURTH SHIFT CORPORATION AND SUBSIDIARIES

                            Consolidated Balance Sheets

                                 As of December 31

                  (In Thousands, Except Share and Per Share Data)

                                    (Continued)

<TABLE>
<CAPTION>


        LIABILITIES AND SHAREHOLDERS' EQUITY                          1997            1996
                                                                   ---------        --------
<S>                                                                <C>              <C>

CURRENT LIABILITIES:
  Current portion of long-term obligations                         $  1,803         $  868
  Current portion of deferred gain on sale of subsidiary                  -            617
  Revolving credit facility                                           2,000              -
  Accounts payable                                                    3,964          4,283
  Accrued expenses                                                    8,001          6,032
  Deferred revenue                                                   10,315          8,860
                                                                   ---------        --------
        Total current liabilities                                    26,083         20,660

LONG-TERM OBLIGATIONS                                                1,299          2,304

DEFERRED GAIN ON SALE OF SUBSIDIARY                                       -          1,121

COMMITMENTS AND CONTINGENCIES (Notes 7, 8 and 9)

SHAREHOLDERS' EQUITY:
  Common stock, $.01 par value, 20,000,000 shares
    authorized; 9,828,447, and 9,605,009 shares
    issued and outstanding                                               98             96
  Additional paid-in capital                                         30,640         29,872
  Accumulated deficit                                               (26,691)       (22,881)
                                                                   ---------        --------
        Total shareholders' equity                                    4,047          7,087
                                                                   ---------        --------
        Total liabilities and shareholders' equity                  $31,429        $31,172
                                                                   ---------        --------
                                                                   ---------        --------
</TABLE>

                   The accompanying notes are an integral part
                       of these consolidated balance sheets.

                                       20

<PAGE>
                      FOURTH SHIFT CORPORATION AND SUBSIDIARIES

                        Consolidated Statements of Operations

                           For the Years Ended December 31

                        (In Thousands, Except Per Share Data)

<TABLE>
<CAPTION>

                                                                      1997           1996           1995
                                                                    --------       --------       --------
<S>                                                                 <C>            <C>            <C>
REVENUE:
  Software license                                                  $21,883        $22,947        $17,128
  Service                                                            27,137         23,822         18,097
  Third-party software and other                                      3,298          2,541          1,999
                                                                    --------       --------       --------
        Total revenue                                                52,318         49,310         37,224
                                                                    --------       --------       --------
OPERATING EXPENSES:
  Cost of licenses                                                    2,767          2,601          1,708
  Cost of services                                                   13,209         11,747          8,868
  Cost of third-party software and other                              2,341          2,008          1,386
  Selling, general and administrative                                27,505         23,046         18,720
  Product development                                                 9,271          8,674          5,732
  Restructuring charge                                                2,566              -            149
                                                                    --------       --------       --------
        Total operating expenses                                     57,659         48,076         36,563
                                                                    --------       --------       --------
        Operating profit (loss)                                      (5,341)         1,234            661

OTHER EXPENSE, net                                                     (432)           (36)          (158)
                                                                    --------       --------       --------
  Income (loss) from continuing operations
    before provision for income taxes                                (5,773)         1,198            503

PROVISION FOR INCOME TAXES                                              328            189            298
                                                                    --------       --------       --------
INCOME (LOSS) FROM CONTINUING OPERATIONS                             (6,101)         1,009            205
                                                                    --------       --------       --------
DISCONTINUED OPERATIONS:
  Loss from discontinued operations                                       -              -         (7,642)
  Net gain on sale of discontinued operations                         2,311            761          2,037
                                                                    --------       --------       --------
        Total discontinued operations                                 2,311            761         (5,605)
                                                                    --------       --------       --------
NET INCOME (LOSS)                                                   $(3,790)       $ 1,770        $(5,400)
                                                                    --------       --------       --------
                                                                    --------       --------       --------

BASIC INCOME (LOSS) PER COMMON SHARE:
  Continuing operations                                             $  (.63)       $   .11        $   .02
  Discontinued operations                                               .24            .08           (.60)
                                                                    --------       --------       --------
        Basic income (loss) per common share                        $  (.39)       $   .19        $ (0.58)
                                                                    --------       --------       --------
                                                                    --------       --------       --------

DILUTED INCOME (LOSS) PER COMMON SHARE:
  Continuing operations                                             $  (.63)       $   .10        $   .02
  Discontinued operations                                               .24            .08           (.59)
                                                                    --------       --------       --------

        Diluted income (loss) per common share                      $  (.39)       $   .18        $  (.57)
                                                                    --------       --------       --------
                                                                    --------       --------       --------

</TABLE>

                    The accompanying notes are an integral part
                    of these consolidated financial statements.

                                       21

<PAGE>

                      FOURTH SHIFT CORPORATION AND SUBSIDIARIES

                   Consolidated Statements of Shareholders' Equity

                 For the Years Ended December 31, 1997, 1996 and 1995

                                    (In Thousands)


<TABLE>
<CAPTION>

                                                          Common Stock
                                                    -----------------------
                                                    Number of          Par      Additional     Accumulated
                                                      Shares          Value   Paid-In Capital    Deficit
                                                    ---------         -----   ---------------  -----------
<S>                                                 <C>               <C>     <C>              <C>
BALANCE, December 31, 1994                             9,217            $92        $28,673      $ (19,133)
  Common stock issued                                    149              2            345              -
  Issuance of restricted shares                            -              -            204              -
  Net loss                                                 -              -              -         (5,400)
  Translation adjustment                                   -              -              -            (83)
                                                    ---------         -----   ---------------  -----------

BALANCE, December 31, 1995                             9,366             94         29,222        (24,616)
  Common stock issued                                    234              2            591              -
  Issuance of restricted shares                            5              -             59              -
  Net income                                               -              -              -          1,770
  Translation adjustment                                   -              -              -            (35)
                                                    ---------         -----   ---------------  -----------

BALANCE, December 31, 1996                             9,605             96         29,872        (22,881)
  Common stock issued                                    223              2            758              -
  Issuance of restricted shares                            -              -             10              -
  Net loss                                                 -              -              -         (3,790)
  Translation adjustment                                   -              -              -            (20)
                                                    ---------         -----   ---------------  -----------
BALANCE, December 31, 1997                             9,828            $98        $30,640      $ (26,691)
                                                    ---------         -----   ---------------  -----------
                                                    ---------         -----   ---------------  -----------
</TABLE>


                    The accompanying notes are an integral part
                    of these consolidated financial statements.

