<PAGE>
 
               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                  FORM 10-KSB

                                 ANNUAL REPORT
                     PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

                         Commission File Number 0-20749

                            ASPECT DEVELOPMENT, INC.
             (Exact name of registrant as specified in its charter)


              Delaware                                         25-1622857
              --------                                         ----------
  (State or other jurisdiction of                           (I.R.S. Employer
   incorporation or organization)                          Identification No.)


                  1300 Charleston Road, Mountain View CA 94043
                  --------------------------------------------
             (Address of principal executive offices and zip code)


                                 (415) 428-2700
                                 --------------
              (Registrant's telephone number, including area code)

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

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

          Securities registered pursuant to Section 12(g) of the Act:

                    COMMON STOCK, $0.001 PAR VALUE PER SHARE
                                (Title of Class)

 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.  [_]

 The aggregate market value of the voting stock held by non-affiliates of the
 Registrant (based on the closing sale price of the Common Stock as reported on
 the Nasdaq National Market on March 13, 1997) was approximately $101,559,000.
 For purposes of this determination, shares of Common Stock held by each officer
 and director and by each person who owns 5% or more of the outstanding Common
 Stock have been excluded in that such persons may be deemed to be affiliates.
 This determination of affiliate status is not necessarily a conclusive
 determination for other purposes.  The number of outstanding shares of the
 Registrant's Common Stock as of the close of business on March 13, 1997 was
 12,463,851.

          DOCUMENTS INCORPORATED BY REFERENCE

The Registrant's definitive Proxy Statement for the 1997 Annual Meeting of
Stockholders to be held on May 21, 1997 is incorporated by reference in Part III
of the Form 10-K to the extent stated herein.
<PAGE>
 
                           ASPECT DEVELOPMENT, INC.
                                  FORM 10-KSB
                  For the Fiscal Year Ended December 31, 1996
                               Table of Contents


                                    PART I

                                                                            Page
                                                                            ----
Item 1.    Business.......................................................     3

Item 2.    Properties.....................................................    11

Item 3.    Legal Proceedings..............................................    11

Item 4.    Submission of Matters to a Vote of Security Holders............    11


                                    PART II

Item 5.    Market for Registrant's Common Equity and Related Stockholder 
           Matters........................................................    12

Item 6.    Selected Consolidated Financial Data...........................    13

Item 7.    Management's Discussion and Analysis of Financial Condition 
           and Results of Operations......................................    14

Item 8.    Financial Statements and Supplementary Data....................    21

Item 9.    Changes in and Disagreements with Accountants on Accounting 
           and Financial Disclosure.......................................    21


                                   PART III

Item 10.   Directors and Executive Officers of the Registrant.............    22

Item 11.   Executive Compensation.........................................    24

Item 12.   Security Ownership of Certain Beneficial Owners and 
           Management.....................................................    24

Item 13.   Certain Relationships and Related Transactions.................    24


                                    PART IV

Item 14.   Exhibits, Financial Statement Schedules and Reports on 
           Form 8-K.......................................................    25

Signatures................................................................    40

                                       2
<PAGE>
 
PART I
------

Forward looking statements in this Annual Report on Form 10-KSB are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995.  Stockholders are cautioned that all forward-looking
statements pertaining to the Company involve risks and uncertainties, including,
without limitation, those contained in Item 7 of this report under the caption
entitled, "Management's Discussion and Analysis Of Financial Condition and
Results of Operations - Factors that May Affect Future Results of Operations"
and other risks detailed from time to time in the Company's periodic reports and
other information filed with the Securities and Exchange Commission.

ITEM 1.   BUSINESS.
          --------

    Aspect Development, Inc. (''Aspect'' or the ''Company'') develops, markets
and supports enterprise client/server software and reference data products that
enable manufacturers to improve product development and business processes
through component and supplier management. Aspect's Component and Supplier
Management ("CSM") solution can reduce product costs and development expense and
accelerate time-to-market by enabling users to manage and integrate information
regarding components, suppliers and designs throughout the enterprise. Aspect's
products enable rapid search, comparison and selection of the optimal components
and suppliers, promote the reuse of design and manufacturing knowledge, support
the consolidation of the supply chain and facilitate automation of the related
design and procurement processes. Aspect's CSM solution provides the information
bridge between design and procurement, complementing the role of Enterprise
Resource Planning ("ERP") systems in planning, manufacturing and order entry and
the role of Product Data Management ("PDM") systems in design release and
configuration management. The Aspect CSM solution provides several key business
advantages, including a unified repository of all CSM data, powerful decision
support, desktop access to industry-wide component reference data, rapid
deployment and workflow/process automation.

     The Aspect CSM solution incorporates two product families: the Explore
family of enterprise client/server software products and the VIP family of
component reference databases. 

    .  Aspect's Explore software, based on third generation object-relational
       technology, enables the creation and management of a unified enterprise
       repository of knowledge regarding components, suppliers and designs,
       facilitates the organization and cross-referencing of such knowledge for
       rapid search and reuse, and supports workflow/process automation. 

    .  Aspect's VIP family of component reference databases contains frequently 
       updated industry-wide information regarding approximately 1.8 million
       standard electronic components, including integrated circuits ("ICs"),
       discrete semiconductors, passive components and connectors and
       electromechanical devices and fasteners standards, from approximately 700
       suppliers worldwide.

    Aspect's CSM solution operates in an open client/server environment allowing
customers to use various UNIX servers from Sun Microsystems, Inc. ("Sun"),
IBM, Hewlett-Packard Company ("HP") and Digital Equipment Corporation ("DEC")
and various client hardware such as Macintoshes using terminal emulation
packages, UNIX workstations and PCs. The Aspect CSM solution also includes
standard interfaces and tools that facilitate CSM integration with CAD, ERP, PDM
and other enterprise systems, including legacy systems. Aspect's products are
designed to provide an out-of-the-box solution for rapid enterprise-wide
deployment and are scalable from a departmental solution to an enterprise
deployment of hundreds or thousands of users in a heterogenous information
technology environment. In order to provide a complete solution, Aspect offers
consulting services to accelerate data migration and CSM implementation.

     The Aspect CSM solution delivers the following key business advantages:

     Unified Repository of CSM Data.  The Aspect CSM solution enables the 
     ------------------------------
management, cross-referencing, integration and sharing of relevant technical and
business information regarding components, suppliers and designs, even when some
or all of the source data is physically resident in other systems or databases.
In addition, users may add internal component and supplier information such as
specifications, CAD schematics, cost and availability to the search and select
parameters and electronics databooks in Aspect's VIP component reference
databases. Designers and procurement professionals are therefore able to access
both the business and technical information necessary for them to make better
and faster decisions, which can reduce costs and shorten time-to-market, all
from a single unified repository of CSM data.

