<PAGE>

                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON DC 20549

                                   FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1997
                                      OR
[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ to ________

Commission file number 0-26376

                           ON TECHNOLOGY CORPORATION
            (Exact name of registrant as specified in its charter)

          Delaware                                04-3162846
 (State of incorporation)             (IRS Employer Identification Number)

                             One Cambridge Center
                        Cambridge, Massachusetts  02142
                                (617) 374-1400
                               http://www.on.com
            (Address and telephone of principal executive offices)
                                  ___________
       Securities registered pursuant to Section 12(b) of the Act: None


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

Indicate by check mark whether 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 this
Form 10-K. [_]

Aggregate market value of the voting stock held by nonaffiliates of the
registrant, based upon the closing sale price of the Company's common stock on
March 6, 1998, as reported by the Nasdaq National Market:  $19,486,654

Indicate the number of outstanding shares of each issuer's classes of common
stock as of March 6, 1998:
Common Stock, par value $0.01 per share: 12,226,920

                                                                       Form 10-K
                                                                       Reference
                                                                        --------
                      DOCUMENTS INCORPORATED BY REFERENCE
(1)  Definitive Proxy Statement for Annual Meeting for Shareholders
     Scheduled for April 30, 1998                                       Part III
(2)  Registration Statement No. 33-92562 on Form S-1, as amended        Part IV

                       THIS DOCUMENT CONTAINS 56 PAGES.
                       THE EXHIBIT INDEX IS ON PAGE 52.
<PAGE>

                                    PART I
                                    ------
Item 1 Business

THE COMPANY

     ON Technology Corporation (the "Company" or "ON") consists of two
business units: (i)  the ON Command CCM (Comprehensive Client Manager) business
unit, which develops, markets and supports enterprise desktop management
products; and (ii) the Groupware business unit, which develops, markets and
supports real-time group scheduling and electronic mail ("e-mail") software.
The Company provides standards-based software for heterogeneous enterprise
networks that is designed to be open, scalable and easy to use and administer.
The Company sells its products to large and medium-sized corporations,
institutions and government entities through a direct enterprise sales force;
the Groupware business unit also employs an enterprise-oriented telesales
organization.

     The Company was founded in 1985, began shipping e-mail products in
1990, and expanded its product line in 1993 to include real-time group
scheduling software with the acquisition of substantially all of the assets of
ON Technology, Inc. ("OTI").  The Company entered the software metering (network
management) business by obtaining the exclusive worldwide rights to SofTrack in
December 1993.  The Company expanded its e-mail offerings with the acquisition
of DaVinci Systems Corporation in 1994.  In August of 1995, the Company
completed an initial public offering of 2,360,000 shares of its Common Stock
resulting in net proceeds of $31,647,000.  In the first quarter of 1996, the
Company entered the firewall software (network security) and anti-virus software
businesses through the acquisitions of neTrend Corporation and Leprechaun
Software International, Ltd., respectively, and purchased the LAN software sales
business from Technocom plc.  On August 6, 1996 the Company announced and
implemented a reorganization and restructuring plan (the "96 Plan") of its
operations.  The 96 Plan was designed to consolidate the three acquisitions made
in the first quarter of 1996 and to reflect the Company's decreased emphasis on
its mature e-mail business and certain catalog products.

     In 1997 the Company entered the Internet usage monitoring business through
the acquisition of Purview Technologies Inc., and entered the enterprise desktop
management business through the acquisition of csd Software GmbH. On July 29,
1997 Company announced and implemented a reorganization and restructuring plan
(the "97 Plan") of its operations. The 97 Plan was designed to implement the
Company's decision to exit the anti-virus business and the de-emphasis of the
Company's investment in new customer acquisitions for the Company's Groupware
business.

     On October 29, 1997 the Company announced that it would seek
shareholder approval to sell its Network Management and Network Security
Businesses along with related marketing systems and organization (the "Assets")
to Elron Software, Inc. ("Elron"), a wholly owned subsidiary of Elron
Electronics Industries (the "Elron Transaction").  In addition, on October 29,
1997, the Company entered into a management agreement with Elron (the
"Management Agreement"), pursuant to which Elron agreed to manage the Assets for
its benefit and at its risk and expense and to pay all salaries and other
employee related expenses with respect to the Assets and transferred employees.
As a result of the Management Agreement, the associated revenues and costs of
the Assets have been excluded from the statement of operations for the period
from October 30, 1997 to December 31, 1997. On February 11, 1998, the Company
consummated the Elron Transaction. In conjunction with the October 29, 1997
announcement, the Company also announced that it would refocus its international
sales organization to concentrate on the enterprise desktop management business
and that it would close its offices in Sydney, Paris and London, while
strengthening its presence in Starnberg, Germany.


                                       2
<PAGE>

PRODUCTS AND TECHNOLOGY
-----------------------

     The following table sets forth certain information about ON Technology's
principal products, including the networks and operating systems supported by
each:
<TABLE>
<CAPTION>
                                                             Client Operating        First       Latest           List
   Product             Principal              Network            Systems            Release      Release       Price Per
  Category              Products             Supported          Supported          Date (1)       Date         100 Users
----------------------------------------------------------------------------------------------------------------------------

<S>                 <C>                      <C>             <C>                    <C>          <C>          <C>
Client              ON Command CCM           TCP/IP           DOS                   1992          2/98         $19,500
Management                                                    Windows 3.X
                                                              Windows 95
                                                              Windows NT

                    InstallCam Development   NA               Windows 95            2/98          2/98         $ 1,295
                    Environment                               Windows NT

                    ON Command Remote        TCP/IP           Windows 3.X           3/96          2/98         $ 2,000
                                             IPX              Windows 95
                                                              Windows NT

Group               Meeting Maker            NetWare          Windows 3.X           3/91          8/97         $ 8,799
Scheduling                                   IPX              Windows NT
                                                              Windows 95
                                             TCP/IP           O/S2, UNIX
                                                              Power Macintosh
                                             Apple Talk       Macintosh

E-mail              Notework                 NetWare          DOS, Windows 3.X      2/90          6/97         $ 5,759
                                                              Windows 95
                                                              Windows NT

                    DaVinci E-mail           NetWare          DOS, Windows 3.X      2/88         11/95         $ 6,159
                                                              Windows 95
                                                              Windows NT
</TABLE>
(1)  Some products were first released prior to the Company's ownership.
(2)  U.S. list prices at December 31, 1997.
This report includes trademarks of companies other than the Company.  All other
company or product names are trademarks or registered trademarks of their
respective owners.

                                       3
<PAGE>

ENTERPRISE DESKTOP MANAGEMENT SOFTWARE
--------------------------------------

BACKGROUND OF THE ENTERPRISE DESKTOP MANAGEMENT BUSINESS
--------------------------------------------------------

     In many organizations, Information Technology ("IT") is increasingly viewed
as a strategic resource rather than simply as a support function.  At the same
time, IT organizations are under increasing pressure to support more PCs with
fewer resources as well as deliver a higher quality of service (or risk being
outsourced).  For example, reducing PC downtime is a major concern for many
organizations because downtime can quickly result in lost revenues or lost
customers due to the unavailability of mission-critical applications.  The
dynamics of the current business and technology environment are also placing
significant demands on IT, such as the need to update desktop PCs with Year
2000-compliant applications and BIOS (Binary Input Output System) programs,
migrate operating system environments from Microsoft Windows 3.1 or OS/2 to
Microsoft Windows 95 or Windows NT, install and configure large numbers of new
and more powerful desktop PCs to support new applications such as electronic
commerce and multimedia, and manage continuous change in the configuration of
desktop clients.

     Traditionally, IT tasks such as PC software installation, configuration and
repair have been handled in a manual, hands-on manner.  In many organizations,
this typically involves sending a technician with a CD-ROM drive to a remote
location, the manufacturing floor, or the trading floor, for example.  In
addition, detailed information about end-user PC configurations -- such as
individualized parameters (username/password, IP address, default font, etc.),
list of installed software and revisions, and dependencies between installed
software packages -- has traditionally been managed in an ad hoc manner, making
it difficult and time-consuming to repair and reconfigure PCs in case of
hardware failure, user misconfiguration, or the addition of new software
packages.

     ON Command CCM is an open and scalable software system for managing
desktop PCs in enterprise networks.   CCM provides total desktop control from a
central administrative workstation, virtually eliminating the need to dispatch
technicians to implement common IT operations at the end-user desktop.  For
example, CCM can remotely install operating system software, update client
application software, or re-configure desktop parameters such as IP addresses or
default screen resolution  on multiple PCs simultaneously, from a central
administrative console.

     ON Command CCM is a scalable system that allows IT organizations to
automate repetitive and error-prone tasks and manage them on an enterprise-wide,
group-wide, or individual PC  basis.  Key benefits of CCM include significantly
reduced Total Cost of Ownership (TCO), enhanced quality of service for IT
organizations, and the ability to rapidly implement strategic enterprise-wide
technology initiatives.

     ON Command CCM is typically targeted at large organizations with 500 to
5,000 PCs. It is primarily sold and supported via a direct sales organization in
the United States, Germany, the United Kingdom and Scandinavia. In addition, ON
is currently exploring partnerships with local resellers and systems integrators
outside of these areas.

     ON Command CCM is an updated and enhanced version of Integra SME, which was
originally developed by csd Software GmbH for the German market in 1992. Since
acquiring csd in January 1997, the Company has continued development and support
of the product, both in the United States and Germany. The first English-
language version of the product was renamed ON Command CCM and launched in the
United States in July 1997; it has since been enhanced in a number of ways
including adding support for Microsoft Windows NT servers as well as the DHCP
(Dynamic Host Configuration Protocol) networking standard.

ON COMMAND CCM'S CAPABILITIES:
-----------------------------

*    Remote Installation of Operating Systems and Applications: CCM's advanced
     ---------------------------------------------------------
     Pre-OS Agent takes control of the PC regardless of its state, allowing the
     system to reformat the disk and install operating systems under central
     control-- even when the PC's hard disk is blank, has been corrupted or
     misconfigured, or when the operating system or network operating system
     (NOS) are not operational. ON Command CCM can also be used to implement
     enterprise-wide operating system upgrades from Windows 3.x or OS/2 to
     Windows 95 or NT, for example. In addition, ON Command CCM can be used to
     install application software packages such as Office 97, Lotus Notes,
     Netscape Navigator, or Year 2000-compliant client side versions of SAP R/3
     or Oracle, for example.

*    Native Install Technology: ON Command CCM installs software by remotely
     -------------------------
     executing standard vendor installation procedures on the target PC. This
     approach is highly reliable because vendor procedures typically adapt in
     real-time to specific PC hardware and software configurations. In addition,
     ON Command CCM's installation technology uses a parametric approach that
     makes it extremely easy to create customized installations for individual
     users or groups of users, simply by modifying a parameter table used to
     drive the installation process from the administrative console. In
     comparison, traditional "snapshot" software installation approaches are
     unreliable and difficult to customize because they blindly copy bulk images
     or binary files to the target PC, based on an idealized hardware and
     software configuration and particular set of installation choices.

*    Remote Configuration of Desktop Parameters: ON Command CCM's Intelligent
     ------------------------------------------
     Desktop Agents can remotely configure parameters such as IP or gateway
     addresses, default printers, or application options such as default fonts
     and URL home pages. In addition, these parameters are stored on the central
     ON Command CCM server so that they can be quickly reloaded in case of
     failure or misconfiguration.

*    Scalable Architecture: ON Command CCM offers powerful grouping
     ---------------------
     capabilities that allow IT organizations to administer groups of PCs as
     single administrative objects. For example, PCs can belong to one or
     multiple groups based on hardware manufacturer, physical location, or
     functional organization. Network scalability is also supported by ON
     Command CCM's ability to perform job scheduling and bandwidth management to
     minimize network load, and by its use of IP as the underlying protocol for
     optimum efficiency.

*    Enterprise-Class Robustness and Ease-of-Use: ON Command CCM offers a
     -------------------------------------------
     number of capabilities for robust operation in enterprise environments,
     including pre- and post-installation dependency checking and detailed
     logging to support automatic

                                       4
<PAGE>

     restart in case of network or power outages. An intuitive Windows-based GUI
     is used for administering and monitoring the status of client management
     tasks, and administering client configuration information.

*    Support for Industry Standards and Heterogeneous Environments: ON Command
     -------------------------------------------------------------
     CCM supports standard servers (Sun Solaris, HP-UX, Sinix (German version
     only), Microsoft Windows NT Server), standard clients (DOS, Windows 3.x,
     Windows 95, Windows NT Workstation), and standard networks (IP, DHCP, and
     boot protocols, Ethernet and Token-Ring connectivity). The Company
     monitors evolving desktop management standards closely and intends to
     support them when appropriate.

*    Open Architecture: ON Command CCM is based on an open architecture that
     -----------------
     allows customers and partners to create customized software installation
     and configuration procedures using the InstallCam(TM) Development
     Environment and the ITool language.

GROUPWARE SOFTWARE
------------------

     Meeting Maker is a client/server, cross-platform network scheduling
     -------------
application that automates the process of proposing meetings, coordinating
agendas, and securing meeting locations with the necessary equipment. To
schedule a meeting using Meeting Maker, a user merely proposes a time for the
meeting and selects the guests. The Meeting Maker client checks with the Meeting
Maker server to determine whether all guests are available at the appointed
time. On approval from the meeting initiator, Meeting Maker will issue an
invitation to all guests. If they are not available, Meeting Maker can
automatically determine the first time when all guests are available to meet.
Meeting Maker then tracks the RSVPs from guests in order to keep the host
informed as to the people who will and will not attend the meeting. Through its
cross-platform architecture, Meeting Maker can be run on Windows (Windows
3.1/95/NT), Macintosh, PowerMac, Unix, and OS/2 workstations -- or seamlessly on
any combination of these platforms in an integrated environment. Meeting Maker
supports networks running either TCP/IP, IPX, AppleTalk, NetBIOS -- or any
combination of these protocols. Large enterprise installations can use the
Windows NT or UNIX server options to support thousands of users; workgroups
typically use a Windows, Macintosh or NetWare server platform. Using IP,
organizations can easily connect Meeting Maker servers around the world via the
Internet. With support for SMTP and MAPI, Meeting Makers can easily send meeting
notices to colleagues, customers, business partners and vendors through many
e-mail packages. Mobile users can use Meeting Maker with their Newton, Psion,
Casio, Sharp, HP, Windows CE V2.0, Palm Pilot and Timex Data Watch portable
devices.

     Notework is an entry-level, easy to use e-mail application for NetWare
     --------
LANs.  While offering the basic features required by practically all e-mail
users, Notework is designed to be installed in five minutes, used by end-users
within five minutes, and administered with minimal effort.  Notework maintains
its simplicity by eliminating complex and little used features while making it
less complicated to perform basic e-mail functions, such as creating, sending,
reading and filing mail.  Support is provided for DOS, Windows, Windows NT, and
Windows under OS/2.  Notework Mobile Office extends the simplicity theme over to
remote users by utilizing the same mail address for both LAN-based and remote
messages -- providing a convenience factor that even sophisticated e-mail
packages cannot offer.  With a gateway in place, Notework can interoperate with
most private and commercial e-mail systems.

     DaVinci eMAIL is a full-featured e-mail application for DOS, Windows,
     -------------
and Macintosh client platforms.  Although DaVinci can run on most types of LANs,
the majority of its installations are operating on NetWare networks.  DaVinci's
administrative functions are designed to benefit from NetWare's underlying
binderies and user directories to eliminate the need for an administrator to
create each user twice, once for the network and once for e-mail.  DaVinci
supports the new, robust MHS Services transport under NDS and NetWare 4.1, and
also supports NetWare 2.x and 3.x, Global MHS 2.0, Connect2 and MHS 1.5. Behind
its intuitive and easy-to-use interface is a powerful and customizable
application.  A configurable toolbar, conversation threading, collapsible
folders, as well as add-on modules for Rules and Remote users, make DaVinci
eMAIL suitable for large organizations and medium-to-small businesses alike.


SALES AND MARKETING
-------------------

     Beginning late in 1996, the Company began its Enterprise Sales program.
This effort focuses on key accounts with larger companies where the opportunity
exists for volume sales and long-term, repeat business. Through the Enterprise
Sales program, the Company is building relationships in which its knowledge of
the customer's needs translates into purchasing advantages and improved support.
Regular visits to the customer's site provide the Company's sales represenatives
with valuable feedback for technology development, future upgrades and service
enhancements. The Company has established

                                       5
<PAGE>

direct sales and support offices in Cambridge, Massachusetts; Tarrytown, New
York; Somerset, New Jersey; and Washington, D.C.

Marketing Programs
------------------

     The Company believes that active marketing is necessary to effectively
communicate to both existing and potential customers the breadth and depth of
the Company's product offerings and new directions in the Company's business or
product strategy.  The Company promotes its products through ongoing contact
with industry press and analysts, a corporate presence on the World Wide Web
(www.on.com), participation in industry trade shows, and regional seminars, and
------------
printed marketing collateral.  The Company also uses direct marketing to
identify and qualify potential customers, particularly in the Groupware
business.

     The Company distributes its Meeting Maker software trials through
electronic distribution via the Internet. The Company operates a World Wide Web
server on the Internet and has its free trials available for download from that
server.

     ON has a limited number of original equipment manufacturer arrangements.
Total revenue derived through these arrangements, however, is not significant.
The Company also attends trade shows and publishes quarterly newsletters which
are mailed to existing and prospective customers.

Business Alliances
------------------

     The Company has established a number of business alliances which are
intended to strengthen its marketing and product development programs. These
include alliances with:

*    Funk Software Inc: The Company offers Funk Software's Proxy software which
     -----------------
     has been repackaged as ON Command Remote(TM), an optional component of ON
     Command CCM which provides one-on-one remote control of desktop clients
     from the administrative console.

*    LANworks Technologies Inc: The Company and Lanworks jointly develop
     -------------------------
     software and firmware that enables ON Command CCM's pre-OS agents to be
     loaded from the network when a PC boots, using Lanwork's Bootware
     technology, without the need for human intervention at the desktop.

*    Microsoft Corporation: The Company is a participant in the Microsoft
     ---------------------
     Developers Network (MSDN) Partner Program for ISVs(C), Microsoft Windows NT
     Solution Provider Program, and the Windows NT 5.0 Early Adopters Program.

*    Sun Microsystems Corp: The Company participated in Sun's announcement of
     ---------------------
     the Sun Enterprise 450 Server, has developed joint marketing collateral
     with Sun, and is working with Sun to identify resellers and customers who
     are interested in using Sun Solaris servers to manage networks of Microsoft
     based desktop clients using ON Command CCM.

*    Tally Systems Corporation: Through a worldwide value-added reseller
     -------------------------
     agreement, the Company offers Tally Systems NetCensus inventory management
     software as an optional component of ON Command CCM.

*    Tivoli Systems Inc: The Company is working with Tivoli to achieve Premier
     ------------------
     Partner status as part of Tivoli's 10/Plus Association partnership program,
     relative to the ON Command CCM product.

*    3Com Corporation: The Company's ON Command CCM software and  3Com's
     ----------------
     enhanced Network Interface Cards (NICs) and its Managed PC Boot Agent (MBA)
     technology can be used together to create a Managed PC environment.