                                       22

<PAGE>
                      FOURTH SHIFT CORPORATION AND SUBSIDIARIES

                        Consolidated Statements of Cash Flows

                           For the Years Ended December 31

                                    (In Thousands)


<TABLE>
<CAPTION>

                                                                     1997            1996         1995
                                                                   --------        --------     --------
<S>                                                                <C>             <C>          <C>

OPERATING ACTIVITIES:
  Net income (loss)                                                 $(3,790)        $1,770        $(5,400)
  Adjustments to reconcile net income (loss)
    to net cash provided by continuing operating
    activities-
     Noncash items:
        Depreciation and amortization                                 3,339          2,065          1,312
        Net gain on sale of discontinued operations                  (2,311)          (761)        (2,037)
        Restructuring charge                                          2,566              -            149
        Loss from discontinued operations                                 -              -          7,642
        Other                                                            10             60            205
     Change in current operating items:
        Accounts receivable, net                                       (994)        (2,878)        (1,526)
        Inventories                                                     114            182            449
        Prepaid expenses                                                (25)          (292)           (82)
        Accounts payable                                               (319)         2,158         (2,149)
        Accrued expenses                                              1,730            272          3,232
        Deferred revenue                                              1,455            587          2,762
                                                                   --------        --------     --------
           Net cash provided by continuing
             operating activities                                     1,775          3,163          4,557
                                                                   --------        --------     --------

INVESTING ACTIVITIES:
  Purchases of furniture, fixtures and equipment                     (1,200)        (4,162)        (1,701)
  Increase in restricted cash                                          (215)          (500)             -
  Capitalized software development costs                             (3,819)        (1,820)             -
  Proceeds from sale of discontinued operations                       1,857            566          1,500
                                                                   --------        --------     --------
        Net cash used for investing activities                      $(3,377)       $(5,916)         $(201)
                                                                   --------        --------     --------
</TABLE>

                                       23

<PAGE>

                      FOURTH SHIFT CORPORATION AND SUBSIDIARIES

                        Consolidated Statements of Cash Flows

                           For the Years Ended December 31

                                    (In Thousands)

                                     (Continued)


<TABLE>
<CAPTION>

                                                                       1997            1996          1995
                                                                     --------       ---------      ---------
<S>                                                                  <C>            <C>            <C>
FINANCING ACTIVITIES:
  Payments of long-term obligations                                   $(963)         $(512)         $(427)
  Proceeds from equipment loans and capital leases                      195          2,004            579
  Borrowings on line of credit                                        2,000          1,350          2,200
  Payments on line of credit borrowings                                    -        (1,350)        (2,200)
  Proceeds on issuance of common stock, net                             213            173             60
                                                                     --------       ---------      ---------
        Net cash provided by financing activities                     1,445          1,665            212

CASH USED IN DISCONTINUED OPERATIONS                                      -              -         (4,198)

EFFECT OF EXCHANGE RATE ON FOREIGN CASH BALANCES                        (20)           (35)           (83)
                                                                     --------       ---------      ---------
        Change in cash and cash equivalents                            (177)        (1,123)           287

CASH AND CASH EQUIVALENTS:
  Beginning of year                                                   5,935          7,058          6,771
                                                                     --------       ---------      ---------
  End of year                                                        $5,758         $5,935         $7,058
                                                                     --------       ---------      ---------
                                                                     --------       ---------      ---------

SUPPLEMENTAL CASH FLOW INFORMATION:
  Cash paid during each period for-
    Interest                                                           $566           $338           $303
    Income taxes                                                       $149           $140           $160
                                                                     --------       ---------      ---------
                                                                     --------       ---------      ---------

</TABLE>

                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                       24

<PAGE>
                      FOURTH SHIFT CORPORATION AND SUBSIDIARIES

                      Notes to Consolidated Financial Statements

                              December 31, 1997 and 1996


1.   NATURE OF BUSINESS AND COMPANY OPERATIONS:

Fourth Shift Corporation (a Minnesota corporation) and its subsidiaries
(collectively referred to as the Company) engage principally in the development,
marketing, licensing and support of integrated client/server application
software used for industrial planning and management processes, primarily for
use in the manufacturing industry.  The Company's principal product, the Fourth
Shift Manufacturing Software System for OBJECTS (MSS) is a family of integrated
manufacturing and financial management applications for intermediate-sized sites
of manufacturing and distribution enterprises.  The MSS system operates in a
Windows NT open computing environment.

The Fourth Shift JIT Enterprise System (JIT Enterprise System), which was
offered through Just In Time Enterprise Systems, Inc. (JIT), a subsidiary of the
Company, is an information management system for industrial companies involved
in aerospace and defense and contract manufacturing which operates in the
UNIX/Oracle environment.  Effective December 31, 1995, the Company sold the
common stock of JIT (see Note 3.)  The operating results of JIT have been
presented as discontinued operations in the accompanying consolidated financial
statements.  Accordingly, the disclosures presented herein relate to the
continuing operations of the Company, unless otherwise noted.

Although the Company had a working capital deficit at December 31, 1997, the
Company believes that cash on hand, cash generated from operations, and cash
available under the Company's credit facility will be adequate to fund the
Company's operations through 1998.