                                       3
<PAGE>
 
    Powerful Decision Support.  The Aspect CSM solution supports advanced search
    -------------------------
techniques that enable users to rapidly search and select the optimal
components, suppliers and reusable designs from a multitude of possible choices.
This solution allows users to access this information much more rapidly and
reliably than using paper databooks or accessing documents, if available, on
suppliers' World Wide Web servers. Advanced analytical capabilities also enable
spreadsheet style comparison of technical and business features.

    Desktop Access to Industry-Wide Reference Data.  The VIP component reference
    ----------------------------------------------
databases provide search and select parameters and electronic databooks for a
wide range of standard components classified and organized for consistency and
ease of search. These reference data products include approximately 1.8 million
components from approximately 700 suppliers worldwide and are updated
frequently. These products are designed to provide access at the desktop for a
wide variety of choices and are organized under a standard classification scheme
(SCS) to enable rapid and consistent search, comparison and selection of
standard components and suppliers.

    Rapid Deployment.  Explore provides powerful Soft Model technology that 
    ----------------
enables companies to model their business processes rapidly and to keep this
data model up-to-date as these processes evolve. A full suite of application
programming interfaces ("APIs") and batch data loading tools are available to
speed legacy data migration and accelerate integration with other enterprise
systems.

    Workflow/Process Automation.  Explore automates the management of ongoing 
    ---------------------------
changes in component and supplier information from qualification through
obsolescence, enabling companies to manage their information in the context of
best business practices and to improve design and procurement productivity.

Customers

    To date the Company's customers have largely consisted of electronics
manufacturers. The Company's revenues in any period are substantially dependent
upon a relatively small number of large sales. The Company expects that this
trend will continue for the foreseeable future.  In 1994, sales to Digital,
Lockheed and Allen-Bradley accounted for 12%, 11% and 10%, respectively, of
total revenues. In 1995, sales to Kodak, IBM and TI each accounted for 11% of
total revenues. In 1996, sales to General Instruments accounted for 13% of total
revenues.

Products

    Aspect offers a comprehensive CSM solution that enables companies to address
component and supplier management demands in today's competitive global
marketplace. The Aspect CSM solution includes the Explore family of
client/server software products and the VIP family of component reference
databases.


Explore Software Products

    The Company's Explore client/server software products are available in two
primary application configurations: Explore-CIS and Explore-Enterprise. Explore-
CIS is a system that enables design and procurement teams to rapidly classify
and search components from legacy data or from VIP reference data licensed by
the customer. Explore-Enterprise is an enterprise-wide solution that enables, in
addition to component classification and search, preferred component and
supplier management, design reuse, design and procurement process automation and
integration with other enterprise systems. Each of these two configurations is
based on the Explore Server and the Explore Client software, although Explore-
CIS is licensed for only a subset of the available functionality. In addition,
the Company offers a range of software options, including CAD/PDM/ERP
Interfaces, Enterprise Integration Tools and a Rapid Application Development
Toolkit.


    The Explore Server.  The Explore Server provides a variety of features for
    ------------------
component and supplier management, including a parametric search engine, a
cascade search engine, a forms editor for workflow/process automation and a
class and object editor. The Explore Server enables the storage and management
of parametric data, metadata, text, images, graphics and CAD files. Objects such
as components, suppliers or reusable design elements can be organized into one
or more classes, and these classes can be organized into one or more hierarchies
for ease of classification and search. Objects can also be characterized by
their electrical, physical, technical, business or other parameters, and by
their datasheets, specifications or CAD descriptions. Relationships and cross-
references between classes or objects can also be defined. The Explore Server is
a portable object-oriented application written in C++ that is supported on
various UNIX server platforms (Sun, IBM and HP) and operates in conjunction with
the Oracle RDBMS. 

                                       4
<PAGE>
 
    .  Parametric Search Engine.  The parametric search engine enables the 
       ------------------------
       browsing of class hierarchies and searching for components or other
       objects by specifying simple or complex parametric criteria, such as
       voltage, speed, packaging, technology, cost or availability. Results of
       these parametric searches can be displayed in a spreadsheet-like
       comparison window and compared side-by-side, and differences can be
       highlighted to accelerate selection. Datasheets, notes, CAD files or
       other information related to the selected objects can be immediately
       retrieved and viewed.

    .  Cascade Search Engine. The cascade search engine enables simultaneous 
       ---------------------
       ad-hoc parametric searching across a combination of component, supplier,
       design reuse or other class hierarchies. Relationships between a class of
       components, such as memory devices, and its manufacturers / distributors
       and its CAD design libraries and preferred parts / suppliers lists, etc.
       can be viewed graphically to assist in the rapid setup of the search
       criteria. This functionality is particularly important when performing
       analytical searches which involve complex combinations of technical and
       business parameters. For example, a user may search for certain memory
       devices with an access time of 50 nanoseconds, lead time of less than two
       weeks, and cost of less than two dollars, from preferred suppliers which
       are ISO9000 certified and for which reusable CAD libraries are already
       available. This type of complex search across multiple classes is
       significantly more difficult to manage without the cascade search
       capability.

    .  Forms Editor for Workflow/Process Automation.  The Explore Server 
       --------------------------------------------
       provides the ability to automate manual, paper-based processes with an
       automated forms generation and management capability. For example, new
       part requests and approvals can be created and managed in the system as
       objects, just like component or supplier information. Customer defined
       routings, signoffs and approvals can be accomplished electronically. 

    .  Class and Object Editor.  This editor enables the easy addition and 
       -----------------------
       modification of classes, objects and parameters, as well as the
       relationships between them, using the graphical user interface (''GUI'').
       It also enables the use of a spreadsheet-like edit window to make
       simultaneous changes to a large number of objects.

    Explore Client.  Explore Client software is supported on a variety of PCs 
    --------------
and UNIX workstations. The client software presents the services and features of
the Explore Server software through such familiar metaphors as folders, icons
and toolbars and supports PC Windows and other graphical environments. Class
hierarchies and relationships can be viewed in a graphical browser. Using point
and click methods, users can rapidly locate the desired class of information for
subsequent searching, initiate parametric or cascade searches, compare results
using spreadsheet windows, and view related data or documents. The Explore
client software GUI configures itself directly from the data model stored in the
Explore Server. Therefore, if the model changes, the GUI reconfigures itself
automatically without any custom programming.

