<PAGE>   1
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-K

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934
         FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO ______

                           Commission File No. 0-22158

                                 NETMANAGE, INC.
             (Exact name of Registrant as specified in its charter)

DELAWARE                                                              77-0252226
(State or other jurisdiction of                (IRS Employer Identification No.)
incorporation or organization)


10725 NORTH DE ANZA BOULEVARD, CUPERTINO, CALIFORNIA                       95014
(Address of principal executive offices)                              (Zip code)

       Registrant's telephone number, including area code: (408) 973-7171

Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
Par Value

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

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

The approximate aggregate market value of the Common Stock held by
non-affiliates of the Registrant, based upon the closing price of the Common
Stock reported on Nasdaq National Market was $92,369,692 as of February 27, 1998
(1).

    The number of shares of Common Stock outstanding as of February 27, 1998
                                was 43,681,331.

                                -----------------
                       DOCUMENTS INCORPORATED BY REFERENCE
Sections of the Registrant's definitive Proxy Statement for the Registrant's
Annual Meeting of Stockholders, to be held May 21, 1998, which will be filed
with the Securities and Exchange Commission, are incorporated by reference into
Part III of this Report to the extent stated herein.


(1)Excludes 8,906,204 shares of Common Stock held by directors and officers and
   stockholders whose beneficial ownership exceeds five percent of the shares
   outstanding at December 31, 1997. Exclusion of shares held by any person
   should not be construed to indicate that such person possesses the power,
   direct or indirect, to direct or cause the direction of the management or
   policies of the Registrant, or that such person is controlled by or under
   common control with the Registrant.
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                                     PART I

ITEM 1 - BUSINESS.

         NetManage, Inc. (the "Company") develops, markets and supports software
tools for connecting personal computers to corporate mainframe, midrange and
UNIX(R) computers, and software that increases the productivity of corporate
call centers. The Company is a recognized leader in "PC Connectivity" and was
one of the first to develop and market a Windows-based transmission protocol
that has since become the industry standard for the Internet. In 1997, the
Company organized its business to take advantage of three major industry
trends: expansion of the Internet, continued mobilization of personal computer
users and broader access to corporate data and information. Its products are
fully compatible with Microsoft Corporation's ("Microsoft") Windows 3.1, Windows
95 and Windows NT platform and IBM operating systems, including OS/2 and
Novell operating systems. The Company was incorporated in 1990 as a California
corporation and changed its incorporation to Delaware in 1993 in conjunction
with its initial public offering.

         The Company is organized into two business units, Core Technology and
Emerging Technology. Current Core Technology products provide the technology to
make the connection between personal computers and large corporate computers
possible. These products leverage the strengths and popularity of the Internet
and offer features to improve network manageability. Core Technology products
include the Company's strongest brands: the Chameleon family (Chameleon HostLink
97, Chameleon UNIX(R) Link 97, Chameleon 3270LT), and the NS/Portfolio family
(NS/Portfolio Enterprise, NS/Portfolio for Mainframe, NS/Portfolio for AS/400(R)
and NS/Router). Emerging Technology develops products that add value to the Core
Technology product offerings and also target new market segments. Current
products include SupportNow and OpSession, real-time software tools that help
reduce the length of support phone calls from end-users.

         During 1997, the Company acquired NetSoft, a California corporation
("NetSoft"), a developer and supplier of software for connecting personal
computers to midrange and mainframe platforms. The NetSoft acquisition expanded
the Company's range of PC connectivity solutions for corporations, especially in
the IBM Corporation ("IBM") AS/400(R) market. Netsoft also had strong brand
equity in its NS/Portfolio name. Its President and CEO, D. Patrick Linehan,
moved into the Company as Senior Vice President and General Manager of the Core
Business Unit. During 1997, the Company also acquired Relay Technology, Inc. a
Delaware corporation  ("Relay"). This purchase brought to NetManage a 3270
terminal emulator, more connectivity software and increased expertise and
penetration in the original equipment manufacturers ("OEM") sales channel.
Theodore (Ted) Joseph, President and CEO of Relay, became Vice President of OEM
sales at NetManage.

        This discussion contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. Such
forward-looking statements include, among others, statements regarding the
Company's expectation that indirect sales will grow as a percentage of both
domestic and total revenues and the Company's expectation that it will continue
to target and expand its marketing and sales efforts in major European and
Asian markets. The Company's actual results could differ significantly from the
results discussed in the forward-looking statements. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and include, among others, those discussed
under the heading "Factors That May Affect Future Results and Financial
Condition."

INDUSTRY BACKGROUND

         Three important industry trends had strong influence on the Company's
business strategy in 1997: (i) the further development of the Internet,
intranets and extranets as mission-critical business applications in large
companies, (ii) an increased desire on the part of corporations to make
information stored in mainframes and midrange computers ("legacy" systems)
broadly accessible and (iii) the continued mobilization of users of personal
computers on a global basis.

         The Company uses the term "inter-networking" to describe the technology
of global connectivity. Inter-networking had its origins in the Internet, a
world-wide "network of networks" which allows communication between different
organizations and locations, each with its own individual network of computers.
With the rapid development of the Internet, the breadth of the connectivity
industry has quickly expanded beyond proprietary-


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based solutions to Web-based technologies and other open protocol solutions. The
application of this same inter-networking technology within a company on its own
computer networks is known as an "intranet" to distinguish it from the larger
public Internet. When companies use inter-networking technology for connecting
to outside customers and suppliers, it's known as an "extranet." Importantly,
inter-networking is comprised of many different applications which must
communicate with one another, each according to its function, and which must
follow certain standards or conventions which ensure interoperability.

         The personal computer has continued to grow in importance as a tool for
facilitating communications, information sharing and group productivity in large
companies. As professional workers have become more and more mobile, there is an
accelerated effort to connect personal computers easily and reliably to
corporate networks to improve communications and organizational productivity. As
a result, the personal computer has become an important tool to connect workers
to shared repositories of information and to other people, regardless of
location, network or type of computer. Inter-networking also facilitates
activities such as mobile computing by allowing users to use and to access more
effectively all of a company's computer systems from a remote location.

         The specific tasks facilitated by inter-networking are numerous and
include basic functions such as file transfer and file sharing capabilities,
remote data access, login to remote computers and information publishing. Within
organizations, PCs must connect not only to other PCs via LANs, but also to
workstations, servers, minicomputers and mainframes, many of which may run
different operating system software and connect to different physical networks.
In addition, more companies are seeking ways to link their computer systems
directly with those of vendors, customers and other business partners to enhance
the flow of information and reduce expenses.

         For a network to function properly, all connected devices must follow
rules or "protocols" that govern access to the network and communication with
other devices. TCP/IP is the name of the protocol family used by all
inter-networking devices and applications because it is an open
(non-proprietary) protocol capable of linking disparate environments. The
Company was one of the first software vendors to deliver the TCP/IP protocol and
related applications for the Microsoft Windows platform. Selling primarily to
the business user, NetManage has promoted standards based on its implementation
of TCP/IP that have been adopted by the industry at large. The most notable
example is the Windows Sockets, or "WinSock" interface, which is used today by a
wide range of Windows inter-networking software vendors including Microsoft.

         The Company believes that because of the open and interoperable
characteristics of inter-networking technology, the use of intranets and the
software that enables them will continue to grow significantly within
organizations, and may emerge as the dominant corporate networking technology --
replacing other proprietary "LAN" (Local Area Network) technology from vendors
such as Novell, Inc. ("Novell"), International Business Machines ("IBM") and
Digital Equipment Corporation ("Digital").

         The required software to implement an inter-networking solution
includes applications for the desktop, the software which transports information
over the wires, the servers at the other end and management and development
tools to create and administer a network of this type. Additionally, an
easy-to-use, intuitive interface extends the use of these software components to
a large, non-technical audience and facilitates adoption by such an audience.

         The Company's vision is to provide inter-networking connectivity
products that greatly improve the communication between personal computers and
legacy systems regardless of where the PCs are located and to deliver products
and services that provide an easy to use, standards-based infrastructure that
ensures businesses run more efficiently, thereby bringing personal computers
together with corporate host systems and connecting both to the Internet. As the
Company continues to deliver on its vision, personal computer users will be able
to access corporate data and information more efficiently and more easily than
ever before.

PRODUCTS AND TECHNOLOGY

         The Company's comprehensive suite of products provides organizations
with cost-effective solutions for connecting people, their computers and their
businesses. The Company's products extend the functionality of


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these organizations' technology investments by providing essential services that
are not included in desktop and network operating systems. The result is
streamlined communication, reductions in the total cost of ownership and
increased productivity throughout an organization.

         The Company has been a long-time proponent of industry standards, and
it pursues partnerships and alliances with key industry players. In addition to
promoting technological progress, these alliances help strengthen the Company's
market insight and lead to improved customer solutions with greater value. Some
of the Company's strategic partners include Microsoft, Intel Corporation, IBM
and AT&T. All NetManage products are developed around the following:

         Ease of Use - The Company's goal is to create applications for
         non-technical users. The Company's products are designed to be set up
         on any personal computer in a few minutes and to determine with minimum
         user intervention all the appropriate settings and installation
         parameters for each PC's configuration and network. For corporate
         users, the cost of training, installation and support can exceed
         software acquisition costs. Ease of use can reduce such costs.
         Moreover, ease of use increases product utilization, thereby
         enhancing product value to the customer. Thus, by reducing costs and
         enhancing value, the benefit of ease of use is significant to the
         Company's target market.

         Manageability - NetManage offers a fully integrated suite of
         applications, improving network manageability for system
         administrators. For example, customers do not have to buy terminal
         emulation from one vendor and file transfer from another, each with its
         own setup, user interface and feature set. Client applications are
         compatible with custom intranet applications built using NetManage
         developer toolkits. The common characteristics of the product suite
         tend to increase user satisfaction and product utilization. A
         well-integrated product lowers the cost of ownership and increases
         product value to the customer.

         Functionality - The depth and completeness of the applications in
         NetManage products are designed to compete with ''best of class''
         functionality from specialist vendors in each category. The value
         proposition of NetManage's product offerings is enhanced by eliminating
         multi-source product purchases with no compromise on advanced software
         functionality. The economic proposition for the customer is enhanced by
         purchasing software and service from a single vendor.

         Supportability - NetManage recognizes its customers need to reduce
         continually the cost-of-ownership associated with personal computer
         connectivity software. Unlike competitors, who have focused solely on
         improved manageability to reduce costs, NetManage has also invested in
         the development of unique support tools. Products are designed with
         well-integrated support tools that reduce the time required to resolve
         software problems and reduce downtime, significantly enhancing the
         value of NetManage's product offerings to customers.

         Adherence to Standards - The very foundation of the Internet is
         predicated upon the notion that any client can talk to any server, and
         that all APIs (Application Program Interfaces) and protocols are
         published as free open standards. In the corporate computing
         environment it is impossible to guarantee a common set of software on
         every client and every server. NetManage's commitment to open standards
         insures that the plug and play interoperability that has made internet
         successful extends to the corporate Intranet as well.

         The Company's best-known products include the Chameleon and
NS/Portfolio product families. The Company recently acquired NetSoft to
increase substantially the capability of its AS/400(R) offering, and Relay
to expand the capability of its mainframe offering and OEM
sales efforts. The Company's products include:


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           Chameleon UNIX(R) Link97        Complete PC-to-UNIX(R) connectivity,
                                           including PC NFS file sharing ,
                                           the most comprehensive suite of
                                           Telnet terminal emulation for
                                           TCP/IP and async connections and
                                           the industry's first web-enabled X
                                           Window server.



           Chameleon HostLink 97           Complete PC-to-IBM mainframe and
                                           AS/400(R) connectivity -- including
                                           Web browser access and simplified
                                           management.



           Chameleon 3270LT                IBM mainframe connectivity software
                                           for TCP/IP networks.



           Chameleon Host Agent            Scalable, server-based host
                                           connectivity software designed for
                                           Windows NT.



           NS/Portfolio Enterprise         Full-featured, manageable access to
                                           IBM mainframes and AS/400(R) systems
                                           from all Windows platforms.

           NS/Portfolio for Mainframes     Comprehensive, fully-featured
                                           PC-to-IBM mainframe communications
                                           solution for all Microsoft Windows
                                           platforms.

           NS/Portfolio for AS/400(R)      Comprehensive, fully-featured
                                           PC-to-IBM AS/400(R) communications
                                           solution for all Microsoft Windows
                                           platforms.

           NS/Router Portfolio             The industry-standard Microsoft
                                           Windows-based APPC router offering
                                           increased productivity, ease of
                                           installation and configuration and
                                           enhanced security for host-server
                                           data.

           NS/Portfolio Toolbox            Software application development
                                           tools for NS/Portfolio clients.

           SupportNow                      Real-time software support tool that
                                           reduces the length of corporate
                                           support calls. It provides
                                           independent software vendors ("ISVs")
                                           a way to offer faster and more
                                           effective technical support to their
                                           customers via interactive sessions.

           SupportNow Server               Comprehensive real-time support
                                           server offering SupportNow Call Queue
                                           Management, conferencing, backend
                                           help desk integration, and proxy
                                           services for OpSession and SupportNow
                                           products.

           OpSession                       Software support tool, like
                                           SupportNow, for corporations. It
                                           enables companies to manage and
                                           complete internal support calls
                                           quickly and efficiently. It enables
                                           real-time, interactive sharing of
                                           documents and applications, and
                                           improves remote training and
                                           demonstrations.

           OpSession SDK                   Comprehensive software developer
                                           tool that enables programmers to add
                                           real-time application and workgroup
                                           sharing capability, using standard
                                           Internet technology, to any Microsoft
                                           Windows 95/NT application.


         Substantially all of the Company's net revenues have been derived from
the sales of products that provide inter-networking applications for the
Microsoft Window environment and are marketed primarily to Windows users. As a
result, sales of the Company's products would be materially adversely affected
by market developments adverse to Windows. In addition, the Company's strategy
of developing products based on the Windows operating environment is
substantially dependent on its ability to gain pre-release access to, and to
develop expertise in,


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current and future Window developments by Microsoft. No assurance can be given
as to the ability of the Company to provide on a timely basis products
compatible with future Windows releases.

         The Company's competitors could seek to expand their product offerings
by designing and selling similar or new technology that could render the
Company's products obsolete or adversely affect sales of the Company's products.
These developments may adversely affect the Company's sales of its own products
either by directly affecting customer purchasing decisions or by making
potential customers delay their purchases of the Company's products.

SALES AND MARKETING

         The Company's products are designed to meet the needs of corporate
end-users, network administrators, system administrators and MIS managers. The
Company, through its Core Business Unit, targets three key connectivity market
segments: connecting personal computers to UNIX(R), IBM AS/400(R) midrange and
IBM mainframe systems. Through its Emerging Technology Business Unit, the
Company recently introduced an innovative software application that reduces the
length of support calls for organizations of all sizes.

         To serve the corporate marketplace, the Company is developing more
robust applications to provide greater value. The Company believes that the
markets for these PC connectivity solutions are large segments where the Company
has established products, reputation and expertise.

         The Company is organized to solve the critical network and application
needs of corporations in a wide range of industries. From education and
government to finance and manufacturing, the Company's products are being used
to streamline communications throughout organizations. The Company's products
are used by more than 30,000 organizations, encompassing more than 9 million
users worldwide.

         The Company's marketing strategy is to establish itself as the
preferred supplier of complete personal computer connectivity solutions for
corporations. It has a competitive advantage as a "single-source" supplier for
corporations. The Company's products are marketed and sold in the United States
and internationally by the Company's direct sales force and authorized channel
partners.

         In the United States, the Company combines advertising and promotion
with direct sales through a telephone-based sales force, assisted by designated
personnel specifically assigned to the needs of major accounts. As part of its
continuing strategy to develop multiple distribution channels, the Company
expects to utilize increasingly indirect channels, such as resellers,
particularly value added resellers and systems integrators, distributors and
original equipment manufacturers. The Company expects that indirect sales will
grow as a percentage of both domestic and total revenues and that any material
increase in the Company's indirect sales as a percentage of revenues will
adversely affect the Company's average selling prices and gross margins due to
the lower unit costs that are typically charged when selling through indirect
channels. There can be no assurance that the Company will be able to attract
resellers and distributors who will be able to market the Company's products
effectively and will be qualified to provide timely and cost-effective customer
support and service. The Company ships products to resellers and distributors
on a purchase-order basis, and many of the Company's resellers and distributors
carry competing product lines. Therefore, there can be no assurance that any
reseller or distributor will continue to represent the Company's products, and
the inability to recruit or retain important resellers or distributors could
adversely affect the Company's results of operations.

         Internationally, the Company has sales offices in Belgium, France,
Germany, Israel, Italy, Japan, Netherlands, Sweden and the United Kingdom. The
Company also utilizes local distributors internationally. The Company supports
the sales activity of these sales offices and distributors in target countries
through localization of products and sales material, local training and
participation in local trade shows.

         In 1997, the Company derived approximately 23% of net revenues from
international sales, including export sales. The Company believes that the
potential international markets for its products are substantial, based


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on the extent to which Windows and inter-networking products are used
internationally. Accordingly, the Company localizes its products for use in the
native language of target countries. Further, the Company has adopted its
software to support computing standards that are unique to these countries, such
as the NEC PC in Japan. The Company will continue to target major European and
Asian countries for additional sales and marketing activity and to expand the
use of its local sales offices and Israel subsidiary in the support of its
international sales. While the Company expects that international sales will
continue to account for a significant portion of its net revenues, there can be
no assurance that the Company will be able to maintain or increase international
market demand for the Company's products or that the Company's distributors will
be able to meet effectively that demand.

         Risks inherent in the Company's international business activities
generally include unexpected changes in regulatory requirements, tariffs and
other trade barriers, costs and risks of localizing products for foreign
countries, longer accounts receivable payment cycles, difficulties in managing
international operations, currency fluctuations, potentially adverse tax
consequences, repatriation of earnings and the burdens of complying with a wide
variety of foreign laws. There can be no assurance that such factors will not
have an adverse effect on the Company's future international sales and,
consequently, on the Company's results of operations.

CUSTOMER SUPPORT

         The Company's domestic support organization consists of an experienced
staff of engineers providing support by telephone from the Company's facilities
in California and New Hampshire. Both telephone support and regular update
releases of the software are provided to customers who purchase an annual
maintenance agreement. The sales and the customer support organizations at
NetManage work together closely to provide customer satisfaction.