The consolidated financial statements include the accounts of Fourth Shift
Corporation (Fourth Shift) and all of its subsidiaries.  All significant
intercompany balances and transactions have been eliminated in consolidation.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

REVENUE RECOGNITION

Software license revenues derived from software license fees with standard
acceptance periods are recognized upon shipment of software if there are no
significant postdelivery obligations and collectibility is reasonably assured.
Insignificant contractual obligations are accrued at the time of revenue
recognition.  For fixed-fee software arrangements, the Company recognizes
revenue on payments due within one year once all significant obligations have
been met and defers the portion of the total fee which is attributable to
insignificant undelivered services or products and recognizes this revenue as
the associated services or products are delivered.

Service revenue includes customer support fees, training, consulting,
installation and project management.  Revenue from customer support agreements
for maintaining, supporting and providing periodic upgrades is recognized
ratably over the maintenance period, which in most cases is one year.  Revenue
is recognized for other services at the time the service is performed.

Third-party software and other revenue is derived from the resale of third-party
licenses and hardware.  Revenue is recognized upon delivery of the product.

SOFTWARE DEVELOPMENT COSTS

Capitalization of computer software development costs begins upon the
establishment of technological feasibility, limited to the net realizable value
of the software product, and ceases when the software product is available for
general release to customers.  Amortization is computed on each product based
upon the greater of the amount

                                       25

<PAGE>

computed on a units sold basis (ratio of gross product revenue to anticipated
future gross revenue for that product) or straight-line basis over the
remaining estimated economic life of the product. Costs of maintenance and
customer support are to be charged to expense when related revenue is
recognized or when those costs are incurred, whichever occurs first.

Historically, the development costs incurred by the Company during the period
between the achievement of technological feasibility, defined by the Company as
the existence of a working model of the product, and the point at which the
product is available for general release to customers, have not been material.
Accordingly,  prior to 1996 the Company charged all software development costs
to expense as incurred.    Beginning in the third quarter of 1996, the Company
began to capitalize development costs related to its next generation product,
Fourth Shift OBJECTS Enterprise Software (OBJECTS).  The Company capitalized
$3,819,000 in 1997 and $1,820,000 in 1996 related to the development of OBJECTS
functionality and related modules that had reached technological feasibility.
In June 1997, the Company introduced Release 1.0 of OBJECTS for general
distribution.  As such, the Company initiated amortization of all previously
capitalized costs related to the development of OBJECTS framework and Release
1.0 application modules.  These costs were amortized assuming a three-year
economic life for the framework and modules.   Amortization expense for 1997
totaled $720,000.

In conjunction with a December 1997 restructuring of the Company's product
development operations (See Note 4), the Company reevaluated its OBJECTS
development activities and product strategy.  As a result of this evaluation,
the Company identified ways to combine some of the OBJECTS technology with the
functionality of the current MSS product, and redirected its development
activities accordingly.  Because of this redirection, components of the
previously developed OBJECTS product will not be incorporated into planned
future product releases.  As such, $1,630,000 of previously capitalized costs
related to these components, net of accumulated amortization, were charged to
restructuring expense in December 1997.

As of December 31, 1997, OBJECTS Release 1.0 is no longer being marketed or
licensed to customers.  As such, the remaining capitalized asset will not be
amortized until such time as the underlying technology is incorporated into a
product that is available for general release. At that time, the remaining
capitalized costs will be amortized to expense over the product's estimated
economic life.

CASH EQUIVALENTS

The Company considers all highly liquid and short-term investments purchased
with a maturity of three months or less to be cash equivalents.  Short-term
investments consist principally of government securities and mutual funds and
are stated at cost, which approximates market.


ACCOUNTS RECEIVABLE

Accounts Receivable are stated net of allowances for losses on uncollectible
accounts.  At December 31, 1997 and 1996, this allowance was $773,000 and
$359,000 respectively.


INVENTORIES

Inventories consist of third-party software held for resale, computer
software media, instruction material and packaging, and are stated at the
lower of first-in, first-out cost or market.

PREPAID EXPENSES

Prepaid expenses consist principally of prepaid rents and rental deposits,
prepaid insurance premiums and deposits on capital leases.


FURNITURE, FIXTURES AND EQUIPMENT

Furniture, fixtures and equipment are recorded at cost and are depreciated
principally under the straight-line method for financial and income tax
reporting purposes over estimated useful lives that range from three to five
years.

                                       26


<PAGE>

RESTRICTED CASH

Restricted cash consists of cash pledged to support certain facilities leases.
These restrictions will decrease over time ending in 2006.


FOREIGN CURRENCY TRANSLATION

For the Company's foreign operations, assets and liabilities are translated at
year-end exchange rates, and items included in the consolidated statement of
operations are translated at average exchange rates prevailing during the year.
Translation adjustments, which have historically been insignificant, are
included in accumulated deficit in the accompanying consolidated balance sheets.


DEFERRED REVENUE

Deferred revenue primarily consists of customer support and other services for
which cash has been received but services have not been provided.  Services that
must be provided relate to normal operations of the Company.


INCOME TAXES

The Company accounts for income taxes under the liability method of accounting.
Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
currently enacted tax rates.

NET INCOME (LOSS) PER COMMON SHARE

In the fourth quarter of 1997 the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 128 "Earnings Per Share" and, retroactively,
restated the earnings (loss) per share (EPS) for 1996 and 1995.  SFAS No. 128
requires presentation of basic and diluted EPS.  Basic EPS is computed by
dividing net income by the number of weighted average common shares
outstanding. Diluted EPS reflects potential dilution from outstanding stock
options, using the treasury stock method.

Reconciliation of weighted average shares used in computing income (loss) per
share are as follows (in thousands):


<TABLE>
<CAPTION>
                                                                       1997           1996           1995
                                                                     -------        -------        --------
<S>                                                                  <C>            <C>            <C>
Weighted average common shares outstanding                            9,738          9,567          9,354
Dilutive effect of stock options outstanding,
  using the treasury stock method                                         -            298            122
                                                                     -------        -------        --------
Shares used in computing diluted income (loss) per share              9,738          9,865          9,476
                                                                     -------        -------        --------
                                                                     -------        -------        --------

</TABLE>


RECLASSIFICATIONS

Certain amounts previously reported in the 1996 financial statements have been
reclassified to conform to the 1997 presentation.  These reclassifications had
no effect on previously reported net income or shareholders' equity.