    Explore Options.  In addition to the basic functionality available with 
    ---------------
either the Explore-CIS or the Explore-Enterprise applications, customers can
choose to enhance their CSM solution with the following optional modules: 

    .  Explore Interfaces.  The Explore interfaces integrate the Explore 
       ------------------
       software with tools from leading electronic and mechanical design
       automation vendors, allowing designers to work in the environment in
       which they are most comfortable, while at the same time providing access
       to the Explore Server to select components, obtain information about
       components used in the current design, find alternatives, or reuse CAD
       libraries. The Explore interfaces also integrate the Explore software
       with leading product data management (PDM) vendors, allowing users to
       select components, find alternatives, and obtain information about
       components and where they are used in various versions of products and
       configurations stored in the PDM system. To date, the Company has
       released interfaces to the Mentor Graphics, Cadence and Parametric
       Technology electronic design automation tools. 


    .  Explore Integration Toolkit.  A range of enterprise integration tools is 
       ---------------------------
       provided to enable integration with existing enterprise systems. An API
       is available to allow real-time, programmatic interfaces between Explore
       and other systems. Batch data import-export utilities are also available
       to enable the upload and download of data and data models to and from
       Explore. This toolkit can be used for developing or extending data models
       or integrating them with other systems. Certain of these tools can be
       used to create new data models for new applications, add special
       functions, create or modify class hierarchies and create one-to-one, one-
       to-many or many-to-many relationships using high-level object-oriented
       methods.

                                       5
<PAGE>
 
    .  Explore Rapid Application Development (RAD)  RAD is a software toolkit 
       -------------------------------------------
       targeted at an application development programmer rather than the Explore
       end user who uses the Explore client. RAD is used to develop Softmodels
       (datamodel) to customize Explore, integrations to legacy systems, or
       unique applications, such as a bill of materials analysis, layered on
       Explore.


The VIP Family of Component Reference Databases

    The Company's VIP family of component reference databases provides regularly
updated information regarding standard electronic, electro-mechanical and
mechanical components. The content of the VIP component reference databases
includes, for most components, an index of search and select parameters that
enables rapid component search, comparison and selection based on form, fit and
function and other technical characteristics, as well as electronic versions of
databooks and datasheets. VIP component reference databases provide broad,
industry-wide coverage of component manufacturers, enabling users to rapidly
access component information at their desktops, electronically and consistently,
instead of searching manually through many different and often inconsistent
paper databooks or receiving information from one manufacturer at a time. The
VIP component reference databases are organized by major device groups,
including ICs and discrete semiconductors, passive components, electromechanical
components and mechanical components, and contain information on approximately
1.8 million standard components available from over 700 suppliers. The Company
updates its VIP component reference databases regularly and delivers these
updates to its customers on computer tape. VIP component reference databases are
integrated with the Company's Explore client/server software to enable a
comprehensive CSM solution for enterprise data management.

    VIP reference databases utilize the Company's Standard Classification 
Scheme and VIP data dictionary, which defines the classification structure in
which the part classes reside and the standard definitions of the search
parameters, including names, descriptions, units of measure, allowable values
and other criteria.

    The VIP family of component reference databases includes the following
individual databases: 

    .  VIP IC and Discrete Semiconductors Reference Database:  ICs database 
       -----------------------------------------------------
       includes memory, programmable logic, digital logic, microprocessor,
       analog and interface devices. Discrete database includes transistor,
       diode, transformer, crystal, triggers, optoelectronic and sensor. 

    .  VIP Passives Reference Database:  This database includes capacitor, 
       -------------------------------
       resistor, inductor and transformer. 

    .  VIP Electro-Mechanical Reference Database:  This database includes 
       -----------------------------------------
       connectors, relays, and switches. 

    .  VIP IC Military Specifications Database:  This database includes military
       ---------------------------------------
       specifications for military-rated IC and semiconductor components. 

    .  VIP Package Standards Database:  This database provides package 
       ------------------------------
       dimensions and outline drawings to international specifications for 
       certain IC components. 

    .  VIP Fasteners Standards Database:  This database includes international
       --------------------------------
       specifications for nuts, bolts, screws, washers, clips, and other 
       standard fasteners.


CAPS Reference Database

    The Company also resells and sublicenses a reference data product containing
information regarding ICs and discrete semiconductors called CAPS, licensed from
the Information Handling Systems division of IHS Group, Inc. (''IHS''). Prior to
the availability of the Company's own VIP component reference databases, the
Company offered the CAPS database to its CIS customers, and later to its Explore
customers. Since the launch of the VIP component reference databases in the
second quarter of 1995, the Company has continued to offer CAPS on a limited
basis to those customers who request it, in addition to the VIP component
reference databases. The Company's agreement with IHS expires in October 1997,
and the Company anticipates that the agreement will not be renewed. However, the
Company anticipates that the number of customers using the CAPS database will
decline over time as the Company's reference data products become more
comprehensive.

                                       6
<PAGE>
 
Products / Services for the World Wide Web

     The Company has developed a product and service designed to expand its
business utilizing World Wide Web technology, including a Web client for the
Explore Server, based on a combination of the Java language and HTML (hypertext
markup language). This will enable authorized users in an Intranet or Internet
environment to use parametric search and other search techniques to access
information in any specific World Wide Web-enabled Explore Server, utilizing
standard World Wide Web browsers. For Intranet applications the Company offers
the Intranet client as an additional option to its UNIX or PC/Windows client
software. For Internet applications, the Company offers a product / service
called Aspect Online where authorized subscribers can access the VIP reference
databases via the World Wide Web. Aspect Online is sold through authorized Value
Added Resellers (VARs) to small / medium sized companies whose primary
requirement is access to reference data with minimal setup costs. There can be
no assurance, however, that the revenues generated, if any, from the use of the
World Wide Web will be greater than the cost of developing, modifying and
supporting products and services for such use.

Pricing

    The Company's Explore software is priced based on a number of factors,
including the base application configuration (i.e., Explore-CIS or Explore-
Enterprise), the modules licensed and the number of licensed users. The list
price for perpetual licenses of the Explore software may range from $50,000 to
over $1 million. The list price for software maintenance is typically based on a
percentage of the associated software list price. The Company's VIP reference
databases are offered on a perpetual license or an annual subscription license
basis, with list prices typically starting at $50,000 per year, depending on the
specific data products licensed, the number of licensed users and other factors.
The Company may offer discounts to customers based on the scope of the
customer's commitment and other commercial considerations. Additionally, the
Company may in the future offer new or different configurations at significantly
lower prices.