PRODUCT DELIVERY
----------------

     The Company has a variety of means to fulfill the product demand created by
its marketing programs. ON Command CCM will be delivered directly to customers
by the Company's field organization. Other methods of distribution may include
system integrators, full service distributors and OEMs. The Company also has
additional experience with the following product delivery techniques:

                                       6
<PAGE>

     Direct Fulfillment
     ------------------

     Most of the Company's orders for its Groupware products are delivered
through direct fulfillment contractors that manufacture and assemble components,
store inventory, and process customer orders received from ON for either same or
next day shipment. Orders are recorded by the ON sales department and
transferred electronically to the fulfillment contractor for processing. ON owns
all of its inventory and has an in-house production staff to purchase inventory
and help ensure availability for shipments. Once orders are shipped by the
fulfillment contractor, shipping confirmation is returned to ON electronically.

     Independent Distributors
     ------------------------

     ON utilizes independent distributors to market its products (other than ON
Command CCM) internationally and, to a substantially lesser extent, in North
America. ON's international distributors are responsible for marketing the
Company's software and for providing technical and customer support to their
customers. While these distributors include some large systems integrators, most
are small companies that market ON's software along with products of other
companies that they represent. The agreements between the Company and its
international distributors typically obligate the distributor to provide
technical support and the most current versions of the Company's products to the
distributor's customers and to provide the Company with information about its
licensees. International distribution agreements generally are terminable by the
Company under certian circumstances, including failure of the distributor to
meet specified sales targets.

     Resellers
     ---------

     ON also markets its Groupware products through resellers, including
Corporate Software, Software Spectrum and 800 Software. These resellers focus
primarily on licensing the Company's software to corporate and government
customers.

CUSTOMERS
---------

     The Company markets its products primarily to large and medium size
corporate, government and institutional customers. None of the Company's
customers accounted for more than 10% of the Company's total revenue in 1994,
1995, 1996 and 1997.

CUSTOMER SUPPORT
----------------

     ON Command CCM Customers
     ------------------------

     The Company employs professional technical support staff in Starnberg,
Germany and Cambridge, Massachusetts to support CCM customers via telephone
hotline, electronic mail and on-site visits. On-site training is also available
on a case-by-case basis.

     GROUPWARE CUSTOMERS
     -------------------

     The Company employs professional technical support staff in Cambridge,
Massachusetts to support its Groupware customers via telephone, fax and
electronic mail. On-site visits are available for the Groupware product Meeting
Maker.

RESEARCH AND DEVELOPMENT
------------------------

     The Company's product development organization, currently consisting of 46
employees and additional full-time and part-time contract programmers, is
responsible for developing new products, adapting acquired products to fit the
ON product strategy and enhancing existing products. Generally, the Company's
contract programmers do not work exclusively for the Company. In addition, the
development organization provides free trial expiration technology, registration
technology and installation technology to third party developers who are
building products for license to ON.

     During product tests, ON dedicates staff from the support and sales
department to monitor alpha and beta sites and solicit detailed reports on
usability and errors occurring in customer environments. Many quality assurance
personnel have been recruited from the technical support department because they
are able to test products with greater awareness of the issues which ight
confuse customers.

     The Company's research and development expenses were approximately
$7,014,000, $9,456,000 and $12,461,000 in 1995, 1996 and 1997, respectively,
excluding charges for purchased incomplete research and development projects.
The Company's practice to date has been to expense all software development
costs as incurred.

                                       7
<PAGE>

COMPETITION
-----------

     The market for the Company's products is highly competitive, and the
Company expects competition to increase in the future. The Company believes that
the principal competitive factors affecting the market for its products include
performance, functionality, ease of use, ease of installation, quality, customer
support, breadth of product line, speed of product delivery, frequency of
upgrades and updates, brand name recognition, company reputation, adherence to
industry standards, integration with third-party solutions and price. Certain of
the criteria upon which the performance and quality of the Company's Groupware
software to compete include speed of response, ease of use, interoperability
with other messaging systems and simplicity of administration. Certain of the
Company's competitors in the Enterprise Desktop Management Software market, such
as Microsoft, Intel, IBM/Tivoli, Hewlett Packard, Computer Associates, Seagate
and McAfee, are larger and have greater resources and name recognition than the
Company.

     In the Enterprise Desktop Management market, the Company faces competition
from large and established companies, such as Microsoft, Intel, Computer
Associates and IBM/Tivoli, which offer client management capabilities as part of
their systems, network and/or desktop management systems. Moreover, Microsoft
has announced the Zero Administration Initiative for Windows ("ZAW"), which
includes a set of technologies that address some of the same client management
issues as ON Command CCM. Microsoft has announced that components of ZAW will be
available for future versions of the Windows NT and Windows 95 operating
systems, as well as the Microsoft Systems Management Server product. There can
be no assurance that the Company can continue to compete effectively against
Client Management software which is included free with operating system
software.

     As is the case in many segments of the software industry, the Company may
encounter increasing price competition in the future. This could reduce average
selling prices and, therefore, profit margins. Competitive pressures could
result not only in sustained price reductions but also in a decline in sales
volume, which could adversely affect the Company's business, condition
(financial or otherwise), prospects or results of operations. There can be no
assurance that the Company will continue to compete effectively against existing
and potential competitors in the Groupware Software market, many of whom have
substantially greater financial, technical, marketing and support resources and
name recognition than the Company.

     The Groupware Software market is highly fragmented, with products offered
by many vendors. In the e-mail market, the Company competes with offerings from
CE Software, Infinite Technologies, Lotus, Microsoft, Novell, Netscape, and
numerous shareware and freeware developers. In the group scheduling market, the
Company competes with Campbell Services, CE Software, Lotus, Microsoft,
Microsystems Software, Novell, Now Software, and with personal information
managers products ("PIMs") that have been enhanced to include some group
scheduling features. Lotus, Microsoft and Novell have in the past bundled
communications software with their operating system products or software
application suite offerings and have publicly announced, or the Company believes
are likely to provide, such bundles with future offerings. There can be no
assurance that the Company can continue to compete effectively against
communications software which is included free with the operating system, as
these bundled products are improved in the future. In addition, the trend toward
enterprise-wide communications software solutions may result in a consolidation
of the communications software market around a smaller number of vendors who are
able to provide all of the necessary software and support capabilities.

     Historically, the Company's international revenue from sales of its
Groupware products have been generated primarily through independent
distributors in Europe, Australia, Israel, South Africa and South America,
certain of which are bound by contracts with the Company but which generally do
not represent the Company exclusively. The Company's Starnberg, Germany office
primarily supports and markets ON Command CCM throught Germany. The competitive
environment for groupware software tools internationally is similar to that in
North America. The Company has only recently begun to compete in Asian markets,
which have significantly lagged behind North America and Europe in their
adoption of LAN technology. There can be no assurance that the Company will be
able to continue to compete successfully in international markets.

     The widespread inclusion of the functionality of the Company's products as
standard features of operating systems software could render the Company's
products obsolete and unmarketable, particularly if the quality of such
functionality were comparable to that of the Company's products. If the Company
were unable to develop new communications and network management software to
further enhance operating systems and to replace successfully any obsolete
products, the Company's business, condition (financial or otherwise), prospects
and results of operations would be materially and adversely affected.


                                       8
<PAGE>

PROPRIETARY TECHNOLOGY
----------------------

     The Company's success is heavily dependent upon its proprietary software
technology. The Company relies on a combination of contractual rights,
trademarks, trade secrets and copyrights to establish and protect its
proprietary rights in its software.

     The Company uses a printed "shrink-wrap" license for users of its Groupware
products distributed through traditional distribution channels in order to
protect its copyrights and trade secrets in those products.  Since these shrink-
wrap licenses are not signed by the licensee, many authorities believe that they
may not be enforceable under many state laws and the laws of many foreign
jurisdictions.  If such licenses are not enforceable, the user would not be
bound by the terms thereof, including the terms which seek to protect the
Company's proprietary technology.  If the printed shrink-wrap licenses prove to
be unenforceable, this may have a material adverse effect on the Company's
business, condition (financial or otherwise), prospects and results of
operations.

     The Company has signed license agreements from users of its Enterprise
Desktop Management products to protect its copyrights and trade secrets in those
products. The licenses may not be enforceable under some state laws and the laws
of many foreign jurisdictions. If such licenses are not enforceable, the user
would not be bound by the terms thereof, including the terms which seek to
protect the Company's proprietary technology. If the signed license agreements
prove to be unenforceable, this may have a material adverse effect on the
Company's business, condition (financial or otherwise), prospects and results of
operations.

     The laws of some foreign countries either do not protect the Company's
proprietary rights or offer only limited protection for those rights.
Furthermore, in countries with a high incidence of software piracy, the Company
may experience a higher rate of piracy of its products.

     The Company has obtained registrations in the United States for the
following trademarks: ON Technology, Notework, Meeting Maker, ON Technology &
Design, ON Location, Instant Update and DaVinci Systems.  The Company has filed
for the trademark "ON Command CCM" in the United States, the European Community,
Canada and Australia.  The Company has obtained only four foreign registrations
of its Notework mark and two foreign registrations of its Meeting Maker mark,
due to significant costs involved in obtaining foreign registrations.  As a
result, the Company may not be able to prevent a third party from using its
trademarks in many foreign jurisdictions.  The Company has not to date
registered any of its copyrights.

     There can be no assurance that the steps taken by the Company to protect
its proprietary software technology will be adequate to deter misappropriation
of this technology.  Lesser sensitivity by corporate, government or
institutional users to avoiding copyright infringement could have a material
adverse effect on the Company's business, conditions (financial or otherwise),
prospects and results of operation.

     There has also been substantial litigation in the software industry
involving intellectual property rights, although, to date, the Company has not
been subject to any such litigation. Although the Company does not believe that
it is infringing the intellectual property rights of others, there can be no
assurance that such claims, if asserted, would not have a material adverse
effect on the Company's business, condition (financial or otherwise), prospects
and results of operations. In addition, as the Company may acquire or license a
portion of the software included in its future products from third parties, its
exposure to infringement actions may increase because the Company must rely upon
such third parties for information as to the origin and ownership of any
software being acquired. The Company generally obtains representations as to the
origin and ownership of such acquired or licensed software and generally obtains
indemnification to cover any breach of such representations. However, there can
be no assurance that such representations are accurate or that such
indemnification will provide adequate compensation for a breach of such
representations. In the future, litigation may be necessary to enforce and
protect trade secrets and other intellectual property rights owned by the
Company. The Company may also be subject to litigation to defend against claimed
infringement of the rights of others or to determine the scope and validity of
the proprietary rights of others. Any such litigation could be costly and cause
diversion of management's attention, either of which could have a material
adverse effect on the Company's business, financial condition or results of
operations. Adverse determinations in such litigation could result in the loss
of the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or prevent
the Company from manufacturing or selling its products, any one of which could
have a material adverse effect on the Company's business, financial condition or
results of operations. Furthermore, there can be no assurance that any necessary
licenses will be available on reasonable terms, or at all.

OPERATIONS
----------

     The Company designs most of its product, marketing and sales materials in-
house.  Product orders are fulfilled under contract with outside fulfillment
agencies.  The balance of other sales and support calls are handled directly by
the Company.

                                       9
<PAGE>

EMPLOYEES
---------

     From December 31, 1996 to December 31, 1997, the number of Company
employees decreased from 288 to 142, primarily due to the restructurings
implemented by the Company in the third and fourth quarters of 1997 and the
implementation of the Management Agreement with Elron.  Competition for
qualified management and technical personnel is intense in the software
industry.  The Company's continued success will depend in part on its ability to
attract and retain qualified personnel.  None of the Company's employees is
represented by a labor union and the Company believes that its employee
relations are good.

MANAGING BUSINESS GROWTH WITH ACQUISITIONS
------------------------------------------

     The Company may in the future undertake acquisitions that could present
challenges to the Company's management, such as integrating and incorporating
new operations, product lines, technologies and personnel.  If the Company's
management is unable to manage these challenges, the Company's business,
financial condition or results of operations could be materially adversely
affected.  Any acquisition, depending on its size, could result in the use of a
significant portion of the Company's available cash, or if such acquisition is
made utilizing the Company's securities, could result in significant dilution to
the Company's stockholders.  Furthermore, there can be no assurance that any
acquired products will gain acceptance in the Company's markets.

ITEM 2.  PROPERTIES

    The Company's headquarters, located in Cambridge, Massachusetts currently
occupies approximately (i) 20,600 square feet under a lease expiring September
30, 1999; and (ii) approximately 19,500 square feet under a sublease ("11 Floor
Sublease") also expiring September 30, 1999. The 11th Floor Sublease has been
assigned to Elron as part of the Elron Transaction.  The Company's Raleigh,
North Carolina offices occupy approximately 6,900 square feet under a lease
expiring February 28, 2002. The Company's subsidiary DaVinci Systems
Corporation, leased approximately 33,100 square feet of space in Morrisville,
North Carolina pursuant to a lease expiring October 31, 1999. This property was
subleased to Northern Telecom Inc. The Company's Marietta, Georgia offices
occupy approximately 3,500 square feet under a lease expiring July 31, 1999. The
Company's United Kingdom offices occupy approximately 14,000 square feet under a
lease expiring September 21, 1998. The Company's Starnberg, Germany offices
occupy 10,174 square feet pursuant to a lease expiring July 31, 1999. The
Company believes that its existing facilities are adequate for the present and
that additional space will be available as needed.

ITEM 3  LEGAL PROCEEDINGS

     The Company is not a party to any material legal proceedings.

ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.

                                       10
<PAGE>

                                    PART II
                                    -------

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

PRICE RANGE OF COMMON STOCK
---------------------------

     The Company effected its initial public offering on August 1, 1995 at a
price of $15.00 per share. Since that date, the Company's Common Stock has
traded on the Nasdaq National Market under the symbol ONTC. The following table
sets forth, for the period indicated, the high and low closing sales prices for
the Common Stock, all as reported by Nasdaq.
<TABLE>
<CAPTION>
                                         High     LOW
                                       ------  -------
<S>                                    <C>     <C>

YEAR ENDED DECEMBER 31, 1997
First Quarter                          $ 6.25  $  3.50
Second Quarter                           4.25     2.50
Third Quarter                            4.375    2.5625
Fourth Quarter                           3.75     1.1563
YEAR ENDED DECEMBER 31, 1996
First Quarter                           19.13    11.00
Second Quarter                          14.75    10.25
Third Quarter                           10.63     4.63
Fourth Quarter                           7.88     5.00
YEAR ENDED DECEMBER 31, 1995
Third Quarter (from August 1, 1995)     19.50    14.75
Fourth Quarter                          17.00    12.00
</TABLE>

     As of December 31, 1997 there were approximately, 1,918 stockholders of
record of the Companys Stock.

DIVIDEND POLICY
---------------

     The Company has not declared or paid cash dividends on its Common Stock
since 1992 when it converted from an S Corporation to a C Corporation. The
Company currently intends to retain any earnings for use in developing and
growing its business, and does not anticipate paying any cash dividends on its
Common Stock in the foreseeable future. The Company's bank line of credit does
not contain any restrictions on the payment of dividends, unless the payment of
such dividends would result in a default thereunder.

RECENT SALES OF UNREGISTERED SECURITIES
---------------------------------------

     During 1996 and the first quarter of 1997, the Company issued 2,042,561
shares of its common stock with an aggregate fair value of $17,751,143 as part
of the consideration for the acquisitions of neTrend Corporation, Leprechaun
Software International, Ltd. and csd Software GmbH, respectively. Each such sale
was a private offering. The Company relied on Section 4(2) of the Securities Act
of 1993 (the "Securities Act") for the exemption of such sales from registration
under the Securities Act. See "Notes to Consolidated Financial Statements".

                                       11
<PAGE>

ITEM 6.

SELECTED CONSOLIDATED FINANCIAL DATA
------------------------------------

     The following table sets forth selected financial data derived from the
Consolidated Financial Statements of the Company. The Consolidated Financial
Statements have been audited by Arthur Andersen LLP, independent public
accountants. The data should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto and with Management's Discussion and
Analysis of Financial Condition and Results of Operations.
<TABLE>
<CAPTION>
                                                                        Years Ended December 31,
                                               ------------------------------------------------------------------------
                                                     1993       1994          1995           1996           1997
                                               ------------------------------------------------------------------------
                                                             (Dollars in thousands, except per share data)
<S>                                              <C>           <C>           <C>            <C>            <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
  Net product revenue                             $ 7,728       $25,240       $43,381        $ 50,165       $ 36,630
  Other revenue                                       177           588           740           1,627          4,652
                                               ------------------------------------------------------------------------
     Total revenue                                  7,905        25,828        44,121          51,792         41,282
                                               ------------------------------------------------------------------------

Operating expenses:
  Cost of product revenue                             763         6,716         8,199          11,951          9,315
  Sales and marketing                               5,009        10,824        20,984          24,176         22,172
  Research and development                          2,364         5,277         7,014           9,456         12,461
  General and administrative                        1,183         2,319         3,184           4,407          5,501
  Charge for purchased research
     and development                                1,537         4,700           ---          13,285         15,898
 Charge for restructuring                             ---           ---           ---           5,415         10,940
                                               ------------------------------------------------------------------------
Income (loss) from operations                      (2,951)       (4,008)        4,740         (16,898)       (35,005)
Interest income (expense), net                        (13)          (80)          554           1,134            233
                                               ------------------------------------------------------------------------
Income (loss) before provision
  for taxes                                        (2,964)       (4,088)        5,294         (15,764)       (34,772)
Provision for income taxes                            ---           (11)       (1,622)            (97)           ---
Net income (loss)                                 $(2,964)      $(4,099)      $ 3,672        $(15,861)      $(34,772)
                                               ========================================================================

Basic earnings per share (1)                      $(1.01)       $(1.27)       $0.52          $(1.46)        $(2.88)
                                               ========================================================================

Diluted earnings per share (1)                    $(1.01)       $(1.27)       $0.40          $(1.46)        $(2.88)
                                               ========================================================================

Basic weighted average shares outstanding           2,923         3,224         6,314          10,854         12,079
                                               ========================================================================

Diluted weighted average shares outstanding         2,923         3,224         9,087          10,854         12,079
                                               ========================================================================

</TABLE>

<TABLE>
<CAPTION>
                                                                              December 31,
                                               ------------------------------------------------------------------------
                                                     1993       1994          1995           1996           1997
                                               ------------------------------------------------------------------------
                                                                         (Dollars in thousands)
<S>                                              <C>           <C>           <C>            <C>            <C>
CONSOLIDATED BALANCE SHEET DATA:
  Cash and cash equivalents                       $   101       $ 2,798        $33,338       $ 20,774       $  6,679
  Working capital (deficit)                        (1,182)        1,299         35,562         25,347          3,803
     Total assets                                   3,929        13,168         50,173         44,142         17,382
  Long-term obligations, less current
     portion                                          280           878          1,506            510             10
  Redeemable convertible preferred stock            3,205        12,188            ---            ---            ---
  Total stockholders' equity (deficit)             (3,235)       (7,840)        40,306         33,493          6,996
</TABLE>

(1) Computed on the basis described in Note 1 of notes to consolidated financial
statements.