USE OF ESTIMATES

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

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Statement of Position (SOP) 97-2, "Software Revenue Recognition," issued in
October 1997, is effective for transactions entered into beginning in January
1998.  This statement supersedes SOP 91-1 and provides guidance on applying
generally accepted accounting principles in recognizing revenue on software
transactions.  The Company

                                       27

<PAGE>

is currently analyzing the implementation of SOP 97-2 and does not believe it
will have a material impact on the Company's financial condition or results
of operations.

The Financial Accounting Standards Board has released SFAS No. 130, "Reporting
Comprehensive Income," effective for fiscal years beginning after December 15,
1997.  SFAS No. 130 establishes standards for reporting and display in the
financial statements of total net income and the components of all other
nonowner changes in equity, referred to as comprehensive income.  The Company
will adopt SFAS No. 130 in 1998 and is currently analyzing the impact it will
have on the disclosures in the financial statements.

The Financial Accounting Standards Board also has released SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," effective
for fiscal years beginning after December 15, 1997.  SFAS No. 131 requires
disclosure of business and geographic segments in the consolidated financial
statements of the Company.  The Company will adopt SFAS No. 131 in 1998 and is
currently analyzing the impact it will have on the disclosures in its financial
statements.

3.   SALE OF JUST IN TIME ENTERPRISE SYSTEMS, INC.

Effective December 31, 1995, the Company sold all of the capital stock of JIT to
Interactive Group, Inc. (IGI).  The Company received cash proceeds of $1,500,000
and a $2,500,000 note collateralized by the common stock of JIT, all receivables
generated by JIT or from the JIT Enterprise System and by the intellectual
property rights associated with the JIT Enterprise System.  The note was
originally payable in quarterly installments over a period of three years and
bears interest at 8.75%. IGI also agreed to pay, commencing on December 31,
1998, an additional amount equal to 4% of the revenues generated from the JIT
Enterprise System after December 31, 1995, up to a total of $1,200,000.

In connection with the sale of JIT in 1995, the Company recognized a gain on the
sale of $2,037,000, equal to the excess of the cash proceeds received over the
deficit book value of JIT, net of transaction costs.  The Company deferred
recognition of the gain associated with the note received from the sale and is
recognizing the gain associated with this note, as well as the additional
amounts receivable based on revenues generated from the JIT Enterprise System,
as such amounts are deemed collectible.  In 1996 the Company recognized a gain
totaling $761,000 related to cash received in 1996 and January 1997.

In 1997 the Company recognized a gain on the sale totaling $2,311,000, of this
amount, $1,661,000 reflects early collections of the balance due under the note
receivable.  In addition, in January 1998, an early payment of $650,000 of the
contingent fee based on JIT revenue was received.

Substantially all income taxes related to this transaction have been offset by
operating losses previously generated by JIT.  In addition, all previously
generated net operating loss carryforwards related to JIT will continue to be
available to offset future taxable income of the Company, subject to the
limitations discussed in Note 7.  The financial position and results of
operations of JIT have been reported separately as discontinued operations in
the accompanying consolidated financial statements.  Revenues related to JIT
were $15,811,000 for the year ended December 31, 1995.

4.   RESTRUCTURING CHARGES:

In the fourth quarter of 1997, the Company evaluated its structure and
organization, primarily in the product development area.  This resulted in a
restructuring of the development operations and an associated change in product
strategy.  All North American development activities were combined into a single
operation - previously the Company maintained two development groups.  The
restructuring charge totaled $2,566,000 and included $394,000 of severance costs
for employees and contractors, $392,000 to provide for  the cost to exit office
space that was no longer needed as a result of the staff reductions, and
$150,000 of prepaid royalties relating to the OBJECTS product that had no future
value.  In addition, $1,630,000 of previously capitalized development costs were
expensed as a result of the change in product strategy (See Note 2).   As of
December 31, 1997, approximately $936,000 of the total restructuring charge
remains to be paid in cash.

                                       28

<PAGE>

In the second quarter of 1995, the Company evaluated its existing cost structure
and the future marketability of its products.  As a result of this
consideration, the Company implemented a cost reduction plan that included a
restructuring of its operations.  Substantially all of this plan was associated
with the JIT operations; however, a restructuring charge of $149,000 was also
provided related to the Company's continuing operations.  This charge was
primarily related to employee severance costs, costs to exit office space and
losses incurred on the disposal of leaseholds and other equipment directly
related to the abandoned office space.  As of December 31, 1996, substantially
all of this charge had been paid in cash.

5.   REVOLVING CREDIT FACILITY:

In November 1995, the Company entered into a $3,000,000 line of credit agreement
with the Company's principal bank.  Borrowings under the credit agreement were
limited to the lesser of the committed line or a borrowing base equal to 75% of
eligible accounts receivable, as defined.  Borrowings were collateralized by the
Company's accounts receivable and all other assets of the Company and bear
interest at prime plus 1.25%.  In November 1996 the agreement was extended to
November 5, 1997 and the line was increased to $5,000,000.  This agreement was
subsequently extended to February 1998.  Maximum borrowings in 1997 under this
facility were $2,000,000, with that amount outstanding at December 31, 1997.
This agreement contained restrictive covenants that included the maintenance of
minimum tangible net worth and profitability levels as well as certain financial
ratios, as defined.  As of December 31, 1997, the Company was not in compliance
with certain of those covenants.

The Company restructured its credit facility with the bank with a new agreement
effective March 2, 1998.  All balances outstanding under the old credit facility
were repaid on that date, and financed with borrowings under the new credit
facility.  The new agreement provides a credit line not to exceed $5,000,000.
Actual borrowings are limited to a percentage of eligible accounts receivable,
with a deduction for the amounts outstanding under the long-term equipment
facility (See Note 6).  Borrowings are collateralized by the Company's accounts
receivable and all other assets of the Company and bear interest at prime plus
2%.  The agreement contains restrictive covenants that include the maintenance
of minimum tangible net worth.  As of March 2, 1998, approximately $3,400,000 of
borrowings were available to the Company under the new agreement.  The agreement
expires on March 2, 1999.