Customer Service and Support

    The Company's customer service and support organization provides customers 
with technical support, training, consulting and implementation services. All of
the Company's current customers have software maintenance agreements with the
Company that provide for one or more of the following services:

    Professional Services.  
    ---------------------

    The Company's consultants work closely with customers to deliver legacy data
conversion and business process reengineering services. Legacy data conversion
services include legacy data migration, standardization, enrichment, and
integration of legacy data with the Company's VIP component reference databases.
Business process reengineering services include process engineering, data
modeling and enterprise architecture definition and integration to deliver
global preferred part management, global preferred supplier management and
design reuse programs. Fees for legacy data conversion services are charged in
addition to and separate from the license fees charged for the Company's
application software and reference data products and are charged on a per part
and per database, or a per diem basis. Fees for business process reengineering
services are typically charged in addition to and separate from the Company's
software and data products on a per diem or fixed price basis. The services
provided by the Company may be obtained from a third party. The Company also
provides customers with implementation support, including installation and
technical support, the fees for which are charged in addition to and separate
from the Company's software and reference data products typically on a per diem
basis.

    Customer Education and Training.  
    -------------------------------

    The Company offers training courses designed to meet the needs of end users,
data modeling and integration experts and system administrators. The Company
also trains customer personnel who in turn train end users in large global
enterprise deployments. Training classes are provided at the Company's offices
in Mountain View, California, Boston, Massachusetts, London, England and through
distributors in Tokyo, Japan and Seoul, South Korea. The Company provides on-
site training services upon request by customers at a higher cost. Fees for
education and training services are in addition to and separate from the fees
for software and data products and are typically charged either per student and
per class, or on a per diem basis.

    Software Maintenance and Support.  
    --------------------------------

    The Company offers telephone, electronic mail and facsimile customer support
through its central technical support staff at the Company's headquarters. The
Company also provides customers with product documentation and release notes
that describe features in new products, known problems and workarounds, and
application notes. Software product license fees do not cover maintenance. Each
customer is entitled to receive certain software updates, maintenance releases
and technical support for an annual fee based on a percentage

                                       7
<PAGE>
 
of the price of the products under license to such customers. The annual
subscription service fee for the Company's reference data products covers all
data updates and maintenance on an ongoing basis for the term of the
subscription.

Sales and Marketing

    The Company markets and sells its products and services primarily through a
direct sales force based in Mountain View, California and field sales offices in
the U.S. metropolitan areas of Atlanta, Boston, Chicago, Dallas, Denver, Los
Angeles and New York and abroad in London, Paris, Munich, Tokyo and Milan. The
Company's sales and marketing organization consisted of 68 employees as of
December 31, 1996. To support its sales force, the Company conducts a number of
marketing programs, which includes public relations, telemarketing, seminars,
trade shows and customer advisory board meetings. The Company also has a
worldwide VAR agreement with Mentor Graphics and SAP AG, a distribution
agreement in Japan with Digital Equipment Corporation Japan, a sales
representative agreement in South Korea with ATE, and a sales representative
agreement in Israel with Onyx.

    The Company's strategy is to expand its distribution channels to reach a 
broad customer base in its targeted industries. The Company's field sales force
conducts multiple presentations and demonstrations of the Company's CSM solution
to management and users at the customer site as a part of the direct sales
effort. Sales cycles generally range from six to twelve months or longer. The
direct sales force is responsible for joint sales efforts and management of
multiple channels.

    International sales accounted for 25.5%, 21.4% and 13.7% of the Company's 
total revenues in 1996, 1995 and 1994, respectively. In addition, although the
Company records revenues based on the billing location, certain domestic
billings include licenses that may be deployed by customers or resold through
indirect channels into international locations. The Company believes that in
order to increase sales opportunities and profitability, it will be required to
expand its international sales. The Company intends to continue to expand its
direct and indirect sales and marketing activities worldwide, which will require
significant management attention and financial resources.

    The Company has committed and continues to commit significant time and
financial resources to developing international sales and support channels.
There are a number of risks inherent in the Company's international business
activities, including unexpected changes in regulatory requirements, tariffs and
other trade barriers, costs and risks of localizing products for foreign
countries, longer accounts receivable payment cycles, potentially adverse tax
consequences, currency fluctuations, repatriation of earnings and the burdens of
complying with a wide variety of foreign laws. In addition, revenues of the
Company earned in various countries where the Company does business may be
subject to taxation by more than one jurisdiction, thereby adversely affecting
the Company's earnings. There can be no assurance that such factors will not
have an adverse effect on the revenues from the Company's future international
sales and, consequently, the Company's business, financial condition or results
of operations.

    The Company generally ships its products within a short period of time after
execution of a license. As a result, the Company typically does not have a
material backlog of unfilled license orders at any given time, and the Company
does not consider backlog to be a meaningful indicator of future performance.

Strategic Relationships

    The Company believes that, in order to provide comprehensive component and
supplier management solutions, it will be necessary to develop, maintain and
enhance close associations with vendors of hardware, software, database, data
and professional services. The Company has established VAR, marketing and
strategic relationships with a number of major vendors in these areas: Baan
Company N.V., Cadence Design Systems, Inc., Digital Equipment Corp., a
relationship with the consulting group of a Big 6 accounting firm, Electronic
Data Systems, Corp., HP, IBM, Mentor Graphics, Metaphase Technology, Inc.,
Oracle, Origin Technology Corp., Parametric Technology Corp., SAP AG, Sherpa
Corporation, Sun, and Viewlogic. The Company's relationships with hardware
vendors have enabled it to integrate its solution with several industry standard
hardware platforms. The Company has formed an Enterprise Partners Program with
five vendors of complementary products. The Company meets regularly with its
Enterprise Partners to enhance integration between their complementary products
and the Company's products. The Company believes these relationships can enhance
the Company's ability to deliver a CSM solution that supports customers'
existing enterprise data management architecture and that is tailored to the
specific requirements of their industry. Although the Company seeks to maintain
close relationships with these companies, if the Company is unable to develop
and retain effective, long-term relationships with these third parties, the
Company's competitive position could be materially adversely affected.

                                       8
<PAGE>
 
Research and Development

    The Company has committed, and expects to continue to commit in the future,
substantial resources to product development. Research and development efforts
are directed at increasing product functionality, improving product performance
and expanding the capabilities of the products to interoperate with third party
software. The Company originally introduced its CIS software in 1992 and
generally commercially introduced the next generation Explore client/server
software and its VIP reference databases in 1995. The Company has regularly
released new products and enhancements to existing products. Although the
Company expects that certain of its new products will be developed internally,
the Company may, based on timing and cost considerations, acquire technology and
products from third parties.

    The Company has operations in Bangalore, India with 156 employees as of
December 31, 1996, 129 of whom were engaged in data and tools development,
maintenance and updates and 27 of whom were engaged in software development.
Accordingly, the Company is dependent to a significant extent upon the ability
of its Indian operations to successfully maintain and upgrade its reference data
products.

    The Company supplements its product development efforts by reviewing 
customer feedback on existing products and working with customers and potential
customers to anticipate future functionality requirements. To assist this
effort, the Company hosts a customer advisory board made up of representatives
from many of its key customers which meets periodically to provide feedback to
the Company's current and future product plans.