                                       12
<PAGE>

ITEM 7

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

OVERVIEW

     ON Technology Corporation and Subsidiaries (the "Company") is engaged in
the development, marketing, sales support, and distribution of Groupware and
Client Management software.

     During 1996, the Company completed three acquisitions. The Company acquired
all of the assets and assumed certain liabilities of Leprechaun Software
International, Ltd., certain technology of neTrend Corporation and certain
intangible assets of Technocom plc. In 1997, the Company acquired all of the
stock of csd Software GmbH, a German developer and marketer, of enterprise
client management software and acquired the stock of Purview Technologies Inc.,
a development stage company engaged in Internet usage monitoring software
development.

     On October 29, 1997, the Company announced that it would seek shareholder
approval to sell its Network Management and Network Security Business along with
related marketing systems and organization (the "Assets") to Elron Software Inc.
("Elron"), a wholly owned subsidiary of Elron Electronics Industries (the "Elron
Transaction"). In addition, on October 29, 1997, the Company entered into a
management agreement with Elron (the "Management Agreement"), pursuant to which
Elron agreed to manage the Assets for its benefit and at its risk and expense
and to pay all salaries and other employee related expenses with respect to the
Assets and transferred employees. As a result of the Management Agreement, the
associated revenues and costs of the Assets have been excluded from the
statement of operations for the period from October 30, 1997 to December 31,
1997. On February 11, 1998, the Company consummated the Elron Transaction.

RESULTS OF OPERATIONS
---------------------

The following table sets forth, for the years indicated, certain financial data
as percentages of the Company's total revenue:

<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                           ---------------------------------------------------
                                                  1995             1996              1997
                                           ---------------------------------------------------
<S>                                          <C>             <C>               <C>
Revenue:
     Net product revenue                              98.3%             96.9%             88.7%
     Other revenue                                     1.7               3.1              11.3
                                           ---------------------------------------------------
       Total revenue                                 100.0             100.0             100.0
                                           ---------------------------------------------------
Operating expenses:
     Cost of product revenue                          18.6              23.1              22.6
     Sales and marketing                              47.6              46.6              53.7
     Research and development                         15.9              18.3              30.2
     General and administrative                        7.2               8.5              13.3
     Charge for purchased R&D                           --              25.6              38.5
     Charge for restructuring                           --              10.5              26.5
                                           ---------------------------------------------------
Income (loss) from operations                         10.7             (32.6)            (84.8)
                                           ---------------------------------------------------
Interest income, net                                   1.3               2.2               0.6
                                           ---------------------------------------------------
Net income (loss) before provision for
 income taxes                                         12.0             (30.4)            (84.2)
                                           ---------------------------------------------------
Provision for income taxes                            (3.7)              (.2)              ---
                                           ---------------------------------------------------
Net income (loss)                                      8.3%           (30.6)%           (84.2)%
                                           ===================================================
</TABLE>

NET PRODUCT REVENUE.  The Company's net product revenue is derived primarily
-------------------
from the licensing of software products. Net product revenue also includes
revenue from catalog sales of third party products and catalog advertising
space. The Company sells advertising space in its catalog for cash or receives
third party advertised product.  Revenue for catalog advertising space for cash
sales is recognized the day the catalog is mailed to customers.  Revenue for
third party advertised product received is recognized as each item is sold.
Revenue from catalog advertising sales that was recognized upon sale of third
party products for the years ended December 31, 1995, 1996 and 1997 was $2.4
million, $2.5 million, and $902 thousand, respectively.  As a result of the
Management Agreement and the subsequent consummation of the Elron Transaction,
the Company has not received since October 30, 1997, and will no longer receive
revenue, from catalog product sales and catalog ad page space.

                                       13
<PAGE>

Net product revenue increased 15.6% from 1995 to 1996, due primarily to the
increase in volume of sales of communications and new network management
software to new customers and to customers upgrading existing licenses. Net
product revenue decreased 27% from 1996 to 1997, due primarily to products de-
emphasized as part of the strategic reorganizations and restructurings
undertaken in 1997 and the consumation of the Elron Transaction. The Company
anticipates that net product revenue will decrease in 1998 in absolute dollars
due to the consummation of the Elron Transaction.

OTHER REVENUE.  The Company's other revenue consists of rentals of portions of
-------------
the Company's customer lists, royalties received in connection with licensing
ON's software to third parties and maintenance revenue.  Other revenue increased
by 119.9% from 1995 to 1996, and 186% from 1996 to 1997.  These increases were
primarily attributable to an increase in revenue from maintenance agreements.
The Company anticipates that other revenue may decrease in 1998 in absolute
dollars due to the Elron Transaction.

COST OF PRODUCT REVENUE.  Cost of product revenue consists primarily of expenses
-----------------------
associated with product documentation, production and fulfillment costs, and
royalty fees associated with products that are licensed from third party
developers.  In addition, cost of product revenue includes the cost of third
party products resold through the Company's catalog, the cost of producing the
catalog and amortization of purchased intangibles.  Cost of product revenue
increased as a percentage of total revenue from 18.6% in 1995 to 23.1% in 1996.
This increase was primarily due to a $571 thousand elimination of profit for
inventory previously sold to Technocom, plc, prior to the Company's acquisition
of Technocom's LAN Software business, a $2.0 million inventory write down
related to the restructuring in the third quarter of 1996, and an increase in
product sales from 1995 to 1996. As part of the Company's 1996 restructuring
plan and reorganization of its operations, the Company decreased its emphasis on
the e-mail business and certain catalog products and ceased to market, sell,
develop, and support other product lines.  As a result, the product inventory
relating to the de-emphasized products, and discontinued product lines were
subsequently identified and written off, all of which is included in cost of
product revenue in the amount of $2.0 million.  The product sales related
increase was consistent as a percentage of total revenue from 1995 to 1996.
Cost of product revenue decreased as a percentage of total revenue from 23.1% in
1996 to 22.6% in 1997.  This decrease was primarily the result of decreased
product revenue.  As part of the reorganization of its operations announced in
July 1997, the Company has ceased to market, sell, develop and support the anti-
virus business and decreased its emphasis on the investment in new customer
acquisitions for its Groupware and Network Management and Security businesses.
As a result, the product inventory related to the discontinued product lines and
de-emphasized products were subsequently identified and written-off, all of
which is included in cost of product revenue in the amount of $849 thousand.
The Company anticipates that cost of product will decrease in 1998 in absolute
dollars due to the consummation of Elron Transaction.

SALES AND MARKETING EXPENSE.  Sales and marketing expense primarily consists of
---------------------------
compensation paid to sales and marketing personnel, the costs of  direct mail
and telemarketing campaigns, and the costs of product trials requested by
potential customers.  Sales and marketing expense also includes the costs of
administering the catalog operation, the costs of public relations, trade shows
and conferences, and the telephone and information technology costs associated
with sales activities.  Sales and marketing expense decreased slightly as a
percentage of total revenue from 47.6% in 1995 to 46.6% in 1996. This slight
decrease was a result of the 1996 restructuring of the Company, offset by the
additional sales personnel required to support the growth in the customer base,
the costs associated with the Company's marketing efforts of existing products,
the beginning of ON Technology UK Ltd's marketing programs in Europe, and the
launch of the Company's firewall product, ON Guard.  Sales and marketing expense
increased as a percentage of total revenue from 45.6% in 1996 to 53.7% in 1997.
This increase was primarily the result of decreased product revenue as a result
of the consummation of the Elron Transaction and increased sales and marketing
expenses related primarily to the Company's expansion of its Client Management
software sales and marketing effort.  The Company anticipates that sales and
marketing expense may decrease in 1998 in absolute dollars due to the Elron
Transaction.

RESEARCH AND DEVELOPMENT EXPENSE.  Research and development expense includes
--------------------------------
costs associated with the development of new products, the enhancement of
existing products, and costs associated with providing technical support.
Research and development expense increased as a percentage of total revenue from
15.9% in 1995 to 18.3% in 1996. This increase was primarily related to the
increase in the size of the product portfolio, the associated costs of product
development, enhancements and maintenance, and the additional costs associated
with the Company's acquisitions of neTrend Corporation and Leprechaun Software
International, Ltd. in the first quarter of 1996.  Research and development
expenses increased  as a percentage of total revenue from 18.3% in 1996 to 30.2%
in 1997.  This increase is primarily related to the increase in the size of the
product portfolio in the first half of the year, and the associated costs of
product development , enhancements and maintenance relating to products acquired
in the acquisitions of csd Software GmbH and Purview Technologies, Inc.  The
Company plans to continue to make significant investments in research and
development related to the Comprehensive Client Management (CCM) business.


<PAGE>

GENERAL AND ADMINISTRATIVE EXPENSE.  General and administrative expense includes
----------------------------------
executive compensation and the continued administrative expense associated with
the Company's foreign operations, executive support costs, accounting
operations, planning, and business development operations.  General and
administrative expense increased as a percentage of sales from 7.2% in 1995 to
8.5% in 1996. The increase reflects personnel growth and associated costs in
general support areas including costs associated with the Company's acquisition
of the LAN software business from Technocom plc in the first quarter of 1996,
resulting in the newly formed ON Technology UK Ltd, and the related expenses of
administering that office.  General and administrative expense increased as a
percentage of total revenue from 8.5% in 1996 to 13.3% in 1997.  The increase is
a direct result of the acquisition of csd Software GmbH and the continued
administrative expense associated with the Company's foreign operations.  The
Company anticipates the percentage of general and administrative expense to
total revenue will increase in 1998 due to reduced sales resulting from the
Elron Transaction.

CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT.  In connection with the
---------------------------------------------
acquisitions of neTrend Corporation, Leprechaun Software International, Ltd. and
the LAN Software business from Technocom plc in 1996, the Company allocated an
aggregate of $13.3 million of the respective purchase prices to incomplete
research and development projects.  These costs were expensed as of the
acquisition dates and the allocations represent the estimated fair values
related to the incomplete projects determined by appraisals using appropriate
assumptions and valuation techniques.  The development of these projects had not
yet reached technological feasibility and the technology had no alternative
future use.  The technology acquired in these acquisitions has required
substantial additional development by the Company.  The neTrend technology was
acquired in January 1996 and a limited product based on the acquired technology
was shipped in June 1996.  Development continued in the product throughout 1996
and 1997 and a commercially viable product was shipped in June 1997.  The
product development investment made by the Company in the neTrend technology
from the date of acquisition through June 1997 was approximately $1.7 million.
The Leprechaun technology was acquired in January 1996 and was developed until
July 1997 when the Company concluded that a commercially viable product could
not be completed and the project was abandoned.  Purchased R&D from the
Technocom assets was not material to the operation of the Company.  The
investment in product development made by the Company in the Leprechaun
technology from the date of acquisition through July 1997 was approximately $1.4
million.  In connection with the acquisitions of Purview Technologies, Inc. and
csd  Software GmbH in 1997, the Company allocated an aggregate of $15.9 million
of the respective purchase prices to incomplete research and development
projects.  These costs were expensed as of the acquisition dates and the
allocations represent the estimated fair values related to the incomplete
projects determined by appraisals using appropriate assumptions and valuation
techniques.  The development of these projects had not yet reached technological
feasibility and the technology had no alternative future use.  The technology
acquired in these acquisitions have required substantial additional development
by the Company.  The Purview acquisition was completed in January 1997 and a
commercially viable product was shipped in September 1997.  The product
development investment in the Purview technology made by the Company from the
date of acquisition through September 1997 was approximately $.4 million.  The
csd acquisition was completed in January 1997 and the acquired company continued
to ship its existing technology.  In August 1997, the Company first shipped the
CCM product based on the acquired technology and on Windows NT Advanced Server.
The product development investment made by the Company from the date of
acquisition through August 1997 was approximately $1.5 million.  CCM uses
client/server architecture which was incomplete at the time of the acquisition.
CCM development continues and a version of the product with an open API for
network management partners is expected to ship in the Spring of 1998.  The
additional product development investment required through the Spring of 1998 is
estimated to be approximately $3.2 million.

CHARGE FOR RESTRUCTURING.  On August 6, 1996, the Company announced that it had
------------------------
implemented a reorganization of its operations and a restructuring plan (the "96
Plan"). The 96 Plan included write-offs and write-downs of certain assets,
including accruing the costs related to a significant reduction in the Company's
work force,  primarily in the technical support and sales and marketing
departments, and the de-emphasis of certain product lines, resulting  in a non-
recurring charge of $5.4 million.  Included in the 96 Plan was an inventory
write-down of $2.0 million which is included in cost of product revenue in
accordance with Emerging Issues Task Force (EITF) 96-9, Classification of
Inventory Markdowns and Other Costs Associated with a Restructuring.

     On July 29, 1997, the Company announced that it had implemented a
reorganization of its operations and a restructuring plan (the "97 Plan").  The
97 Plan included write-offs and write-downs of certain assets, including
accruing the costs related to a significant reduction in the workforce,
primarily in the technical support and sales and marketing departments.  In
addition, the Company exited from the anti-virus business and de-emphasized its
investment in new customer acquisitions for the Company's Groupware and Network
Management and Security businesses.  As a result of the 97 Plan, the Company
recorded a restructuring charge of $4.5 million.  Included in the 97 Plan was an
additional inventory write-down of $849 thousand which is included in cost of
product revenue in accordance with EITF 96-9.

                                       15
<PAGE>

     On October 29, 1997, the Company announced it would refocus its
international sales organization to concentrate on the Client Management
Business and would close its offices in Sydney, Paris and London, while
strengthening its presence in Starnberg, Germany. As a result, the Company
recorded a restructuring charge related to the write-off and write down of
certain assets, accruing the costs related to the reduction of its international
workforce (excluding csd Software GmbH) primarily in the technical support and
sales and marketing departments and accruing the associated costs with closing
its international locations (excluding csd Software GmbH). As a result, the
Company recorded a restructuring charge of $6.4 million

INTEREST INCOME  (EXPENSE), NET.  Interest income (expense), net increased as a
-------------------------------
percent of total revenue from 1.3% in 1995 to 2.2% in 1996.  This increase was
primarily due to higher cash balances available for investment as a result of
the Company's initial public offering completed in August of 1995.  Interest
income (expense), net decreased as a percent of total revenue from 2.2% in 1996
to 0.6% in 1997.  This decrease was primarily due to lower cash balances
available for investment.

INCOME TAXES.  The tax provision for 1995 was calculated based upon the
-------------
Company's effective tax rate, giving benefit to available net operating loss and
credit carry-forwards.  In the year ended December 31, 1996, the Company
incurred a significant operating loss. However, included in the book charges
were amounts not currently deductible for income taxes.  The 1996 tax provision
includes the amount currently payable with an offsetting deferred tax benefit to
record a portion of the Company's deferred tax asset.  In the year ended
December 31, 1997, the Company incurred a significant operating loss for both
book and tax purposes and gave benefit to refundable income taxes which offset
certain foreign tax provisions and as a result no tax provision was recorded.

                                       16
<PAGE>

SELECTED QUARTERLY OPERATING RESULTS
------------------------------------

The following tables set forth certain unaudited quarterly results of operations
for each of the eight quarters in the period ended December 31, 1997.  In the
opinion of management, this information has been prepared on the same basis as
the audited Consolidated Financial Statements and includes all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of this information in accordance with generally accepted
accounting principles.  Such quarterly results are not necessarily indicative of
future results of operations and should be read in conjunction with the audited
Consolidated Financial Statements and the Notes thereto.

<TABLE>
<CAPTION>
(Dollars in thousands, except                                      THREE MONTHS ENDED
                                -------------------------------------------------------------------------------------
per share data)                   MAR. 31,   JUNE 30,  SEPT 30,   DEC. 31,  MAR. 31,   JUNE 30,   SEPT 30,   DEC. 31,
                                    1996       1996      1996       1996      1997       1997       1997       1997
                                -------------------------------------------------------------------------------------
<S>                               <C>        <C>       <C>        <C>       <C>        <C>        <C>        <C>
Revenue:
     Net product revenue          $ 10,967    $13,405   $12,248    $13,546  $ 11,460    $13,137    $ 9,051   $  2,983
     Other revenue                     342        421       389        474     1,033      1,078      1,363      1,178
                                -------------------------------------------------------------------------------------
       Total revenue                11,309     13,826    12,637     14,020    12,493     14,215     10,414      4,161
                                -------------------------------------------------------------------------------------
Operating expenses:
     Cost of product revenue         2,770      2,520     4,423      2,238     2,076      2,307      3,208      1,724
     Sales and marketing             5,471      6,577     6,172      5,953     6,306      7,189      5,501      3,176
     Research and development        1,965      2,317     2,493      2,681     3,138      3,542      3,275      2,506
     General and administrative        947      1,142     1,102      1,217     1,088      1,222      1,723      1,468
     Charge for purchased R&D       13,285         --        --         --    15,898         --         --         --
     Charge for restructuring           --         --     5,415         --        --         --      4,530      6,410
                                -------------------------------------------------------------------------------------
(Loss) income from operations      (13,129)     1,270    (6,968)     1,931   (16,013)       (45)    (7,823)   (11,123)
                                -------------------------------------------------------------------------------------
Interest income (expense), net         342        282       259        250       122         53         59         (1)
                                -------------------------------------------------------------------------------------
Net (loss) income before
 provision (benefit) for income
 taxes                             (12,787)     1,552    (6,709)     2,181   (15,891)         8     (7,764)   (11,124)
                                -------------------------------------------------------------------------------------


Provision (benefit) for income
 taxes                                 327        112      (483)       141        --        775       (642)      (133)
                                -------------------------------------------------------------------------------------
Net (loss) income                 $(13,114)   $ 1,440   $(6,226)   $ 2,040  $(15,891)   $  (767)   $(7,122)  $(10,991)
                                =====================================================================================
Basic earnings per share (1)      $ (1.22)    $  0.13   $ (0.56)   $  0.18  $ (1.35)    $ (0.06)   $ (0.58)  $ (0.90)
                                =====================================================================================
Diluted earnings per share (1)    $ (1.22)    $  0.12   $ (0.56)   $  0.18  $ (1.35)    $ (0.06)   $ (0.58)  $ (0.90)
                                =====================================================================================
Basic weighted average shares
outstanding                        10,675      10,977    10,980     10,786   11,725      12,030     12,160     12,207
                                =====================================================================================
Diluted weighted average
shares outstanding                 10,675      11,285    10,980     10,993   11,725      12,030     12,160     12,207
                                =====================================================================================
</TABLE>
(1) Computed on the basis described in Note 1 of notes to consolidated financial
statements.

     Historically, revenues in the first quarter have been lower than in the
preceding fourth quarter due to customer budgeting and purchasing patterns.  The
Company's results of operations have been and may in the future be subject to
significant quarterly fluctuations.  These fluctuations may be due to a variety
of factors, including the timing of significant orders, the timing of the
introduction or announcement of new or enhanced products by the Company or its
competitors, variations in net revenue by product and distribution channel,
increased price and other competition, capital spending patterns of end-users,
delays in shipping new or existing products, conditions within the software and
networking industries, and economic conditions generally.  Revenue decreased in
the fourth quarter of 1997 as a result of the Management Agreement.