6.   LONG-TERM OBLIGATIONS:

Long-term obligations consisted of the following at December 31 (in thousands):



<TABLE>
<CAPTION>
                                                        1997           1996
                                                      -------        --------
<S>                                                   <C>            <C>

          Capital lease obligations, varying
            interest rates, due in various
            monthly installments through 2001       $  1,335       $  1,167
          Bank equipment financing                     1,767          2,005
          Less current portion                        (1,803)          (868)
                                                      -------        --------
                    Long-term obligations             $1,299         $2,304
                                                      -------        --------
                                                      -------        --------
</TABLE>



Future minimum payments under noncancelable capital leases, net of amounts
representing interest are $703,000 in 1998, $446,000 in 1999, $176,000 in 2000
and $10,000 in 2001.

At December 31, 1997, long-term obligations included capital lease obligations
of approximately $328,000 related to prior years' sale/leaseback arrangements
associated with certain of the Company's furniture, fixtures and equipment.  No
gain or loss was recognized as a result of these transactions.

In April 1996, the Company entered into a $1,500,000 long-term equipment
facility with the Company's principal bank to finance the purchase of capital
equipment.  The facility bears interest at 9.25% and is payable monthly.
Principal payments are due in thirty-six equal monthly installments starting in
May 1997 through April 2000.   This facility is governed by the same restrictive
covenants as the revolving credit facility (See Note 5).

In September 1996, the Company entered into an additional $600,000 long-term
equipment facility to finance the purchase of capital equipment in connection
with international expansion.  The facility bears interest at 9.5% and is

                                       29

<PAGE>

payable monthly.  Principal payments were originally due in thirty-six equal
monthly installments starting in October 1997 through September 2000.  Under the
terms of the March 1998 revolving credit facility agreement, all amounts
outstanding under this equipment facility were repaid using proceeds from the
revolving credit facility.  At December 31, 1997 the balance on this long-term
equipment facility was $550,000, which is included in the current portion of
long-term obligations.

Future minimum payments under these facilities (including prepayment described
above) are $1,100,000 in 1998, $500,000 in 1999 and $167,000 in 2000.  The
carrying value of the Company's long-term obligations approximates fair value.

7.   INCOME TAXES:

At December 31, 1997, the Company had available net operating loss carryforwards
of approximately $19,400,000 and tax credit carryforwards of approximately
$1,504,000.  These net operating losses and tax credit carryforwards will expire
from 1999 to 2011.


The utilization of a portion of these net operating loss carryforwards may be
subject to Internal Revenue Code section 382 if certain significant investors
sell or purchase ownership interests.  If an ownership change does occur, the
Company's ability to utilize its tax net operating loss carryforwards to offset
any future federal taxable income would be limited to a maximum amount in any
one year.

The provision for income taxes is comprised of the following for the years ended
December 31 (in thousands):


<TABLE>
<CAPTION>
                                         1997           1996           1995
                                        ------         ------         ------
<S>                                     <C>            <C>            <C>

          Current tax provision:
            State                        $105            $43            $42
            Foreign                       223            146            256
                                        ------         ------         ------
                                         $328           $189           $298
                                        ------         ------         ------
                                        ------         ------         ------
</TABLE>

The Company records deferred taxes for the difference between the financial
reporting and income tax bases of certain assets and liabilities, computed in
accordance with tax laws in effect currently.  The principal differences which
give rise to deferred taxes are as follows (in thousands):


<TABLE>
<CAPTION>
                                                       1997           1996
                                                     --------       ---------
<S>                                                   <C>            <C>
          Net operating loss and tax credit
            carryforwards                            $ 8,890         $7,670
          Deferred gain on sale of JIT                     -            735
          Accruals and reserves not currently
            deductible for tax purposes                  887            565
          Capitalized R&D costs                       (1,304)          (690)
          Other                                         (159)           (57)
          Less valuation allowance                    (8,314)        (8,223)
                                                     --------       ---------
          Net deferred taxes                         $     -        $     -
                                                     --------       ---------
                                                     --------       ---------
</TABLE>

The Company has provided a valuation allowance for the net deferred tax benefit
resulting from net operating loss carryforwards and other differences between
the reported book and tax bases of certain assets and liabilities, as the
realizability of this net deferred tax benefit is not reasonably assured.

The Company's effective tax rate related to continuing operations differs from
the statutory federal income tax rate of 34% as a result of state and foreign
taxes.

                                       30

<PAGE>

8.   COMMITMENTS AND CONTINGENCIES:

OPERATING LEASES

The Company has operating leases for its corporate headquarters, additional
office space and for certain office equipment.  The aggregate future minimum
rental payments under these leases, net of amounts to be received related to the
sublease of certain office space, are as follows (in thousands):



<TABLE>
<CAPTION>

          Year                                                       Amount
          ----                                                     ---------
          <S>                                                      <C>
          1998                                                     $  2,182
          1999                                                        2,163
          2000                                                        1,865
          2001                                                        1,820
          2002                                                        1,827
          Thereafter                                                 10,672
                                                                   ---------
                                                                   $ 20,529
                                                                   ---------
                                                                   ---------
</TABLE>

Rent expense, including amounts paid under short-term arrangements, was
approximately $2,935,000,  $2,340,000, and $2,478,000, in 1997, 1996 and 1995,
respectively.

LITIGATION

The Company is subject to litigation in the normal course of business.  In the
opinion of management, the resolution of these matters will not have a material
adverse effect on the Company's consolidated results of operations or financial
position.