    The Company's future success will depend in part upon its ability to enhance
its current products and to develop and introduce new products on a timely basis
that keep pace with technological developments, emerging industry standards and
the increasingly sophisticated needs of its customers. There can be no assurance
that the Company will be successful in developing or marketing product
enhancements or new products that respond to technological change or evolving
industry standards, that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of these
products or that its new products or product enhancements will adequately meet
the requirements of the marketplace and achieve market acceptance. If the
Company is unable, for technological or other reasons, to develop and introduce
new products or enhancements, the Company's business, financial condition or
results of operations could be materially adversely affected.

    In addition, applications software and reference data products as complex as
those offered by the Company frequently contain undetected errors or failures
when first introduced or when new versions are released. The Company has in the
past discovered software and data errors in certain of its products and
enhancements, both before and after initial shipments, and has experienced
delays or lost revenues during the period required to correct these errors.
There can be no assurance that, despite testing by the Company and by current
and potential customers, errors will not occur in products, data or releases
after commencement of commercial shipments, resulting in loss of or delay in
market acceptance, which could have a material adverse effect upon the Company's
business, financial condition or results of operations.

    As of December 31, 1996, the Company's research and development organization
consisted of 217 full time employees, 156 of whom are employed by the Company's
operations in Bangalore, India. During 1996, 1995 and 1994, research and
development expenses were approximately $7.1 million, $4.9 million and $3.1
million, respectively.


Competition

    The market for the Company's products is competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants. The Company's products are targeted at the
emerging market for open, client/server software solutions, and the Company's
competitors offer a variety of products and services to address this market.
Among the Company's principal competitors is IHS. The Company has licensed a
reference data product from IHS since 1992 which the Company continues to offer
on a limited basis to certain current and potential customers who typically use
it in addition to the Company's VIP reference databases. The Company anticipates
that its revenues from subscription agreements for the IHS reference data
product will not be material in the current period or future periods and that
subscription agreements and renewals for the IHS reference data product will
decrease over time as the Company's reference data products become more
comprehensive. However, there can be no assurance that the Company would be able
to retain all the customers who license such data when the Company's agreement
with IHS terminates in October 1997. The Company also currently faces direct
competition from CADIS,

                                       9
<PAGE>
 
Inc., a privately held software company. Further, the Company currently faces
indirect competition from third-party professional service organizations and
internal management information systems and computer-aided design departments of
potential customers that develop custom internal software.

    In the future, because there are relatively low barriers to entry in the
software industry, the Company could experience additional competition from
other established or emerging companies as the client/server application
software market continues to develop and expand. In particular, RDBMS vendors,
ERP vendors, PDM vendors, CAD vendors or professional service providers may in
the future enter the Company's market with competitive products. To the extent
that the Company expands into Internet-based or other forms of delivery of data,
the Company may encounter additional competition from its existing competitors
and other established or emerging companies. Many of these potential competitors
have well-established relationships with the Company's current and potential
customers, have extensive knowledge of the client/server industry, better name
recognition and significantly greater financial, technical, sales, marketing and
other resources and are capable of offering single vendor solutions which span
multiple industries. It is also possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. The Company
also expects that competition will increase as a result of software industry
consolidations. The Company's competitors may be able to respond more quickly to
new or emerging technologies and changes in customer requirements, or to devote
greater resources to the development, promotion and sale of their products.

    Increased competition may result in price reductions, reduced gross margins 
and loss of market share, any of which could materially adversely affect the
Company's business, financial condition or results of operations. There can be
no assurance that the Company will be able to compete successfully against
current or future competitors or that competitive pressures will not materially
adversely affect its business, financial condition or results of operations.

    The Company believes that the principal competitive factors affecting its 
market include features such as openness, scalability, ability to integrate with
third party products, functionality, adaptability, ease of use, product
reputation, quality, performance, price, customer service and support,
effectiveness of sales and marketing efforts and company reputation. Although
the Company believes that it currently competes favorably with respect to such
factors, there can be no assurance that the Company can maintain its competitive
position against current and potential competitors, especially those with
greater financial, marketing, service, support, technical and other resources
than the Company.


Proprietary Rights and Licensing

    The Company's success is heavily dependent upon proprietary technology. The
Company relies primarily on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions with its
employees, consultants and business partners and in its license agreements to
protect its proprietary rights. The Company seeks to protect its software,
published data, documentation and other written materials under 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 product or to obtain and use information that the
Company regards as proprietary. While the Company is not aware that any of its
products infringes the proprietary rights of third parties, there can be no
assurance that third parties will not claim infringement by the Company with
respect to current or future products.

    In addition, the Company relies on certain software and data that it
licenses from third parties, including software and data that are used in the
Company's products to perform certain functions. There can be no assurance that
such firms will remain in business, that they will continue to support their
products or that their products will otherwise continue to be available to the
Company on commercially reasonable terms. The Company believes that
substantially all of the software it licenses is available from vendors other
than the Company's current vendors and could be replaced with equivalent
software in a timely manner. However, it is possible that the loss of or
inability to maintain any of these software licenses could result in delays or
cancellations in products shipments until equivalent software can be identified
and licensed or developed and integrated with the Company's products. Any such
delay or cancellation could materially adversely affect the Company's business,
financial condition or results of operations.

    The Company's products are generally provided to customers in object code
(machine-readable) format only. From time to time, in limited circumstances, the
Company has licensed source code (human-readable) format subject to customary
protections such as use restrictions and confidentiality agreements. In
addition, certain customers have entered into source code escrow arrangements
with the Company, pursuant to which the Company's source code will be released
to the customer upon the occurrence of certain events, such as the commencement
of bankruptcy or 

                                       10
<PAGE>
 
insolvency proceedings by or against the Company, or certain material breaches
of the agreement. In the event of any release of the source code from escrow,
the customer's license is generally limited to use of the source code to
maintain, support and configure the Company's software products.

Employees

    As of December  31, 1996, the Company employed 300 persons, of whom 133 were
based in the United States, and 167 were based in India and other foreign
countries. Of the total, 68 were engaged in sales and marketing, 217 were in
product development and technical support and 15 were in finance and
administration. None of the Company's employees is represented by a labor union
with respect to his or her employment by the Company. The Company has
experienced no organized work stoppages and believes its relationship with its
employees is good. The Company believes that its future success will also depend
to a significant extent upon its ability to attract, train and retain highly
skilled technical, management, sales, marketing and consulting personnel.
Competition for such personnel in the computer software industry in both the
United States and India is intense. The Company has from time to time
experienced difficulty in locating candidates with appropriate qualifications.
There can be no assurance that the Company will be successful in attracting or
retaining such personnel, and the failure to attract or retain such personnel
could have a material adverse effect on the Company's business or results of
operations.