                                       17

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

     The Company has funded its operations to date primarily through private and
public placements of capital stock.  At December 31, 1995, 1996, and 1997  the
Company had available cash and cash equivalents of $33.3 million, $20.8 million,
and $6.7 million, respectively, and working capital of $35.6 million, $25.3
million, and $3.8 million, respectively.  On April 1, 1996, the Company acquired
a new line of credit with a commercial bank for $10.0 million  that allows the
Company to borrow up to the lesser of $10.0 million or the sum of 80% of
qualified domestic accounts receivable and 40% of qualified foreign accounts
receivable.  Borrowings bear interest at the bank's prime rate.  The line
expires April 1, 1998.  Advances pursuant to the line of credit are secured by
liens granted on the Company's accounts receivables. At December 31, 1996 and
1997, the Company did not have an outstanding balance under the line of credit
agreement.

     Net cash used in operating activities for the years ended December 31,
1995, 1996 and 1997 was $265 thousand, $656 thousand, and $5.3 million,
respectively.  In 1995, net cash used in operating activities consisted of $3.7
million of net income from operations, offset by a $2.0 million increase in
accounts receivable and a $2.0 million increase in inventories.  The increase in
inventories was due primarily to new product introductions, increased stocking
levels as a result of increased revenue and related unit shipments, and
procedures put in place by the Company during 1995 to help ensure more complete
availability of product in stock.   In 1996, net cash used in operating
activities consisted of $15.9 million net loss from operations which was the
result of a $13.3  million charge for purchased incomplete research and
development relating to the acquisitions of Leprechaun Software International,
Ltd, neTrend Corporation and the LAN Software business from Technocom, plc, a
$3.0 million charge for asset write-down related to restructure charges,
depreciation and amortization of $3.2 million, offset by an increase in accounts
receivable of $3.2 million and increase in prepaid assets of $1.4 million.  In
1997, net cash used in operating activities consisted of $34.8 million loss from
operations which was the result of a $15.9 million charge for purchased
incomplete research and development relating to the acquisitions of Purview
Technologies Inc and csd Software GmbH, a $5.0 million charge for asset write-
down related to restructuring charges, depreciation and amortization of $3.4
million, partially offset by a decrease in accounts receivable of $7.2 million.

     Net cash used in investing activities for the years ended December 31,
1995, 1996 and 1997 was $611 thousand, $9.5 million, and $8.6 million,
respectively.  This primarily reflects purchases of property and equipment of
$1.2 million, $4.5 million, and $1.7 million respectively.  Direct costs in 1996
relate to the acquisition of Leprechaun Software International, Ltd, neTrend
Corporation, the LAN software business of Technocom plc,  of $628 thousand, $2.3
million, and $2.0 million, respectively.  Direct costs in 1997 relate to the
acquisition of csd Software GmbH, and Purview Technologies Inc., of $5.8 million
and $1.1 million, respectively.

     Net cash (used in) provided by financing activities for the years ended
December 31, 1995, 1996 and 1997 was $31.4 million, ($2.6) million, and ($169)
thousand, respectively.  In 1995, this was a result of principal repayments on
obligations of capital leases of  $869 thousand, and $31.6 million in net
proceeds from the issuance of common stock from the initial public offering in
August 1995.  In 1996, this was a result of principal repayments on obligations
of capital leases of $1.2 million and the purchase of treasury stock of $1.6
million. In 1997, this was a result of the exercise of stock options of $28
thousand and the sale of stock under the Employee Stock Purchase Plan of $73
thousand which were partially offset by the purchase of treasury stock of $47
thousand and principal repayments of obligations under capital leases of $223
thousand.

     On February 11, 1998, the Company received shareholder approval to sell to
Elron the Assets. The Company received $12 million in cash and paid $3 million
related to its guarantee of actual accounts receivable. The Company has the
possibility to receive up to an additional $1.5 million in cash if certain
performance targets are met.

     The Company believes that its existing cash balances, funds generated from
operations, and available borrowings under its line of credit will be sufficient
to finance the Company's operations through December 1998.  In the event the
Company acquires one or more businesses or products, the Company's capital
requirements could increase substantially, and there can be no assurance that
additional capital will be available on terms acceptable to the Company, if at
all.

                                       18
<PAGE>

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

Some statements contained in this Form 10K that are not historical statements
(including but not limited to, statements concerning estimates of future
revenues, operating expense levels and such operating expense levels relative to
the Company's total revenues) constitute forward-looking statements under the
safe harbour provisions of the Private Securities Litigation Reform Act of 1995.
The following risk factors, among other factors (including the accuracy of the
Company's internal estimates of revenue and operating expense level and other
risks detailed from time to time in the Company's filings with the Securities
and Exchange Commission), may cause the Company's actual results to differ
materially from the results stated in such forward looking statements.

CHANGE IN MARKETING STRATEGY

     Historically, the Company has marketed all of its products other than the
Comprehensive Client Management ("CCM") products through its Free Trial
Marketing system. Pursuant to the Elron Transaction, the Company sold, among
other things, its Free Trial marketing system, subject to a limited license-back
to the Company.  This license will allow the Company to continue to use the Free
Trial Marketing system to market its current Groupware products, including
future versions and feature extensions of such products, to existing customers
and identified potential customers, for a period of three years from the closing
date of the Elron Transaction (the "Closing Date"), subject to termination in
the event of a sale of the Groupware products or a sale of all or substantially
all of the Company's business or assets.

     Although the Company retains limited rights to the Free Trial Marketing
system, the Company's ability to implement a marketing strategy based on the
Free Trail Marketing system has been severely curtailed because the Company no
longer has the personnel and infrastructure necessary to support such a
strategy. Moreover, the Company has made the strategic decision to limit its
Groupware marketing efforts to exclusively selling new seats to its existing
customer base, while focusing the majority of its management, financial and
technical resources on its Enterprise Desktop Management products.

CCM PRODUCT MARKETING STRATEGY

     The target market for the CCM products is entirely different from the
target market for the products the Company has marketed and sold through its
Free Trial Marketing system. The target market for CCM products consists
primarily of large corporations such as Deutsche Telekom and Munich Reinsurance
(both existing CCM customers). In addition, CCM product sales per customer are
generally in the range of $20,000 to $500,000, as opposed to an average sale per
customer for the Company's Groupware products of approximately $2,500. Sales of
CCM products pose significantly greater financial risks, and require greater up-
front investments in marketing, technical and financial resources, than sales of
the Company's historical products. As a result, the Company is adopting a new
and untested marketing strategy using a direct sales force and in-field service
organization. This marketing strategy requires significant investments in
additional marketing and technical personnel, retraining of existing personnel,
ongoing product development and creation of an in-field service organization. To
date, substantially all of the Company's marketing of CCM products has been in
Europe. While the Company has developed valuable experience and expertise in
Europe, there can be no assurance that the Company will be able to transfer such
experience and expertise to the North American market.

     As a result of the Elron Transaction, the Company will rely on fewer large
customers for its revenue since the target market for CCM products is primarily
large corporations. Currently, only one customer accounts for more than 10% of
the Company's net revenue. For the twelve months ended December 31, 1997,
Deutsche Telekom accounted for $4.5 million, or 52% of net revenue from the
Company's current products. It is possible that the Company's change in
marketing strategy will result in other customers accounting for more than 10%
of the Company's net revenues.

                                       19

<PAGE>

TECHNOLOGICAL REQUIREMENTS OF THE CCM PRODUCTS; PRODUCT DEVELOPMENT

     The technological demands of the CCM products require a commitment of
significant ongoing financial, technical and personnel resources to product
development, training of service technicians and customer training.  Because the
Company's historical products were not as technologically demanding as the CCM
products, the Company has not to date made the required investment and has not
proven that it can develop and maintain the organization required to support
such products.  The Company believes that its experience with the CCM products
in Europe will provide a valuable base on which to build the necessary
financial, technical and personnel resources to sell, market, develop and
support the CCM products in North America; however, there can be no assurance
that the Company will be able to expand and develop its resources to support CCM
products in North America.

     The CCM product is typically larger and more complex than the products that
the Company has previously developed. The Company's ability to continue to
enhance the CCM product to meet customer and market requirements will depend
substantially on its ability to effectively manage its development effort, to
attract and retain the required development personnel in Cambridge,
Massachusetts and Starnberg, Germany and to coordinate and manage geographically
remote development efforts.

FINANCIAL RESOURCES REQUIRED BY THE CCM PRODUCTS

     The Company has estimated that the product development, marketing and sales
costs of the CCM products are approximately $1.0 to $1.5 million per month. The
Company believes that it has sufficient financial resources to fund these costs
through at least December 1998. There can be no assurance that the Company's
estimate of the marketing, sales and product development costs of the CCM
products will prove correct, that such costs will not increase beyond the
Company's available financial resources, or that additional sources of capital,
if and when needed, will be sufficient or available.


RAPID TECHNOLOGICAL CHANGE

     The Groupware and Enterprise Desktop Management software markets are
characterized by rapid technological developments, changes in customer
requirements, evolving industry standards and frequent new product
introductions. The Company's future success will depend, in part, unpon its
ability to enhance its existing applications, develop and introduce new products
that take advantage of technological advances, and respond promptly to new
customer requirements and evolving industry standards. As discussed above, the
Company has made a strategic decision to limit its Groupware marketing efforts
to exclusively selling new seats to its existing customer base. The Company has
identified a number of enhancements to CCM which it believes are important to
its continued success in the Enterprise Desktop Management software market.
There can be no assurance that the Company will be successful in developing and
marketing, on a timely basis, enhancements to its existing products or new
products, or that its new products will adequately address the changing needs of
the marketplace. Failure by the Company in any of these areas could materially
and adversely affect the Company's business, condition (financial and
otherwise), prospects and results of operations. In addition, from time to time
the Company or its competitors may announce new products with capabilities or
technology that could have a potential to replace or shorten the life cycles of
the Company's existing products or render such products obsolete. There can be
no assurance that announcements by the Company or its competitors of new
products will not cause customers to defer purchasing the Company's existing
products. In addition, there can be no assurance that future changes in DOS,
Windows, Windows NT, UNIX, NetWare or other popular operating systems would not
result in incompatibility with the Company's products. The Company's failure to
introduce new products on a timely basis that are compatible with operating
systems and environments preferred by desktop customer users would have a
material adverse effect on the Company's business, condition (financial or
otherwise), prospects and results of operations.


COMPETITION

     The market for the Company's products is highly competitive, and the
Company expects competition to increase in the future.  The Company believes
that the principal competitive factors affecting the market for its products
include performance, functionality, ease of use, ease of installation, quality,
customer support, breadth or product line, speed of

                                       20
<PAGE>

product delivery, frequency of upgrades and updates, brand name recognition,
company reputation, adherence to industry standards, integration with third-
party solutions and price. Certain of the criteria upon which the performance
and quality of the Company's Groupware software compete includes speed of
response, ease of use, ease of installation, interoperability with other
messaging systems and simplicity of administration. The Company believes that it
generally competes favorably with repect to each of these factors; howver, there
can be no assurance that the Company will be able to continue to compete
successfully against current and future competitors. Certain of the Company's
cometitors have been in the market longer than the Company, and other
competitors are larger and may have greater name recognition that the Company.
As is the case in many segments of the software industry, the Company may
encounter increasing price competition in the future. This could reduce average
selling prices and, therefore, profit margins. Competitive pressures could
result not only in sustained price reductions but also in a decline in sales
volume, which could have a material adverse effect on the Company's business,
condition (financial or otherwise), prospects and results of operations. There
can be no assurance that the Company will continue to compete effectively
against existing and potential competitors in these markets, many of whom have
substantially greater financial, technical, marketing and support resources and
name recognition than the Company.

     The Groupware, Network Management and Security and Client Management
software markets are highly fragmented, with products offered by many vendors.
In the e-mail market, the Company competes with offerings from software,
shareware and freeware developers.  Shareware is software that is made available
electronically on bulletin boards systems.  Shareware users are encouraged to
evaluate the software for a short period of time and then either cease using it
or pay a license fee.  In the group scheduling market, the Company also competes
with personal information manager products ("PIMs") that have been enhanced to
include some group scheduling features.  In addition, the trend toward
enterprise-wide communications software solutions may result in a consolidation
of the communications software market around a smaller number of vendors who are
able to provide all of the necessary software and support capabilities.

     In the Client Management market, the Company faces competition from large
and established companies, such as Microsoft, Intel and IBM/Tivoli, which offer
client management capabilities as part of their systems, network and/or desktop
management systems.  Moreover, Microsoft has announced the Zero Administration
Initiative for Windows ("ZAW"), which includes a set of technologies that
address some of the same client management issues as CCM.  Microsoft has
described components of ZAW as being available for future versions of the
Windows NT and Windows 95 operating systems, as well as the Microsoft Systems
Management Server product.  There can be no assurance that the Company can
continue to compete effectively against Client Management software which is
included free with operating system software.  See "BUSINESS-Competition."


PRODUCT DEVELOPMENT

     The Company has in the past experienced delays in software development, and
there can be no assurance that it will not experience further delays in
connection with its current or future product development activities.  The
Company puts all of its products through alpha and beta test cycles and makes
significant efforts to debug all products before commercial release.  The
Company makes well-marked alpha and beta versions of its software available for
evaluation and testing and solicits and responds to input from evaluators.
However, there can be no assurance that the Company's products will not contain
undetected errors or version compatibility issues, particularly when first
introduced or when new versions are released, resulting in loss of or delay in
market acceptance.  Delays and difficulties associated with new product
introductions or product enhancements could have a material adverse effect on
the Company's business, condition (financial or otherwise), prospects and
results of operations.

     In addition to developing new products, the Company's internal development
staff is focused on developing upgrades and updates to existing products and
modifying, enhancing and completing any acquired products and incomplete
projects.  Future enhancements may, among other things, include additional
functionality, respond to user problems or address issues of compatibility with
changing operating systems and environments.  Failure to release such
enhancements on a timely basis could have a material adverse effect on the
Company's business, condition (financial or otherwise), prospects and results of
operations.  There can be no assurance that the Company will be successful in
these efforts.

     If the Company believes that a licensed product continues to be valuable
after the expiration of the initial license term, it will seek to extend the
term of the license. There can be no assurance that the Company will be able to
extend the term of expiring licenses, or that the economic arrangements for such
extensions would be comparable to the arrangements in effect during the initial
license term.

                                       21
<PAGE>

INCLUSION OF CCM AND GROUPWARE IN SYSTEM SOFTWARE AND APPLICATION SUITES

     In the future, vendors of operating system software and applications sold
for a single price (generally referred to as application suites) may continue to
enhance their products to include certain functions that are currently provided
most often by CCM and Groupware software or may bundle these products in their
application suites at no additional charge. The widespread inclusion of the
functions provided by the Company's products as standard features of operating
system software could, particularly if the quality of such functions were
comparable to that of the Company's products, render the Company's products
obsolete and unmarketable. Furthermore, even if the CCM and Groupware software
functions provided as standard features by operating systems are more limited
than those of the Company's products, there is no assurance that a significant
number of customers would not elect to accept such functions in lieu of
purchasing additional software. If the Company were unable to develop new CCM
and Groupware software products to further enhance operating systems and to
replace successfully any obsolete products, the Company's business, condition
(financial or otherwise), prospects and results of operations would be
materially and adversely affected.


POTENTIAL ACQUISITIONS

     The Company may in the future undertake additional acquisitions that could
present challenges to the Company's management, such as integrating and
incorporating new operations, product lines, technologies and personnel. If the
Company's management is unable to manage these challenges, the Company's
business, financial condition or results of operations could be materially
adversely affected. Any acquisition, depending on its size, could result in
significant dilution to the Company's stockholders. Furthermore, there can be no
assurance that any acquired products will gain acceptance in the Company's
markets.


PAST ACQUISITIONS

     The Company has in the past made a number of acquisitions that have been
and are being integrated and incorporated into the Company's operations, along
with the acquired product lines, technologies and personnel. If the Company's
management is unable to continue to manage these challenges, the Company's
business, financial condition or results of operations could be materially
adversely affected. There can be no assurance that any acquired products will
gain acceptance in the Company's markets.


INDIRECT CHANNELS OF DISTRIBUTION

     The Company markets its products (other than ON Command CCM) through
distributors and resellers in addition to its direct sales force. These
distributors and resellers also sell other products that are complementary to,
or compete with, those of ON. There can be no assurance that these distributors
and resellers will not give greater priority to products of other suppliers.
They have no long-term obligation to purchase products from the Company. Since
the Company's agreements with its distributors provide for a right of return,
revenue recognized upon sales to distributors is subject to a reserve for
returns. Although management believes that the current reserve balance is
adequate to cover this exposure, there can be no assurance that any future
period reserves for returns will be adequate. In addition, the Company may be
unaware of the nature and scope of the representations made to customers by
these distributors and resellers. For example, they could make representations
to customers about the Company's current and future products which are
inaccurate or incomplete. This could result in the products not meeting the
customers' expectations or requirements. Although the Company's agreements with
its distributors generally provide the Company with recourse against
unauthorized action taken by the distributors, there can be no assurance that
the Company could recover adequate compensation to cover the damage caused by an
inaccurate representation.


PROPRIETARY TECHNOLOGY

     The Company's success is heavily dependent upon its proprietary software
technology.  The Company relies on a combination of contractual rights,
trademarks, trade secrets and copyrights to establish and protect its
proprietary rights in its software.

                                       22
<PAGE>

     The Company uses a printed "shrink-wrap" license for users of its Groupware
products distributed through traditional distribution channels in order to
protect its copyrights and trade secrets in those products.  Since these shrink-
wrap licenses are not signed by the licensee, many authorities believe that they
may not be enforceable under many state laws and the laws of many foreign
jurisdictions.  If such licenses are not enforceable, the user would not be
bound by the terms thereof, including the terms which seek to protect the
Company's proprietary technology.  If the printed shrink-wrap licenses prove to
be unenforceable, this may have a material adverse effect on the Company's
business, condition (financial or otherwise), prospects and results of
operations.

     The Company has signed license agreements from users of its Enterprise
Desktop Management products to protect its copyrights and trade secrets in those
products. The licenses may not be enforceable under some state laws and the laws
of many foreign jurisdictions. If such licenses are not enforceable, the user
would not be bound by the terms thereof, including the terms which seek to
protect the Company's proprietary technology. If the signed license agreements
prove to be unenforceable, this may have a material adverse effect on the
Company's business, condition (financial or otherwise), prospects and results of
operations.

     The laws of some foreign countries either do not protect the Company's
proprietary rights or offer only limited protection for those rights.
Furthermore, in countries with a high incidence of software piracy, the Company
may experience a higher rate of piracy of its products.

     The Company has obtained registrations in the United States for the
following trademarks: ON Technology, Notework, Meeting Maker, ON Technology &
Design, ON Location, Instant Update and DaVinci Systems.  The Company has filed
for the trademark "ON Command CCM" in the United States, the European Community,
Canada and Australia.  The Company has obtained only four foreign registrations
of its Notework mark and two foreign registrations of its Meeting Maker mark,
due to significant costs involved in obtaining foreign registrations.  As a
result, the Company may not be able to prevent a third party from using its
trademarks in many foreign jurisdictions.  The Company has not to date
registered any of its copyrights.