9.   OPTIONS AND COMPENSATION PLANS:

STOCK OPTIONS

Under the terms of the Company's 1989 stock option plan (the 1989 Plan), options
granted to employees expire no later than ten years after the date of grant, and
the exercise price must be at least 100% of the fair market value of the shares
at the date of grant.  The 1989 Plan covers both incentive and nonqualified
stock options and is limited to 200,000 total shares.  Incentive stock options
granted to employees, who immediately before such grant owned stock directly or
indirectly representing more than 10% of the voting power of all classes of the
stock of the Company, may not be exercisable more than five years after the date
of grant and the exercise price per share must be at least 110% of the fair
market value of the shares at the date of grant.  Options vest over varying
periods not to exceed five years.  This plan is to remain in effect until
October 17, 1999.

In June 1993, the Company's board of directors approved a new stock option plan
(the 1993 Plan).  The 1993 Plan covers both incentive and nonqualified stock
options and is limited to 2,250,000 shares.  The 1993 Plan terminates in
June 2003.

                                       31

<PAGE>

Stock option plan activity is summarized as follows:


<TABLE>
<CAPTION>

                                                                              1993                              Option Price
                                                        1989 Plan             Plan            Total                Per Share
                                                        ----------          --------        ---------           --------------
<S>                                                     <C>                 <C>             <C>                 <C>

Option shares outstanding at December 31, 1994            168,238           486,807          655,045             $2.00 -$8.25

    Options granted                                             -           549,750           549,750            $2.625-$6.50
    Options exercised                                      (3,100)                -            (3,100)               $2.00
    Options forfeited                                           -          (120,500)         (120,500)           $3.25-$5.375
                                                        ----------          --------        ---------           --------------

Option shares outstanding at December 31, 1995            165,138           916,057         1,081,195            $2.00-$8.25
    Options granted                                         4,000           210,000           214,000            $3.75-$7.625
    Options exercised                                     (77,375)           (3,250)          (80,625)           $2.00-$5.00
    Options forfeited                                        (400)          (77,000)          (77,400)           $2.00-$8.25
                                                        ----------          --------        ---------           --------------


Option shares outstanding at December 31, 1996             91,363        1,045,807         1,137,170             $2.00-$8.25
    Options granted                                             0          383,000           383,000             $3.25-$5.50
    Options exercised                                     (84,063)         (14,375)          (98,438)            $2.00-$3.25
    Options forfeited                                      (3,300)        (211,691)         (214,991)            $2.00-$8.25
                                                        ----------          --------        ---------           --------------

Option shares outstanding at December 31, 1997              4,000        1,202,741         1,206,741             $2.63-$8.25

                                                        ----------          --------        ---------           --------------
                                                        ----------          --------        ---------           --------------
<CAPTION>

                                                                              1997              1996           1995
                                                                          -----------       ------------   ------------
<S>                                                                       <C>               <C>            <C>
Options exercisable at year-end                                               524,586           379,172        247,879
Weighted average price of options exercisable at year-end                       $5.31             $4.79          $4.04
Weighted average fair market value of options granted                           $3.96             $4.03          $3.63

</TABLE>

                                       32

<PAGE>

The Company accounts for these stock option plans under APB Opinion No. 25,
under which no compensation cost has been recognized.  Had compensation cost for
these plans been determined consistent with FASB Statement No. 123, the
Company's net income (loss) and earnings (loss) per share would have been as
follows:


<TABLE>
<CAPTION>
                                                                1997           1996           1995
                                                              --------       --------       --------
<S>                                     <C>                   <C>            <C>            <C>
Net income (loss):                      As reported           $(3,790)       $  1,770       $(5,400)
                                        Pro forma             $(4,917)       $    984       $(5,834)

Basic income (loss) per common share:   As reported           $  (.39)       $    .19       $  (.58)
                                        Pro forma             $  (.50)       $    .10       $  (.62)

Diluted income (loss) per common share: As reported           $  (.39)       $    .18       $  (.57)
                                        Pro forma             $  (.50)       $    .10       $  (.62)
</TABLE>



Because the Statement 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.  The fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option pricing model with the following assumptions: risk-free interest rate of
5.0 percent and expected life of 7.7 years for 1997, 1996, and 1995; expected
annualized volatility of 1.03, .85 and .99 for 1997, 1996 and 1995,
respectively.

OTHER EMPLOYEE COMPENSATION PLANS

The Company has a 401(k) plan that covers substantially all domestic employees
over 21 years of age with at least six months of continuous service.  The
Company may make discretionary matching contributions to the plan based upon
employee contributions.  The Company made matching contributions to this plan of
approximately $353,000 in 1996.  No matching contributions were made in 1997 or
1995.

The Company has an employee stock purchase plan (the Stock Purchase Plan).
Under the Stock Purchase Plan, participating full-time employees and directors
of the Company are able to purchase shares of the Company's common stock at 85%
of market value, as defined.  A total of up to 900,000 shares of the Company's
common stock has been reserved under the Stock Purchase Plan.  In 1995, the
Company issued approximately 97,000 shares of its common stock, which were
purchased by participants of this plan during 1994.  In 1996, the Company issued
150,000 shares of which 100,000 were purchased in 1995 and 50,000 through June
of 1996. In 1997, the Company issued 125,000 shares, of which 50,000 were
purchased in 1996 and 75,000 through June of 1997.  The weighted average fair
value of shares purchased was $643,750 in 1997, $707,000 in 1996, and $266,000
in 1995.

BOARD OF DIRECTORS' COMPENSATION PLAN

The board of directors has approved a compensation plan whereby certain
directors may receive cash compensation for each directors' meeting attended or,
in lieu of cash payment, shares of common stock through the Company's Stock
Purchase Plan.  The number of shares issued in lieu of cash fees is adjusted to
reflect the fair market value of the common stock in accordance with the
Company's Stock Purchase Plan.  In addition, nonemployee directors are entitled
to receive options to purchase shares of the Company's common stock under this
plan.  Total shares of approximately 22,000, 18,000, and 20,000 were issued
under this plan in 1997, 1996 and 1995, respectively.  The expenses recognized
in connection with options issued to nonemployee directors was approximately
$77,000, $55,000, and $72,000 in 1997, 1996, and 1995 respectively.