ITEM 2.  PROPERTIES
         ----------

     The Company's principal administrative, sales, marketing, support and
software research and development facility is located in approximately 22,000
square feet of space in Mountain View, California. This facility is leased to
the Company through May 1998. The Company also leases facilities of
approximately 6,000 square feet of space in Nashua, New Hampshire and
approximately 11,000 square feet of space in two locations in Bangalore, India.
The Nashua facility is leased to the Company through July 1997. The Company
intends to lease new facilities in New Hampshire as needed. The Bangalore
facilities are occupied under leases which expire in 1999 and 2004. In addition,
the Company maintains sales and support offices in the metropolitan areas of
Atlanta, Boston, Chicago, Dallas, Denver, Los Angeles, New York and London,
Paris, Milan and Tokyo. The Company believes that its current facilities are
adequate for its needs through the end of 1997, and that, should it be needed,
suitable additional or alternative space will be available in the future on
commercially reasonable terms.


ITEM 3.   LEGAL PROCEEDINGS.
          -----------------

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


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

    No matters were submitted to a vote of security holders during the quarter
ended December 31, 1996.

                                       11
<PAGE>
 
                                    PART II


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

Market Price of Common Stock and Dividend Policy

    The Company's Common Stock has been traded in the over-the-counter market
and the NASDAQ National Market System since the Company's initial public
offering in May of 1996. According to the Company's transfer agent, the Company
had approximately 104 stockholders of record as of January 31, 1997. The
following table sets forth the low and high sale price as of the close of market
of the Company's Common Stock in each of the Company's last three fiscal
quarters:
<TABLE>
<CAPTION>
 
Year ended December 31, 1996            High     Low
----------------------------            ----     ---
<S>                                     <C>     <C>
Second quarter (May 24 to June 30)      36.50   19.50
Third quarter                           33.25   18.00
Fourth quarter                          41.00   20.25
 
</TABLE>

    The Company's policy has been to reinvest earnings to fund future growth.
Accordingly, the Company has not paid dividends and does not anticipate
declaring dividends on its Common Stock in the foreseeable future.  There are
certain restrictions regarding payment of cash dividends in the Line of Credit
agreement with Silicon Valley Bank. See Note 5 of Notes to Consolidated
Financial Statements

                                       12
<PAGE>
 
ITEM 6.   SELECTED CONSOLIDATED FINANCIAL DATA.
          ------------------------------------

    The following selected consolidated financial data is qualified by reference
to and should be read in conjunction with the consolidated financial statements
and related notes thereto and the section captioned "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and other financial
information included elsewhere in this Annual Report on Form 10-KSB.

<TABLE> 
<CAPTION> 

CONSOLIDATED STATEMENTS OF OPERATIONS DATA
(in thousands, except per share amounts)
Year ended December 31,                            1996        1995       1994         1993       1992
--------------------------------------------------------------------------------------------------------
<S>                                               <C>         <C>         <C>         <C>         <C> 
Revenues:
  Licenses                                        $12,263     $ 7,143     $ 3,478     $ 2,476     $1,110
  Subscription and maintenance                      8,943       4,964       2,962         715        245
  Service and other                                 3,029       1,586       2,044         762        488
                                                  -------     -------     -------     -------     ------
    Total revenues                                 24,235      13,693       8,484       3,953      1,843
                                                  -------     -------     -------     -------     ------

Cost of revenues:
  Cost of license revenues                            612         298         197         106         92
  Cost of subscription and maintenance revenues     1,116         938         735         261         84
  Cost of service and other revenues                1,679         612       1,333         353        206
                                                  -------     -------     -------     -------     ------
    Total cost of revenues                          3,407       1,848       2,265         720        382
                                                  -------     -------     -------     -------     ------
Gross profit                                       20,828      11,845       6,219       3,233      1,461
                                                  -------     -------     -------     -------     ------

Operating expenses:
  Research and development                          7,052       4,859       3,096       2,388      1,100
  Sales and marketing                               8,819       4,490       3,047       1,728        645
  General and administrative                        2,975       1,660       1,084         517        367
                                                  -------     -------     -------     -------     ------
    Total operating expenses                       18,846      11,009       7,227       4,633      2,112
                                                  -------     -------     -------     -------     ------

Operating income (loss)                             1,982         836      (1,008)     (1,400)      (651)
Interest and other income, net                      1,566          78          78          37         12
Interest expense                                     (209)        (83)        (46)        (70)        (9)
                                                  -------     -------     -------     -------     ------
Income (loss) before income taxes                   3,339         831        (976)     (1,433)      (648)
Provision for income taxes                            330         150         144           -          -
                                                  -------     -------     -------     -------     ------
Net income (loss)                                 $ 3,009     $   681     $(1,120)    $(1,433)    $ (648)  
                                                  =======     =======     =======     =======     ======
Net income (loss) per share                       $  0.24     $  0.06     $ (0.23)    $ (0.29)    $(0.13)
                                                  =======     =======     =======     =======     ======
Number of shares used in computing
  per share amounts                                12,719      10,912       4,936       4,896      4,830
                                                  =======     =======     =======     =======     ======

CONSOLIDATED BALANCE SHEET DATA
(in thousands)
As of December 31,                                  1996        1995       1994         1993       1992
--------------------------------------------------------------------------------------------------------
Cash and short-term investments                   $47,818     $ 3,159     $ 2,437      $2,955     $  987
Working capital                                    45,485       1,024         854       2,177         72
Total assets                                       59,000       9,979       5,439       4,990      1,568
Long-term obligations, less current portion           379         634         311         273        421
Stockholders' equity (deficit)                    $48,754      $2,134      $1,374      $2,489      $ (69)
</TABLE> 

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

    This section contains certain trend analysis and forward-looking statements.
Actual results may differ materially from the results described in such trend
analysis and forward looking statements.  Factors that might cause such a
difference include, but are not limited to, those discussed in "Business
Factors."

Overview

    The Company develops, markets and supports enterprise client/server software
and reference data products that enable manufacturers to improve product
development and business processes through component and supplier management.
The Company was incorporated in 1990 and was in the development stage, engaging
primarily in research and development, until 1992. In 1992, the Company
commenced shipment of its first generation component and supplier management
software product, CIS 1.0. The Company's second generation CSM software product,
Explore, first became generally commercially available in the second quarter of
1995. In 1993, the Company began development of component reference data
products, and its first internally developed reference data products, VIP,
became generally commercially available in the second quarter of 1995. As a
result of greater market acceptance of the Company's CIS products and the
introduction of the Explore and VIP products, the Company's revenues have grown
rapidly in recent years, increasing from $4.0 million in 1993 to $24.2 million
in 1996. The Company realized operating losses in 1993 and 1994 but achieved
limited profitability in 1995 and realized almost 50% of its 1996 net income in
its final fiscal quarter. The losses in 1993 and 1994 and limited profitability
in 1995 and 1996 primarily reflect the Company's substantial investment in
research and development to develop its software and reference data products and
in sales and marketing to expand its marketing presence.