     There can be no assurance that the steps taken by the Company to protect
its proprietary software technology will be adequate to deter misappropriation
of this technology.  Lesser sensitivity by corporate, government or
institutional users to avoiding copyright infringement could have a material
adverse effect on the Company's business, condition (financial or otherwise),
prospects and results of operation.

     There has been substantial litigation in the software industry involving
intellectual property rights of technology companies, although, to date, the
Company has not been subject to any such litigation.  Although the Company does
not believe that it is infringing the intellectual property rights of others,
there can be no assurance that such claims, if asserted, would not have a
material adverse effect on the Company's business, financial condition and
results of operations.  In addition, as the Company may acquire or license a
portion of the software included in its future products from third parties, its
exposure to infringement actions may increase because the Company must rely upon
such third parties for information as to the origin and ownership of any
software being acquired.  The Company generally obtains representations as to
the origin and ownership of such acquired or licensed software and generally
obtains indemnification to cover any breach of such representations.  However,
there can be no assurance that such representations are accurate or that such
indemnification will provide adequate compensation for a breach of such
representations.  In the future, litigation may be necessary to enforce and
protect trade secrets and other intellectual property rights owned by the
Company.  The Company may also be subject to litigation to defend against
claimed infringement of the rights of others or to determine the scope and
validity of the proprietary rights of others.  Any such litigation could be
costly and cause diversion of management's attention, either of which could have
a material adverse effect on the Company's business, financial condition or
results of operations.  Adverse determinations in such litigation could result
in the loss of the Company's proprietary rights, subject the Company to
significant liabilities, require the Company to seek licenses from third parties
or prevent the Company from manufacturing or selling its products, any one of
which could have a material adverse effect on the Company's business, condition
(financial or otherwise), prospects and results of operations.  Furthermore,
there can be no assurance that any necessary licenses will be available on
reasonable terms, or at all.

     The Company could be subjected to lawsuits by customers, past, present or
future, and others due to possible errors in the Company's software.  The
Company is not aware of any material errors in its software or any pending or
threatened litigation.  The Company maintains insurance covering such
liabilities in the amounts of $12 million domestically and $4 million
internationally.  The Company believes that its insurance coverages are
sufficient to cover any such losses.

INTERNATIONAL REVENUE

     In fiscal 1996 and 1997, total revenue from international licenses (license
revenue from outside the United States) represented approximately 17% and 37%,
respectively, of the Company's total revenue.  The Company expects that
international revenue will constitute a significantly greater portion of the
Company's total revenue in 1998.  Accordingly, a greater

                                       23
<PAGE>

percentage of the Company's total revenue will be subject to the risks inherent
in international sales, including the impact of fluctuating exchange rates on
demand for its products, longer payment cycles, greater difficulty in protecting
intellectual property, greater difficulty in accounts receivable collection,
unexpected changes in legal and regulatory requirements, seasonality due to the
slowdown of European business activity in the third quarter and tariffs and
other trade barriers. There can be no assurance that these factors will not have
a material adverse effect on the Company's future international license revenue.

LOSS OF KEY MANAGEMENT PERSONNEL

     The Company's success depends to a significant extent upon a number of key
technical and management employees. While the Company's employees are required
to sign standard agreements concerning confidentiality and ownership of
inventions, the employees, with the exception of Messrs. Herman DeLatte, Loren
Platzman, John Bogdan and Edward Green, are generally not otherwise subject to
employment agreements or noncompetition covenants. The loss of the services of
any of the Company's key employees could have a material adverse effect on the
Company's business, condition (financial or otherwise), prospects and results of
operation. The Company does not maintain life insurance policies on key
employees. The Company's success also depends in large part upon its ability to
attract and retain highly skilled technical, managerial, sales and marketing
personnel.

     Competition in the software industry for such personnel is intense. There
can be no assurance that the Company will be successful in retaining its
existing key personnel and in attracting and retaining the personnel it
requires.

GROUPWARE BUSINESS

     The Company has made the strategic decision to limit its Groupware
marketing efforts to exclusively selling new seats to its existing customer
base, while focusing the majority of its management, financial and technical
resources on the CCM products. The Company believes that in the short-term the
Company can significantly reduce the costs associated with the Groupware
products while continuing to generate cash flow from the sale of these products.
However, there can be no assurance that cash flow from the sale of the Groupware
products will not decrease faster than expected. In addition, over the longer
term, the Company's strategic decision to cease marketing the Groupware products
to new customers will lead to an erosion of the customer base and a reduction of
revenue from such products.

     The Company's ability to attract and retain the employees needed to service
the Groupware products may be materially adversely affected by the Company's
strategic decision to de-emphasize the Groupware products. Any loss of revenue
from the Groupware products may have a material adverse effect on the Company's
business, condition (financial or otherwise), prospects and results of
operation.

STRATEGIC REORGANIZATION

On July 29, 1997, the Company reorganized and restructured its operations.  On
October 29, 1997, additional restructuring actions were implemented.  These
actions were designed to focus the Company on the CCM business.  To date, the
implementation of this new corporate strategy has included hiring a new Chief
Executive Officer, electing a new Chairman of the Board of Directors, de-
emphasizing the acquisition of new customers in the Company's Groupware and
Network Management and Security business, discontinuing sales of the Company's
virus protection software, closing or reducing the Company's offices in Sydney,
Australia; Paris, France; London, United Kingdom; and Munich, Germany while
building up the Company's office in Starnberg, Germany and laying off
approximately 118 employees.  There can be no assurance that the Company's new
corporate strategy will be successfully implemented.  Furthermore, there can be
no assurance that the Company will not engage in further reorganizations or
restructurings in the future.

VARIABILITY OF QUARTERLY OPERATING RESULTS

     The Company's licensing activity and results of operations can fluctuate
significantly on a quarterly basis.  Causes of such fluctuations may include,
among other factors the volume and timing of new and repeat orders, the
introduction or

                                       24
<PAGE>

announcement of new products or product enhancements by ON or third parties,
failure to ship trials, changes in response rates to the Company's mailings and
telemarketing programs, interruption in the Company's overnight delivery,
telephone or internal networks and databases, work stoppages, changes in product
prices, changes in operating expenses, changes in product mix, increase in
international sales as a percentage of total revenue, seasonality, trends in the
computer industry, unavailability of product, potential software viruses and
perceived threats thereof, customer order deferrals, general economic
conditions, extraordinary events such as acquisitions or litigation and the
occurrence of unexpected events. While to date, the Company has not experienced
any work stoppages or unavailability of products, there can be no assurance any
of such events will not occur in the future. The occurrence of any such event
could have a material adverse effect on the Company's business, condition
(financial or otherwise), prospects and results of operations. Because of the
nature of its distribution methods for its Groupware, the Company has virtually
no backlog with respect to such products and generally cannot predict when users
will license such products. As a result of the longer enterprise sales and
product roll-out cycle for CCM, the Company will be better able to assess
anticipated customer orders for CCM. Historically, repeat orders have accounted
for a significant portion of the Company's total revenue; however, there can be
no assurance that the Company will be able to sustain current repeat order rates
in the future, especially after consummation of the Proposed Transaction and in
light of the de-emphasis in marketing efforts for the Groupware and Network
Management and Security products. Furthermore, since the Company's cost of total
revenue is relatively low and its operating expenses are relatively fixed, any
revenue shortfall in a quarter will result in a substantially similar shortfall
in net income. In addition, significant quarterly fluctuations in licensing
activity will cause significant fluctuations in the Company's cash flows and
cash equivalents, accounts receivable and deferred revenue accounts on the
Company's balance sheet.

     The Company's business has experienced and is expected to continue to
experience seasonality, due in part to customer buying patterns.  In recent
years, the Company generally has had greater demand for its products in the
fourth quarter and has had weaker demand for its products during the first
quarter.  These fluctuations are caused primarily by customer budgeting and
purchasing patterns.  The Company believes this pattern will continue.

     The Company believes that period-to-period comparisons of its financial
results should not be relied upon as an indication of future performance.

VOLATILITY OF STOCK PRICE

     The trading price of the Company's Common Stock has been, and in the future
may be, subject to wide fluctuations in response to actual or anticipated
quarterly operating results of the Company, announcements of technological
innovations or new applications by the Company or its competitors and general
market conditions in the software industry, as well as other events or factors.
In addition, stock markets have experienced extreme price and volume trading
volatility in recent years.  This volatility has had a substantial effect on the
market price of many technology companies and has often been unrelated to the
operating performance of those companies.  This volatility may adversely effect
the market price of the Company's Common Stock.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     The Company does not hold any market risk sensitive instruments.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The financial statements and supplementary data of the Company required by
this item are set forth at the pages indicated in Item 14(a).

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

     Not applicable.


                                       25
<PAGE>

                                   PART III
                                   --------

ITEM 10.  DIRECTORS AND OFFICERS OF THE REGISTRANT

     The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1998.

ITEM 11.  EXECUTIVE COMPENSATION

     The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1998.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1998.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1998.

                                       26
<PAGE>

                                    PART IV
                                    -------

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

(a)(1)  Financial Statements:
<TABLE>
<CAPTION>

                                                                    Page Number
                                                                    -----------
<S>                                                                <C>

          Report of Independent Public Accountants                          27
          Consolidated Balance Sheets:
            December 31, 1997 and 1996                                      28
          Consolidated Statements of Operations:
            Years ended December 31, 1997, 1996 and 1995                    29
          Consolidated Statements of Redeemable Convertible
            Preferred Stock and Stockholders' Equity (Deficit):
            Years ended December 31, 1997, 1996 and 1995                    30
          Consolidated Statements of Cash Flows:
            Years ended December 31, 1997, 1996 and 1995                 31-32
          Notes to the Consolidated Financial Statements                 33-44
</TABLE>
(a)(2)    Consolidated Financial Statement Schedules
<TABLE>

          Schedule II - Valuation and Qualifying Accounts
<S>                                                                <C>
            Years ended December 31, 1997, 1996 and 1995                    36
</TABLE>

     Other Schedules are omitted because the conditions required for filing do
not exist or the required information is included in the financial statements or
notes thereto.

(a)(3) Exhibits:  See Index to Exhibits on Page 48.  The Exhibits listed in the
       accompanying Index of Exhibits are filed or incorporated by reference as
       part of this report.

(b)    Reports on Form 8-K: None were filed in the fourth quarter of 1997.

                                       27
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To ON Technology Corporation and Subsidiaries:

     We have audited the accompanying consolidated balance sheets of ON
Technology Corporation (a Delaware corporation) and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of operations,
redeemable convertible preferred stock and stockholders' equity (deficit) 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 ON Technology 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.


                                                 Arthur Andersen LLP
Boston, Massachusetts
January 28, 1998

(except with respect to the matter discussed in
Note 12, as to which the date is February 11, 1998)

                                      28
<PAGE>

                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                            (dollars in thousands)

<TABLE>
<CAPTION>
                                                            December 31,
                                                   ----------------------------
                                                      1997              1996
                                                   ----------        ----------
<S>                                                <C>               <C>
ASSETS
Current Assets:
Cash and cash equivalents                           $  6,679          $ 20,774
Accounts receivable, net of allowance
      of $2,975 and $1,191, respectively               2,970             9,852
Inventories                                              267             2,323
Prepaid expenses and other current assets              2,508             2,537
Assets held for sale, net                              1,755               ---
                                                   ----------        ----------
      Total current assets                            14,179            35,486
                                                   ----------        ----------
Property and Equipment, at cost:
Computers and equipment                                2,892             6,226
Equipment under capital leases                         2,443             3,895
Furniture and fixtures                                   292               247
                                                   ----------        ----------
Less-Accumulated depreciation and amortization         3,477             4,527
                                                   ----------        ----------
                                                       2,150             5,841
                                                   ----------        ----------

Direct marketing costs                                   ---             1,067
Other assets and deposits                                 81                86
Purchased intangibles, net of  $1,106 and $1,261
      of accumulated amortization, respectively          972             1,662
                                                   ----------        ----------
                                                    $ 17,382          $ 44,142
                                                   ==========        ==========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of capital lease obligations        $    356          $  1,063
Accounts payable                                       5,072             5,619
Accrued expenses                                       3,719             2,252
Reserve for distributor inventories                      216               204
Deferred revenue                                       1,013             1,001
                                                   ----------        ----------
      Total current liabilities                       10,376            10,139
                                                   ----------        ----------
Capital lease obligations, net of current portion         10               510
                                                   ----------        ----------
Commitments (Note 6)

Stockholders' Equity:
Common stock, $.01 par value  Authorized -
      20,000,000 shares Issued and
      outstanding - 12,223,213 shares and
      11,008,243 shares, respectively                    122               110
Additional paid-in capital                            62,665            55,637
Deferred compensation                                   (229)              ---
Accumulated deficit                                  (55,126)          (20,354)
Accumulated deficit of S corporation                    (354)             (354)
Cumulative translation adjustment                        (35)               88
Treasury stock (15,000 and 257,867
      shares at cost, respectively)                      (47)           (1,634)
                                                   ----------        ----------
      Total stockholders' equity                       6,996            33,493
                                                   ----------        ----------
                                                    $ 17,382          $ 44,142
                                                   ==========        ==========
</TABLE>

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

                                      29
<PAGE>

                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                 (dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                                  For the Year Ended December 31,
                                                                ------------------------------------------------------------------
                                                                        1997                   1996                   1995
                                                                --------------------    -------------------    -------------------
<S>                                                             <C>                     <C>                    <C>
Revenue:
Net product revenue                                              $     36,630            $     50,165           $     43,381
Other revenue                                                           4,652                   1,627                    740
                                                                --------------------    -------------------    -------------------
              Total revenue                                            41,282                  51,792                 44,121
                                                                --------------------    -------------------    -------------------

Operating expenses:

Cost of product revenue                                                 9,315                  11,951                  8,199
Sales and marketing                                                    22,172                  24,176                 20,984
Research and development                                               12,461                   9,456                  7,014
General and administrative                                              5,501                   4,407                  3,184
Charge for purchased incomplete research
     and development                                                   15,898                  13,285                    ---
Charge for restructuring                                               10,940                   5,415                    ---
                                                                --------------------    -------------------    -------------------
              (Loss) income from operations                           (35,005)                (16,898)                 4,740
Interest expense                                                         (178)                   (250)                  (288)
Interest income                                                           411                   1,384                    842
                                                                --------------------    -------------------    -------------------
              (Loss) income before provision
                   for income taxes                                   (34,772)                (15,764)                 5,294
Provision for income taxes                                                ---                     (97)                (1,622)
                                                                --------------------    -------------------    -------------------
              Net (loss) income                                   $   (34,772)           $    (15,861)           $     3,672
                                                                ====================    ===================    ===================

     Basic earnings per share                                     $     (2.88)           $      (1.46)           $      0.52
                                                                ====================    ===================    ===================
     Diluted earnings per share                                   $     (2.88)           $      (1.46)           $      0.40
                                                                ====================    ===================    ===================

     Basic weighted average shares outstanding                     12,079,264              10,853,814              6,314,429
                                                                ====================    ===================    ===================

     Diluted weighted average shares outstanding                   12,079,264              10,853,814              9,086,764
                                                                ====================    ===================    ===================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

                                      30
<PAGE>


                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
    CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
                        STOCKHOLDERS' EQUITY (DEFICIT)
                            (Dollars in thousands)

<TABLE>
<CAPTION>
                                                     Redeemable Convertible Preferred Stock
                                      -------------------------------------------------------------------------------
                                            Series A             Series B                Series C
                                       -----------------     -----------------       -----------------
                                       Number     $.01       Number       $.01       Number       $.01
                                         of        Par         of         Par          of         Par
                                       shares     value      shares      value       shares      value       Total
                                      -------------------------------------------------------------------------------
<S>                                     <C>     <C>         <C>        <C>          <C>        <C>         <C>
Balance , December 31, 1994              231    $  1,361      1,166    $  1,930      14,921    $  8,897    $  12,188

Exercise of common stock options         ---         ---        ---         ---         ---         ---          ---
Accretion of preferred stock dividends   ---          50        ---         ---         ---         397          447
Sale of common stock, net of issuance
  costs of  $1,275                       ---         ---        ---         ---         ---         ---          ---
Conversion of  preferred stock          (231)     (1,411)    (1,166)     (1,930)    (14,921)     (9,294)     (12,635)
 Tax benefit from stock options          ---         ---        ---         ---         ---         ---          ---
Net income                               ---         ---        ---         ---         ---         ---          ---
                                       ------------------   --------------------    ---------------------------------
Balance, December 31, 1995               ---         ---        ---         ---         ---         ---          ---

Issuance of common stock in
  connection with acquisitions           ---         ---        ---         ---         ---         ---          ---
Sale of common stock under the
  Employee Stock Purchase Plan           ---         ---        ---         ---         ---         ---          ---
Exercise of common stock options         ---         ---        ---         ---         ---         ---          ---
Purchase  of treasury stock              ---         ---        ---         ---         ---         ---          ---
Cumulative translation adjustment        ---         ---        ---         ---         ---         ---          ---
Net loss                                 ---         ---        ---         ---         ---         ---          ---
                                       ------------------   --------------------    ---------------------------------
Balance, December 31, 1996               ---         ---        ---         ---         ---         ---          ---

Issuance of common stock in
  connection with acquisitions           ---         ---        ---         ---         ---         ---          ---
Sale of common stock under the
  Employee Stock Purchase Plan           ---         ---        ---         ---         ---         ---          ---
Exercise of common stock options         ---         ---        ---         ---         ---         ---          ---
Deferred compensation related to
  grants of common stock options         ---         ---        ---         ---         ---         ---          ---
Amortization of deferred
  compensation related to
  grants of common stock options         ---         ---        ---         ---         ---         ---          ---
Purchase of treasury stock               ---         ---        ---         ---         ---         ---          ---
Cumulative translation adjustment        ---         ---        ---         ---         ---         ---          ---
Net loss                                 ---         ---        ---         ---         ---         ---          ---
                                       ------------------   --------------------    ---------------------------------
Balance, December 31, 1997               ---    $    ---        ---    $    ---         ---    $    ---    $     ---
                                       ==============================================================================

</TABLE>



<TABLE>
<CAPTION>
                                                                         Stockholder's Equity (Deficit)
                                                  -------------------------------------------------------------------------------
                                                      Common Stock
                                                   Number       $.01         Additional                                 Accumulated
                                                     0f         Par           Paid-in       Deferred      Accumulated   Deficit of
                                                   Shares      Value          Capital     Compensation      Deficit     Adjustment
                                                  --------     ------        --------     ------------    -----------  ------------
<S>                                              <C>           <C>          <C>            <C>           <C>            <C>
Balance , December 31, 1994                        3,533        $  35        $    198        $ ---         $ (7,718)      $ (354)