                                       33

<PAGE>

10.  INTERNATIONAL OPERATIONS:

Sales, services and marketing operations outside the United States are conducted
principally through foreign sales subsidiaries and through various
representatives and distributorship arrangements.  Financial information by
geographical segment is as follows (in thousands):


<TABLE>
<CAPTION>

                                  North
                                 America          Asia         Europe      Eliminations    Consolidated
                                ---------       --------      ---------    ------------    ------------
<S>                             <C>             <C>           <C>          <C>             <C>
1997:
  Revenue                        $37,050         $7,093         $8,175           $  -        $52,318
  Operating profit (loss)         (5,414)          (396)           469              -         (5,341)
  Total assets                    26,511          3,531          4,168         (2,781)        31,429
1996:
  Revenue                        $33,588         $8,786         $6,936        $     -        $49,310
  Operating profit (loss)         (1,127)         1,253          1,108              -          1,234
  Total assets                    24,788          6,236          4,678         (4,530)        31,172
1995:
  Revenue                        $26,785         $5,170         $5,269        $     -        $37,224
  Operating profit (loss)           (737)           563            835              -            661
  Total assets                    20,981          3,960          3,243         (3,690)        24,494
</TABLE>


                                       34

<PAGE>

11.  QUARTERLY FINANCIAL DATA (UNAUDITED):

The following is a condensed summary of actual quarterly results of operations
for 1997 and 1996 (in thousands, except per share data):


<TABLE>
<CAPTION>
                                                                                 1997
                                               ---------------------------------------------------------------------
                                                  First         Second          Third         Fourth          Total
                                               ---------       --------       ---------     ---------      ---------
<S>                                            <C>             <C>            <C>           <C>            <C>

Revenue                                         $10,805        $12,876        $13,433        $15,204        $52,318
Operating profit (loss)                          (1,450)           (61)          (219)        (3,611)        (5,341)
Income (loss) from continuing operations         (1,496)          (145)          (394)        (4,066)        (6,101)
Results of discontinued operations                  201            205          1,255            650          2,311
                                               ---------       --------       ---------     ---------      ---------
Net income (loss)                               $(1,295)       $    60        $   861        $(3,416)       $(3,790)
                                               ---------       --------       ---------     ---------      ---------
                                               ---------       --------       ---------     ---------      ---------

Basic income (loss) per common share
  Continuing operations                         $ ( .15)       $ ( .01)       $ ( .04)       $  (.43)       $ ( .63)
  Discontinued operations                           .02            .02            .13            .07            .24
                                               ---------       --------       ---------     ---------      ---------
Basic income (loss) per common share            $ ( .13)       $   .01        $   .09        $  (.36)      $  ( .39)
                                               ---------       --------       ---------     ---------      ---------
                                               ---------       --------       ---------     ---------      ---------

Diluted income (loss) per common share:
  Continuing operations                         $ ( .15)       $ ( .01)       $ ( .04)       $  (.43)      $  ( .63)
  Discontinued operations                           .02            .02            .13            .07            .24
                                               ---------       --------       ---------     ---------      ---------
Diluted income (loss) per common share          $ ( .13)       $   .01        $   .09        $  (.36)      $  ( .39)
                                               ---------       --------       ---------     ---------      ---------
                                               ---------       --------       ---------     ---------      ---------

<CAPTION>
                                                                                 1996
                                               ---------------------------------------------------------------------
                                                  First         Second          Third         Fourth          Total
                                               ---------       --------       ---------     ---------      ---------
<S>                                            <C>             <C>            <C>           <C>            <C>

Revenue                                         $10,572        $12,423        $11,891        $14,424        $49,310
Operating profit                                    154            651            187            242          1,234
Income from continuing operations                   126            567            162            154          1,009
Results of discontinued operations                  184            188            193            196            761
                                               ---------       --------       ---------     ---------      ---------
Net income                                      $   310         $  755         $  355         $  350       $  1,770
                                               ---------       --------       ---------     ---------      ---------
                                               ---------       --------       ---------     ---------      ---------

Basic income per common share:
  Continuing operations                         $   .01         $  .06         $  .02         $  .02         $  .11
  Discontinued operations                           .02            .02            .02            .02            .08
                                               ---------       --------       ---------     ---------      ---------
  Basic income per common share                 $   .03         $  .08         $  .04         $  .04         $  .19
                                               ---------       --------       ---------     ---------      ---------
                                               ---------       --------       ---------     ---------      ---------
Diluted income per common share:
  Continuing operations                         $   .01         $  .06         $  .02         $  .01         $  .10
  Discontinued operations                           .02            .02            .02            .02            .08
                                               ---------       --------       ---------     ---------      ---------
  Diluted income per common share               $   .03         $  .08         $  .04         $  .03         $  .18
                                               ---------       --------       ---------     ---------      ---------
                                               ---------       --------       ---------     ---------      ---------

</TABLE>

                                       35

<PAGE>

                       REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Fourth Shift Corporation:

We have audited the accompanying consolidated balance sheets of Fourth Shift
Corporation (a Minnesota corporation) and Subsidiaries as of December 31, 1997
and 1996, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1997.  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 Fourth Shift Corporation and
Subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.


                                             /s/  ARTHUR ANDERSEN LLP

Minneapolis, Minnesota
    March 2, 1998


                                       36

<PAGE>

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


Not applicable.






                                       37

<PAGE>
                                       PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 with respect to executive officers is
included under a separate caption entitled "Executive Officers" in Part I of the
Form 10-K.  The information with respect to directors is incorporated by
reference to the information under the caption "Election of Directors-Nominees"
of the Company's definitive proxy statement for its May 6, 1998 Annual Meeting
of Shareholders.

ITEM 11.  EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated by reference to the
information under the captions "Election of Directors-Director Compensation,"
"Executive Compensation - Summary Compensation Table," "Executive Compensation -
Stock Options," and "Executive Compensation - Long-Term Incentive Plan Awards"
of the Company's definitive proxy statement for its May 6, 1998 Annual Meeting
of Shareholders.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by Item 12 is incorporated by reference to the
information under caption "Security Ownership of Certain Beneficial Owners and
Management" of the Company's definitive proxy statement for its May 6, 1998
Annual Meeting of Shareholders.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated by reference to the
information under the caption "Election of Directors-Director Compensation" of
the Company's definitive proxy statement for its May 6, 1998 Annual Meeting of
Shareholders.