         International customers are supported by local distributors who are
trained by the Company and also are supported by Company personnel located in
various sales offices.

COMPETITION

         The market for the Company's products is intensely competitive and
characterized by rapidly changing technology, evolving industry standards,
changes in customers' needs and frequent new product introductions. To maintain
or improve its position in this industry, the Company must continue to enhance
its current products and develop new products on a timely and cost-effective
basis. Several key factors will contribute to the continued growth of the
Company's marketplace, including the migration from 16- to 32-bit Microsoft
Windows platforms, the proliferation of Microsoft Windows NT client and server
technology, the proliferation of multi-user Microsoft Windows NT systems and
the implementation of Web-based access to corporate mainframe and midrange
computer systems and information.

        Any failure by the Company to anticipate or respond adequately to
changes in technology and customer preferences, or any significant delays in
product development or introduction, would have a material adverse effect on
the Company's results of operations. The failure to develop on a timely basis
these or other enhancements incorporating new functionality could cause
customers to delay purchase of the Company's current products or cause
customers to purchase products from the Company's competitors; either situation
would adversely affect the Company's results of operations. There can be no
assurance that the Company will be successful in developing new products or
enhancing its existing products on a timely basis, or that such new products or
product enhancements will achieve market acceptance.

         The Company competes directly with providers of Windows
inter-networking applications, such as FTP Software, Hummingbird Communications,
Ltd., Attachmate Corporation, Wall Data, Inc., IBM, WRQ, Inc., Microsoft and
Novell, as well as several other companies. It is imperative that the Company's
development efforts remain competitive in this marketplace, particularly given
that the market is rapidly evolving and subject to rapid technological change.
There is no assurance that the Company will be successful in its efforts to do
so.

         Many of the Company's competitors have substantially greater financial,
technical, sales, marketing and other resources, as well as greater name
recognition and a larger customer base, than the Company. The market for



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the Company's products is characterized by significant price competition, and
the Company anticipates that it will face increasing pricing pressures from
current competitors in the future. Moreover, given that there are low barriers
to entry into the software market and that the market is rapidly evolving and
subject to rapid technological change, the Company believes that competition
will persist and intensify in the future. Accordingly, there can be no assurance
that the Company will be able to provide products that compare favorably with
the products of the Company's competitors or that competitive pressures will not
require the Company to reduce its prices. The Company has continued to
experience price declines for its products, contributing to lower revenues in
1997 as compared to prior periods. Any further material reduction in the price
of the Company's products would negatively affect gross margins as a percentage
of net revenues and would require the Company to increase software unit sales in
order to maintain net revenues at existing levels.

PROPRIETARY RIGHTS

         The Company relies primarily on a combination of copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under patent, trade secret
and copyright laws, which afford only limited protection. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult, and while the Company is unable to determine the extent
to which piracy of its software products exists, software piracy can be expected
to be a persistent problem. In selling its products, the Company relies
primarily on "shrink wrap" licenses that are not signed by licensees and,
therefore, may be unenforceable under the laws of certain jurisdictions. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that the Company's means of protecting its proprietary
rights will be adequate or that the Company's competitors will not independently
develop similar technology. In addition, the Company has received, and may
receive in the future, communications from third parties asserting that the
Company's products infringe, or may infringe, the proprietary rights of third
parties, seeking indemnification against such infringement or indicating that
the Company may be interested in obtaining a license from such third parties.
There can be no assurance that any of such claims would not result in protracted
and costly litigation.

         The Company believes that, due to the rapid pace of innovation within
its industry, factors such as the technological and creative skills of its
personnel are more important to establishing and maintaining a technology
leadership position within the industry than are the various legal means of
protecting its technology. The Company believes that its products and technology
do not infringe any existing proprietary rights of others, although there can be
no assurance that third parties will not assert infringement claims in the
future.

EMPLOYEES

         As of December 31, 1997, the Company had a total of 440 full-time
employees, of whom 219 were engaged in sales, marketing and technical support,
76 in general management, administration and finance, 137 in software
development and engineering and 8 in production. None of the Company's employees
are subject to a collective bargaining agreement, and the Company has not
experienced any work stoppage. The Company believes that its employee relations
are good.

         The majority of the Company's employee workforce is located in the
extremely competitive employment markets of the Silicon Valley and Irvine in
California and in Haifa, Israel. During the latter half of 1996 and through
1997, the Company experienced high attrition at all levels and across all
functions of the Company. The attrition experienced by the Company was
attributable to various factors including, among others, industry-wide demand
exceeding supply for experienced engineering and sales professionals. The
Company has and will continue to address the issue of attrition. Managing
employee attrition, integrating acquired operations and products and expanding
both the geographic area of its customer base and operations have resulted in
substantial demands on the Company's management resources. The Company's future
operating results will be dependent in part on its ability to attract and retain
its employee workforce, train and manage its management and employee base and
continue to


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implement and improve its operating and financial controls. There can be no
assurance that the Company will be able to manage such challenges successfully.

EXECUTIVE OFFICERS OF THE REGISTRANT

         The executive officers of the Company and their ages as of December 31,
1997 are as follows:

<TABLE>
<CAPTION>
           NAME                     AGE              POSITION
           ----                     ---              --------
<S>                                 <C>      <C>
           Zvi Alon                   46    Chairman of the Board, President and Chief
                                            Executive Officer
           Gary R. Anderson           51    Chief Financial Officer, Senior Vice
                                            President, Finance and Secretary
           D. Patrick Linehan         50    Senior Vice President, General Manager of the
                                            Core Business Unit
           Patricia M. Roboostoff     44    Senior Vice President, Human Resources
</TABLE>


         Zvi Alon is the founder of the Company and has served as its Chairman
of the Board, President and Chief Executive Officer since the Company's
formation. From 1986 to 1989, Mr. Alon was the President of Halley Systems, a
manufacturer of networking equipment including bridges and routers. He also has
served as Manager, Standard Product Line at Sytek, Inc., a networking company,
and Manager of the Strategic Business Group for Architecture, Graphics and Data
Communications at Intel Corporation ("Intel"), a semiconductor manufacturer. Mr.
Alon received a B.S. degree in electrical engineering from the Technion-Israel
Institute of Technology in Haifa, Israel. Mr. Alon is the son-in-law of Mr. Uzia
Galil, a director of the Company.

         Gary R. Anderson has served as Senior Vice President, Finance and Chief
Financial Officer since December 1997 when he joined the Company. From September
1996 to July 1997, Mr. Anderson was Chief Financial Officer and Executive Vice
President of NetSource Communications, a telecommunications and telemanagement
services provider and from April 1995 to April 1996 he was Chief Financial
Officer and Vice President of Air Net Communications, a telecommunications
hardware developer. Mr. Anderson also served as Senior Vice President and Chief
Financial Officer of WYSE Technology, Inc., a hardware manufacturer from June
1989 to January 1995. Mr. Anderson is a Certified Public Accountant.

         D. Patrick Linehan joined the Company in July 1997 as Senior Vice
President, General Manager of the Core Business Unit. Prior to joining the
Company, he served as President and Chief Executive Officer of NetSoft
(acquired by NetManage in July 1997), a software developer, since May 1996. From
January 1995 to May 1996 Mr. Linehan was President and Chief Executive Officer
of MiraLink Corporation, a hardware manufacturer and software developer.
Previously, he was Chief Executive Officer at Starbase Corporation, a software
developer, from October 1993 to January 1995 and President and Chief Executive
Officer of Castelle, Inc., a networking hardware manufacturer, from July 1991 to
October 1993. Mr. Linehan received a B.A. degree in business administration from
the University of Washington in Seattle.

         Patricia M. Roboostoff joined the Company in December 1994 as Vice
President, Human Resources and since March of 1996 has held the position of
Senior Vice President, Human Resources. Prior to joining NetManage, she was Vice
President Administration/Human Resources at Maxtor Corporation, a disk drive
manufacturer, since October 1991. From 1978 to 1991 Ms. Roboostoff was at Intel,
in several positions, most recently as Human Resources Manager of the
Microprocessor/Technology/Manufacturing organization.



ITEM 2 - PROPERTIES.

         In the United States, the Company's principal sales, marketing,
technical support, administration, product development and support functions
occupy an aggregate of approximately 83,000 square feet of facilities comprised
of two buildings located in Cupertino, California, one building in San Diego,
California and one building in Irvine,



                                       9
<PAGE>   10
California. The Company also leases approximately 12,000 square feet in Nashua,
New Hampshire, which is used for sales and technical support and 10,000 square
feet in Vienna, Virginia which is used for sales.

         Internationally, the Company leases approximately 35,000 square feet in
Haifa, Israel for the purpose of international sales, marketing and technical
support, administration, and product development. The Company also leases sales
office space in Belgium, France, Germany, Italy, Japan, Netherlands, Sweden and
the United Kingdom.



ITEM 3 - LEGAL PROCEEDINGS.

         On January 9, 1997, a securities class action complaint, Head, et al.
v. NetManage, Inc., et al., No. 07763295, was filed in the Superior Court of
California, Santa Clara County, against the Company and certain of its directors
and current and former officers. On January 10, 1997, the same plaintiffs filed
a securities class action complaint, Head, et al. v. NetManage, Inc., et al.,
No. C-97-20061-CRB, in the United States District Court for the Northern
District of California, against the same defendants. Both complaints allege
that, between July 25, 1995 and January 11, 1996, the defendants made false or
misleading statements of material fact about the Company's prospects and failed
to follow generally accepted accounting principles. The state court complaint
asserts claims under California state law; the federal court complaint asserts
claims under the federal securities laws. In addition, on September 10, 1997,
the Company and several of its officers and directors were named in a securities
class action complaint filed in the Northern District of California, Beasley v.
NetManage, Inc., et al., C-97-3329 FMS, (N.D. Cal.). This complaint is
substantially similar to the previously-filed case of Head et al. v. NetManage,
Inc. et al., discussed above, and contains similar allegations, names the same
defendants, and purports to represent purchasers of NetManage stock during the
same class period as in the previously-filed complaint. The complaints seek an
unspecified amount of damages. On February 24, 1998, the federal court granted
the defendants' motion to dismiss the federal class action complaint in Head, et
al. V. NetManage, Inc., et al. Plaintiffs are expected to file an amended
complaint. The Company believes there is no merit to these cases and intends to
defend both cases vigorously. There can be no assurance that the Company will be
able to prevail in the lawsuits, or that the pendency of the lawsuits will not
adversely affect the Company's operations. As the outcome of these matters
cannot be reasonably determined, the Company has not accrued for any potential
loss contingencies.

         On March 21, 1997, a securities class action complaint, Interactive
Data Systems, Inc., et al. v. NetManage, Inc., et al., No. CV764945, was filed
in the Superior Court of California, Santa Clara County, against the Company and
certain of its directors and officers. On June 19, 1997, one of the plaintiffs
in that action filed a securities class action complaint, Molinari v. NetManage,
Inc., et al., No. C-97-20544-CRB, in the United States District Court for the
Northern District of California against the same defendants. Both complaints
allege that, between April 18, 1996 and July 18, 1996, the defendants made false
or misleading statements of material fact about the Company's prospects. The
state court complaint asserts claims under California state law; the federal
complaint asserts claims under the federal securities laws. Both complaints seek
an unspecified amount of damages. The Company believes there is no merit to
either case and intends to defend both cases vigorously. There can be no
assurance that the Company will be able to prevail in the lawsuits, or that the
pendency of the lawsuits will not adversely affect the Company's operations. As
the outcome of these matters cannot be reasonably determined, the Company has
not accrued for any potential loss contingencies.

         On October 10, 1997, a verified derivative complaint was filed in the
United States District Court for the Northern District of California against
nine present and former officers and directors of the Company alleging that
these persons violated various duties to the Company. Sucher v. Alon et al., No.
C-97-20897-CRB. The derivative complaint also names the Company as a nominal
defendant. The derivative complaint is predicated on the factual allegations
contained in the class action complaints discussed above. No demand was
previously made to the Company's Board of Directors concerning the allegations
of the derivative complaint, which seeks an unspecified amount of damages.

         On November 26, 1997, a complaint was filed against the Company in the
Superior Court of California, San Diego County, Shaw et al. v. NetManage, Inc.,
No. 716081. The plaintiffs, who held a significant ownership


                                       10
<PAGE>   11
interest in AGE before it was acquired by NetManage, bring causes of action
alleging fraud, negligent misrepresentation, negligence and breach of contract
with respect to the Company's acquisition of AGE. The complaint seeks an
unspecified amount of damages. The Company believes there is no merit to the
case and intends to defend the case vigorously. There can be no assurance that
the Company will be able to prevail in the lawsuit, or that the pendency of the
lawsuit will not adversely affect the Company's operations. As the outcome of
this matter cannot be reasonably determined, the Company has not accrued for any
loss contingencies.

         The Company may be contingently liable with respect to certain asserted
and unasserted claims that arise during the normal course of business. In the
opinion of management, the outcome of all other such matters presently known to
management will not have a material adverse effect on the Company's business,
financial position or results of operations.




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

         Not applicable.




                                       11
<PAGE>   12
                                     PART II

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

         The Company's common stock is traded on the Nasdaq National Market
System under the symbol NETM. As of February 27, 1998 there were 672
stockholders of record.

         The high and low closing prices of the Company's common stock for each
quarter of 1997 and 1996 are as follows:

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

                    High          $   6.47          $   3.75         $   4.28          $   4.94
                    Low           $   2.78          $   2.53         $   2.75          $   2.19


         1996
                    High          $  22.69          $  18.00         $  12.75          $   8.56
                    Low           $   9.88          $   9.75         $   7.88          $   5.63
</TABLE>


         The Company has not paid cash dividends on its common stock and does
not intend to pay any cash dividends in the foreseeable future.


ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA.


For the five years ended December 31,
(in thousands, except per share data)

<TABLE>
<CAPTION>
                                              1997             1996            1995           1994         1993
                                         --------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
<S>                                        <C>              <C>             <C>            <C>            <C>
Net revenues                               $  61,524        $ 104,596       $ 125,446      $  71,466      $ 29,106

Income (loss) from operations(1)           $ (42,074)       $ (13,653)      $  29,596      $  26,619      $  9,183

Net income (loss)                          $ (33,755)       $  (5,705)      $  22,297      $  17,815      $  5,676

Net income (loss) per share, diluted(2)    $   (0.78)       $   (0.13)      $    0.52      $    0.43      $   0.19

Weighted average common
    shares, diluted                           43,385           42,341          42,955         41,103        29,262

BALANCE SHEET DATA:

Working capital                            $  55,542        $  71,668       $  83,738      $  64,091      $ 39,686

Total assets                               $ 119,593        $ 152,529       $ 154,471      $ 116,358      $ 47,762

Total stockholders' equity                 $  96,087        $ 129,291       $ 129,397      $  99,306      $ 41,475
</TABLE>

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

(1)  Loss from operations includes write-offs of in-process research and
     development of $20.6 million and $13.4 million for the years ended December
     31, 1997 and 1996, respectively.

(2)  Net income (loss) per share has been restated for all periods presented in
     accordance with SFAS No. 108. See Note 2 of Notes to Consolidated Financial
     Statements.



                                       12
<PAGE>   13
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

        This Annaul Report on Form 10-K contains, in addition to historical
information, forward-looking statements that involve risks and uncertainties.
Such forward-looking statements include, among others, statements regarding
expected revenues from newly introduced products, the amount of restructuring
charges and the funding of these charges from operations, statements regarding
expected fluctuations in operating expenses and capital spending, statements
regarding the Companys's expectation that indirect sales will increase as a
percentage of domestic and total revenues, the Company's expectation that it
will increase its marketing and sales efforts in major European and Asian
markets and statements regarding the Company's expectations as to the
composition of revenues as between Core Technology Products and Emerging
Technology Products. The Company's actual results could differ significantly
from the results discussed in the forward-looking statements. Factors that
could cause or contribute to such differences include, among others, that the
markets for the Company's products, including Chameleon UNIX(R) Link 97 and
Chameleon HostLink 97, could fail to grow at the rate expected by the Company
and market analysts, or the Company will not be able to take advantage of
growth in those markets. In addition, there is no assurance that the Company's
acquisitions of NetSoft and/or Relay or the Company's other organizational
changes and plans implemented in 1997 will prove successful, that the Company's
existing products or those of the combined companies will continue to meet with
customer acceptance, that the Company will not suffer increased competitive
pressures, that the buying decisions of the Company's corporate customers will
not be influenced by the actions of the Company's competitors or other market
factors or that the Company will return to profitability and growth. Additional
factors are identified under the heading "Factors That May Affect Future
Results and Financial Condition". The following discussion should be read in
conjunction with the consolidated financial statements and notes thereto.


OVERVIEW

         NetManage develops, markets and supports PC connectivity software for
the Microsoft Windows 3.1, Windows 95 and Windows NT platforms and IBM system
OS/2 and Novell, offering applications for UNIX(R), AS/400(R) and IBM mainframe
host systems. The Company also provides remote access, application sharing and
help desk technology. Its products are sold and serviced worldwide by the
Company's direct sales force, international subsidiaries and authorized channel
partners. Since the Company's inception, revenues from the Chameleon family of
products have represented substantially all of the Company's revenues, and the
Company expects that revenues from these products will continue to account for a
substantial portion of the Company's revenues for the foreseeable future.

         In November 1997, the Company acquired all of the outstanding shares of
Relay, a privately-held company, for $4.2 million in cash. Relay was primarily
engaged in the development, marketing and support of network connectivity, file
transfer and terminal emulation software. The acquisition has been accounted for
as a purchase. In connection with the purchase, net intangibles of approximately
$5.8 million were acquired, of which $4.6 million is reflected as a charge to
operations for the write-off of in-process research and development that had not
yet reached technological feasibility and, in management's opinion, had no
probable alternative future use.

         In July 1997, the Company acquired all of the outstanding shares of
Network Software Associates, Inc., a California corporation ("NSA") for $26.0
million in cash. NSA is a holding company for NetSoft, a privately-held company
specializing in the development, marketing and support of PC-to-Host
connectivity software solutions. As of the date of acquisition, NSA and NetSoft
have continued as wholly-owned subsidiaries of NetManage. The acquisition was
accounted for using the purchase method of accounting and, accordingly, the
results of NetSoft from the acquisition date forward have been recorded in the
Company's consolidated financial statements. In connection with the acquisition,
net intangibles of approximately $18.6 million were acquired, of which $16.0
million was reflected as a charge to operations for the write-off of in-process
research and development that had not yet reached technological feasibility and,
in management's opinion, had no probable alternative future use.