Exercise of common stock options                     445            4             148          ---              ---          ---
Accretion of preferred stock dividends               ---          --              ---          ---             (447)         ---
Sale of common stock, net of issuance
  costs of  $1,275                                 2,360           24          31,623          ---              ---          ---
Conversion of  preferred stock                     3,842           39          12,596          ---              ---          ---
 Tax benefit from stock options                      ---          --              486          ---              ---          ---
Net income                                           ---          --              ---          ---            3,672          ---
                                                  -------------------------------------------------------------------------------
Balance, December 31, 1995                        10,180          102          45,051          ---           (4,493)        (354)

Issuance of common stock in
  connection with acquisitions                       727            7          10,351          ---              ---          ---
Sale of common stock under the
  Employee Stock Purchase Plan                         9          --               93          ---              ---          ---
Exercise of common stock options                      92            1             142          ---              ---          ---
Purchase  of treasury stock                          ---          --              ---          ---              ---          ---
Cumulative translation adjustment                    ---          --              ---          ---              ---          ---
Net loss                                             ---          --              ---          ---          (15,861)         ---
                                                  -------------------------------------------------------------------------------
Balance, December 31, 1996                        11,008          110          55,637          ---          (20,354)        (354)
Issuance of common stock in
  connection with acquisitions                     1,150           12           6,535          ---              ---          ---
Sale of common stock under the
  Employee Stock Purchase Plan                        23          --               73          ---              ---          ---
Exercise of common stock options                      42          --               28          ---              ---          ---
Deferred compensation related to
  grants of common stock options                     ---          --              392         (392)             ---          ---
Amortization of deferred
  compensation related to
  grants of common stock options                     ---          --              ---          163              ---          ---
Purchase of treasury stock                           ---          --              ---          ---              ---          ---
Cumulative translation adjustment                    ---          --              ---          ---              ---          ---
Net loss                                             ---          --              ---          ---          (34,772)         ---
                                                  ===============================================================================
Balance, December 31, 1997                        12,223        $ 122        $ 62,665        $(229)        $(55,126)      $ (354)
                                                  ===============================================================================
</TABLE>


<TABLE>
<CAPTION>
                                                            Stockholder's Equity (Deficit)
                                              --------------------------------------------------------------
                                                                                        Treasury Stock
                                                Cumulative     Number            ***COPY NOT ON PAGE FOR***
                                                Translation      of              *******THESE COLUMNS******
                                                Adjustment     Shares
                                                -----------    ------           -----------       ----------
<S>                                           <C>              <C>               <C>            <C>
Balance , December 31, 1994                       ---           ---                ---             $   ---

Exercise of common stock options                  ---           ---                ---                 152
Accretion of preferred stock dividends            ---           ---                ---                (447)
Sale of common stock, net of issuance
  costs of  $1,275                                ---           ---                ---              31,647
Conversion of  preferred stock                    ---           ---                ---              12,635
 Tax benefit from stock options                   ---           ---                ---                 486
Net income                                        ---           ---                ---               3,672

Balance, December 31, 1995                        ---           ---                ---              40,306

Issuance of common stock in
  connection with acquisitions                    ---           ---                ---              10,358
Sale of common stock under the
  Employee Stock Purchase Plan                    ---           ---                ---                  93
Exercise of common stock options                  ---           ---                ---                 143
Purchase  of treasury stock                       ---           ---                ---                (258)
Cumulative translation adjustment                  88           ---                ---                  88
Net loss                                          ---           ---                ---             (15,861)

Balance, December 31, 1996                         88          (258)            (1,634)             33,493
Issuance of common stock in
  connection with acquisitions                    ---           258              1,634               8,181
Sale of common stock under the
  Employee Stock Purchase Plan                    ---           ---                ---                  73
Exercise of common stock options                  ---           ---                ---                  28
Deferred compensation related to
  grants of common stock options                  ---           ---                ---                 ---
Amortization of deferred
  compensation related to
  grants of common stock options                  ---           (15)               (47)                (47)
Purchase of treasury stock
Cumulative translation adjustment                (123)          ---                ---                (123)
Net loss                                          ---           ---                ---             (34,772)
                                               ===========================================================
Balance, December 31, 1997                     $  (35)          (15)          $    (47)          $   6,996
                                               ===========================================================

</TABLE>
             The accompanying notes are an integral part of these
                      consolidated financial statements.


                                      31
<PAGE>

                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                            (dollars in thousands)
<TABLE>
<CAPTION>
                                                                         Year ended December 31,
                                                                ----------------------------------------
                                                                   1997           1996           1995
                                                                ----------     -----------    ----------
<S>                                                             <C>            <C>            <C>
Cash Flows from Operating Activities:
   Net  (loss)  income                                           $ (34,772)     $  (15,861)    $   3,672
Adjustments to reconcile net  (loss) income
to net cash used in operating activities

   Charge for purchased incomplete research and development         15,898          13,285           ---
   Asset write-down related to restructuring charge                  4,975           3,048           ---
   Depreciation and amortization                                     3,384           3,217         1,880
   Change in direct marketing costs                                     31          (1,074)         (842)
   Amortization of deferred compensation                               163             ---           ---
   Change in net deferred income taxes                               1,543            (481)          ---
   Changes in assets and liabilities, net of
    acquisitions:
     Accounts receivable                                             7,240          (3,211)       (1,953)
     Inventories                                                     1,001             524        (2,030)
     Prepaid expenses and other current assets                        (827)         (1,440)         (785)
     Accounts payable                                               (1,402)          1,823           (91)
     Accrued expenses                                                  345             (11)         (311)
     Reserve for distributor inventories                                12            (730)         (279)
     Deferred revenue                                               (2,858)            255           474
                                                                ----------     -----------    ----------

        NET CASH USED IN OPERATING ACTIVITIES                       (5,267)           (656)         (265)
                                                                ----------     -----------    ----------
Cash Flows from Investing Activities:
   Escrow receivable                                                   ---             ---           625
   Change in other assets and deposits                                   5             (27)            4
   Purchase of property and equipment, net                          (1,728)         (4,476)       (1,240)
   Purchase of Leprechaun Software International, Ltd,
      net of cash acquired                                             ---            (628)          ---
   Purchase of technology from neTrend Corporation                     ---          (2,260)          ---
   Purchase of certain assets from Technocom, plc                      ---          (1,963)          ---
   Purchase of Purview Technologies Inc, net of cash acquired       (1,121)            ---           ---
   Purchase of csd Software GmbH, net of cash acquired              (5,781)            ---           ---
                                                                 ----------     -----------    ----------
        NET CASH USED IN INVESTING ACTIVITIES                       (8,625)         (9,354)         (611)
                                                                 ----------     -----------    ----------
Cash Flows from Financing Activities:
   Exercise of stock options                                            28             143           152
   Sale of stock under the Employee Stock Purchase                      73              93           ---
    Plan
   Tax benefit  from stock options                                     ---             ---           486
   Purchase of treasury stock                                          (47)         (1,634)          ---
   Principal repayments on obligations under capital lease            (223)         (1,168)         (869)
   Net proceeds from sale of common stock                              ---             ---        31,647
                                                                ----------     -----------    ----------
        NET CASH (USED IN) PROVIDED BY FINANCING                      (169)         (2,566)       31,416
         ACTIVITIES
                                                                ----------     -----------    ----------

   Effect of exchange rates on cash and cash                           (34)             12           ---
    equivalents

NET (DECREASE) INCREASE IN CASH AND CASH                           (14,095)        (12,564)       30,540
 EQUIVALENTS

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                      20,774          33,338         2,798
                                                                ----------     -----------    ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD                        $    6,679        $ 20,774      $ 33,338
                                                                ==========     ===========    ==========
</TABLE>

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

                                      32
<PAGE>

                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
               CONSOLIDATED STATEMENTS OF CASH FLOWS-(CONTINUED)
                            (dollars in thousands)
<TABLE>
<CAPTION>
                                                                        Year ended December 31,
                                                           ----------------------------------------
                                                              1997           1996           1995
                                                           ----------     ----------     ----------
<S>                                                         <C>            <C>            <C>
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
  AND FINANCING ACTIVITIES:

Accretion of preferred stock dividends                      $    ---       $    ---       $    447
                                                           ==========     ==========     ==========
Conversion of preferred stock into common stock             $    ---       $    ---       $ 12,635
                                                           ==========     ==========     ==========
Acquisition of equipment under capital leases               $    ---       $     91       $  2,124
                                                           ==========     ==========     ==========

ACQUISITION OF LEPRECHAUN SOFTWARE INTERNATIONAL, LTD
       Fair value of assets acquired                        $    ---       $  1,158       $    ---
       Fair value of stock issued                                ---           (158)           ---
       Liabilities assumed                                       ---           (370)           ---
       Cash acquired                                             ---             (2)           ---
                                                           ----------     ----------     ----------

      Cash paid for acquisition and direct costs
      net of cash acquired                                  $    ---       $    628       $    ---
                                                           ==========     ==========     ==========

ACQUISITION OF INTANGIBLE ASSETS FROM
      NETREND CORPORATION AND VIMAL VAIDYA
       Fair value of assets acquired                        $    ---       $ 12,460       $    ---
       Fair value of stock issued                                ---        (10,200)           ---
                                                           ----------     ----------     ----------
      Cash paid for acquisition and direct costs            $    ---       $  2,260       $    ---
                                                           ==========     ==========     ==========

 ACQUISITION OF TECHNOCOM PLC.
       Fair value of assets acquired                        $    ---       $  1,963       $    ---
                                                           ----------     ----------     ----------
      Cash paid for acquisition and direct costs            $    ---       $  1,963       $    ---
                                                           ==========     ==========     ==========

ACQUISITION OF PURVIEW TECHNOLOGIES, INC.
       Fair value of assets acquired                        $  2,379       $    ---       $    ---
       Fair value of stock issued                             (1,139)           ---            ---
       Liabilities assumed                                      (107)           ---            ---
       Cash acquired                                             (12)           ---            ---
                                                           ----------     ----------     ----------
      Cash paid for acquisition and direct costs
      net of cash acquired                                  $  1,121       $    ---       $    ---
                                                           ==========     ==========     ==========

ACQUISITION OF CSD SOFTWARE GMBH
       Fair value of assets acquired                        $ 17,949       $    ---       $    ---
       Fair value of stock issued                             (7,042)           ---            ---
       Liabilities assumed                                    (5,100)           ---            ---
       Cash acquired                                             (26)           ---            ---
                                                           ----------     ----------     ----------
      Cash paid for acquisition and direct costs
      net of cash acquired                                  $  5,781       $    ---       $    ---
                                                           ==========     ==========     ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for-
         Interest                                           $    178       $    205       $    271
                                                           ==========     ==========     ==========
         Income taxes                                       $  1,181       $  1,302       $    657
                                                           ==========     ==========     ==========
</TABLE>

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

                                      33
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(1)  OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

     ON Technology Corporation and Subsidiaries (the "Company") is engaged in
the development, marketing, sales support, and distribution of software for
local area networks.

     During 1996, the Company completed three acquisitions. The Company acquired
all of the assets and assumed certain liabilities of Leprechaun Software
International, Ltd, certain technology of neTrend Corporation and certain
intangible assets of Technocom plc. These acquisitions were accounted for as the
purchase of business combinations in accordance with Accounting Principles Board
(APB) No. 16 (see Note 2).

     In 1997, the Company acquired all of the stock of csd Software GmbH, a
German developer and marketer of PC Desktop Software Management Tools, and
acquired the stock of Purview Technologies Inc., a development stage company
engaged in Internet usage monitoring software development. These acquisitions
were accounted for as a purchase in accordance with APB No. 16 (see Note 2).

     The accompanying consolidated financial statements reflect the application
of certain significant accounting policies as described below and elsewhere in
the notes to the consolidated financial statements.

Principles of Consolidation
---------------------------

     The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.

Management 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 expense during the
reporting period. Actual results could differ from those estimates.

Revenue Recognition
-------------------

     Revenue from software product sales is recognized upon shipment of the
product to customers where the Company has no significant vendor obligations.
The Company sells advertising space in its catalog for cash or receives third
party advertising product. Revenue for catalog advertising space for cash is
recognized the day the catalog is mailed to customers. Revenue for third party
advertised product received is recognized as each item is sold. The deferred
revenue balance at December 31, 1997 and 1996 relates primarily to revenue on
software maintenance contracts, which is recognized ratably as it is earned. The
reserve for distributor inventories balance at December 31, 1997 and 1996
relates to sales to distributors for which the Company has accrued its estimate
of future distributor returns when the product was shipped. In addition, the
Company accrues the costs associated with providing telephone support related to
certain products.

Cash and Cash Equivalents
-------------------------

     The Company follows the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities.  The Company has classified its cash equivalents as held-to-maturity
and recorded them at amortized cost, which approximates market value.  The
Company considers all highly liquid cash investments with maturities of three
months or less at

                                      34
<PAGE>

                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

the date of acquisition to be cash equivalents. Cash equivalents consisted of
commercial paper and money market funds at December 31, 1997 and 1996.

Fair Value of Financial Instruments
-----------------------------------

     SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
requires disclosure of an estimate of the fair value of certain financial
instruments. The Company's financial instruments consist of cash equivalents,
accounts receivable and capital leases. The estimated fair value of these
financial instruments approximates their carrying value at December 31, 1997 and
1996. The estimated fair values have been determined through information
obtained from market sources and management estimates.

Direct Marketing Costs
----------------------

     The Company sells its products through various channels, including free
trial marketing. The Company incurs substantial costs in advance of a free trial
campaign, including the rental of mailing lists, postage and printing. The
Company capitalizes such costs in accordance with the American Institute of
Certified Public Accountants' (AICPA) Statement of Position 93-7, Reporting on
Advertising Costs. The Company amortizes such costs over a three-month period,
which approximates the period of expected revenues. The Company has recorded $0
and $1,067 of net capitalized direct marketing costs in the accompanying
consolidated balance sheets at December 31, 1997 and 1996, respectively. As part
of the sale of assets (see Note 12), the Company has not capitalized any direct
marketing costs as of December 31, 1997. The Company recorded $5,891, $7,387 and
$7,291 of direct marketing expense for the years ended December 31, 1997, 1996
and 1995, respectively.

Inventories
-----------

     The Company values inventories at the lower of cost (first-in, first-out)
or market. Inventories consist principally of computer software disks, computer
hardware, packaging costs and other related purchased computer peripheral items.
The components of inventories are as follows:

<TABLE>
<CAPTION>

(Dollars in thousands)                   1997           1996
                                       --------       --------
<S>                                    <C>             <C>
Raw Materials.....................       $  94          $  637
Finished Goods....................         173           1,686
                                       --------       --------
                                         $ 267          $2,323
                                       ========       ========
</TABLE>

Depreciation
------------

     The Company provides for depreciation by charges to operations in amounts
estimated to allocate the cost of the assets over their estimated useful lives,
using the straight-line method, as follows:

<TABLE>
<CAPTION>
                                                            ESTIMATED
ASSET CLASSIFICATION                                       USEFUL LIFE
--------------------                                       -----------
<S>                                                        <C>
Computers and equipment..................................    3-7 Years
Equipment acquired under capital leases..................  Life of lease
Furniture and fixtures...................................    5-7 Years
</TABLE>

                                      35
<PAGE>

                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

The Company accounts for its long-term assets in accordance with SFAS No. 121,
Accounting for the Impairment of Long -lived Assets and for Long- lived Assets
to be Disposed of. Under SFAS No. 121, the Company is required to assess the
valuation of its long-lived assets, including cost in excess of net assets
acquired, based on the estimated future cash flows to be generated by such
assets. At each balance sheet date, the Company evaluated the realizability of
goodwill based on profitability expectations, using the undiscounted cash flow
method, for each subsidiary having a material goodwill balance. Based on it's
most recent analysis, the Company believes that no impairment of goodwill exists
at December 31, 1997.

Software Development Costs
--------------------------

     Costs incurred in the development of computer software to be sold have been
expensed as research and development costs in the accompanying consolidated
statements of operations, in accordance with SFAS No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed. SFAS No. 86
requires that costs incurred in creating a computer software product be charged
to research and development expense until technological feasibility has been
established for the product. The costs incurred subsequent to the attainment of
technological feasibility in 1995, 1996 and 1997 are insignificant. The Company
has recorded charges for purchased incomplete research and development related
to the acquisitions discussed in Note 2. In each case, the Company determined
that technological feasibility of the in-process purchased technology acquired
had not been established and that the technology had no alternative future use.

Foreign Currency Translation
----------------------------

     The Company translates the assets and liabilities of its foreign
subsidiaries at the exchange rates in effect at fiscal year-end in accordance
with SFAS No. 52, Foreign Currency Translation. Revenues and expenses are
translated using exchange rates in effect during each period.

Postretirement Benefits
-----------------------

     The Company has no obligations for postretirement benefits.

Concentration of Credit Risk
----------------------------

     SFAS No. 105, Disclosure of Information about Financial Instruments with
Off-balance-sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance sheet and credit risk
concentrations. The Company has no significant off-balance-sheet concentrations
of credit risk such as foreign exchange contracts, option contracts or other
foreign hedging arrangements. The Company's financial instruments that subject
the Company to credit risk consist of cash and cash equivalents and accounts
receivable. The Company maintains the majority of cash balances with four
financial institutions. The Company's accounts receivable credit risk is not
concentrated within any geographic area, and no single customer accounts for
greater than 10% of revenues or represents a significant credit risk to the
Company.

                                      36
<PAGE>

                  ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)


Earnings (Loss) per Share
-------------------------

     SFAS 128, Earnings Per Share replaces the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Basic
earnings per share is calculated by dividing net income (loss) by the weighted
average number of common shares outstanding for the period. Diluted earnings per
share reflects the potential dilution of stock options that could share in the
earnings of the Company.

     Basic and diluted earnings per share, as required by SFAS No. 128, are as
follows:

<TABLE>
<CAPTION>
(Dollars in thousands, except per share data)
                                                     1997                1996                1995
                                                 ------------        ------------        ------------
<S>                                              <C>                 <C>                 <C>
Net (loss) income                                $    (34,772)       $    (15,861)       $      3,672
                                                 ============        ============        ============
Less: preferred stock dividends                           ---                 ---                 383
                                                 ------------        ------------        ------------
Net income (loss) available to common
 stockholders                                    $    (34,772)       $    (15,861)       $      3,289
                                                 ============        ============        ============


Basic weighted average shares outstanding          12,079,264          10,853,814           6,314,429

Convertible preferred stock                               ---                 ---           2,273,404

Weighted average common equivalent shares                 ---                 ---             498,931
                                                 ------------        ------------        ------------

Diluted weighted average shares outstanding        12,079,264          10,853,814           9,086,764
                                                 ============        ============        ============

Basic earnings per share                         $      (2.88)       $      (1.46)       $       0.52
                                                 ============        ============        ============
Diluted earnings per share                       $      (2.88)       $      (1.46)       $       0.40
                                                 ============        ============        ============
Anti-dilutive securities, that were not
 included in the above table are as follows:
  Stock Options                                     1,935,628           1,022,906              65,035
                                                 ============        ============        ============
</TABLE>

New Accounting Standards
------------------------

     In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 requires disclosure of all components of comprehensive income on an
annual and interim basis. Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from nonowner sources. SFAS No. 130 is effective for
fiscal years beginning after December 15, 1997.