                                       38

<PAGE>

                                       PART IV

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

a.   Financial Statements

     1.   See the Financial Statement information contained in Item 8 of this
          Form 10-K
     2.   Financial Statement Schedules

               No Financial Statement Schedules are required

b.   Reports on Form 8-K:

     None

c.   Exhibits

<TABLE>
<CAPTION>

Exhibit No.       Description
-----------------------------
<S>            <C>
     3.1       Restated Articles of Incorporation of the Company, as amended
               (incorporated by reference to Exhibit 4.1 of the Company's 10-Q
               for the quarter ended March 31, 1994)

     3.2       Bylaws of the Company, as amended (incorporated by reference
               to Exhibit 3.2 to the Company's Form 10-K for the year ended
               December 31, 1994)

     4.1       Form of Certificate for Common Stock (incorporated by reference
               to Exhibit 4.1 of Amendment No. 1 to the Company's Registration
               Statement on Form S-1 filed June 28, 1993 (File No. 33-63012))

     10.1      1989 Stock Option Plan (incorporated by reference to Exhibit 10.4
               of the Company's Registration Statement of Form S-1 filed May 19,
               1993 (File No. 33-63012))

     10.2      Fourth Shift Corporation 1994 Employee Stock Purchase Plan, as
               amended (incorporated by reference to Exhibit 10.5 to the
               Company's 10-K for the year ended December 31, 1994)

     10.3      Fourth Shift Corporation 1993 Stock Incentive Plan, as amended
               (incorporated by reference to Exhibit 10.6 to the Company's 10-K
               for the year ended December 31, 1994)

     10.4      Office Lease dated as of December 18, 1992 among the Company and
               International Plaza Joint Venture, as amended (incorporated by
               reference to Exhibit 10.8 of the Company's Registration Statement
               on Form S-1 filed May 19, 1993 (File No. 33-63012))

     10.5      Purchase and Sale Agreement, dated December 15, 1995, between
               Fourth Shift Corporation and Interactive Group, Inc.
               (incorporated by reference to Exhibit 2.1 to the Company's 8-K
               dated as of December 15, 1995)

     10.6      Titanium Runtime Distribution License Agreement dated June 20,
               1995 between Fourth Shift Corporation and Micro Data Base
               Systems, Inc. (incorporated by reference to Exhibit 10.8 to the
               Company's 10-K for the year ended December 31, 1995)


                                       39

<PAGE>

     10.7      License Agreement dated as of March 30, 1996 between Fourth Shift
               Corporation and Teknekron Software Systems, Inc. (a.k.a. TIBCO)
               (incorporated by reference to Exhibit 10.16 to the Company's 10-K
               for the  year ended December 31, 1996)

     *10.8     Severance Pay Agreement dated October 21, 1997 between the
               Company and Marion Melvin Stuckey

     *10.9     Severance Pay Agreement dated October 21, 1997 between the
               Company and Jimmie H. Caldwell

     *10.10    Severance Pay Agreement dated October 21, 1997 between the
               Company and David Latzke

     10.11     Business Partner Agreement dated July 1, 1997 between Fourth
               Shift Corporation and Micro Data Base Systems, Inc.

     10.12     Tailored Technical Services Agreement dated July 1, 1997 between
               Fourth Shift Corporation and Micro Data Base Systems, Inc.

     10.13     Cooperative Sales Support Agreement dated July 1,1997 between
               Fourth Shift Corporation and Micro Data Base Systems, Inc.

     10.14     Office Lease dated November 12, 1997 between Fourth Shift
               Corporation and Meridian Crossings LLC

     10.15     Loan and Security Agreement dated March 2, 1998 as amended
               between   Fourth Shift Corporation and Silicon Valley Bank

     23.1      Consent of Arthur Andersen LLP

     27.0      Financial Data Schedule (For SEC use only)

</TABLE>

------------------------
*Management contract or compensatory plan.


                                       40

<PAGE>
                                     SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on March 25, 1998.

                                        Fourth Shift Corporation

                                        By:  /s/ MARION MELVIN STUCKEY
                                             ----------------------------
                                        Marion Melvin Stuckey
                                        Chairman and Chief Executive Officer


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

<TABLE>
<CAPTION>

            Name                                    Position                                    Date
            ----                                    --------                                    -----
<S>                                     <C>                                               <C>
 /s/ MARION MELVIN STUCKEY              Chairman, Chief Executive Officer,                March 25, 1998
-------------------------------         (principal executive officer) and
Marion Melvin Stuckey                   Director

/s/ JIMMIE H. CALDWELL                  President, Chief Operating Officer and            March 25, 1998
-------------------------------         Director
Jimmie H. Caldwell

/s/ DAVID G. LATZKE                     Vice President and Chief Financial                March 25, 1998
-------------------------------         Officer, Treasurer and Secretary
David G. Latzke                         (principal financial officer)

/s/ MOLLY D. MONROE                     Vice President of Finance                         March 25, 1998
-------------------------------         (principal accounting officer)
Molly D. Monroe

/s/ MICHAEL J. ADAMS                    Director                                          March 26, 1998
-------------------------------
Michael J. Adams

/s/ DAVID J. ALLIO                      Director                                          March 26, 1998
-------------------------------
David J. Allio

/s/ TONY J. CHRISTIANSON                Director                                          March 26, 1998
-------------------------------
Tony J. Christianson

/s/ PORTIA ISAACSON                     Director                                          March 26, 1998
-------------------------------
Portia Isaacson

/s/ STEVE J. LAIR                       Director                                          March 26, 1998
-------------------------------
Steve J. Lair

/s/ ROBERT M. PRICE                     Director                                          March 26, 1998
-------------------------------
Robert M. Price

</TABLE>
                                     41