    Licenses of the Company's software and reference data products have
historically accounted for the substantial majority of the Company's revenues,
and the Company anticipates that this will continue for the foreseeable future.
Accordingly, any decline in the demand for or market acceptance of the Company's
software or reference data products would have a material adverse effect on the
Company's business, financial condition and results of operations. Although the
Company has experienced significant revenue growth in recent periods, there can
be no assurance that the Company will sustain such growth in revenues or that
the Company will remain profitable in the future on a quarterly or an annual
basis. A significant portion of the Company's revenues has historically been
derived from relatively large sales to a limited number of customers, and the
Company expects that this trend will continue for the foreseeable future. The
license of the Company's software and data products generally requires the
Company to engage in a sales cycle of six to twelve months or longer and to
provide a significant level of education to prospective customers regarding the
use and benefits of the Company's products. For these reasons, sales cycles are
subject to a number of significant delays over which the Company has little or
no control. Accordingly, any delay in the sale of a larger license or a number
of smaller licenses would have a material adverse effect on the Company's
business, financial condition or results of operations and cause the Company's
operating results to vary significantly from quarter to quarter.

    The Company's revenues are divided into three categories: license revenues,
subscription and maintenance revenues and service and other revenues. License
revenues are comprised principally of perpetual license fees for the Company's
client/server software and reference data products. Subscription and maintenance
revenues are comprised principally of annual subscription and maintenance fees
for the Company's products, including its Explore client/server software, its
VIP family of component reference databases and the CAPS reference data product.
Service and other revenues are comprised principally of fees for consulting,
development and training services performed by the Company. The Company
recognizes revenues in accordance with the American Institute of Certified
Public Accountants Statement of Position 91-1 on Software Revenue Recognition.
License revenues are recognized after execution of a license agreement, or
receipt of a definitive purchase order, and shipment of the product if no
significant vendor obligations remain and collection of the resulting
receivables is deemed probable.  Product returns and sales allowances (which
were not significant through December 31, 1996) are estimated and provided for
at the time of sale.  When delivery involves significant installation
obligations at multiple sites, revenues are recognized on a per-site basis upon
completion of installation. Revenues from subscription and maintenance
agreements are deferred and recognized on a straight-line basis over the life of
the related agreement, which is typically twelve months. Service revenues from
training and consulting are recognized upon completion of the work to be
performed. Development revenues are recognized in accordance with the terms of
the agreements, generally when related costs have been incurred.

                                       14
<PAGE>
 
    The Company's total revenues in any period are substantially dependent upon
a relatively small number of large sales. Sales to the Company's three largest
customers in each of 1994 and 1995 and its largest customer in 1996 accounted
for 33%, 33% and 13% of total revenues, respectively. The Company expects that
this trend will continue for the foreseeable future.

Results of Operations

    The following table sets forth certain operating data, expressed as a
percentage of total revenues, for each of the years ended December 31, 1994,
1995 and 1996.

<TABLE> 
<CAPTION> 

                                                       1994     1995     1996
                                                      -----    -----    -----
<S>                                                   <C>      <C>      <C>
Revenues:
  Licenses                                             41.0%    52.2%    50.6%
  Subscription and maintenance                         34.9     36.2     36.9
  Service and other                                    24.1     11.6     12.5
                                                      -----    -----    -----
    Total revenues                                    100.0    100.0    100.0
                                                      -----    -----    -----
Cost of revenues:
  Cost of license revenues                              2.3      2.2      2.5
  Cost of subscription and maintenance revenues         8.7      6.8      4.6
  Cost of service and other revenues                   15.7      4.5      6.9
                                                      -----    -----    -----
    Total cost of revenues                             26.7     13.5     14.0
                                                      -----    -----    -----
Gross margin                                           73.3     86.5     86.0
                                                      -----    -----    -----
Operating expenses:
  Research and development                             36.5     35.5     29.1
  Sales and marketing                                  35.9     32.8     36.4
  General and administrative                           12.8     12.1     12.3
                                                      -----    -----    -----
      Total operating expenses                         85.2     80.4     77.8
                                                      -----    -----    -----
Operating income (loss)                               (11.9)     6.1      8.2
Interest and other income, net                          0.9      0.6      6.5
Interest expense                                       (0.5)    (0.6)    (0.9)
                                                      -----    -----    -----
Income (loss) before income taxes                     (11.5)     6.1     13.8
Provision for income taxes                              1.7      1.1      1.4
                                                      -----    -----    -----
Net income (loss)                                     (13.2)%    5.0%    12.4%
                                                      =====    =====    =====
</TABLE>

Net Revenue

  Revenues

     Licenses.  
     -------- 

    Revenues from licenses increased from approximately $3.5 million in 1994 to
approximately $7.1 million in 1995, due primarily to increased market acceptance
of the Company's CIS products. License revenues increased from $7.1 million in
1995 to $12.3 million in 1996. This increase was due primarily to the increased
market acceptance of the Company's first generation CIS products and the general
commercial introduction of the Company's Explore client/server software and VIP
component reference databases in 1995. The Explore client/server software and
VIP component reference databases generally have higher average license revenues
than the CIS products.

    Subscription and maintenance.  
    ----------------------------

    Subscription and maintenance revenues were $3.0 million, $5.0 million, and
$8.9 million, respectively, in 1994, 1995 and 1996. The increase in subscription
and maintenance fee revenues from 1994 to 1995 was principally the result of the
general commercial introduction of the Company's VIP component reference
databases in 1995 and increased market acceptance of the VIP database and the
expanded base of customer licensees that acquired subscription and maintenance
contracts from the Company, including significant subscription agreements for
the CAPS reference data product. The increase from 1995 to 1996 was primarily
due to the increased base of customers entering into maintenance contracts.

    Service and other.  
    -----------------

    Service and other revenues decreased from $2.0 million in 1994 to $1.6
million in 1995 due primarily to the conclusion of a significant development
contract for a customer, offset in part by a significant increase in consulting
fees. Service and other revenues increased from $1.6 million in 1995 to $3.0
million in 1996 due to the

                                       15
<PAGE>
 
increased number and size of consulting contracts in 1996 offset by a decrease
in development revenues caused by the conclusion of the development contract in
1995.