     In July 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information. SFAS No. 131 requires certain financial and
supplementary information to be disclosed on an annual and interim basis for
each reportable segment of an enterprise. SFAS No. 131 is effective for fiscal
years beginning after December 15, 1997. Unless impracticable, companies would
be required to restate prior period information upon adoption

                                      37
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(2)  ACQUISITIONS

Acquisition  of  Intangible Assets from neTrend Corporation and Vimal Vaidya
----------------------------------------------------------------------------

     On January 30, 1996, the Company acquired certain intangible assets,
consisting primarily of incomplete firewall software technology from Vimal
Vaidya and acquired technology from neTrend Corporation, a development stage
company wholly owned by Vimal Vaidya, which, together with Vimal Vaidya,
developed firewall software technology.  The aggregate purchase price including
direct acquisition costs of $12,460 was allocated based on fair value of the
intangible assets acquired as follows:

(Dollars in thousands)
<TABLE>
<S>                                                        <C>
     Acquired technology.................................  $   676
     Purchased incomplete research and development.......   11,784
                                                           -------
                                                           $12,460
                                                           =======
</TABLE>

     As consideration, the Company paid $2,000 in cash, issued 717,300 shares of
common stock with a fair value of $14.22 per share and incurred $260 in direct
acquisition costs (see Note 12).

Acquisition  of Leprechaun Software International, Ltd.
------------------------------------------------------

     On March 6, 1996, the Company acquired substantially all the assets and
assumed certain liabilities of Leprechaun Software International, Ltd, a company
engaged in the development of an anti-virus software product.  The aggregate
purchase price  including direct acquisition costs of $1,158 was allocated based
on fair value of the tangible and intangible assets acquired as follows:

(Dollars in thousands)
<TABLE>
<S>                                                                  <C>
    Current assets..............................................     $   51
    Property and equipment......................................         13
    Purchased intangible assets, including acquired technology..        157
    Purchased incomplete research and development...............        937
                                                                     ------
                                                                     $1,158
                                                                     ======
</TABLE>

     As consideration, the Company paid $330 in cash, $200 in notes, issued
9,471 shares of common stock of the Company with a fair value of $16.68 per
share, assumed $370 in liabilities and incurred $100 in direct acquisition
costs. This transaction was accounted for as a purchase and, accordingly, the
results since March 6, 1996 are included in the accompanying consolidated
financial statements. Included in purchased intangible assets are amounts
related to acquired technology and goodwill (see Note 3).

Acquisition of Technocom plc.
----------------------------

     On March 29, 1996 the Company acquired certain assets of Technocom plc's
LAN software distribution business. The aggregate purchase price including
direct acquisition costs of $1,963 was allocated based on the fair value of the
tangible and intangible assets acquired as follows:

(Dollars in thousands)
<TABLE>
<S>                                                                  <C>
    Property and equipment......................................     $  110
    Purchased intangible assets, including acquired technology..      1,289
    Purchased incomplete research and development...............        564
                                                                     ------
                                                                     $1,963
                                                                     ======
</TABLE>

                                      38
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  As consideration, the Company paid $1,803 in cash and incurred $160 in direct
acquisition costs. Also, included in cost of product revenue for the year ended
December 31, 1996 is a $571 charge for the elimination of profit for inventory
previously sold to Technocom plc. This transaction was accounted for as a
purchase and, accordingly, the results since March 29, 1996 are included in the
accompanying consolidated financial statements. Included in purchased intangible
assets are amounts related to acquired technology, goodwill, trade names and
customer lists (see Note 3).

Acquisition of Purview Technologies, Inc.

  On January 24, 1997, the Company acquired all of the capital stock of Purview
Technologies, Inc., a company engaged in Internet access monitoring and
management software.  The aggregate purchase price of $2,379 was allocated based
on the fair market value of the tangible and intangible assets acquired as
follows:

(Dollars in thousands)
<TABLE>
<S>                                                                <C>
Current Assets.....................  ...........................    $   51
Purchased intangible assets, including acquired technology......       210
Purchased incomplete research and development...................     2,118
                                                                    ------
                                                                    $2,379
                                                                    ======
</TABLE>

As consideration, the Company paid $1,000 in cash and issued 205,251 shares of
common stock with a fair market value of $5.55 per share, assumed $107 in
liabilities, and incurred $133 in direct acquisition costs.  This transaction
was accounted for as a purchase, and accordingly, the results since January 24,
1997, are included in the accompanying condensed consolidated financial
statements (see Note 12).

Acquisition of csd Software GmbH (csd)

  On January 28, 1997, Wilma 96 Vermogensverwaltungs GmbH ("Wilma GmbH") a
wholly-owned subsidiary of the Company purchased all of the capital stock of
csd, a German corporation engaged in the development of PC desktop software
management tool products.  The aggregate purchase price of $15,048 was allocated
based on the fair market value of the tangible and intangible assets acquired as
follows:

(Dollars in thousands)
<TABLE>
<S>                                                                  <C>
Purchased intangible assets, including acquired technology..........  $ 1,268
Purchased incomplete research and development.......................   13,780
                                                                      -------
                                                                      $15,048
                                                                      =======
</TABLE>

  Unaudited pro forma operating results for the Company, assuming the
acquisition of csd occurred on January 1, 1996 is as follows:

<TABLE>
<CAPTION>
                                                                                December 31,
(Dollars in  thousands)                                                             1996
                                                                                ------------
<S>                                                                             <C>
Net sales                                                                        $    57,640
Net loss                                                                             (18,068)
Basic and diluted net loss per share                                             $     (1.48)
Shares used in computing profoma basic and diluted net loss per share             10,853,814
</TABLE>

  For purposes of these pro forma operating results, the in-process R&D was
assumed to have been written off prior to January 1, 1996, so that the operating
results presented include only recurring costs.

As consideration, the Company paid $5,000 in cash and issued 1,253,854 shares of
Common Stock of the Company with a fair value of $5.62, assumed $5,100 in
liabilities, and incurred $734 in direct acquisition costs.  This transaction
was accounted for as a purchase, and accordingly, the results since January 28,
1997, are included in the accompany condensed consolidated financial statements.

                                      39
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  For all acquisitions in 1997 and 1996, intangible assets are being amortized
on a straight line basis over the estimated useful life not to exceed three
years.  The portion of the purchase price allocated to incomplete research and
development projects that had not yet reached technological feasibility and did
not have any future alternative use was expensed as purchased incomplete
research and development as of the acquisition dates.  The amounts allocated to
incomplete research and development projects represents the estimated fair value
related to these projects determined by an independent appraisal.  Proven
valuation procedures and techniques were utilized in determining the fair value
of the purchased intangible assets.  To bring these projects to technological
feasibility, high risk development  and testing issues needed to be resolved
which required substantial additional effort and testing.


(3)  CHARGE FOR RESTRUCTURING.

  On August 6, 1996, the Company announced that it had implemented a
reorganization of its operations and a restructuring plan (the "96 Plan"). The
96 Plan included write-offs and write-downs of certain assets, including
accruing the costs related to a significant reduction in the Company's work
force,  primarily in the technical support and sales and marketing departments,
and the de-emphasis of certain product lines, resulting  in a non-recurring
charge of $5,415.  Included in the 96 Plan was an additional inventory write-
down of $2,026 which is included in cost of product revenue in accordance with
Emerging Issues Task Force (EITF) 96-9, Classification of Inventory Markdowns
and Other Costs Associated with a Restructuring.

The following are the significant components of the $5,415 charge for
restructuring:
<TABLE>
<CAPTION>
(Dollars in thousands)
<S>                                                         <C>
Employee severance, benefits and related costs              $1,531
Write-off and write-down of assets to net realizable
 value excluding inventory                                   3,522
Provision for costs in closing facility                        362
                                                            ------
                                                            $5,415
                                                            ======
</TABLE>

The total cash impact of the restructuring amounted to $2,367 which had been
paid as of December 31, 1996.

  On July 29, 1997, the Company announced that it had implemented a
reorganization of its operations and a restructuring plan (the "97 Plan").  The
97 Plan included write-offs and write-downs of certain assets, including
accruing the costs related to a significant reduction in the workforce,
primarily in the technical support and sales and marketing departments.  In
addition, the Company has exited from the anti-virus business and de-emphasized
its investment in new customer acquisitions for the Company's groupware, network
management and security businesses.  As a result of the 97 Plan the Company
recorded a restructuring charge of $4,530.  Included in the 97 Plan was an
additional inventory write-down of $849 which is included in cost of product
revenue in accordance with EITF 96-9.

The following are the significant components of the $4,530 charge for
restructuring:

<TABLE>
<CAPTION>
(Dollars in thousands)
<S>                                                              <C>
Employee severance, benefits and related costs                   $1,980
Write-off and write-down of assets to net realizable
  value excluding inventory                                       1,346
Provision for costs in closing facilities                         1,204
                                                                 ------
                                                                 $4,530
                                                                 ======
</TABLE>

The total cash impact of the restructuring is $2,834 of which $1,468 was paid by
December 31, 1997.  The Company anticipates the balance of the restructuring
cost to be paid in 1998.

                                      40
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  On October 29, 1997, the company announced that it would seek shareholder
approval to sell its Network Management and Network Security Business along with
related marketing systems and organization to Elron Software Inc. (Elron)., a
wholly owned subsidiary of Elron Electronics Industries (see Note 12).
Concurrently, the Company announced that it would refocus its international
sales organization to concentrate on the Client Management Business and would
close its offices in Sydney, Paris and London, while strengthening its presence
in Starnberg, Germany.  As a result, the Company recorded a restructuring charge
related to the write-off and write-down of certain assets, accruing the costs
related to the reduction of its international workforce (excluding csd)
primarily in the technical support and sales and marketing departments and
accruing the associated costs with closing its international locations
(excluding csd).

The following are the significant components of the $6,410 charge for
restructuring:

<TABLE>
<CAPTION>
(Dollars in thousands)
<S>                                                           <C>
Employee severance, benefits and related costs                $  762
Write-off and write-down of assets to net realizable value     3,600
Provision for costs in closing facilities                      2,048
                                                              ------
                                                              $6,410
                                                              ======
</TABLE>

The total cash impact of the restructuring is $1,332 of which $640 was paid by
December 31, 1997.  The Company anticipates the balance of the restructuring
cost to be paid in 1998.


(4)  INCOME TAXES

  The Company provides for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes.  Under the liability method specified by SFAS No.
109, a deferred tax asset or liability is determined based on the difference
between the financial statement and tax basis of assets and liabilities, as
measured by the enacted tax rates assumed to be in effect when these differences
reverse.  In the year ended December 31, 1997, the Company incurred a
significant operating loss for both book and tax purposes and gave benefit to
refundable income taxes which offset certain foreign tax provisions and as a
result no tax provision was recorded.  The income tax provision for the years
ended December 31, 1996 and 1995 was calculated based on the Company's effective
tax rate giving benefit to available net operating loss and research and
development credit carry-forwards and by recognizing a portion of the Company's
deferred tax asset in the year ended December 31, 1996.

The components of domestic and foreign income (loss) before the provision for
income taxes are as follows:

(Dollars in thousands)
<TABLE>
<CAPTION>
                               1997         1996         1995
                              ------       ------       ------
<S>                       <C>           <C>           <C>
Domestic                    $(27,644)    $(12,330)      $5,294
Foreign                       (7,128)      (3,434)         ---
                            --------     --------       ------
                            $(34,772)    $(15,764)      $5,294
                            ========     =========      ======
</TABLE>

                                      41
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)      1997         1996          1995
                           ------       ------        ------
<S>                      <C>          <C>            <C>
Current
    Federal               $ (409)      $   735        $1,092
    State                    (72)          444           530
    Foreign                  ---           ---           ---
                          ------       -------        ------
                            (481)        1,179         1,622
Deferred
    Federal                 (496)         (675)          ---
    State                    (87)         (407)          ---
    Foreign                1,064           ---           ---
                          ------       -------        ------
                             481        (1,082)          ---
                          ------       -------        ------
                          $  ---       $    97        $1,622
                          ======       =======        ======
</TABLE>

  In the year ended December 31, 1996, the Company incurred a significant
operating loss. However, included in the book changes were amounts not currently
deductible for income taxes.  The 1996 tax provision includes the amount
currently payable with an offsetting deferred tax benefit to record a portion of
the Company's deferred tax asset.  The Company provides deferred income taxes
for temporary differences between assets and liabilities recognized for
financial reporting and income tax purposes.  The income tax effects of these
temporary differences are as follows:

<TABLE>
<CAPTION>
(Dollars in thousands)                                      1997            1996
                                                           ------          ------
<S>                                                      <C>            <C>
Deferred tax asset ---
   Accounts receivable allowance.................         $     558       $  479
   Inventory reserve.............................               134        1,215
   Purchased intangibles.........................            11,884        5,910
   Reserve for distributor inventories...........                87           82
   Other temporary differences...................             2,047          461
   Net operating loss and tax credit                          6,861          571
   carry-forwards................................
                                                             21,571        8,718
                                                          ---------     --------
Deferred tax liability---
   Direct marketing costs and prepaid expenses...               (62)        (535)
                                                          ---------     --------
Valuation allowance..............................           (21,509)      (7,702)
                                                          ---------     --------
                                                          $      --     $    481
                                                          =========     ========
</TABLE>

  The Company has placed a full valuation allowance against its net deferred tax
asset as of December 31, 1997.  The valuation allowance increased during 1997 by
$13,807 since the Company believes it is "more likely than not" that it will not
be able to utilize it's deferred tax asset.

  As of December 31, 1997, the Company has available Federal net operating loss
carry-forwards of $15,879.  These carry-forwards expire through 2012 and are
subject to review and possible adjustment by the Internal Revenue Service.

The Tax Reform Act of 1986 contains provisions that may limit the amount of net
operating loss and credit carry-forwards that the Company may utilize in any one
year in the event of certain cumulative changes in ownership over a three-year
period in excess of 50%, as defined.

                                      42
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

A reconciliation of the federal statutory rate to the Company's effective tax
rate is as follows:

<TABLE>
<CAPTION>
(Dollars in thousands)                                                              1997       1996       1995
                                                                                 -----------------------------
<S>                                                                                <C>        <C>        <C>
Federal Statutory Rate...........................................................  (34.0%)    (34.0%)     34.0%
State taxes, net of federal benefit..............................................   (6.2%)     (6.2%)      6.6%
Generation (recognition) of net operating loss carry-forwards....................   40.2       39.6%     (10.0%)
                                                                                 -----------------------------
Effective tax rate...............................................................    ---        0.6%      30.6%
                                                                                 =============================
</TABLE>

(5)  LINE OF CREDIT

  The Company has a $10,000 line of credit (the "Line") that allows the Company
to borrow up to the lesser of $10,000 or 80% of qualified eligible accounts
receivable, as defined,  plus 40% of foreign qualified receivables, as defined.
Borrowings bear interest at the bank's prime rate (8.5% at December 31, 1997).
The Line expires on April 1, 1998, at which time all outstanding borrowings must
be repaid.  The Company has pledged all accounts receivable as collateral.  The
Line requires the Company to meet certain financial covenants, as defined.  At
December 31, 1997, the Company was in compliance with all of these covenants.
As of December 31, 1997, no amounts were outstanding.

(6)  LONG-TERM OBLIGATIONS AND COMMITMENTS

Leases

  The Company conducts its operations in leased facilities and leases certain
equipment under operating and capital leases expiring at various times through
1999.

  The Company has a master lease agreement, as modified, that allows the Company
to enter into up to $3,000 in fair market value equipment leases.  Borrowings
under both lease agreements are payable in monthly installments ranging from $1
to $9, including interest ranging from 7.01 % to 24.49% with terms ranging
between 36 and 50 months.  As of December 31, 1997, the Company had the ability
to borrow up to $3,000 under this master lease agreement.

The approximate minimum annual lease payments under both the operating and
capital leases are as follows:

<TABLE>
<CAPTION>
                                                   OPERATING       CAPITAL
(Dollars in thousands)                              LEASES         LEASES
                                                   ----------     --------
<S>                                                <C>            <C>
1998.............................................  $   694        $   388
1999.............................................      512             11
                                                   -------
                                                   $ 1,206            399
                                                   =======
Less --- Amount representing interest............                      33
                                                                  -------
Present value of minimum lease payments..........                     366
Less --- Current portion.........................                     356
                                                                  -------
                                                                  $    10
                                                                  =======
</TABLE>

  Total rental expense included in the accompanying consolidated statements of
operations for the years ended December 31, 1997, 1996 and 1995 was  $1,954,
1,418 and $846, respectively.

                                      43
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

The amount of equipment under capital lease and the related accumulated
amortization are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)                              1997            1996
                                                   ------          ------
<S>                                             <C>               <C>
    Equipment acquired under capital lease       $ 2,443           $ 3,895
    Accumulated amortization..............        (2,201)           (2,559)
                                                 -------           -------
    Net equipment acquired under capital
    lease.................................       $   242           $ 1,336
                                                 =======           =======
</TABLE>

  Total amortization expense included in the accompanying consolidated
statements of operations for the years ended December 31, 1997, 1996 and 1995 is
$998, $1,259 and  $1,001 , respectively.

Royalties

  The Company had entered into several software license agreements.   These
agreements provided the Company with exclusive worldwide licenses to distribute
certain software products.  The Company was required to pay royalties on all
related sales, subject to certain royalty targets to maintain exclusive
distribution rights to that software product.  As a result of the software
products sold to Elron (see Note 2), the Company has no minimum royalty
requirement to maintain exclusive distribution rights as of December 31, 1997.

  Total royalty expense included in the accompanying consolidated statements of
operations for the years ended December 31, 1997, 1996 and 1995 was $1,412,
$2,178 and $2,333, respectively.

(7)  STOCKHOLDERS' EQUITY

Initial Public Offering

  In August of 1995, the Company completed an initial public offering ( the
"IPO") of 2,360,000 shares of common stock for $15.00 per share.  The sale of
common stock resulted in net proceeds to the Company of $31,647, after deducting
all expenses related to the IPO. In connection with the Company's initial public
offering, the redeemable convertible preferred shares were automatically
converted into 3,841,632 shares of common stock.

Common Stock

  The Company has 20,000,000 authorized shares of common stock $.01 par value,
of which 12,223,213 shares were issued and outstanding at December 31, 1997.

Preferred Stock

  The Company has an authorized class of Preferred Stock consisting of 2,000,000
shares, which may be issued from time to time in one or more series.  The
Company's Board of Directors has authority to issue the shares of Preferred
Stock in one or more series, to establish the number of shares to be included in
each series and to fix the designation, powers preferences and rights of the
shares of each series and the qualifications, limitations or restrictions
thereof, without any further vote or action by the stockholders.  The issuance
of Preferred Stock could decrease the amount of earnings and assets available
for distribution to holders of Common Stock, and may have the effect of
delaying, deferring or preventing a change in control of the Company.  The
Company has not issued any shares of preferred stock as of  December 31, 1997.

Reserved Shares of Stock

  The Company had reserved 3,411,617 shares of common stock at December 31, 1997
for the exercise of stock options under the 1992 Employee and Consultant Stock
Option Plan, 1995 Directors Stock Option Plan and 1995 Employee Stock Purchase
Plan.