         As described in detail under the heading "Factors That May Affect
Future Results and Financial Condition" acquisitions involve a number of risks,
including the integration of the acquired company's operations, personnel and
products. There can be no assurance that the Relay and/or NetSoft integrations,
or the integration of any future acquisition, will be accomplished


                                       13
<PAGE>   14
successfully, and the failure to accomplish effectively any of these
integrations could have a material adverse effect on NetManage's results of
operations and financial condition.

         In the third quarter of 1997, the Company initiated a plan to
restructure its operations worldwide due to business conditions. The plan is
intended to realign the Company to focus solely on its core competencies:
UNIX(R), AS/400(R) midrange and IBM mainframe connectivity. In connection with
the plan, the Company recorded a $5.2 million charge to operating expenses. The
restructuring charge includes approximately $1.8 million of estimated
employee-related expenses for employee terminations, approximately $2.4 million
for the write-off of excess equipment and facilities related expenses associated
with the consolidation of operations and approximately $1.0 million for the
write-off of intangible assets related to certain unprofitable products. The
restructuring plan includes the termination of employees worldwide and the
reduction in worldwide office space, which primarily consists of the
consolidation of certain domestic technical support and engineering locations.
As of December 31, 1997, the Company had incurred costs totaling approximately
$4.3 million related to the restructuring. The remaining actions are expected to
be completed within one year from the date the restructuring plan was initiated.
The Company anticipates that these remaining restructuring actions will require
the expenditures of approximately $0.9 million of cash during 1998, which the
Company expects will be funded by internally generated cash.

         In July 1996, the Company acquired all of the outstanding stock of
Maximum Information, Inc., a California corporation ("MaxInfo"), in exchange for
approximately 590,000 shares of the Company's common stock. This transaction was
accounted for as a pooling of interests during the third quarter of 1996. The
operations of MaxInfo, however, were not material to the Company's consolidated
results of operations and financial position and, therefore, the historical
financial statements have not been restated to reflect the acquisition
retroactively. Accordingly, the operations of MaxInfo from the date of
acquisition forward have been recorded in the Company's consolidated financial
statements.

         In November 1995, the Company acquired all of the outstanding stock of
AGE Logic, Inc., a California corporation ("AGE"), in exchange for approximately
833,000 shares of the Company's common stock. The transaction was accounted for
as a pooling of interests and, accordingly, the Company's consolidated financial
statements for the years ended December 31, 1995, 1994 and 1993 have been
restated to combine the results of AGE and the Company. The Company also
acquired all of the outstanding stock of Syzygy Communications, Inc., a
California corporation ("Syzygy"), in exchange for approximately 394,000 shares
of the Company's common stock, in October 1995. This transaction was also
accounted for as a pooling of interests. The operations of Syzygy, however, were
not material to the Company's consolidated results of operations and financial
position and, therefore, the historical financial statements have not been
restated to reflect the acquisition retroactively. Accordingly, the operations
of Syzygy from the date of acquisition forward have been recorded in the
Company's consolidated financial statements.


RESULTS OF OPERATIONS

        During the past year, the Company has discontinued several low revenue
generating products and focused efforts on controlling costs in order to reduce
operating expenses and attempt to return the Company to profitability. As
previously discussed, in the third quarter of 1997 the Company initiated a plan
to restructure its operations worldwide and focus on its core competencies.
Additionally, during the fourth quarter of 1996 the Company consolidated its
operations into two distinct business groups, each with dedicated development,
sales, marketing and support resources. The Core Technology Business Unit
products provide the technology to make the connection between personal
computers and large corporate computers possible. These products leverage the
strengths and popularity of the Internet and offer features to improve network
manageability. Core Technology products include the Company's strongest brands:
the Chameleon family (Chameleon HostLink 97, Chameleon UNIX(R) Link 97,
Chameleon 3270LT), and the NS/Portfolio family (NS/Portfolio Enterprise,
NS/Portfolio for Mainframe, NS/Portfolio for AS/400(R) and NS/Router). The
Emerging Technology Business Unit develops products that add value to the Core
Technology product offerings and also target new market segments. Current
products include SupportNow and OpSession, real-time software tools that help
reduce the length of support phone calls from end-users.


                                       14
<PAGE>   15
         For the year ended December 31, 1997 as compared to the prior year, the
Company experienced a significant decline in net revenues and an increase in net
loss. The decline in net revenues primarily reflects the Company's lack of
success in marketing and selling its products, particularly in Europe and Japan,
as well as increased competition and pricing pressures. While additional
revenues resulted from both the NetSoft and Relay acquisitions, consolidated net
revenues also declined as a direct result of these acquisitions as the Company
was incorporating acquired products into existing product lines, integrating the
operations of NetManage and the acquired companies and restructuring the
combined companies' focus on becoming the premier single source provider of
PC-to-Host connectivity. As a result of these integration efforts, as well as
the timing of the acquisitions of NetSoft and Relay in the third and fourth
quarters of 1997, respectively, the acquisitions did not contribute
significantly to revenue for the year ended December 31, 1997. Finally,
Chameleon HostLink 97 began shipping towards the end of the third quarter of
1997 and, therefore, did not contribute significantly to revenues until the
fourth quarter of 1997.

         Operating expense levels are based in part on the Company's
expectations as to future revenues and to a large extent are fixed. Operating
expenses, excluding the write-off of in-process research and development and
restructuring charges, have decreased in absolute dollars for the year ended
December 31, 1997 compared to 1996. Operating expenses are expected to remain
relatively constant throughout 1998 and will fluctuate as a percentage of net
revenues as the Company integrates both NetSoft and Relay into its operations
and as the Company's newly introduced products contribute more significantly to
revenue. While the Company will continue to adjust its operations to address
these issues, there can be no assurance that net revenues or net income will
stabilize or improve in the future.



                                       15
<PAGE>   16
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------
(Dollars in millions)                             December 31,                      Change
Year ended                                  1997            1996               $              %
-------------------------------------------------------------------------------------------------

Net revenues:
<S>                                       <C>              <C>               <C>          <C>
    License fees                          $    45.8        $   89.3          $  (43.5)     (48.7%)
    Services                                   15.7            15.3               0.5        3.1%
                                          ---------        --------          --------
      Total net revenues                  $    61.5        $  104.6          $  (43.1)     (41.2%)

  As a percentage of net revenues:
    License fees                               74.4%           85.4%
    Services                                   25.6%           14.6%
                                          ----------       ---------
      Total net revenues                      100.0%          100.0%

Gross margin                              $    57.4        $   92.8          $  (35.3)     (38.1%)
    As a percentage of net revenues            93.3%           88.7%

Research and development                  $    20.7        $   27.9          $   (7.3)     (26.0%)
    As a percentage of net revenues            33.6%           26.7%

Sales and marketing                       $    41.4        $   52.2          $  (10.7)     (20.5%)
    As a percentage of net revenues            67.4%           49.9%

General and administrative                $    10.4        $   11.2          $   (0.8)      (6.9%)
    As a percentage of net revenues            16.9%           10.7%

Write-off of in-process
      research and development            $    20.6        $   13.4          $    7.3       54.2%
    As a percentage of net revenues            33.6%           12.8%

Restructuring charge                      $     5.2        $      -          $    5.2         n/a
    As a percentage of net revenues             8.4%              -

Interest income                           $     4.6        $    5.6          $   (1.1)     (18.9%)
    As a percentage of net revenues             7.4%            5.4%

Equity in income (losses) of
      unconsolidated affiliate            $     1.1        $   (1.0)         $    2.2     (213.9%)
    As a percentage of net revenues             1.0%            1.0%

Unrealized gain on investment in
      unconsolidated affiliate            $     2.2        $     -           $    2.2         n/a
    As a percentage of net revenues             3.5%             -

Benefit for income taxes                  $    (0.5)       $   (3.3)         $    2.9      (86.2%)
    Effective tax rate                           n/a             n/a

Net loss                                  $   (33.8)       $   (5.7)         $  (30.2)     491.7%
    As a percentage of net revenues              n/a             n/a
------------------------------------------------------------------------------------------------
</TABLE>


                                       16
<PAGE>   17
Net Revenues

         Historically, substantially all of the Company's net revenues have been
derived from software license fees. Service revenues have been primarily
attributable to maintenance agreements associated with licenses.

         License fees decreased substantially both in absolute dollars and as a
percentage of total net revenues during the year ended December 31, 1997 as
compared to the same period of 1996. As previously discussed, the decline in
license fees was primarily attributable to increased competition and heightened
pricing pressures and the Company's lack of success in marketing and selling its
products, particularly in the international marketplace. Further, as discussed
above, the timing of the NetSoft and Relay acquisitions and the release of the
Company's Chameleon HostLink 97 product prevented these events from contributing
significantly to revenues during the year ended December 31, 1997. While the
Company did realize increased revenues on a sequential quarterly basis in the
fourth quarter of 1997 as a result of the Company's recently introduced
products, including both Chameleon HostLink 97 and UNIX(R) Link 97 as well as
the Company's 1997 acquisitions, there can be no assurance that revenues will
continue to increase or stabilize in the future. The increase in service
revenues as a percentage of total net revenues for the year ended December 31,
1997 as compared to 1996 primarily reflects the decline in the total net
revenues base as a result of the aforementioned decline in license fee revenues.

         The Company has operations worldwide with sales offices located in the
United States, Europe and Japan. International revenues as a percentage of total
net revenues were approximately 23% and 33% for the years ended December 31,
1997 and 1996, respectively. The decline in international revenues as a
percentage of total net revenues was due largely to the Company's lack of
success in marketing and selling its products, particularly in Europe and Japan,
the latter of which accounted for the majority of the Company's international
revenues during 1996. NetSoft has historically been successful in marketing and
selling its products internationally, and the Company is in the process of
integrating and streamlining overlapping functions, particularly in Europe, to
benefit from NetSoft's success historically in the international marketplace.
The Company is addressing and taking steps with respect to staffing and
management, distributor relationships, and product marketing in Europe as well
as in Japan. There can be no assurance that such integration will be
accomplished expeditiously or successfully, or that the Company will succeed in
its attempts to improve its international marketing and sales efforts.

         Software license fees are generally recognized as revenue upon shipment
if there are no, or insignificant, post-delivery obligations, and allowances for
returns and doubtful accounts are provided based on historical rates of returns
and write-offs, which have not been material to date. Certain of the Company's
sales to distributors are under agreements providing rights of returns and price
protection on unsold merchandise. Accordingly, the Company defers recognition of
such sales until the merchandise is sold by the distributor.

         The Company provides ongoing maintenance and support to its customers,
generally under annual service agreements. Maintenance and support is comprised
of software updates for existing products and telephone support. Service
revenues are recognized on a pro-rata basis over the term of such agreements.
Periodically the Company has provided training and consulting services to
selected customers. Such revenue is recognized as the related services are
performed and has not been material to date. The Company does not expect that
revenues generated from such training and consulting services will become
materially significant in the future.

         No customer accounted for more than 10% of net revenues during the
years ended December 31, 1997 and 1996.

Gross margin

         Cost of revenues primarily includes royalties paid to third parties for
licensed software incorporated into the Company's products, costs associated
with product packaging, documentation and software duplication and the
amortization and writedown of purchased software. A charge of approximately $2.7
million is included in cost of revenues for the year ended December 31, 1996,
for the amortization and write-off of software purchased in early 1996. The
write-off of purchased software primarily resulted from the Company's decision
during the fourth quarter of 1996 to discontinue its ChameleonNFS for Mac OS and
Xoftware for Mac OS product lines. Amounts incurred for the amortization and
writedown of purchased software in 1997 were immaterial. Gross margin, as a


                                       17
<PAGE>   18
percentage of net revenues, increased between the years ended December 31, 1996
and 1997 primarily as a result of decreased packaging and documentation costs as
well as the 1996 charge of $2.7 million for the amortization and writedown of
purchased software discussed above. Cost of service revenues through December
31, 1997 has not been material and is not reported separately.

         Gross margin as a percentage of net revenues may fluctuate in the
future due to increased price competition, the mix of distribution channels used
by the Company, the mix of license fee revenues versus service revenues, the mix
of products sold and the mix of international versus domestic revenues. The
Company typically recognizes higher gross margins on direct sales than on sales
through indirect channels and higher gross margins on license fee revenues than
on service revenues. The Company expects that indirect sales will grow as a
percentage of both domestic and total revenues and that any material increase
in the Company's indirect sales as a percentage of revenues will adversely
affect the Company's average selling prices and gross margins due to lower unit
costs that are typically charged when selling through indirect channels.

Research and development

         Research and development ("R&D") expenses consist primarily of salaries
and benefits, occupancy and travel expenses, as well as fees paid to outside
consultants. The decrease in R&D expenses in absolute dollars for the year ended
December 31, 1997 as compared to the prior year is primarily the result of cost
savings, particularly salaries and benefits, associated with employee attrition
and the previously discussed restructuring. The decline in the total net
revenues base resulted in the increase in R&D expenses as a percentage of net
revenues for the year ended December 31, 1997 as compared 1996.

         The Company expects that R&D spending in absolute dollars will remain
relatively constant for 1998 and, as a percentage of revenues, will fluctuate
depending on future revenue levels, acquisitions and licensing of technology.

         Software development costs are accounted for in accordance with
Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed," under which the
Company is required to capitalize software development costs after technological
feasibility is established, which the Company defines as a working model and
further defines as a beta version of the software. The establishment of
technological feasibility and the ongoing assessment of the recoverability of
these costs requires considerable judgment by management with respect to certain
external factors, including, but not limited to, anticipated future gross
product revenue, estimated economic life and changes in technology. Costs that
do not qualify for capitalization are charged to R&D expense when incurred. To
date, internal software development costs that were eligible for capitalization
have not been significant and the Company has charged all internal software
developments costs to R&D expense as incurred.

Sales and marketing

         Sales and marketing ("S&M") expenses consist primarily of salaries and
commissions of sales and marketing personnel, advertising and promotional
expenses and customer service and support costs. The decrease in S&M expenses in
absolute dollars for the year ended December 31, 1997 as compared to the prior
year, primarily reflects cost savings related to employee attrition and the
restructuring discussed above, and the resulting declines in salaries and
benefits, as well as a decline in advertising as the Company re-evaluated its
marketing and selling strategies. As a percentage of total net revenues for the
year ended December 31, 1997 as compared to 1996, the increase in S&M expenses
was attributable to the decreased total net revenues base.

         The Company believes that S&M expenses will increase in absolute
dollars during 1998 as the Company implements its marketing and selling
strategies, particularly related to advertising and promotion. The Company
expects S&M expenses as a percentage of total net revenues will fluctuate
depending on future revenue levels.

General and administrative

         General and administrative ("G&A") expenses decreased in absolute
dollars for the year ended December 31, 1997 as compared to the prior year due
to cost savings related to employee attrition and the previously discussed
restructuring. As a percentage of total net revenues for the year ended December
31, 1997 as compared to 1996, the increase in G&A expenses was attributable to
the decreased total net revenue base. The Company believes that G&A expenses
will remain relatively constant throughout 1998 and, as a percentage of
revenues, will fluctuate depending on future revenue levels.


                                       18
<PAGE>   19
Write-off of in-process research and development

         As previously discussed, in connection with the acquisitions of all of
the outstanding shares of NSA and Relay during the third and fourth quarters of
1997, respectively, the Company acquired a total of $24.4 million of intangible
assets. Of this amount, $20.6 million was reflected as a charge to operations
for the write-off of in-process research and development that had not reached
technological feasibility and, in management's opinion, had no probable
alternative future use. This charge is reflected in the Company's Consolidated
Statement of Operations for the year ended December 31, 1997.

         During the fourth quarter of 1996, the Company purchased technology
from Applicom Software Industries (1990) Ltd. and U.S. Computer Software, Inc.
In management's opinion, neither of these purchased technologies had reached
technological feasibility nor had probable alternative future use. Accordingly,
these technology purchases, totaling approximately $13.4 million, were deemed to
be in-process research and development and were charged to operations for the
year ended December 31, 1996.

Restructuring charge

         As discussed above, in the third quarter of 1997, the Company initiated
a plan to restructure its operations worldwide. In connection with this plan, a
restructuring charge of $5.2 million was recorded in the Company's statement of
operations for the year ended December 31, 1997. No such charges were incurred
for the year ended December 31, 1996.

Interest income

         The decline in interest income for the year ended December 31, 1997 as
compared to the same period of the prior year is primarily the result of a
decrease in the aggregate cash and investments from $103.3 million at December
31, 1996 to $69.3 million at December 31, 1997. The increase in interest income
as a percentage of total net revenues for the year ended December 31, 1997 as
compared to 1996 is attributable to the decreased total net revenues base.

Equity in income (losses) of unconsolidated affiliate and unrealized gain on
investment in unconsolidated affiliate

         In December 1997, NetVision, Ltd., a provider of internet services in
Israel and an unconsolidated affiliate of the Company issued an additional
800,000 preferred shares which were sold to Tevel Israel International
Communications, Ltd ("Tevel'), an unrelated party, for $10.0 million cash in
exchange for a one-third interest in NetVision. As a result of the issuance and
sale of these shares by NetVision, the Company's ownership interest in NetVision
decreased from 50% to approximately 32%. In connection with this transaction,
the Company recorded an unrealized gain on the sale of stock by NetVision of
$2,152,000 million, which is included in the accompanying Consolidated Statement
of Operations for the year ended December 31, 1997.

Benefit for income taxes

         The Company recorded a benefit for income taxes for the years ended
December 31, 1997 and 1996 of approximately $0.5 million and $3.3 million,
respectively, on a pretax loss of $34.2 million and $9.0 million, respectively.

         At December 31, 1997, the Company had a net deferred tax asset of
approximately $7.3 million. Realization of the net deferred tax asset is
dependent on the Company generating sufficient future taxable income. Although
realization is not assured, management believes that it is more likely than not
that the net deferred tax asset will be realized. The amount of the net deferred
tax asset, however, could be reduced in the near term if actual future taxable
income differs from estimated amounts.