                                      44
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

Stock Split

  On May 18, 1995, the Board of Directors approved a one-for-six reverse stock
split.  Accordingly, all shares of common stock and the conversion ratio of
preferred stock have been retroactively adjusted in the accompanying
consolidated financial statements for all periods presented to reflect this
split.

(8)  STOCK OPTION PLANS

  In July 1992, the Company adopted the 1992 Employee and Consultant Stock
Option Plan (the Plan).  Pursuant to the Plan, the Company may grant to
employees and consultants of the Company statutory and nonstatutory stock
options to purchase up to 3,300,000 shares of common stock as amended.

  The Company's 1995 Directors Stock Option Plan ( the "Director's Plan") was
adopted on May 18, 1995 and provides for the granting of options to purchase up
to 100,000 shares of Common Stock to directors who are not employees of the
Company.

Stock option activity for the option plans was as follows:

<TABLE>
<CAPTION>
                                                                                             WGHT AVG
                                          NUMBER                                             EXERCISE
                                            OF                    EXERCISE PRICE               PRICE
                                          SHARES                 RANGE PER SHARE             PER SHARE
                                       ------------      --------------------------------  --------------
<S>                                    <C>                <C>                               <C>
   Outstanding, December 31, 1994....    1,078,441         $    .0307   -    $     2.4600    $     1.1685
   Granted...........................      308,607             2.4600   -         17.5000         10.7900
   Exercised.........................     (444,878)             .0307   -          9.0000           .3412
   Terminated........................     (318,446)             .5040   -         16.1250          2.0496
                                     -------------     --------------------------------------------------
   Outstanding, December 31, 1995....      623,724              .0307   -         17.5000          5.6373
   Granted...........................      603,217             5.1250   -         16.7500          8.8626
   Exercised.........................      (91,795)             .5040   -          9.0000          1.5642
   Terminated........................     (112,240)             .5040   -         16.1250          8.6597
                                     -------------     --------------------------------------------------
   Outstanding, December 31, 1996....    1,022,906              .0307   -         17.5000          7.5710
   Granted...........................    2,124,689              .0100   -          5.7500          2.3910
   Exercised.........................      (41,537)             .0100   -          2.4600           .6732
   Terminated........................   (1,170,430)             .0100   -         16.7500          6.4940
                                     -------------     --------------------------------------------------
   Outstanding, December 31, 1997....    1,935,628         $    .0100   -    $    17.5000    $     2.6554
                                     =============     ==================================================

   Exercisable, December 31, 1997....      219,274         $    .0100   -    $    17.5000    $     5.2380
                                     =============     ==================================================
</TABLE>

  In October 1995, the Financial Accounting Standards Board issued SFAS No. 123
Accounting for Stock Based Compensation, which requires the measurement of the
fair value of stock options or warrants to be included in the statement of
operations or disclosed in the notes to the financial statements.  The Company
has determined that it will continue to account for stock-based compensation for
employees under APB No. 25 and elect the disclosure-only alternative under SFAS
No. 123 for options granted after January 1, 1995 using the Black-Scholes option
pricing model  prescribed by SFAS No. 123.  The weighted average assumptions
used are as follows:

<TABLE>
<CAPTION>
                                 1997         1996
                                ------       ------
<S>                           <C>            <C>
Risk-free interest rate.....     7.00%         6.34%
Expected dividend yield.....      ---           ---
Expected lives..............     7             7
Expected volatility.........   111.27%        73.56%
</TABLE>

                                      45
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  Had compensation cost for these plans been determined consistent with SFAS No.
123, the Company's net loss and basic and diluted net loss per share would have
been reduced to the following pro forma amounts:

<TABLE>
<CAPTION>
(Dollars in thousands, except per
 share data)                                                   1997                1996                 1995
                                                              ------              -----                ------
<S>                                      <C>                 <C>                  <C>                  <C>
Net Income (Loss)                        As Reported         (34,772)             (15,861)               3,672
                                         Pro Forma           (36,270)             (16,846)               3,378
Basic Net Income (Loss) Per Share        As Reported           (2.88)               (1.46)                0.52
                                         Pro Forma             (3.00)               (1.55)                0.53
Diluted Net Income (Loss) Per Share      As Reported           (2.88)               (1.46)                0.40
                                         Pro Forma             (3.00)               (1.55)                0.37
</TABLE>

  Because the method prescibed by SFAS No. 123 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 Company has recorded $392 of deferred compensation during the year ended
December 31, 1997.  The deferred compensation represents the excess of the fair
market value of the Company's common stock over the exercise price of certain
options on the date of the grant.  Deferred compensation will be amortized to
compensation expense over the vesting period of each employee's stock option.

Employee Stock Purchase Plan

  On May 18, 1995, the Company adopted the 1995 Employee Stock Purchase plan
pursuant to which up to 1,000,000 shares of common stock may be issued.  The
plan consists of semiannual offerings commencing on the first day the Company's
common stock was publicly traded and each subsequent offering commencing on
January 1 and July 1 of each year.  The maximum number of shares of common stock
that may be purchased by an employee is determined on the first day of each
offering period, as defined.  The price at which the shares are purchased is the
lower of  85% of the closing price on the first or last day of the offering
period.

(9)   401 (K) PLAN

  In 1994, the Company established a plan under Section 401 (k) of the Internal
Revenue Code  (the "401 (k) Plan") covering all eligible employees, as defined.
Participants in the 401 (k) Plan may not contribute more than the lesser of
specified statutory amount or 15% of his or her pretax total compensation.  The
401 (k) Plan permits, but does not require, additional contributions to the
401(k) Plan by the Company.  The Company made no contributions during 1997, 1996
or 1995.

(10)  ACCRUED EXPENSES

  Accrued expenses consisted of the following:

<TABLE>
<CAPTION>
(Dollars in thousands)                      1997         1996
                                           ------       ------
<S>                                        <C>         <C>
    Payroll and payroll related..........  $  728      $  691
    Royalties............................     108         240
    Restructuring........................   2,225         ---
    Other................................     658       1,321
                                           ------      ------
                                           $3,719      $2,252
                                           ======      ======
</TABLE>

                                      46
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(11)  GEOGRAPHIC INFORMATION

Export Revenue

  Export revenue as a percentage of total revenue for the years ended December
31, 1997, 1996 and 1995 was 37%, 17% and 14%, respectively.

Geographic information for 1997 is as follows:

Geographic Sales by Destination
-------------------------------

North America                      65%
Europe                             33%
Other                               2%
                                 ----
Total                             100%

<TABLE>
<CAPTION>
                                         North
                                        America          Europe          Other           Elimination          Total
                                   ------------------------------------------------------------------------------------
<S>                                  <C>             <C>             <C>             <C>                  <C>
(Dollars in thousands)
Sales to unaffiliated customers           $ 26,930         $13,679         $   673             $      0        $ 41,282
Transfers between geographic areas           3,847             ---             ---               (3,847)            ---
                                   ------------------------------------------------------------------------------------
Total Sales                                 30,777          13,679             673               (3,847)         41,282

Operating loss                             (27,828)         (6,105)         (1,023)                 184         (34,772)
Identifiable assets                         34,440           4,122               4              (21,184)         17,382
</TABLE>

Transfers between geographic areas are accounted for equivalent to an arm's
length basis.  Geographic information has not been included for the years ended
December 31, 1996 and 1995 since foreign operations were not greater that 10%
and are not meaningful.

(12)  ASSETS HELD FOR SALE

  On October 29, 1997, the Company announced it would seek shareholder approval
to sell to Elron for an aggregate price of $12 million, with the possibility of
an additional performance bonus of up to $1.5 million, (a) all of the Company's
right, title and interest as owner of the computer software programs known as
ONGuard Internet Manager, ONGuard Firewall, and the Odyssey Application Software
and Database, and as license of SofTrack (collectively, the "Software"), (b) all
of the Company's right, title and interest in its catalog business, including
management information systems, sales and marketing databases and customer
lists; (c) all of the Company's right, title and interest in and to the
methodology, procedures, techniques and documentation utilized by the Company
for the sale and distribution of computer software, hardware and peripherals,
(collectively, the "free Trial Marketing System"); (d) all of the Company's
right title and interest in certain contracts, agreements, real and personal
property leases, licenses and other instruments; (e) certain accounts
receivable, notes and notes receivable, with a Company-guaranteed value of
$3,000,000; (f) certain equipment, furniture, leasehold improvements; (g)
certain inventory; (h) certain trade names and trademarks; and (i) the goodwill
associated with the foregoing assets (collectively, the "Proposed Assets").  As
part of the Transaction, the Company transferred approximately 100 employees
including Ivan O'Sullivan, the Company's Vice President - World Wide Marketing,
and Chadwick Roll, the Company's Vice President of Inside Sales to Elron.

                                      47
<PAGE>

                   ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  On October 29, 1997 the Company entered into a management agreement with
Elron, pursuant to which Elron shall manage the Proposed Assets for its benefit
and at its risk and expense and shall pay all salaries and other employee
related expenses with respect to the Proposed Assets and transferred employees.
As a result of the management agreement the associated revenues and costs of the
Proposed Assets have been excluded from the statement of operations for the
period from October 30, 1997 to December 31, 1997.  As of December 31, 1997
assets held for sale, net; represent the net book value of the Proposed Assets
as of October 29, 1997.

On February 11, 1998, the Company received shareholder approval to sell to Elron
the Proposed Assets.  In addition, the Company received $12 million in cash and
paid $3 million related to the accounts receivable guarantee.  In the first
quarter of  1998 the Company will record a gain equal to the difference between
the sum of the deal costs associated with the proposed transaction and the value
of the assets held for sale, less the $9 million purchase price.

  Unaudited pro forma operating results for the Company, assuming the sale of
assets occurred on January 1, 1996 is as follows:

<TABLE>
<CAPTION>
                                                December 31,    December 31,
(Dollars in thousands, except per share data)       1997           1996
                                                ------------    ------------
<S>                                           <C>              <C>
Net sales                                       $    23,454     $    27,400
Net loss                                        $   (40,233)    $   (26,247)
Basic and diluted net loss per share            $     (3.33)    $     (2.42)
Shares used in computing profoma basic and
diluted net loss per share                       12,079,264      10,853,814
</TABLE>

  For purposes of  these proforma operating results, the associated revenues and
costs of the Proposed Assets have been excluded from the Statement of Operations
for 1996 and 1997.  The associated gain on the sale of assets has not been
included in accordance with the Securities and Exchange Commission regulations
on non-recurring charges.

                                      48
<PAGE>

SCHEDULE II
                   ON Technology Corporation and Subsidiaries
                       Valuation and Qualifying Accounts
              For the years Ended December 31, 1995, 1996 and 1997
                             (dollars in thousands)

<TABLE>
<CAPTION>
                                      BALANCE,          CHARGED TO        OTHER ADDITIONS                    BALANCE, END
                                  BEGINNING OF YEAR       EXPENSE         TO ALLOWANCE(1)     WRITE-OFFS       OF YEAR
<S>                               <C>                 <C>                <C>                <C>                <C>
Allowance for doubtful accounts
-------------------------------
Year ended December 31, 1995           $  434             $  256                ---                $85          $  605

Year ended December 31, 1996           $  605             $  639                ---                $53          $1,191

Year ended December 31, 1997           $1,191             $1,535               $301                $52          $2,975
</TABLE>
(1)  Additions arising through the acquisition of csd Software GmbH in 1997.

                                      49
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To ON Technology Corporation and Subsidiaries

We have audited in accordance with generally accepted standards, the
consolidated financial statements of ON Technology Corporation and Subsidiaries
included in this Form 10-K and have issued our reporting thereon dated January
25, 1998 (except for the matters discussed in Note 12 as to which the dates are
February 11, 1998).  Our audit was made for the purpose of forming an opinion on
the basic consolidated financial statements taken as a whole.  The schedule
listed in Item 14 of this Form 10-K is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements.  This schedule has been subjected to the
auditing procedures applied in the audit of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects, the
financial data required to be set forth therein, in relation to the basic
consolidated financial statements taken as a whole.



                                   /s/ Arthur Andersen LLP
                                   -----------------------
                                   ARTHUR ANDERSEN LLP

Boston, Massachusetts
March 25, 1998

                                       50
<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 TECHNOLOGY CORPORATION



                                              /s/ Herman DeLatte
                                           ---------------------------------
Date: March 30, 1998                       Name:  Herman DeLatte
                                           Title:  President
                                                   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.


                                           /s/ John M. Bogdan
                                        ---------------------------------
Date: March 30, 1998                    Name:  John M. Bogdan
                                        Title:  Vice President of Finance
                                                and Chief Financial Officer

                                           /s/ William C. Hulley
                                        ---------------------------------
Date: March 30, 1998                    Name:  William C. Hulley
                                        Title:  Chairman and Director

                                           /s/ Christopher A. Risley
                                        ---------------------------------
Date: March 30, 1998                    Name:  Christopher A. Risley
                                        Title:  Director


                                           /s/ Brian T. Horey
                                        ---------------------------------
Date: March 30, 1998                    Name:  Brian T. Horey
                                        Title:  Director


                                           /s/ Michael J. Zak
                                        ---------------------------------
Date: March 30, 1998                    Name:  Michael J. Zak
                                        Title:  Director


                                           /s/ R. Stephen Cheheyl
                                        ---------------------------------
Date: March 30, 1998                    Name:  R. Stephen Cheheyl
                                        Title:  Director

                                      51
<PAGE>

                               INDEX TO EXHIBITS
                                                            Sequentially
                                                            Numbered
Exhibit No.  Exhibit Title  Pages
-----------  -------------  -----

   3.1.+     Fourth Amended and Restated Certificate of Incorporation of
             ON Technology Corporation, incorporated by reference to
             exhibit 3.1 to the Company's Registration Statement on Form S-1
             (Reg. No. 33-92562).

   3.2.+     Amended and Restated By-Laws of ON Technology Corporation,
             incorporated by reference to exhibit 3.2 to the Company's
             Registration Statement on Form S-1 (Reg. No. 33-92562).

  10.1.*+    1992 Employee and Consultant Stock Option Plan, as amended.

  10.2.*+    1995 Directors Stock Option Plan, incorporated by reference to
             exhibit 10.2 to the Company's Registration Statement on
             Form S-1 (Reg. No. 33-92562).

  10.3.*+    1995 Employee Stock Purchase Plan, as amended.

  10.4.+     Second Restated Registration Rights Agreement dated June 1, 1994 by
             and among ON Technology Corporation and the holders of its
             Series A, B and C Convertible Preferred Stock and First Amendment
             thereto dated January 12, 1995, incorporated by reference to
             exhibit 10.4 to the Company's Registration Statement on Form S-1
             (Reg. No. 33-92562).

  10.5.*+    Employment Agreement dated May 18, 1995 by and between ON
             Technology Corporation and Christopher A. Risley, incorporated by
             reference to exhibit 10.5 to the Company's Registration Statement
             on Form S-1 (Reg. No. 33-92562).

  10.6.*+    Employment Agreement dated May 18, 1995 by and between ON
             Technology Corporation and John A. Rizzi, incorporated by
             reference to exhibit 10.6 to the Company's Registration Statement
             on Form S-1 (Reg. No. 33-92562).

  10.7.+     * Employment Agreement dated May 18, 1995 by and between ON
             Technology Corporation and Loren K. Platzman, incorporated by
             reference to exhibit 10.7 to the Company's Registration Statement
             on Form S-1 (Reg. No. 33-92562).

  10.8.+     * Employment Agreement dated May 18, 1995 by and between ON
             Technology Corporation and Ivan J. O'Sullivan, incorporated by
             reference to exhibit 10.8 to the Company's Registration Statement
             on Form S-1 (Reg. No. 33-92562).

  10.9.+     * Employment Agreement dated May 18, 1995 by and between ON
             Technology Corporation and John M. Bogdan, incorporated by
             reference to exhibit 10.9 to the Company's Registration Statement
             on Form S-1 (Reg. No. 33-92562).

  10.10.+    * Employment Agreement dated May 18, 1995 by and between ON
             Technology Corporation and James A. Batson, incorporated by
             reference to exhibit 10.10 to the Company's Registration Statement
             on Form S-1 (Reg. No. 33-92562).

  10.11.+    * Form of Indemnity Agreement by and between ON Technology and its
             directors and executive offices, incorporated by reference to
             exhibit 10.11 to the Company's Registration Statement on Form S-1
             (Reg. No. 33-92562).

  10.12.+    Lease dated July 9, 1993 by and between ON Technology Corporation
             and Boston Properties, incorporated by reference to exhibit 10.12
             to the Company's Registration Statement on Form S-1 (Reg. No. 33-
             92562).

  10.13.+    Sublease dated October 7, 1994 by and between On Technology
             Corporation and RSTAR Corporation, incorporated by reference to
             exhibit 10.13 to the Company's Registration Statement on Form S-1
             (Reg. No. 33-92562).

  10.14.+    Lease entered into in August 1994 by and between ON Technology
             Corporation and Perimeter Park West, incorporated by reference to
             exhibit 10.14 to the Company's Registration Statement on Form S-1
             (Reg. No. 33-92562).

  10.15.+    Letter Agreement dated January 20, 1994 between Fleet Bank of
             Massachusetts, N.A. and ON Technology Corporation, as amended by
             Loan Modification Agreement dated as of May 31, 1994, Second Loan
             Modification Agreement dated January 11, 1995 and Third Loan
             Modification Agreement dated May 18, 1995, incorporated by
             reference to exhibit 10.15 to the Company's Registration

<PAGE>

             Statement on Form S-1 (Reg. No. 33-92562).

  10.16.+    Software License Agreement among ON Technology Corporation and e.g.
             Software, Inc. dated July 1, 1994, incorporated by reference to
             exhibit 10.16 to the Company's Registration Statement on Form S-1
             (Reg. No. 33-92562).

  10.17.+    Software License Agreement among ON Technology Corporation,
             Integrity Software, Inc. and Integrity Software, Ltd. dated
             December 20, 1993, incorporated by reference to exhibit 10.17 to
             the Company's Registration Statement on Form S-1 (Reg. No. 33-
             92562).

  10.18+     Agreement by and between Database America Information Systems, Inc.
             and ON Technology Corporation dated July 6, 1995, incorporated by
             reference to exhibit 10.18 to Amendment No. 1 to the Company's
             Registration Statement on Form S-1 (Reg. No. 33-92562).

  10.19.+    * Directors and officers liability insurance policies issued by
             SteadFast Insurance Company and Evanston Insurance Company
             incorporated by reference to exhibit 10.1 to the Company's
             Quarterly report on Form 10-Q for the quarter ended September 30,
             1995.

  10.20.+    Asset Purchase Agreement by and between ON Technology Corporation
             and Elron Software, Inc. dated October 29, 1997, incorporated by
             reference to the exhibit to the Company's Current Report on Form
             8-K as filed on January 9, 1998.

  21.0.      Subsidiaries of the registrant.

  23.1.      Consent of Arthur Andersen LLP.

  27.0.      Financial Data Schedule

*  Management contracts or compensatory plans or arrangments covering executive
   officers or directors of ON Technology Corporation.
+  Previously filed.