                                       19
<PAGE>   20
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------
(Dollars in millions)                           December 31,                      Change
Year ended                                 1996             1995              $             %
------------------------------------------------------------------------------------------------

Net revenues:
<S>                                        <C>              <C>              <C>         <C>
    License fees                           $   89.3         $ 112.1          $  (22.7)    (20.3%)
    Services                                   15.3            13.4               1.9      14.2%
                                           --------         -------               ---
      Total net revenues                   $  104.6         $ 125.5          $  (20.8)    (16.6%)

  As a percentage of net revenues:
    License fees                               85.4%           89.3%
    Services                                   14.6%           10.7%
                                               -----           -----
      Total net revenues                      100.0%          100.0%

Gross margin                               $   92.8         $ 112.4          $  (19.6)    (17.4%)
    As a percentage of net revenues            88.7%           89.6%

Research and development                   $   27.9         $  23.9          $    4.1      17.1%
    As a percentage of net revenues            26.7%           19.0%

Sales and marketing                        $   52.2         $  46.1          $    6.1      13.1%
    As a percentage of net revenues            49.9%           36.8%

General and administrative                 $   11.2         $   9.8          $    1.4      14.2%
    As a percentage of net revenues            10.7%            7.8%

Write-off of in-process
      research and development             $   13.4         $   -            $   13.4     100.0%
    As a percentage of net revenues            12.8%            -

Acquisition costs                          $    0.2         $   1.7          $   (1.5)    (88.3%)
    As a percentage of net revenues             0.2%            1.4%

Interest income                            $    5.6         $   4.5          $    1.1      25.2%
    As a percentage of net revenues             5.4%            3.6%

Provision (benefit) for income taxes       $   (3.3)        $  11.5          $  (14.8)   (129.0%)
    Effective tax rate                          n/a            34.0%

Net income (loss)                          $   (5.7)        $  22.3          $  (28.0)   (125.6%)
    As a percentage of net revenues             n/a            17.8%
------------------------------------------------------------------------------------------------
</TABLE>

Net revenues

         During the year ended December 31, 1996 license fees declined
significantly and service revenues increased in absolute dollars year over year
by approximately 14%.

         License fees decreased both in absolute dollars and as a percentage of
net revenues during the year ended December 31, 1996 as compared to the same
period of 1995. The decline in license fees was primarily attributable to
increased competition, heightened pricing pressures and the general confusion
within the marketplace resulting from rapidly changing technology and product
introductions, the delayed release of Windows NT 4.0 and the slow


                                       20
<PAGE>   21
adoption of Windows 95 in corporate accounts, all of which contributed to
delayed buying decisions, particularly by corporate users. In addition, the
decline reflects the Company's lack of success in marketing and selling its
products in the United States and Japan in particular and also reflects the
inability of the Company to realize any significant revenues from its 1995 and
1996 acquisitions of products and technology. These factors lead to lower unit
volumes as well as lower average prices. Service revenues increased in absolute
dollars year over year by approximately 14% and as a percentage of net revenues
increased to nearly 15% of total net revenues. These increases primarily reflect
the Company's focus on marketing its customer support services domestically in
1996.

         During mid-1995, the Company expanded its worldwide operations with new
sales offices internationally in Europe and Japan. International revenues as a
percentage of total net revenues were 33% and 30% for the years ended December
31, 1996 and 1995, respectively. During the fourth quarter of 1996, in
particular, the Company was unsuccessful in marketing and selling its products
in Japan, which in 1995 and the first half of 1996 accounted for the majority of
the Company's international revenues.

         No customer accounted for more than 10% of net revenues during the
years ended December 31, 1996 and 1995.

Gross margin

         Cost of revenues primarily included royalties paid to third parties for
licensed software incorporated into the Company's products, costs associated
with product packaging, documentation and software duplication, and the
amortization and writedown of purchased software. A charge of approximately $2.7
million was included in cost of revenues for the year ended December 31, 1996
for the amortization and write-off of software purchased in early 1996. The
write-off of purchased software primarily resulted from the Company's decision
during the fourth quarter of 1996 to discontinue its ChameleonNFS for Mac OS and
Xoftware for Mac OS product lines. No such charges for the amortization and
writedown of purchased software were incurred for the year ended December 31,
1995. Gross margin, as a percentage of net revenues, declined slightly between
the years ended December 31, 1996 and 1995, primarily as a result of the decline
in the revenue base and the write-off discussed above. Cost of service revenues
through December 31, 1996 was not material and was not reported separately.

Research and development

         Research and development ("R&D") expenses consisted primarily of
salaries and benefits, occupancy and travel expenses, as well as fees paid to
outside consultants. The increase in R&D for the year ended December 31, 1996 as
compared to the prior year primarily reflects the hiring of product development
engineers in the United States and Israel during 1996, in part reflecting the
high employee attrition experienced in both locations.

Sales and marketing

         Sales and marketing ("S&M") expenses consisted primarily of salaries
and commissions of sales and marketing personnel, advertising and promotional
expenses, and customer service and support costs. The increase in S&M expenses
for the year ended December 31, 1996 compared to the prior year, both in
absolute dollars and as a percentage of net revenues, reflects increased costs
related to the Company's investment in expanding its direct corporate sales and
support functions in the United States and increased marketing activities,
including advertising, trade show participation and promotions.

General and administrative

         General and administrative ("G&A") expenses increased in absolute
dollars and as a percentage of net revenues for the year ended December 31,
1996, compared to the prior year. This increase was primarily the result of
increased staffing and associated expenses necessary to support and improve the
Company's infrastructure. The increase as a percentage of net revenues was also
attributable to the decreased revenue base.

Write-off of in-process research and development

         During the year ended December 31, 1996, the Company purchased
technology from several parties. The majority of the $13.4 million fourth
quarter charge is attributable to the Company's purchases of technology from
Applicom Software Industries (1990) Ltd. and U.S. Computer Software, Inc. In
management's opinion, both purchases of technology had not reached technological
feasibility and had no probable alternative future use.


                                       21
<PAGE>   22
Accordingly, such amounts were deemed to be in-process research and development
and were charged to operations for the year ended December 31, 1996. No such
expenses were incurred for the year ended December 31, 1995.

Acquisition costs

         The Company incurred acquisition costs during the year ended December
31, 1996 related to the aforementioned acquisition of MaxInfo, which was
accounted for as a pooling of interests. Acquisition costs for the year ended
December 31, 1995 primarily related to the aforementioned acquisitions of Syzygy
and AGE, which were also accounted for as poolings of interests. Acquisition
costs consisted primarily of investment banking, legal, accounting and other
related expenses.

Interest income

         Interest income increased in absolute dollars and as a percentage of
net revenues primarily as a result of higher average cash and investment
balances during the year ended December 31, 1996 compared to the prior year.

Provision (benefit) for income taxes

         The Company recorded a benefit for income taxes of approximately $3.3
million on a pretax loss of approximately $9.0 million for the year ended
December 31, 1996 compared to a provision for income taxes of approximately
$11.5 million on pretax income of approximately $33.8 million for the year ended
December 31, 1995.


DISCLOSURES ABOUT MARKET RISK

Interest rate risk

         The Company's exposure to market risk for changes in interest rates
relates primarily to the Company's investment portfolio. The Company places its
investments with high credit quality issuers and, by policy, limits the amount
of credit exposure to any one issuer. As stated in its policy, the Company is
averse to principal loss and seeks to preserve its invested funds by limiting
default risk, liquidity risk and territory risk.

         The Company mitigates default and liquidity risks by investing in only
safe and high credit quality securities and by positioning its portfolio to
respond appropriately to a significant reduction in a credit rating of any
investment issuer or guarantor. The portfolio includes only marketable
securities with active secondary or resale markets to ensure portfolio
liquidity. The Company mitigates territory risk by only allowing up to 25% of
the portfolio to be placed outside of the United States.

         The table below presents the carrying value, market value and related
weighted average interest rates for the Company's investment portfolio as of
December 31, 1997. All investments mature, by policy, in four years or less.


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
(In millions, except for                                      Carrying        Market          Average
    average interest rates)                                  Value             Value        Interest Rate
----------------------------------------------------------------------------------------------------------
Investment Securities:
<S>                                                         <C>              <C>                <C>
    Cash equivalents - fixed rate                           $  4.5           $   4.5            4.87%
    Short-term investments - fixed rate                       36.8              37.0            6.11%
    Long-term investments - fixed rate                        19.7              19.8            5.90%
                                                            ------           -------
       Total investment securities                            61.0              61.3            5.95%

    Money market funds - variable rate                         0.4               0.4            5.30%
                                                            ------           -------

       Total interest bearing instruments                   $ 61.4           $  61.7            5.95%
                                                            ======           =======
----------------------------------------------------------------------------------------------------------
</TABLE>


                                       22
<PAGE>   23
Foreign currency risk

         The Company transacts business in various foreign currencies primarily
in Europe and Israel. The Company has established a foreign currency hedging
program, utilizing foreign currency forward exchange contracts ("forward
contracts") to hedge certain foreign currency exposures in certain European
countries. Under this program, increases or decreases in the Company's foreign
currency transactions are partially offset by gains and losses on the forward
contracts, so as to mitigate the possibility of short-term earnings volatility.
The Company does not use forward contracts for trading purposes. All outstanding
forward contracts at the end of a period are marked-to-market with unrealized
gains and losses included in interest income and, thus, are recognized in income
in advance of the actual foreign currency cash flows. As these forward contracts
mature, the realized gains and losses are recorded and are included in net
income (loss) as a component of interest income. The Company's ultimate realized
gain or loss with respect to currency fluctuations will depend upon the currency
exchange rates and other factors in effect as the contracts mature.

         The table below provides information as of December 31, 1997 about the
Company's forward contracts. The information is provided in U.S. dollar
equivalent amounts. The table presents the notional amount (at contract exchange
rates) and the contractual foreign currency exchange rates. These forward
contracts mature in less than thirty days.


<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
(In thousands, except for                                   Notional         Contract
    average contract rates)                                  Amount            Rate
-------------------------------------------------------------------------------------

Forward contracts:
<S>                                                          <C>              <C>
    British pound sterling                                   $ 609             0.60
    German deutschemarks                                     $ 700             1.77
    French francs                                            $ 568             5.92
    Belgian francs                                           $  33            36.20

-------------------------------------------------------------------------------------
</TABLE>
         The unrealized gain (loss) on the outstanding forward contracts at
December 31, 1997 was immaterial to the Company's consolidated financial
statements. Due to the short-term nature of the forward contracts, the fair
value at December 31, 1997 was negligible. The realized gain (loss) on these
contracts as they matured was not material to the consolidated operations of the
Company.

<TABLE>
<CAPTION>
LIQUIDITY AND CAPITAL RESOURCES
---------------------------------------------------------------------------------------
                                                                  As of December 31,
(In millions)                                                 1997                1996
---------------------------------------------------------------------------------------

<S>                                                          <C>                <C>
Cash and cash equivalents                                    $ 12.7             $  19.5
Short-term investments                                       $ 36.8             $  46.6
Long-term investments                                        $ 19.7             $  37.2
Net cash provided by (used in) operating activities          $ (5.8)            $  13.7
Net cash used in investing activities                        $ (1.9)            $ (30.8)
Net cash provided by financing activities                    $  1.2             $   4.7
---------------------------------------------------------------------------------------
</TABLE>


         Since the Company's inception, growth has been financed primarily
through cash provided by operations and sales of capital stock. The Company's
primary financing activities to date consist of its initial and secondary stock
offerings and preferred stock issuances, and have aggregated net proceeds to the
Company of approximately


                                       23
<PAGE>   24
$72.5 million. The Company does not have a bank line of credit or an equipment
lease facility, other than those acquired in connection with the NetSoft
acquisition which are not material to the Company.

         During the year ended December 31, 1997, the Company's aggregate cash
and cash equivalents, short-term investments and long-term investments decreased
from $69.3 million to $103.3 million. This decrease was due primarily to the
acquisition of NetSoft and Relay in 1997.

         Net cash used in operating activities for the year ended December 31,
1997 reflects the Company's operating loss for the year primarily offset by
non-cash operating charges, such as the write-off of in-process research and
development and depreciation and amortization.

         The Company's principal investing activities to date have been the
purchase of short-term and long-term investments, purchases of technology, and
business acquisitions. Cash expenditures for the acquisitions of businesses
amounted to $26.7 million in 1997. The Company does not have any specific
commitments with regard to future capital expenditures and it is anticipated
that such spending will decline.

         Net cash provided by financing activities in 1997 reflects proceeds
from the issuance of common stock under the Company's stock purchase plan and
stock option plans.

         At December 31, 1997, the Company had working capital of $55.5 million.
The Company believes that its current cash balances and future operating cash
flows will be sufficient to meet the Company's working capital and capital
expenditure requirements for the foreseeable future.


FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION

         The Company has experienced and expects to experience in future periods
significant fluctuations in operating results that may be caused by many factors
including, among others, demand for the Company's products, introduction or
enhancements of products by the Company or its competitors, technological
changes in computer networking, market acceptance of new products, customer
order deferrals in anticipation of new products, the size and timing of
individual orders, mix of international and domestic revenues, mix of
distribution channels through which the Company's products are sold, seasonality
of revenues, quality control of products, changes in the Company's operating
expenses, personnel changes, foreign currency exchange rates and general
economic conditions. As a result, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance.

         Because the Company generally ships software products within a short
period after receipt of an order, the Company typically does not have a material
backlog of unfilled orders, and revenues in any quarter are substantially
dependent on orders booked in that quarter and particularly in the last month of
that quarter. The Company's expense levels are based in part on its expectations
as to future revenues and to a large extent are fixed. Therefore, the Company
may be unable to adjust spending in a timely manner to compensate for any
unexpected revenues shortfall. Accordingly, any significant shortfall of demand
in relation to the Company's expectations or any material delay of customer
orders would have an almost immediate adverse impact on the Company's operating
results and on the Company's ability to achieve profitability. Fluctuations in
operating results are likely to result in volatility in the price of the
Company's common stock.

         During 1997, the Company initiated a plan to restructure its operations
and to focus on its core competencies in UNIX(R), AS/400(R) midrange and IBM
mainframe connectivity. The Company undertook the restructuring in response to
business conditions in order to improve the Company's future financial
performance. No assurance, however, can be given that the restructuring will be
successful, that future operating results will improve, or that the actions
undertaken in the restructuring will not disrupt the Company's remaining
operations. Further, there can be no assurance that additional reorganization of
the Company's operations will not be required in the future.


                                       24
<PAGE>   25
Acquisitions

         The Company's merger and acquisition transactions, including the 1997
acquisitions of NetSoft and Relay, have been motivated by various factors,
including the desire to obtain new technologies, expand and enhance the
Company's product offerings, attract key personnel and strengthen the Company's
presence in the international marketplace. Product and technology acquisitions
entail numerous risks, including the diversion of management's attention away
from day-to-day operations, difficulties in the assimilation of acquired
operations and personnel (such as sales, engineering and customer support), the
incorporation of acquired products into existing product lines, the failure to
realize anticipated benefits in terms of cost savings and synergies, undisclosed
liabilities, adverse short-term effects on reported operating results, the
amortization of acquired intangible assets, the potential loss of key employees
from acquired companies and the difficulty of presenting a unified corporate
image.

         The Company and its acquired companies each have different systems and
policies and procedures in many operational areas that also must be integrated.
To achieve profitability, the Company will need to integrate successfully and
streamline overlapping or duplicative functions. To date, the Company's previous
acquisitions have not contributed significantly to revenues. Uncertainty in the
marketplace or customer hesitation related to acquisitions could negatively
affect the Company's future revenues and results of operations. Failure to
effectively integrate the operations of acquired companies with the Company
could have a material adverse effect on the Company's results of operations and
financial condition.

         The Company regularly evaluates product and technology acquisition
opportunities and anticipates that it may make additional acquisitions in the
future if it determines that an acquisition would further its corporate
strategy. No assurance can be given that any acquisition by the Company will or
will not occur, that if an acquisition does occur that it will not materially
and adversely affect the Company or that any such acquisition will be successful
in enhancing the Company's business. If the operations of an acquired company or
business do not meet the Company's expectations, the Company may be required to
restructure the acquired business or write-off the value of some or all of the
assets of the acquired business.

Product Development and Competition

         The market for the Company's products is intensely competitive and
characterized by rapidly changing technology, evolving industry standards,
changes in customers' needs and frequent new product introductions. Particularly
over the past year, many customers have delayed purchase decisions due to the
confusion in the marketplace relating to rapidly changing technology and product
introductions. To maintain or improve its position in this industry, the Company
must continue to enhance its current products and to develop, introduce
successfully and market new products on a timely and cost-effective basis. Any
failure by the Company to anticipate or respond adequately to changes in
technology and customer preferences, or any significant delays in product
development or introduction, would have a material adverse effect on the
Company's results of operations. The failure to develop on a timely basis these
or other enhancements incorporating new functionality could cause customers to
delay purchase of the Company's current products or cause customers to purchase
products from the Company's competitors; either situation would adversely affect
the Company's results of operations. There can be no assurance that the Company
will be successful in developing new products or enhancing its existing products
on a timely basis, or that such new products or product enhancements will
achieve market acceptance.

         Many of the Company's competitors have substantially greater financial,
technical, sales, marketing and other resources, as well as greater name
recognition and a larger customer base, than the Company. The market for the
Company's products is characterized by significant price competition and the
Company anticipates that it will face increasing pricing pressures from its
current and new competitors in the future. Moreover, given that there are low
barriers to entry into the software market and that the market is rapidly
evolving and subject to rapid technological change, the Company believes that
competition will persist and intensify in the future. Accordingly, there can be
no assurance that the Company will be able to provide products that compare
favorably with the products of the Company's competitors or that competitive
pressures will not require the Company to reduce its prices. The Company has
recently experienced price declines for its products, contributing to lower
revenues. Any further material reduction in the price of the Company's products
would require the Company to increase unit sales


                                       25
<PAGE>   26
in order to maintain revenues at existing levels. There can be no assurance that
the Company will be successful in doing so.

         The Company's competitors could seek to expand their product offerings
by designing and selling products using TCP/IP or other technology that could
render obsolete or adversely affect sales of the Company's products. These
developments may adversely affect the Company's sales of its own products either
by directly affecting customer purchasing decisions or by causing potential
customers to delay their purchases of the Company's products.

         Substantially all of the Company's net revenues have been derived from
the sales of products that provide inter-networking applications for the
Microsoft Windows environment and are marketed primarily to Windows users. As a
result, sales of the Company's products would be materially adversely affected
by market developments adverse to Windows. In addition, the Company's strategy
of developing products based on the Windows operating environment is
substantially dependent on its ability to gain pre-release access to, and to
develop expertise in, current and future Windows developments by Microsoft. No
assurance can be given as to the ability of the Company to provide products
compatible with future Windows releases on a timely basis.

Marketing and Distribution

         As part of its strategy to develop multiple distribution channels, the
Company expects to increase its use of indirect distribution channels such as
resellers, particularly value added resellers and system integrators, in
addition to distributors and original equipment manufacturers. The Company
expects that indirect sales will grow as a percentage of both domestic and total
revenues and that any material increase in the Company's indirect sales as a
percentage of revenues will adversely affect the Company's average selling
prices and gross margins due to the lower unit costs that are typically charged
when selling through indirect channels. There can be no assurance that the
Company will be able to attract resellers and distributors who will be able to
market the Company's products effectively and will be qualified to provide
timely and cost-effective customer support and service. The Company ships
products to resellers and distributors on a purchase order basis, and many of
the Company's resellers and distributors carry competing product lines.
Therefore, there can be no assurance that any reseller or distributor will
continue to represent the Company's products, and the inability to recruit or
retain important resellers or distributors could adversely affect the Company's
results of operations.

Proprietary Rights

         The Company relies primarily on a combination of copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under patent, trade secret
and copyright laws, which afford only limited protection. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult, and while the Company is unable to determine the extent
to which piracy of its software products exists, software piracy can be expected
to be a persistent problem. In selling its products, the Company relies
primarily on "shrink wrap" licenses that are not signed by licensees and,
therefore, may be unenforceable under the laws of certain jurisdictions. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that the Company's means of protecting its proprietary
rights will be adequate or that the Company's competitors will not independently
develop similar technology. In addition, the Company has received, and may
receive in the future, communications from third parties asserting that the
Company's products infringe, or may infringe, the proprietary rights of third
parties, seeking indemnification against such infringement or indicating that
the Company may be interested in obtaining a license from such third parties.
There can be no assurance that any of such claims would not result in protracted
and costly litigation.

         The Company believes that, due to the rapid pace of innovation within
its industry, factors such as the technological and creative skills of its
personnel are more important to establishing and maintaining a technology
leadership position within the industry than are the various legal means of
protecting its technology. The Company believes that its products and technology
do not infringe any existing proprietary rights of others, although there can be
no assurance that third parties will not assert infringement claims in the
future.

Global Market Risks

         The Company derived approximately 22% of net revenues from
international sales during the year ended December 31, 1997. While the Company
expects that international sales will continue to account for a significant
portion of its net revenues, there can be no assurance that the Company will be
able to maintain or increase international market demand for the Company's
products or that the Company's distributors will be able to effectively meet
that demand. Risks inherent in the Company's international business activities
generally include unexpected changes in regulatory requirements, tariffs and
other trade barriers, costs and risks of localizing products for foreign
countries, longer accounts receivable payment cycles, difficulties in managing
international operations, currency fluctuations, potentially adverse tax
consequences, repatriation of earnings and the burdens of complying with a wide
variety of foreign laws. There can be no assurance that such factors will not
have an adverse effect on the Company's future international sales and,
consequently, on the Company's results of operations.

Employee Retention

         The majority of the Company's employee workforce is located in the
extremely competitive employment markets of the Silicon Valley and Irvine in
California and in Haifa, Israel. During the latter half of 1996 and through
1997, the Company experienced high attrition at all levels and across all
functions of the Company. The attrition experienced by the Company was
attributable to various factors including, among others, industry-wide demand
exceeding supply for experienced engineering and sales professionals. The
Company has and will continue to address the issue of attrition. Managing
employee attrition, integrating acquired operations and products and expanding
both the geographic area of its customer base and operations have resulted in
substantial demands on the Company's management resources. The Company's future
operating results will be dependent in part on its ability to attract and retain
its employee workforce, train and manage its management and employee base, and
continue to


                                       26
<PAGE>   27
implement and improve its operating and financial controls. There can be no
assurance that the Company will be able to manage such challenges successfully.

Year 2000

         The Company is aware of the issues associated with the programming code
in existing computer systems as the millennium ("year 2000") approaches. The
issue is whether computer systems will properly recognize date-sensitive
information when the year changes to 2000. The Company believes that any costs
incurred related to year 2000 compliance will not have a material impact on its
business, operations or financial condition.


QUARTERLY FINANCIAL INFORMATION

         The following table sets forth unaudited quarterly financial
information for the Company's last eight quarters. This unaudited information
has been prepared on the same basis as the audited consolidated financial
statements and, in the opinion of management, includes all adjustments
(consisting only of normal recurring adjustments) necessary for the fair
presentation of the information for the periods presented.

         The Company has experienced, and expects to experience in future
periods, significant fluctuations in operating results that may be caused by
many factors, including, among others, those described above within "Factors
That May Affect Future Results and Financial Condition". The Company's future
revenues and results of operations could be subject to significant volatility
and may also be unpredictable due to shipment patterns typical of the software
industry. A significant percentage of the Company's revenues are generally
expected to be recognized in the third month of each quarter and tend to occur
in the latter half of that month. The Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance.


<TABLE>
<CAPTION>
                                                  1996                                               1997
                               --------------------------------------------      -----------------------------------------------
(In thousands, except            Mar. 31    June 30    Sept. 30    Dec. 31        Mar. 31     June 30     Sept. 30       Dec. 31
per share data)                --------------------------------------------      -----------------------------------------------

Statement of Operations Data:
<S>                              <C>        <C>        <C>          <C>          <C>          <C>          <C>          <C>
Net revenues                     $33,022    $26,775    $ 25,426     $ 19,373     $ 16,379     $ 12,701     $ 13,556     $ 18,888

Gross margin                      29,751     24,238      23,043       15,727       15,254       11,802       12,667       17,708

Income (loss) from
  operations(1)                    6,792        640        (443)     (20,642)      (3,785)      (6,198)     (28,432)      (3,659)

Net income (loss)                  5,020      1,635         241      (12,601)      (2,739)      (4,548)     (26,902)         434

Net income (loss) per share,
  diluted(2)                     $  0.12    $  0.04    $   0.01     $  (0.29)    $  (0.06)    $  (0.10)    $  (0.62)    $   0.01

Weighted average common
  shares, diluted                 43,141     43,521      43,049       42,931       43,182       43,328       43,454       44,057

Price range per common           $  9.88-   $  9.75-   $  7.88-     $   5.63-    $   2.78-    $   2.53-    $   2.75-    $   2.19-
  share(3)                       $ 22.69    $ 18.00    $  12.75     $   8.56     $   6.47     $   3.75     $   4.28     $   4.94
</TABLE>
------------
(1)  Loss from operations includes write-offs of in-process research and
     development of $13.4 million, $16.0 million and $4.6 million for the
     quarters ended December 31, 1996, September 30, 1997 and December 31, 1997,
     respectively.

(2)  Net income (loss) per share has been restated for all periods presented in
     accordance with SFAS No. 108. See Note 2 of Notes to Consolidated Financial
     Statements.

(3)  The Company's common stock is traded on the Nasdaq National Market System
     under the symbol NETM. Price range per share is based on the quarterly high
     and low closing prices for the Company's common stock as reported by
     Nasdaq. As of February 27, 1998 there were 672 stockholders of record.

ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         The information required by Item 7A is incorporated by reference from
the section entitled "Disclosures about Market Risk" found in Item 7
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations."



                                       27
<PAGE>   28
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

<TABLE>
<CAPTION>
         Index to Consolidated Financial Statements                                              Page

           Financial Statements:

<S>                                                                                             <C>
                 Report of Independent Public Accountants                                          29
                 Consolidated Balance Sheets at December 31, 1997 and 1996                         30
                 Consolidated Statements of Operations --
                   Years ended December 31, 1997, 1996 and 1995                                    31
                 Consolidated Statements of Stockholders' Equity --
                   Years ended December 31, 1997, 1996 and 1995                                    32
                 Consolidated Statements of Cash Flows --
                   Years ended December 31, 1997, 1996 and 1995                                    33
                 Notes to Consolidated Financial Statements                                     34-46

           Financial Statement Schedules

                 II.  Valuation and Qualifying Accounts                                            50
</TABLE>


                 All other schedules are omitted because they are not required
                 or the required information is shown in the consolidated
                 financial statements or notes thereto.


                                       28
<PAGE>   29
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To NetManage, Inc.:

         We have audited the accompanying consolidated balance sheets of
NetManage, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements and the schedule referred to
below are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements and schedule 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 NetManage, Inc. 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.

         Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed under Item 14(a) is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in our audits of
the basic 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 financial statements taken as a whole.




                                                             ARTHUR ANDERSEN LLP



San Jose, California
January 26, 1998


                                       29
<PAGE>   30
                                 NETMANAGE, INC.
                           CONSOLIDATED BALANCE SHEETS
               (In thousands, except share and per share amounts)

<TABLE>
<CAPTION>
                                                                                    DECEMBER 31,
                                                                              -----------------------
                                                                                 1997          1996
                                                                              ---------     ---------
ASSETS

CURRENT ASSETS:
<S>                                                                           <C>           <C>
   Cash and cash equivalents                                                  $  12,706     $  19,483
   Short-term investments                                                        36,845        46,609
   Accounts receivable, less allowances of $1,375 and $2,012, respectively       13,408        13,915
   Prepaid expenses and other current assets                                     15,726        13,191
                                                                              ---------     ---------
        Total current assets                                                     78,685        93,198
                                                                              ---------     ---------


PROPERTY AND EQUIPMENT, at cost:
   Computer software and equipment                                               13,010        14,874
   Furniture and fixtures                                                         5,512         5,622
   Leasehold improvements                                                         1,308         1,434
                                                                              ---------     ---------
                                                                                 19,830        21,930
   Less - Accumulated depreciation                                              (10,999)       (9,872)
                                                                              ---------     ---------
        Net property and equipment                                               8,831        12,058
                                                                              ---------     ---------

LONG-TERM INVESTMENTS                                                            19,734        37,201
GOODWILL AND OTHER INTANGIBLES, net                                               3,293         1,763
OTHER ASSETS                                                                      9,050         8,309
                                                                              ---------     ---------
                                                                              $ 119,593     $ 152,529
                                                                              =========     =========


LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
   Accounts payable                                                           $   1,674     $   2,060
   Accrued liabilities                                                            5,185         4,154
   Accrued payroll and payroll-related expenses                                   4,804         4,779
   Deferred revenue                                                               9,118         8,839
   Income taxes payable                                                           2,362         1,698
                                                                              ---------     ---------
        Total current liabilities                                                23,143        21,530
                                                                              ---------     ---------
LONG-TERM LIABILITIES                                                               363         1,708
                                                                              ---------     ---------

COMMITMENTS AND CONTINGENCIES (Note 5)

STOCKHOLDERS' EQUITY:
   Common stock, $0.01 par value -
      Authorized - 75,000,000 shares
      Outstanding - 43,752,930 shares and 43,148,350 shares, respectively           438           431
   Additional paid-in capital                                                    91,564        90,193
   Retained earnings                                                              5,996        39,751
     Cumulative translation adjustment                                           (1,911)       (1,084)
                                                                              ---------     ---------
        Total stockholders' equity                                               96,087       129,291
                                                                              =========     =========
                                                                              $ 119,593     $ 152,529
                                                                              =========     =========
</TABLE>




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


                                       30
<PAGE>   31
                                NETMANAGE, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                             ------------------------------------
                                                               1997          1996          1995
                                                             --------     ---------     ---------

NET REVENUES:
<S>                                                          <C>          <C>           <C>
   License fees                                              $ 45,795     $  89,334     $ 112,079
   Services                                                    15,729        15,262        13,367
                                                             --------     ---------     ---------
        Total net revenues                                     61,524       104,596       125,446

COST OF REVENUES                                                4,093        11,837        13,065
                                                             --------     ---------     ---------

GROSS MARGIN                                                   57,431        92,759       112,381
                                                             --------     ---------     ---------

OPERATING EXPENSES:
   Research and development                                    20,670        27,938        23,861
   Sales and marketing                                         41,455        52,167        46,117
   General and administrative                                  10,428        11,198         9,808
   Write-off of in-process research and development            20,643        13,384            --
   Amortization of goodwill                                     1,137         1,526         1,298
   Restructuring charge                                         5,172            --            --
   Acquisition costs                                               --           199         1,701
                                                             --------     ---------     ---------

        Total operating expenses                               99,505       106,412        82,785
                                                             --------     ---------     ---------

INCOME (LOSS) FROM OPERATIONS                                 (42,074)      (13,653)       29,596

INTEREST INCOME                                                 4,562         5,625         4,494
EQUITY IN INCOME (LOSSES) OF UNCONSOLIDATED AFFILIATE           1,145        (1,005)         (306)
UNREALIZED GAIN ON INVESTMENT IN UNCONSOLIDATED AFFILIATE       2,152            --            --
                                                             --------     ---------     ---------

INCOME (LOSS) BEFORE INCOME TAXES                             (34,215)       (9,033)       33,784
PROVISION (BENEFIT) FOR INCOME TAXES                             (460)       (3,328)       11,487
                                                             --------     ---------     ---------
NET INCOME (LOSS)                                            $(33,755)    $  (5,705)    $  22,297
                                                             --------     ---------     ---------

NET INCOME (LOSS) PER SHARE:
   Basic                                                     $  (0.78)    $   (0.13)    $    0.55
   Diluted                                                   $  (0.78)    $   (0.13)    $    0.52

WEIGHTED AVERAGE COMMON SHARES AND EQUIVALENTS:
   Basic                                                       43,385        42,341        40,749
   Diluted                                                     43,385        42,341        42,955
</TABLE>


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



                                       31
<PAGE>   32
                                 NETMANAGE, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                      (In thousands, except share amounts)


<TABLE>
<CAPTION>
                                                                    Additional               Cumulative
                                                Common Stock         Paid-in     Retained    Translation
                                             Shares      Amount      Capital     Earnings    Adjustment       Total
                                             ------      ------      -------     --------    ----------       -----
<S>                                        <C>            <C>       <C>          <C>        <C>             <C>

BALANCE, DECEMBER 31, 1994                 40,320,287     $ 203     $ 74,752     $ 24,351   $      --       $ 99,306
   Two-for-one stock dividend                      --       199         (199)          --           --            --
   Sale of common stock under
     employee stock purchase plan             145,145         2        2,020           --           --         2,022
   Exercise of stock options                  740,550         8        2,734           --           --         2,742
   Compensation costs related to stock
     option grants                                 --        --          109           --           --           109
   Income tax benefit from stock
     option transactions                           --        --        2,080           --           --         2,080
   Pooling of interests with Syzygy
     Communications, Inc.                     394,000         4        1,251         (798)          --           457
   Common stock issued in connection
     with the acquisition of Pacer
     Software, Inc.                            64,600         1          773           --           --           774
   Repurchase of common stock from
     employees for cash                        (4,250)       --           --           --           --            --
   Translation adjustment                          --        --           --           --         (390)         (390)
   Net income                                      --        --           --       22,297           --        22,297
                                          -----------     -----     --------     --------     --------     ---------
BALANCE, DECEMBER 31, 1995                 41,660,332       417       83,520       45,850         (390)      129,397
   Sale of common stock under
     employee stock purchase plan             226,124         2        1,868           --           --         1,870
   Exercise of stock options                  666,399         7        2,831           --           --         2,838
   Income tax benefit from stock
     option transactions                           --        --          642           --           --           642
   Pooling of interests with Maximum
     Information, Inc.                        590,448         6          334         (394)          --           (54)
   Issuance of common stock for
     purchase of technology                   121,997         1          999           --           --         1,000
   Repurchase of common stock from
     employees for cash                      (116,950)       (2)          (1)          --           --            (3)
   Translation adjustment                          --        --           --           --         (694)         (694)
   Net loss                                        --        --           --       (5,705)          --        (5,705)
                                          -----------     -----     --------     --------     --------     ---------
BALANCE, DECEMBER 31, 1996                 43,148,350       431       90,193       39,751       (1,084)      129,291
   Sale of common stock under
     employee stock purchase plan             343,142         4          785           --           --           789
   Exercise of stock options                  272,035         3          437           --           --           440
   Income tax benefit from stock
     option transactions                           --        --          149           --           --           149
   Repurchase of common stock from
     employees for cash                       (10,597)       --           --           --           --            --
   Translation adjustment                          --        --           --           --         (827)         (827)
   Net loss                                        --        --           --      (33,755)          --       (33,755)
                                          -----------     -----     --------     --------     --------     ---------
BALANCE, DECEMBER 31, 1997                 43,752,930     $ 438     $ 91,564     $  5,996     $ (1,911)    $  96,087
                                          ===========     =====     ========     ========     ========     ==========
</TABLE>



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


                                       32
<PAGE>   33
                                 NETMANAGE, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                                          YEARS ENDED DECEMBER 31,
                                                                                          ------------------------

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

  CASH FLOWS FROM OPERATING ACTIVITIES:
        Net income (loss)                                                             $(33,755)       $ (5,705)       $ 22,297
        Adjustments to reconcile net income (loss) to net cash provided
            by operating activities:
        Depreciation and amortization                                                    8,204           9,846           6,545
        Compensation costs related to stock issuances and stock option grants               --              --             109
        Provision for doubtful accounts and returns                                        268             886           1,842
        Equity in (income) losses of unconsolidated affiliate                           (1,145)          1,005             306
        Write-off of in-process research and development                                20,643          13,384              --
        Write-down of assets related to restructure                                      1,831              --              --
        Write-down of purchased technology to net realizable value                          --           1,248              --
        Unrealized gain on investment in unconsolidated affiliate                       (2,152)             --              --
        Changes in assets and liabilities, net of business combinations:
           Accounts receivable                                                           6,688           5,611          (7,885)
           Prepaid expenses and other current assets                                    (1,012)         (6,201)         (4,407)
           Accounts payable                                                             (1,447)         (2,689)          3,073
           Accrued liabilities, payroll and payroll-related expenses                    (2,838)           (330)            424
           Deferred revenue                                                             (4,034)         (2,094)          3,625
           Income taxes payable                                                          2,918          (1,268)          2,183
                                                                                      --------        --------        --------
           Net cash provided by (used in) operating activities                          (5,831)         13,693          28,112
                                                                                      --------        --------        --------

  CASH FLOWS FROM INVESTING ACTIVITIES:
        Purchases of short-term investments                                            (27,395)        (44,201)        (75,550)
        Proceeds from maturities of short-term investments                              36,320          45,045          47,220
        Purchases of long-term investments                                             (23,925)        (32,841)        (15,133)
        Proceeds from maturities of long-term investments                               40,675          23,205          11,111
        Purchases of property and equipment                                               (326)         (4,716)        (10,103)
        Acquisition of businesses, net of cash acquired                                (26,651)         (1,325)            540
        Acquisition of in-process research and development                                  --         (11,384)             --
        Purchases of technology and other intangible assets                               (530)         (2,668)             --
        Investment in unconsolidated affiliate                                             (58)         (1,929)         (1,529)
                                                                                      --------        --------        --------
           Net cash used in investing activities                                        (1,890)        (30,814)        (43,444)
                                                                                      --------        --------        --------

  CASH FLOWS FROM FINANCING ACTIVITIES:
        Proceeds from sale of common stock, net of issuance costs                        1,229           4,708           4,764
        Repurchase of common stock                                                          --              (3)             --
                                                                                      --------        --------        --------
           Net cash provided by financing activities                                     1,229           4,705           4,764
                                                                                      --------        --------        --------
   EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                (285)           (694)           (390)
                                                                                      --------        --------        --------
   NET DECREASE IN CASH AND CASH  EQUIVALENTS                                           (6,777)        (13,110)        (10,958)
   CASH AND CASH EQUIVALENTS, beginning of year                                         19,483          32,593          43,551
                                                                                      --------        --------        --------
   CASH AND CASH EQUIVALENTS, end of year                                             $ 12,706        $ 19,483        $ 32,593
                                                                                      ========        ========        ========


   SUPPLEMENTAL CASH FLOW INFORMATION:
       Cash paid during the year for:
           Interest                                                                   $     --        $     --        $     46
           Income taxes                                                                    358           2,852          11,240
</TABLE>


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


                                       33
<PAGE>   34
                                 NETMANAGE, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       NATURE OF OPERATIONS AND ORGANIZATION:

         NetManage, Inc. (the "Company") develops, markets and supports software
tools for connecting personal computers to corporate mainframe, midrange and
UNIX(R) computers and software that increases the productivity of corporate call
centers. The Company is a recognized leader in "PC Connectivity" and was one of
the first to develop and market a Windows-based transmission protocol that has
since become the industry standard for the Internet. In 1997, the Company
organized its business to take advantage of three major industry trends:
expansion of the Internet, continued mobilization of personal computer users and
broader access to corporate data and information. Its products are fully
compatible with Microsoft Corporation's ("Microsoft") Windows 3.1, Windows 95,
and Windows NT platforms and IBM systems, including OS/2, and Novell operating
systems.

         Substantially all of the Company's net revenues have been derived from
the sales of products that provide inter-networking applications for the
Microsoft Windows environment and are marketed primarily to Windows users. As a
result, sales of the Company's products would be materially adversely affected
by market developments adverse to Windows. In addition, the Company's strategy
of developing products based on the Windows operating environment is
substantially dependent on its ability to gain pre-release access to, and to
develop expertise in, current and future Windows developments by Microsoft. No
assurance can be given to the ability of the Company to provide products
compatible with future Windows releases on a timely basis.

         Additionally, the market for the Company's products is intensely
competitive and characterized by rapidly changing technology, evolving industry
standards, changes in customers' needs and frequent new product introductions.
To maintain or improve its position in this industry, the Company must continue
to enhance its current products and develop new products on a timely and
cost-effective basis. There can be no assurance that the Company will be
successful in developing new products or enhancing its existing products on a
timely basis, or that such new products or product enhancements will achieve
market acceptance.


2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Principles of Consolidation

         The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All intercompany accounts and
transactions have been eliminated. The Company's investment in NetVision, Ltd.
("NetVision") is accounted for using the equity method.

Use of Estimates

         The preparation of consolidated 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
disclosures of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.

Foreign Currency Translation and Foreign Exchange Contracts

         The functional currency of the Company's foreign subsidiaries is the
local currency. Gains and losses resulting from the translation of the foreign
subsidiaries' financial statements are reported as a separate component of
stockholders' equity. The Company enters into forward exchange contracts to
reduce the impact of foreign currency fluctuations on those balance sheet
accounts denominated in foreign currency, other than the entities' local
currency, that give rise to transaction gains or losses. The notional amount of
the forward contracts was approximately $1.9 million, $2.9 million and $11.2
million at December 31, 1997, 1996 and 1995, respectively. The 1997 contracts
expired on January 30, 1998. Gains and losses on foreign exchange contracts were
immaterial for the years ended December 31, 1997, 1996 and 1995.

Revenue Recognition

         License fees are earned under software license agreements to end-users
and resellers and are generally recognized when a customer purchase order has
been received, the software has been shipped, the Company has a right to invoice
the customer, collection of the receivable is probable and there are no
significant obligations remaining. The Company offers its customers a 30-day
right of return on sales and records an estimate of such returns at the time of
product delivery based on historical experience. To date, such returns have been
insignificant. Certain of the Company's sales are made to domestic distributors
under agreements allowing rights of return and price protection on unsold
merchandise. Accordingly, the Company defers recognition of such sales until the
merchandise is sold by the distributor. The Company's international distributors
generally do not have return rights and, as such, the Company generally
recognizes sales to international distributors upon shipment, if all other
revenue recognition criteria has been met.


                                       34
<PAGE>   35
         Service revenues consist of fees for providing system updates for
existing software products, user documentation and technical support, generally
under annual service agreements, and are recognized ratably over the term of
such agreements. If such services are included in the initial licensing fee, the
value of the services is unbundled and recognized ratably over the related
service period. The cost of service revenues is not material and is included in
cost of revenues in the accompanying Consolidated Statements of Operations.

Cash and Cash Equivalents

         The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.

Short-term and Long-term Investments

         The Company accounts for its investments under the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". Under SFAS No. 115, the
Company's investments are classified as held-to-maturity and are valued using
the amortized cost method. The Company's investments mature at various dates
through April 2000. Investments with a maturity of greater than one year from
the balance sheet date are classified as long-term investments. At December 31,
1997 and 1996, the fair value of the investments approximated amortized cost
and, as such, gross unrealized holding gains and losses were not material. The
fair value of the investments was determined based on quoted market prices at
the reporting dates for those instruments. The carrying value of the Company's
investments by major security type consisted of the following as of December 31,
1997 and 1996 (in thousands):

<TABLE>
<CAPTION>
DESCRIPTION                                            1997           1996
------------------------------------------------    -----------    -----------
<S>                                                 <C>             <C>
Municipal bonds                                      $  44,754      $  69,441
Auction rate securities                                  3,500         11,200
Corporate bonds                                          4,313              -
CDs/Bankers acceptance notes                                12          1,669
Government securities                                    4,000          1,500
                                                     ---------      ---------
                                                     $  56,579      $  83,810
                                                     =========      =========
</TABLE>


Property and Equipment

         Property and equipment are recorded at cost. Betterments, renewals and
extraordinary repairs that extend the life of the asset are capitalized, other
repairs and maintenance are expensed. Depreciation is computed using the
straight-line method over the following estimated useful lives:

<TABLE>
<CAPTION>
CLASSIFICATION                           LIFE
--------------------------------------   ---------------------------------------------------------
<S>                                      <C>
Computer software and equipment          2 to 3 years
Furniture and fixtures                   5 years
Leasehold improvements                   Shorter of the lease term or the estimated useful life
</TABLE>

Goodwill

         Goodwill arising from the Company's acquisitions (see Note 3) is
amortized on a straight-line basis over two years. Accumulated amortization was
$3,117,000 and $3,137,000 at December 31, 1997 and 1996, respectively.

Software Development Costs

         Software development costs are accounted for in accordance with SFAS
No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed," under which capitalization of software development costs
begins upon the establishment of technological feasibility of the product, which
the Company defines as the development of a working model and further defines as
the development of a beta version of the software. The establishment of
technological feasibility and the ongoing assessment of the recoverability of
these


                                       35
<PAGE>   36
costs requires considerable judgment by management with respect to certain
external factors, including, but not limited to, anticipated future gross
product revenue, estimated economic life and changes in technology. Such costs
are reported at the lower of unamortized cost or net realizable value.
Amortization of purchased software is generally computed on a straight-line
basis over one to five years or, if less, the estimated remaining economic life
of the underlying products. To date, internal software development costs that
were eligible for capitalization have not been significant and the Company has
charged all software development costs to research and development as incurred.

         For the year ended December 31, 1997 and 1996, approximately $0.4 and
$2.7 million, respectively, is included in the accompanying Consolidated
Statements of Operations in cost of revenues for the amortization and writedown
to net realizable value of software purchased and capitalized during 1996 and
1997. Prior to 1996, purchased software costs eligible for capitalization had
not been significant and the Company charged all such costs to research and
development as incurred.

Concentrations of Credit Risk

         Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash investments and trade
receivables. The Company has cash investment policies that limit the amount of
credit exposure to any one issuer and restrict placement of these investments to
issuers evaluated as credit worthy. Concentrations of credit risk with respect
to trade receivables are limited due to the large number of customers comprising
the Company's customer base and their dispersion across many different
industries and geographies.

Net Income (Loss) Per Share

         In 1997, the Company adopted SFAS No. 128, "Earnings Per Share." SFAS
No. 128 requires companies to compute net income (loss) per share under two
different methods, basic and diluted. Basic net income (loss) per share data has
`been computed using the weighted average number of shares of common stock
outstanding during the periods. Diluted net income (loss) per share data has
been computed using the weighted average number of shares of common stock and
dilutive potential common shares. Potential common shares include dilutive
shares issuable upon the exercise of outstanding common stock options computed
using the treasury stock method. Potentially dilutive securities of 3,697,106,
4,270,780 and 2,385,061 were not included in the computation of diluted earnings
per common share because to do so would have been antidilutive for the years
ended December 31, 1997, 1996 and 1995, respectively.

         For the years ended December 31, 1997 and 1996, the number of shares
used in the computation of diluted earnings per share were the same as those
used for the computation of basic earnings per share. For the year ended
December 31, 1995 a reconciliation of the shares used in the computation of
basic and diluted earnings per share is as follows:

<TABLE>
<CAPTION>
                                                       NUMBER OF        PER SHARE
                                                        SHARES            AMOUNT
                                                    --------------    -------------
<S>                                                   <C>               <C>
Basic earnings per share                               40,749,000           $ 0.52
Common stock options                                    2,206,000             0.03
                                                     -------------    -------------
Diluted earnings per share                             42,955,000           $ 0.55
                                                     =============    =============
</TABLE>


Reclassifications

         Certain prior year financial statement amounts have been reclassified
to conform to the current year presentation.

New Accounting Standards

         In 1997, the Company adopted SFAS No. 129, "Disclosure of Information
About Capital Structure." SFAS No. 129 requires companies to disclose certain
information about their capital structure. SFAS No. 129 did not have a material
impact on the Company's consolidated financial statement disclosures.


                                       36
<PAGE>   37
         In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Comprehensive Income," which will be adopted by the Company in the
first quarter of 1998. SFAS No. 130 requires companies to report a new,
additional measure of income on the income statement or to create a new
financial statement that has the new measure of income on it. "Comprehensive
Income" is to include foreign currency translation gains and losses and other
unrealized gains and losses that have been previously excluded from net income
and reflected instead in equity. The Company anticipates that SFAS No. 130 will
not have a material impact on its consolidated financial statements.

         In 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which the Company will adopt in its 1998
annual consolidated financial statements. SFAS No. 131 requires companies to
report financial and descriptive information about its reportable operating
segments, including segment profit or loss, certain specific revenue and expense
items, and segment assets, as well as information about the revenues derived
from the Company's products and services, the countries in which the Company
earns revenues and holds assets, and major customers.

         In 1997, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
97-2, "Software Revenue Recognition," which will be adopted by the Company in
the first quarter of 1998. SOP 97-2 provides guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions.
The Company anticipates that SOP 97-2 will not have a material impact on its
consolidated financial statements.


3.        ACQUISITIONS AND OTHER INVESTMENTS:

         In December 1997, NetVision, Ltd., ("NetVision") a provider of internet
services in Israel and an unconsolidated affiliate of the Company issued an
additional 800,000 preferred shares which were sold to Tevel Israel
International Communications, Ltd ("Tevel'), an unrelated party, for $10.0
million cash in exchange for a one-third interest in NetVision. As a result of
the issuance and sale of these shares by NetVision, the Company's ownership
interest in NetVision decreased from 50% to approximately 32%. In connection
with this transaction, the Company recorded an unrealized gain on NetVision's
sale of stock of $2,152,000 which is included in the accompanying Consolidated
Statement of Operations for the year ended December 31, 1997.

         In July 1995, the Company had agreed to an investment by Elron
Electronics, Ltd. ("Elron") in NetVision. Elron's investment in NetVision,
comprised of various assets, was equal to the net equity of NetVision as of June
30, 1995. Following the investment by Elron, the Company's ownership interest in
NetVision decreased from 100% to 50%. During 1996, the Company and Elron each
invested approximately an additional $1,500,000 in NetVision. The Company's
ownership percentage did not change as a result of this investment. Neither the
Company nor Elron invested additional monies in NetVision in 1997. The
investment in NetVision of approximately $4,968,000 and $1,859,000 is included
in other assets in the accompanying Consolidated Balance Sheets at December 31,
1997 and 1996, respectively.

         A director of the Company also serves as the Chairman of the Board of
Directors, President and Chief Executive Officer of Elron. Elron holds an
investment in the common stock of the Company representing approximately 2% of
the Company's outstanding shares as of December 31, 1997.

         In November 1997, the Company acquired all of the outstanding shares of
Relay Technology, Inc. ("Relay"), a privately-held company, primarily engaged in
the development, marketing and support of network connectivity, file transfer
and terminal emulation software for $4.2 million in cash. The acquisition has
been accounted for as a purchase, and accordingly, the results of Relay from the
date of acquisition forward have been recorded in the Company's consolidated
financial statements. In connection with the purchase, net intangibles of
approximately $5.8 million were acquired, of which $4.6 million is reflected as
a charge to operations for the write-off of in-process research and development
that had not yet reached technological feasibility and, in



                                       37
<PAGE>   38
management's opinion, had no probable alternative future use. The remaining
intangible of $1.2 million, consisting of goodwill, is included in goodwill and
other intangibles in the accompanying balance sheet and is being amortized over
its estimated useful life of two years. Comparative pro forma financial
information has not been presented as the results of Relay are not material to
the Company's consolidated financial statements.

         In July 1997, the Company acquired all of the outstanding shares of
Network Software Associates, Inc. ("NSA") for $26.0 million in cash. NSA is a
holding company for NetSoft ("NetSoft"), a privately-held company specializing
in the development, marketing and support of PC-to-Host connectivity software
solutions. As of the date of the acquisition, NSA and NetSoft have continued as
wholly-owned subsidiaries of NetManage. The acquired company hereinafter will be
referred to as NetSoft. The acquisition was accounted for using the purchase
method of accounting and, accordingly, the results of NetSoft from the date of
acquisition forward have been recorded in the Company's consolidated financial
statements. In connection with the acquisition, net intangibles of $18.6 million
were acquired, of which $16.0 million was reflected as a charge to operations
for the write-off of in-process research and development that had not reached
technological feasibility and, in management's opinion, had no probable
alternative future use. The remaining intangible of $2.6 million, consisting of
goodwill, is included in goodwill and other intangibles in the accompanying
Consolidated Balance Sheets and is being amortized over its estimated useful
life of two years.

         In connection with the NetSoft acquisition, net assets acquired were as
follows (in thousands):

<TABLE>
<S>                                                     <C>
Cash and cash equivalents                               $   2,719
Trade accounts receivable and other current                 8,802
assets
Intangibles, including in-process research and             18,589
development
Property, equipment and other long-term assets              2,733
Current liabilities assumed                               (6,224)
Long-term liabilities                                       (619)
                                                     ------------
    Net assets acquired                                 $  26,000
                                                     ============
</TABLE>


         The following unaudited pro forma information shows the result of
operations for the years ended December 31, 1997 and 1996 as if the NetSoft
acquisition had occurred at the beginning of each of the years presented and at
the purchase price established in July 1997. The results are not necessarily
indicative of what would have occurred had the acquisition actually been made at
the beginning of each of the respective years presented or the future operations
of the combined companies.

<TABLE>
<CAPTION>
                                               YEARS ENDED DECEMBER 31,
                                             --------------------------
                                                1997             1996
                                             --------         ---------
<S>                                           <C>             <C>
Revenue                                       $ 81,103        $ 134,214
Net loss                                      $(35,137)       $  (4,565)
Net loss per share, diluted                   $  (0.80)       $   (0.11)
Weighted average common shares, diluted         43,385           42,341
</TABLE>


         In November 1996, the Company purchased collaborative computing
software technology from Applicom Software Industries (1990) Ltd. ("Applicom")
for cash consideration of approximately $10.0 million. In the opinion of
management, the purchased technology had not reached technological feasibility
and had no probable alternative future use. Accordingly, the entire purchase
price was deemed to be in-process research and development and was charged to
operations in 1996.

         In July 1996, the Company acquired all of the outstanding stock of
Maximum Information, Inc. ("MaxInfo"), in exchange for approximately 590,000
shares of the Company's common stock. The Company also assumed MaxInfo's
outstanding employee stock options, which were converted into options to
purchase approximately 129,000 shares of the Company's common stock. This
transaction was accounted for as a pooling of interests during the third quarter
of 1996. The operations of MaxInfo, however, were not material to the Company's

                                       38
<PAGE>   39
consolidated results of operations and financial position and, therefore, the
historical financial statements have not been restated to reflect the
acquisition retroactively. Accordingly, the operations of MaxInfo from the date
of acquisition forward have been recorded in the Company's consolidated
financial statements.

         In November 1995, the Company acquired all of the outstanding common
and preferred stock of AGE Logic, Inc. ("AGE") in exchange for approximately
833,000 shares of the Company's common stock. AGE was a supplier of
Desktop-to-UNIX(R) connectivity software and provided a full family of high
performance X server, file sharing and terminal emulation products for PC and
Macintosh desktops. The Company also assumed AGE's outstanding employee stock
options and warrants, which were converted to options and warrants to purchase
approximately 167,000 shares of the Company's common stock. The merger was
accounted for as a pooling of interests and, accordingly, the Company's
financial statements for the years ended December 31, 1995 and 1994 were
restated to include the results of AGE.

         Prior to the merger with the Company, in March 1995, AGE acquired all
of the outstanding stock, stock options and warrants of Pacer Software, Inc.
("Pacer") in exchange for approximately 64,600 shares of the Company's common
stock. Pacer was involved in the development and marketing of computer software
products. The acquisition was accounted for as a purchase. Accordingly, the
results of Pacer from the date of the acquisition forward have been recorded in
the Company's consolidated financial statements. The value of the Company's
common stock issued in connection with the acquisition was equal to the net
assets acquired from Pacer which approximated $774,000. Accordingly, no goodwill
was recorded for this transaction. Comparative pro forma financial information
has not been presented as the results of operations for Pacer were not material
to the Company's consolidated financial statements.

         In October 1995, the Company acquired all of the outstanding stock of
Syzygy Communications, Inc. ("Syzygy") in exchange for approximately 394,000
shares of the Company's common stock. Syzygy was an inter-networking
communications software company and developer of interconnection and network
management software for hardware and software vendors and also provided custom
communications software for commercial customers. The Company also assumed
Syzygy's outstanding employee stock options and warrants, which were converted
to options and warrants to purchase approximately 48,000 shares of the Company's
common stock. The transaction was accounted for as a pooling of interests. The
operations of Syzygy were not material to the Company's consolidated operations
and financial position and, therefore, prior period financial statements were
not restated. The results of Syzygy from the date of acquisition forward have
been recorded in the Company's consolidated financial statements.


4.       RESTRUCTURING OF OPERATIONS

         In the third quarter of 1997, the Company initiated a plan to
restructure its operations worldwide due to business conditions. The plan is
intended to realign the Company to focus solely on its core competencies -
UNIX(R), AS/400(R) midrange and IBM mainframe connectivity. In connection with
this plan, the Company recorded a $5.2 million charge to operating expenses. The
restructuring charge includes approximately $1.8 million of estimated
employee-related expenses for employee terminations, approximately $2.4 million
for the write-off of excess equipment and facilities-related expenses associated
with the consolidation of operations and approximately $1.0 million for the
write-off of intangible assets related to certain unprofitable products. The
restructuring plan includes the termination of employees worldwide and the
reduction in worldwide office space, which primarily consists of the
consolidation of sales offices in Europe resulting from the acquisition of
NetSoft in the third quarter of 1997 as well as the consolidation of certain
domestic technical support and engineering locations. As of December 31, 1997,
the Company had incurred costs totaling approximately $4.3 million related to
the restructuring. The remaining actions are expected to be completed within one
year from the date the restructuring plan was initiated. The Company anticipates
that these remaining restructuring actions will require the expenditures of
approximately $0.9 million of cash during 1998, which the Company expects will
be funded by internally generated cash. Accrued liabilities at December 31, 1997
included a reserve related to this restructuring plan of approximately $0.9
million.



                                       39
<PAGE>   40
5. COMMITMENTS AND CONTINGENCIES:

         On January 9, 1997, a securities class action complaint, Head, et al.
v. NetManage, Inc., et al., No. 07763295, was filed in the Superior Court of
California, Santa Clara County, against the Company and certain of its directors
and current and former officers. On January 10, 1997, the same plaintiffs filed
a securities class action complaint, Head, et al. v. NetManage, Inc., et al.,
No. C-97-20061-CRB, in the United States District Court for the Northern
District of California, against the same defendants. Both complaints allege
that, between July 25, 1995 and January 11, 1996, the defendants made false or
misleading statements of material fact about the Company's prospects and failed
to follow generally accepted accounting principles. The state court complaint
asserts claims under California state law; the federal court complaint asserts
claims under the federal securities laws. In addition, on September 10, 1997,
the Company and several of its officers and directors were named in a securities
class action complaint filed in the Northern District of California, Beasley v.
NetManage, Inc., et al., C-97-3329 FMS, (N.D. Cal.). This complaint is
substantially similar to the previously-filed case of Head et al. v. NetManage,
Inc. et al., discussed above, and contains similar allegations, names the same
defendants, and purports to represent purchasers of NetManage stock during the
same class period as in the previously-filed complaint. The complaints seek an
unspecified amount of damages. On February 24, 1998, the federal court granted
the defendants' motion to dismiss the federal class action complaint in Head, et
al. V. NetManage, Inc., et al. Plaintiffs are expected to file an amended
complaint. The Company believes there is no merit to these cases and intends to
defend both cases vigorously. There can be no assurance that the Company will be
able to prevail in the lawsuits, or that the pendency of the lawsuits will not
adversely affect the Company's operations. As the outcome of these matters
cannot be reasonably determined, the Company has not accrued for any potential
loss contingencies.

         On March 21, 1997, a securities class action complaint, Interactive
Data Systems, Inc., et al. v. NetManage, Inc., et al., No. CV764945, was filed
in the Superior Court of California, Santa Clara County, against the Company and
certain of its directors and officers. On June 19, 1997, one of the plaintiffs
in that action filed a securities class action complaint, Molinari v. NetManage,
Inc., et al., No. C-97-20544-CRB, in the United States District Court for the
Northern District of California against the same defendants. Both complaints
allege that, between April 18, 1996 and July 18, 1996, the defendants made false
or misleading statements of material fact about the Company's prospects. The
state court complaint asserts claims under California state law; the federal
complaint asserts claims under the federal securities laws. Both complaints seek
an unspecified amount of damages. The Company believes there is no merit to
either case and intends to defend both cases vigorously. There can be no
assurance that the Company will be able to prevail in the lawsuits, or that the
pendency of the lawsuits will not adversely affect the Company's operations. As
the outcome of these matters cannot be reasonably determined, the Company has
not accrued for any potential loss contingencies.

         On October 10, 1997, a verified derivative complaint was filed in the
United States District Court for the Northern District of California, Sucher v.
Alon et al., No. C-97-20897-CRB, against nine present and former officers and
directors of the Company alleging that these persons violated various duties to
the Company. The derivative complaint also names the Company as a nominal
defendant. The derivative complaint is predicated on the factual allegations
contained in the class action complaints discussed above. No demand was
previously made to the Company's Board of Directors concerning the allegations
of the derivative complaint, which seeks an unspecified amount of damages.

         On November 26, 1997, a complaint was filed against the Company in the
Superior Court of California, San Diego County, Shaw et al. v. NetManage, Inc.,
No. 716081. The plaintiffs, who held a significant ownership interest in AGE
before it was acquired by NetManage, bring causes of action alleging fraud,
negligent misrepresentation, negligence and breach of contract with respect to
the Company's acquisition of AGE. The complaint seeks an unspecified amount of
damages. The Company believes there is no merit to the case and intends to
defend the case vigorously. There can be no assurance that the Company will be
able to prevail in the lawsuit, or that the pendency of the lawsuit will not
adversely affect the Company's operations. As the outcome of this matter cannot
be reasonably determined, the Company has not accrued for any loss
contingencies.


                                       40
<PAGE>   41
         The Company may be contingently liable with respect to certain asserted
and unasserted claims that arise during the normal course of business. In the
opinion of management, the outcome of all other such matters presently known to
management will not have a material adverse effect on the Company's business,
financial position or results of operations.

         Facilities and equipment are leased under noncancelable operating
leases expiring on various dates through the year 2007. As of December 31, 1997,
future minimum rental payments under operating leases are as follows (in
thousands):

<TABLE>
<CAPTION>
                        YEAR
                        -------------
                        <S>                          <C>
                        1998                         $   5,197
                        1999                             3,317
                        2000                             2,193
                        2001                               885
                        2002                               757
                        Thereafter                       1,613
                                                     ---------
                                                     $  13,962
                                                     =========
</TABLE>


         Rent expense was approximately $3,945,000, $3,448,000 and $2,885,000
for the years ended December 31, 1997, 1996 and 1995, respectively.


6.       CAPITAL STOCK:

Common Stock

         In April 1995 the Company effected a two-for-one stock split (in the
form of a stock dividend) of the Company's common stock. All share and per share
amounts in the accompanying consolidated financial statements and notes have
been adjusted retroactively to reflect the stock dividend.

         As of December 31, 1997, the Company has reserved the following shares
of authorized but unissued common stock:

<TABLE>
                <S>                                        <C>
                Employee stock option plan                 7,496,057
                Directors' stock option plan                 739,835
                Employee stock purchase plan               1,474,091
                                                      ---------------
                                                           9,709,983
                                                      ===============
</TABLE>


Employee Stock Option Plan

         During 1992, the Company established the 1992 Employee Stock Option
Plan (the "Plan"). The Company currently has authorized a total of 9,800,000
shares for issuance under this Plan. The Company may grant incentive stock
options or non-statutory stock options to employees, officers, directors and
consultants at an exercise price of not less than 100% of the fair market value
of the common stock on the date of grant, except that non-statutory options may
be granted at 85% of such fair value. Up until mid-1997, options granted under
the Plan generally become exercisable at a rate of one-fourth of the shares
subject to the option at the end of the first year and 1/48 of the shares
subject to the option at the end of each calendar month thereafter. Since then,
options granted under the Plan for new hires generally become exercisable at a
rate of one-fifth of the shares subject to the option at the end of the first
year and 1/60 of the shares subject to the option at the end of each calendar
month thereafter. The maximum term of a stock option under the Plan is ten
years, but if the optionee at the time of grant has voting power over more than
10% of the Company's outstanding capital stock, the maximum term is five years.


                                       41
<PAGE>   42
         The Company has assumed certain options granted to former employees of
the companies acquired during 1995 and 1996 (the "Acquired Options"). The
Acquired Options were assumed by the Company outside of the Plan, but all are
administered as if assumed under the Plan. All of the Acquired Options have been
adjusted to effectuate the conversion under the Agreements and Plans of
Reorganization between the Company and the companies acquired. The Acquired
Options related to two of the companies acquired became immediately exercisable
under the original terms of the option agreements. The Acquired Options related
to the other company acquired continue to vest under the original vesting
schedule over a four-year period. No additional options will be granted under
any of the acquired companies' plans.

         In September 1997, January 1997 and February 1996, upon approval by the
Company's Board of Directors, the Company repriced 1,703,624, 3,451,079 and
2,302,338 options, respectively, originally issued at prices ranging from $3.25
to $6.00, $6.63 to $21.25, and $11.63 to $24.62, respectively. The options were
repriced at the then current market value of the Company's common stock of $3.06
for the September 1997 repricing, $6.00 for the January 1997 repricing, and
$11.13 for the February 1996 repricing. The Company's Board of Directors
extended the vesting period for all options repriced in February 1996 by an
additional six months.

Directors' Stock Option Plan

         In July 1993, the Company adopted the 1993 Directors' Stock Option Plan
(the "Directors' Plan") and reserved 800,000 shares of common stock for issuance
thereunder. Under the Directors' Plan, options may be granted only to
non-employee directors of the Company at an exercise price of 100% of the fair
market value of the stock on the date of grant. Options granted under the
Directors' Plan become exercisable at a rate of one-fourth of the shares subject
to the option at the end of the first year and 1/48 of the shares subject to the
option at the end of each calendar month thereafter. The maximum term of a stock
option under the Directors' Plan is ten years.

Employee Stock Purchase Plan

         In July 1993, the Company adopted the Employee Stock Purchase Plan (the
"Purchase Plan") and reserved 2,400,000 shares of common stock for future
issuance under the Purchase Plan. Under the Purchase Plan, the Company's
employees, subject to certain restrictions, may purchase shares of common stock
at a price per share that is equal to 85% of the lower of the fair market value
of the common stock on the commencement date of each offering period or the
relevant purchase date. For the years ended December 31, 1997, 1996 and 1995
shares issued under the Purchase Plan were 343,142, 226,124 and 145,145,
respectively, at prices ranging from $2.28 to $2.34 per share, $5.79 to $12.54
per share and $12.22 to $15.51 per share, respectively.

Stock-Based Compensation Plans

         The Company accounts for the above plans under Accounting Principles
Board Opinion ("APB") No. 25, under which no compensation cost has been
recognized. Had compensation cost for these plans been determined consistent
with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net
income (loss) and net income (loss) per share would have been adjusted to the
following pro forma amounts (in thousands, except per share amounts):


<TABLE>
<CAPTION>
                                                                           YEARS ENDED DECEMBER 31,
                                                               ------------------------------------------------
                                                                     1997             1996             1995
                                                               --------------   --------------   --------------

<S>                              <C>                           <C>               <C>               <C>
Net income (loss):               As reported                     $  (33,755)       $  (5,705)        $  22,297
                                 Pro forma                          (42,453)         (11,135)           16,548

Net income (loss) per  share     As reported                     $    (0.78)       $   (0.13)        $    0.52
                                 Pro forma - Basic                    (0.98)           (0.26)             0.39
                                 Pro forma - Diluted                  (0.98)           (0.26)             0.41
</TABLE>


         Because the method of accounting prescribed by SFAS No. 123 has not
been applied to options granted prior to January 1, 1995, the resulting pro
forma effect of compensation cost may not be representative of that to be
expected in future years.


                                       42
<PAGE>   43
         Option activity, including the Acquired Options, under the Company's
stock option plans was as follows:

<TABLE>
<CAPTION>
                                                                                     OUTSTANDING OPTIONS
                                                                    -------------------------------------------------------
                                                                                                              WEIGHTED
                                                      OPTIONS                                                  AVERAGE
                                                     AVAILABLE         SHARES         PRICE PER SHARE       EXERCISE PRICE
                                                   --------------   -------------   ----------------------------------------
<S>                                                <C>             <C>              <C>       <C>            <C>
Balance at December 31, 1994                           3,086,933       3,741,697    $  0.08   -$ 13.00        $   6.74
    Authorized                                         1,000,000               -
    Granted                                          (2,288,420)       2,288,420       0.76   -  21.25           10.52
    Exercised                                                  -       (689,561)       0.08   -  13.00            3.87
    Terminated                                           749,495       (749,495)       0.08   -  20.63            8.11
                                                   -------------    ------------
Balance at December 31, 1995                           2,548,008       4,591,061       0.08   -  21.25            8.83
    Authorized                                         2,000,000               -
    Granted                                          (1,852,317)       1,852,317       2.03   -  16.63            9.71
    Exercised                                                  -       (631,142)       0.08   -  13.00            4.42
    Terminated                                         1,541,456     (1,541,456)       0.08   -  21.25           10.32
                                                  --------------   -------------
Balance at December 31, 1996                           4,237,147      4,270,780        0.08   -  21.25            9.99
    Granted                                          (7,856,064)       7,856,064       2.63   -   6.00            4.28
    Exercised                                                  -       (272,035)       0.08   -   4.00            1.62
    Terminated                                         8,157,703     (8,157,703)       0.08   -  21.25            7.50
                                                   --------------   -------------
Balance at December 31, 1997                           4,538,786       3,697,106       0.08   -   6.00            3.04
                                                   ==============   =============
</TABLE>


         The following table summarizes the Company's outstanding options as of
December 31, 1997:

<TABLE>
<CAPTION>
                                OPTIONS OUTSTANDING                                     OPTIONS EXERCISABLE
     ------------------------------------------------------------------------------ -----------------------------
                                        WEIGHTED AVERAGE                                              WEIGHTED
        RANGE OF          NUMBER         REMAINING LIFE      WEIGHTED AVERAGE        NUMBER           AVERAGE
     EXERCISE PRICE    OUTSTANDING          (YEARS)           EXERCISE PRICE       EXERCISABLE     EXERCISE PRICE
     --------------    -----------          -------           --------------       -----------     --------------
<S>                   <C>               <C>                  <C>                 <C>              <C>
     $ 0.08 - $ 2.94         993,786          8.42                $ 2.37                 266,028       $ 1.24

         $ 3.06            2,463,955          8.59                $ 3.06                 598,977       $ 3.06

     $ 3.44 - $ 6.00         239,365          7.76                $ 5.51                 166,747       $ 6.00
                      --------------                                             ---------------
       Total               3,697,106          8.49                $ 3.04               1,031,752       $ 3.07
                      ==============                                             ===============
</TABLE>


         The weighted average fair values of options granted during 1997, 1996
and 1995 were $3.55, $6.20 and $14.08 per share, respectively. The fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option pricing with the following weighted average assumptions used for grants
in 1997, 1996 and 1997:


<TABLE>
<CAPTION>
                                     1997                   1996                  1995
                              -------------------    -------------------   -------------------
<S>                            <C>                   <C>                   <C>
     Volatility                    183.16%                 77.89%                77.89%
     Risk-free interest rate    4.93% - 5.79%          4.94% - 6.68%         4.94% - 6.65%
     Dividend yield                 0.00%                  0.00%                 0.00%
     Expected term               3 - 7 months           3 - 7 months          3 - 7 months
                               beyond vest date       beyond vest date      beyond vest date
</TABLE>




                                       43
<PAGE>   44
7.       INCOME TAXES:

         The provision (benefit) for income taxes is based upon income (loss)
before income taxes as follows (in thousands):

<TABLE>
<CAPTION>
                                        YEARS ENDED DECEMBER 31,
                          ----------------------------------------------------
                               1997               1996              1995
                          --------------    --------------    ---------------
<S>                       <C>                <C>                <C>
        Domestic               $ (25,573)         $ (5,502)          $ 22,803
        Foreign                   (8,642)           (3,531)            10,981
                          --------------     -------------     --------------
                               $ (34,215)         $ (9,033)          $ 33,784
                          ==============     =============     ==============
</TABLE>



         The components of the provision (benefit) for income taxes are as
follows (in thousands):

<TABLE>
<CAPTION>
                                               YEARS ENDED DECEMBER 31,
                                   --------------------------------------------------
                                         1997             1996              1995
                                    --------------    -------------    --------------
<S>                                      <C>             <C>                <C>
      Current -
         Federal                         $ (3,134)       $    2,008         $   8,575
         State                                   1              536             2,398
         Foreign                               235              830               367
                                    --------------    -------------    --------------

            Total current                  (2,898)            3,374            11,340
                                    --------------    -------------    --------------

      Deferred -
         Federal                             2,231          (4,816)               423
         State                                 207          (1,886)             (276)
                                    --------------    -------------    --------------

            Total deferred                   2,438          (6,702)               147
                                    --------------    -------------    --------------
      Provision (benefit)
         for income taxes                $   (460)       $  (3,328)         $  11,487
                                   ==============     ============     ==============
</TABLE>


         The provision (benefit) for income taxes differs from the amounts which
would result by applying the applicable statutory Federal income tax rate to
income before taxes, as follows (in thousands):

<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                                   ------------------------
                                                             1997           1996            1995
                                                             ----           ----            ----
<S>                                                      <C>             <C>            <C>
Provision (benefit) at Federal statutory rate            $(11,975)       $(3,162)       $ 11,824
State income taxes, net of Federal tax benefit             (2,068)          (546)          2,042
Nontaxable interest income                                   (982)        (1,016)         (1,219)
Foreign losses benefited at a lower tax rate                2,140             --              --
Nondeductible write-off of in-process research and
   development                                              8,464          1,803              --
Change in valuation allowance                               3,292             --              --
Acquisition costs                                              --            161             701
Tax credits                                                    --           (889)           (868)
Tax savings from foreign operations                            --         (1,429)         (2,095)
Nondeductible expenses                                         94            240             150
Foreign taxes                                                 235            830              --
Other                                                         340            680             952
                                                         --------        -------        --------
     Provision (benefit) for income taxes                $   (460)       $(3,328)       $ 11,487
                                                         ========        =======        ========
     Effective tax rate                                         1%            37%             34%
                                                         ========        =======        ========
</TABLE>



                                       44
<PAGE>   45
         The components of the net deferred income tax asset are as follows (in
thousands):





<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                                            ------------
                                                                        1997            1996
                                                                      --------        --------
<S>                                                                   <C>             <C>
Deferred revenue recognized currently for tax purposes                $  1,079        $    817
Reserves and accruals not currently deductible for tax purposes          2,499           2,565
Net operating loss carryforwards                                         1,179              28
Tax credit carryforwards                                                   185             139
State taxes, not currently deductible for federal tax purposes              35             112
Write-off of in-process research and development,
  not currently deductible for tax purposes                              5,819           6,056
Depreciation and amortization                                             (291)            651
Deemed dividend due to excess foreign passive assets                        --            (171)
Other temporary differences                                                579              33
                                                                      --------        --------
      Total deferred tax asset                                          11,084          10,230
Less: Valuation allowance                                               (3,292)             --
                                                                      --------        --------
      Net deferred tax asset                                          $  7,792        $ 10,230
                                                                      ========        ========
</TABLE>

         Realization of the net deferred tax asset of $7,792,000 is dependent on
generating sufficient future taxable income. Although realization is not
assured, management believes it is more likely than not that the net deferred
tax asset will be realized. The amount of the deferred tax asset considered
realizable, however, could be reduced if actual future taxable income differs
from estimated amounts.

         The Company's subsidiary in Haifa, Israel has a ten-year tax holiday,
which commenced January 1, 1995. During the first two years of the tax holiday,
the subsidiary was exempt from taxation on income generated during that period.
During the remaining eight years, income generated by the subsidiary will be
taxed at a reduced income tax rate of 10%. The Haifa tax holiday decreased the
consolidated net loss by approximately $1,429,000 ($0.03 per share) for the year
ended December 31, 1996, and increased consolidated net income by approximately
$593,000 ($0.01 per share) for the year ended December 31, 1995. There was no
impact on the net loss for the year ended December 31, 1997.


8.       OPERATIONS BY GEOGRAPHIC AREA AND SIGNIFICANT CUSTOMERS:

         Operating primarily in one industry segment, the Company's products are
marketed and sold in the United States and internationally by the Company's
direct sales force and authorized channel partners.

         The following table presents a summary of operations by geographic area
(in thousands):



                                       45
<PAGE>   46
<TABLE>
<CAPTION>
                                            YEARS ENDED DECEMBER 31,
                                   ---------------------------------------
                                      1997           1996           1995
                                   ---------      ---------      ---------
Revenues:
<S>                                <C>            <C>            <C>
   Domestic operations             $  48,155      $  74,996      $  99,262
   European operations                10,574         16,377         14,395
   Asian operations                    2,795         13,223         11,789
                                   ---------      ---------      ---------
      Consolidated                 $  61,524      $ 104,596      $ 125,446
                                   =========      =========      =========

Income (loss) from operations:
   Domestic operations             $ (29,877)     $ (10,780)     $  26,128
   European operations               (12,380)        (3,396)        (6,339)
   Asian operations                      133            523          9,807
                                   ---------      ---------      ---------
      Consolidated                 $ (42,074)     $ (13,653)     $  29,596
                                   =========      =========      =========

Identifiable assets:
   Domestic  operations            $ 121,582      $ 147,581      $ 145,526
   European operations                27,690         23,299         31,503
   Asian operations                    1,433          2,204         14,138
   Eliminations                      (31,112)       (20,555)       (36,696)
                                   ---------      ---------      ---------
      Consolidated                 $ 119,593      $ 152,529      $ 154,471
                                   =========      =========      =========
</TABLE>


        Domestic revenues include export revenues of approximately $750,000,
$3,207,000 and $5,994,000 to Asia for the years ended December 31, 1997, 1996
and 1995, respectively, and $2,447,000, $2,090,000 and $4,585,000 to the rest
of the world for the years ended December 31, 1997, 1996 and 1995,
respectively.

         There were no customers that accounted for more than 10% of net
revenues for the years ended December 31, 1997, 1996 or 1995.


                                       46
<PAGE>   47
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE.

         None.



                                    PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The Company's definitive Proxy Statement will be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Company's Annual Meeting of Stockholders, to be held on May 21,
1998 (the "Proxy Statement"). Certain information required by this item is
incorporated by reference from the information contained in the Proxy Statement
under the captions "Election of Directors" and "Security Ownership of Certain
Beneficial Owners and Management Compliance with the Reporting Requirements of
Section 16(a)." For information regarding executive officers of the Company, see
Part I of this Form 10-K under the caption "Business - Executive Officers of the
Registrant."


ITEM 11 - EXECUTIVE COMPENSATION.

         The information required by this item is incorporated by reference from
the information contained in the Company's Proxy Statement under the caption
"Executive Compensation", except for the information appearing under the
captions "-- Report of the Compensation Committee of the Board of Directors on
Executive Compensation" and "-- Performance Measurement Comparison."

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The information required by this item is incorporated by reference from
the information contained in the Company's Proxy Statement under the caption
"Security Ownership of Certain Beneficial Owners and Management."



ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         The information required by this item is incorporated by reference from
the information contained in the Company's Proxy Statement under the caption
"Certain Transactions."




                                       47
<PAGE>   48
                                     PART IV

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

         (a)      The following documents are filed as part of this Report on
                  Form 10-K:

                 1.  Financial Statements

                     See Index to Consolidated Financial Statements at Item 8 on
                     page 27 of this Report.

                 2.  Financial Statement Schedule

                     See Index to Consolidated Financial Statements at Item 8 on
                     page 27 of this Report.

                 3.  Exhibits

<TABLE>
<CAPTION>
               EXHIBIT
               NUMBER    EXHIBIT TITLE
               -----------------------------------------------------------------------
<S>            <C>       <C>
                 3.1     Certificate of Incorporation of the Registrant.(1)
                 3.1a    Amended Certificate of Incorporation of the Registrant
                 3.2     Bylaws of the Registrant.(1)
                 4.1     Amended Stock Rights Agreement, among the Registrant and the parties
                         named therein, dated as of March 12, 1993.(1)
                 4.2     Form of Common Stock certificate.(1)
                 10.1    Form of Indemnity Agreement entered into among the Registrant and
                         its directors and officers.(1)
                 10.2*   Registrant's 1992 Stock Option Plan, as amended, including forms of
                         option agreements.(1)
                 10.3*   Registrant's 1993 Non-Employee Directors Stock Option Plan,
                         including form of option agreements.(1)
                 10.4*   Registrant's 1993 Employee Stock Purchase Plan, including form
                         of offering document.(1)
                 10.5    Lease between the Registrant and Stevens Creek Office
                         Center Associates, dated as of November 30, 1992.(1)
                 10.6    Lease between the Registrant and Beim & James Properties III,
                         dated January 3, 1994.(2)
                 10.7    Lease between the Registrant and Cupertino Industrial Associates,
                         dated September 30, 1994. (3)
                 10.8    Lease between the Registrant and the Flatley Company,
                         dated January 30, 1995. (4)
                 10.9    Lease between the Registrant and Cupertino Brown Investment,
                         dated April 28, 1995. (5)
                 10.10   Agreement between NetManage, Ltd., Elron Electronic Industries, Ltd.,
                         and NetVision, Ltd., dated July 1, 1995. (5)
                 10.11   Agreement and Plan of Reorganization among the Registrant,
                         NetManage Acquisition Corporation, Syzygy Communications, Inc.
                         and the Designated Shareholders, dated October 16, 1995. (5)
                 10.12   Agreement and Plan of Reorganization among the Registrant,
                         NetManage Acquisition Corporation and AGE Logic, Inc.,
                         dated November 17, 1995. (5)
</TABLE>



                                       48
<PAGE>   49
<TABLE>
<S>              <C>     <C>
                 10.13   Stock Purchase Agreement by and among the registrant, Network
                         Software Associates, Inc. a California corporation, NetSoft, a
                         California corporation, holders of securities of NSA and holders
                         of securities of NetSoft, dated as of July 8, 1997. (6)
                 21.1    Subsidiaries of Registrant.
                 23.1    Consent of Independent Public Accountants
                 24.1    Power of Attorney. Reference is made to the signature page to
                         this Form 10-K.
                 27.1    Financial Data Schedule
</TABLE>


                  (1)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Registration Statement on Form S-1
                           (No. 33-66460) dated July 24, 1993, as amended, which
                           became effective September 20, 1993.

                  (2)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Registration Statement on Form S-1
                           (No. 33-74364) dated January 24, 1994, as amended,
                           which became effective February 10, 1994.

                  (3)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Form 10-Q for the quarter ended
                           September 30, 1994.

                  (4)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Form 10-Q for the quarter ended
                           March 31, 1995.

                  (5)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Form 10-K for the year ended
                           December 31, 1995.

                  (6)      Incorporated by reference to the Exhibits filed with
                           the Registrants Form 8-K dated July 29, 1997.

                  *        Employee Benefit Plan

         (b)      Reports on Form 8-K

                  A Current Report on Form 8-K dated July 29, 1997 was filed by
                  the Registrant on August 8, 1997 to report under Item 5
                  thereof, the Registrant's acquisition of all of the
                  outstanding shares of Network Software Associates, Inc.

                  A Current Report on Form 8-K/A was filed by the Registrant on
                  October 14, 1997, to amend its report on Form 8-K dated July
                  29, 1997, to include the financial statements of Network
                  Software Associates, Inc. and pro forma combined financial
                  statements for the Company and Network Software Associates,
                  Inc.

         (c)      Exhibits
                  The exhibits required by this Item are listed under Item
                  14(a).

         (d)      Financial Statement Schedules
                  The financial statement schedule required by this Item is
                  listed under Item 14(a).


Copyright (C) 1998 NetManage, Inc. All rights reserved. NetManage, Chameleon
UNIX(R) Link, Chameleon HostLink, NS/Portfolio, NS/Router, the NetManage logo
and the lizard logos are trademarks or registered trademarks of NetManage, Inc.
in the United States and other countries. UNIX is a registered trademark in the
U.S. and other countries, licensed exclusively through X/Open Company Limited.
AS/400 is a registered trademark in the U.S. and other countries of
International Business Machines Corporation. All other trademarks are the
property of their respective owners.


                                       49
<PAGE>   50
                                                                     SCHEDULE II

                                 NETMANAGE, INC.
                        VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                BALANCE AT     CHARGED TO REVENUES,   DEDUCTIONS    BALANCE AT
                                               BEGINNING OF           COSTS OR      AND WRITE-OFFS    END OF
                                                  PERIOD            EXPENSES                          PERIOD
                                             --------------------------------------------------------------------
<S>                                              <C>                 <C>              <C>            <C>
Year ended December 31, 1995:
   Allowance for doubtful accounts and
      sales returns                              $ 2,281              $ 1,842          $ (1,607)      $ 2,516

Year ended December 31, 1996:
   Allowance for doubtful accounts and
      sales returns                                2,516                  886            (1,390)        2,012

Year ended December 31, 1997:
   Allowance for doubtful accounts and
      sales returns                                2,012                  268              (905)        1,375
</TABLE>




                                       50
<PAGE>   51
                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Form 10-K Annual
Report to be signed on its behalf by the undersigned, thereunto duly authorized
on the 31st day of March 1998.

                                 NETMANAGE, INC.

                                 By: /s/ Zvi Alon
                                    --------------------------------------------
                                 Zvi Alon
                                 Chairman of the Board, President and Chief
                                 Executive Officer

                                POWER OF ATTORNEY

         Each person whose signature appears below constitutes and appoints ZVI
ALON and GARY R. ANDERSON his or her true and lawful attorneys-in-fact and
agents, each acting alone, with the power of substitution and resubstitution,
for him or her and in his or her name, place and stead, in any and all
capacities, to sign any amendments to this Form 10-K Annual Report, and to file
the same, with exhibits thereto and other documents in connections therewith,
with the Securities and Exchange Commission, hereby ratifying and confirming all
that each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.

         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 and on the dates indicated.

<TABLE>
<CAPTION>
             SIGNATURE                                  TITLE                                    DATE
             ---------                                  -----                                    ----
<S>                                  <C>                                                    <C>
/s/ Zvi Alon                         Chairman of the Board, President and Chief             March 31, 1998
---------------------------------    Executive Officer (Principal Executive
     Zvi Alon                        Officer)


/s/ Gary R. Andersen                 Chief Financial Officer and Senior Vice                March 31, 1998
---------------------------------    President, Finance and Secretary
     Gary R. Andersen                (Principal Financial and Accounting Officer)


/s/ John Bosch                       Director                                               March 31, 1998
---------------------------------
     John Bosch

/s/ Uzia Galil                       Director                                               March 31, 1998
---------------------------------
     Uzia Galil

/s/ Shelley Harrison, PhD.           Director                                               March 31, 1998
---------------------------------
     Shelley Harrison, PhD.

/s/ Darrell Miller                   Director                                               March 31, 1998
---------------------------------
     Darrell Miller

/s/ Abraham Ostrovsky                Director                                               March 31, 1998
---------------------------------
     Abraham Ostrovsky
</TABLE>




                                       51
<PAGE>   52

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
               EXHIBIT
               NUMBER    EXHIBIT TITLE
               -------------------------------------------------------------------------------
<S>            <C>       <C>
                 3.1     Certificate of Incorporation of the Registrant.(1)
                 3.1a    Amended Certificate of Incorporation of the Registrant
                 3.2     Bylaws of the Registrant.(1)
                 4.1     Amended Stock Rights Agreement, among the Registrant and the parties
                         named therein, dated as of March 12, 1993.(1)
                 4.2     Form of Common Stock certificate.(1)
                 10.1    Form of Indemnity Agreement entered into among the Registrant and
                         its directors and officers.(1)
                 10.2*   Registrant's 1992 Stock Option Plan, as amended, including forms of
                         option agreements.(1)
                 10.3*   Registrant's 1993 Non-Employee Directors Stock Option Plan,
                         including form of option agreements.(1)
                 10.4*   Registrant's 1993 Employee Stock Purchase Plan, including form
                         of offering document.(1)
                 10.5    Lease between the Registrant and Stevens Creek Office
                         Center Associates, dated as of November 30, 1992.(1)
                 10.6    Lease between the Registrant and Beim & James Properties III,
                         dated January 3, 1994.(2)
                 10.7    Lease between the Registrant and Cupertino Industrial Associates,
                         dated September 30, 1994. (3)
                 10.8    Lease between the Registrant and the Flatley Company,
                         dated January 30, 1995. (4)
                 10.9    Lease between the Registrant and Cupertino Brown Investment,
                         dated April 28, 1995. (5)
                 10.10   Agreement between NetManage, Ltd., Elron Electronic Industries, Ltd.,
                         and NetVision, Ltd., dated July 1, 1995. (5)
                 10.11   Agreement and Plan of Reorganization among the Registrant,
                         NetManage Acquisition Corporation, Syzygy Communications, Inc.
                         and the Designated Shareholders, dated October 16, 1995. (5)
                 10.12   Agreement and Plan of Reorganization among the Registrant,
                         NetManage Acquisition Corporation and AGE Logic, Inc.,
                         dated November 17, 1995. (5)
                 10.13   Stock Purchase Agreement by and among the registrant, Network
                         Software Associates, Inc. a California corporation, NetSoft, a
                         California corporation, holders of securities of NSA and holders
                         of securities of NetSoft, dated as of July 8, 1997. (6)
                 21.1    Subsidiaries of Registrant.
                 23.1    Consent of Independent Public Accountants
                 24.1    Power of Attorney. Reference is made to the signature page to
                         this Form 10-K.
                 27.1    Financial Data Schedule
</TABLE>


                  (1)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Registration Statement on Form S-1
                           (No. 33-66460) dated July 24, 1993, as amended, which
                           became effective September 20, 1993.

                  (2)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Registration Statement on Form S-1
                           (No. 33-74364) dated January 24, 1994, as amended,
                           which became effective February 10, 1994.

                  (3)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Form 10-Q for the quarter ended
                           September 30, 1994.

                  (4)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Form 10-Q for the quarter ended
                           March 31, 1995.

                  (5)      Incorporated by reference to the Exhibits filed with
                           the Registrant's Form 10-K for the year ended
                           December 31, 1995.

                  (6)      Incorporated by reference to the Exhibits filed with
                           the Registrants Form 8-K dated July 29, 1997.

                  *        Employee Benefit Plan

         (b)      Reports on Form 8-K

                  A Current Report on Form 8-K dated July 29, 1997 was filed by
                  the Registrant on August 8, 1997 to report under Item 5
                  thereof, the Registrant's acquisition of all of the
                  outstanding shares of Network Software Associates, Inc.

                  A Current Report on Form 8-K/A was filed by the Registrant on
                  October 14, 1997, to amend its report on Form 8-K dated July
                  29, 1997, to include the financial statements of Network
                  Software Associates, Inc. and pro forma combined financial
                  statements for the Company and Network Software Associates,
                  Inc.

         (c)      Exhibits
                  The exhibits required by this Item are listed under Item
                  14(a).

         (d)      Financial Statement Schedules
                  The financial statement schedule required by this Item is
                  listed under Item 14(a).