    International sales were $1.2 million, $2.9 million and $6.2 million,
respectively, in 1994, 1995 and 1996, representing 13.7%, 21.4% and 25.5% of
total revenues, respectively, in each year. The increased volume of
international sales from 1994 to 1996 is primarily attributable to an increase
in the Company's international marketing efforts. The Company intends to
continue to expand its international operations and to enter additional
international markets. The Company currently maintains sales offices in the
United Kingdom, France, Japan and Italy and has a sales representative agreement
with ATE in South Korea and a distribution agreement with Digital Equipment
Corporation Japan and a worldwide distribution agreement with Mentor Graphics
Corporation. In addition, although the Company records revenues based on the
billing location, certain domestic billings include licenses that may be
deployed by customers or resold by indirect channel partners into international
locations. International sales are denominated and collected in both U.S. and
foreign currency. Accordingly, a portion of the Company's international revenues
are subject to foreign currency fluctuation risks. In those jurisdictions in
which the Company's sales are denominated in foreign currency, fluctuations in
such currencies could adversely affect the profitability of sales made in such
jurisdictions and therefore materially adversely affect the Company's business,
financial condition or results of operations. Further, an increase in the value
of the U.S. dollar relative to foreign currencies could make the Company's
products more expensive and, therefore, potentially less competitive in those
markets in which the Company's sales are denominated in U.S. dollars. The
Company to date has not engaged in any foreign currency hedging activities.

  Cost of revenues

    Cost of licenses.  
    ----------------

    Cost of licenses consists primarily of license fees and royalties paid to
third party vendors, primarily Oracle, and shipping expenses. Cost of licenses
was $197,000, $298,000 and $612,000, respectively, in 1994, 1995 and 1996
representing 5.7%, 4.2% and 5.0%, respectively, of the related license revenues
for each year. The increase in the dollar amount of cost of licenses in each
successive year reflects the higher volumes of licenses entered into in each
year. Cost of licenses decreased as a percentage of related revenues from 1994
to 1995 due principally to a large number of conversions of CIS product licenses
to Explore product licenses, which do not require payment of third party
royalties. The increase as a percentage of revenues from 1995 to 1996 was
primarily due to the addition of an additional third party vendor's product
licensed in conjunction with Aspect's products. Because all development costs
incurred in the research and development of products and enhancements to
existing software products have been expensed as incurred, cost of licenses
includes no amortization of capitalized software development costs. See Note 1
of Notes to Consolidated Financial Statements.

    Cost of subscription and maintenance revenues.  
    ---------------------------------------------

    Cost of subscription and maintenance revenues consists primarily of license
fees and royalties paid to third-party vendors, primarily IHS for the CAPS
reference data product, and personnel-related costs incurred in providing
centralized telephone support and related technical support to customers. Cost
of subscription and maintenance revenues was $735,000, $938,000 and $1.1
million, respectively, in 1994, 1995 and 1996, representing 24.8%, 18.9% and
12.5%, respectively, of related subscription and maintenance revenues for each
year. The decrease in cost of subscription and maintenance revenues as a
percentage of related revenues over such periods is primarily the result of
allocating related costs over a larger customer base and an increased proportion
of sales of the VIP reference databases as compared to the CAPS reference data
product.

    Cost of service and other revenues.  
    ----------------------------------

    Cost of service and other revenues consist primarily of personnel-related
costs incurred in providing consulting services, development services and
training to customers. Cost of service and other revenues was $1.3 million,
$612,000 and $1.7 million, respectively, in 1994, 1995 and 1996, representing
65.2%, 38.6% and 55.4%, respectively, of related revenue for each year. The
higher cost of service and other revenues in 1994 was principally the result of
costs associated with development services performed for a single customer which
were concluded in 1995, causing costs of service and other revenues to decrease
in dollar amount and as a percentage of related revenues in 1995. The increase
in absolute dollars and as a percent of revenues in 1996 compared to 1995 is due
to an increase in the number and size of consulting contracts.

                                       16
<PAGE>
 
  Gross profit

    Gross profit was $6.2 million, $11.8 million and $20.8 million, 
respectively, in 1994, 1995 and 1996, representing 73.3%, 86.5% and 86.0%,
respectively, of total revenues for each year. The increase in absolute dollars
was primarily the result of an increased level of revenues and the allocation of
costs over a larger customer base. The Company currently expects that gross
profits may decrease as a percentage of total revenues in the future as services
and other revenues, which generally have lower gross margins than the Company's
other revenues, increase as a percentage of total revenues.


  Operating Expenses

    Research and development.  
    ------------------------

    Research and development expenses consist primarily of engineering personnel
costs. Research and development expenses for 1994, 1995 and 1996 were
approximately $3.1 million, $4.9 million and $7.1 million, respectively. These
expenses as a percentage of total revenues were 36.5%, 35.5% and 29.1%,
respectively, during the three years. The increases in research and development
expenses in absolute dollars since 1994 were primarily attributable to increased
staffing and associated support for technical staff and the use of consultants
and outside service providers required to develop and enhance the Company's
products. The reduction as a percentage of revenue is due to revenues increasing
at a higher rate than research and development expenses. The Company believes
that a significant level of research and development expenses will be required
to be competitive in the future. Accordingly, the Company expects that the
absolute dollar amounts of research and development expenses may increase in the
future, but may decline as a percentage of total revenues in the event that
revenues increase.

    Sales and marketing.  
    -------------------

    Sales and marketing expenses include salaries, commissions, advertising,
travel, trade show, public relations and other selling and marketing related
expenses. Sales and marketing expenses for 1994, 1995 and 1996 were
approximately $3.0 million, $4.5 million and $8.8 million, respectively,
representing 35.9%, 32.8%, and 36.4% of total revenues, respectively. The
increases in sales and marketing expenses in absolute dollars in 1995 and 1996
and as a percent of total revenue in 1996, were primarily due to the addition of
sales and marketing personnel and increased marketing activities, including
trade shows, promotional expenses and continued expansion internationally. The
Company believes that such expenses will increase in dollar amounts and may
increase as a percentage of total revenues in the future as the Company expands
its sales and marketing staff.

    General and administrative.  
    --------------------------

    General and administrative expenses include personnel costs for
administration, finance, human resources and general management, along with
legal and accounting expenses and other professional services. General and
administrative expenses increased from $1.1 million in 1994 to $1.7 million in
1995 and $3.0 million in 1996. These expenses represented 12.8%, 12.1% and 12.3%
of total revenues, respectively during those three years. The increases in
dollar amounts were primarily the result of increased staffing and associated
expenses necessary to manage and support the Company's growth. The Company
believes that its general and administrative expenses will increase in dollar
amounts in the future as the Company expands its staffing, continues its
international expansion and as the Company experiences higher costs associated
with being a public company, but may decrease as a percentage of total revenues
in the event that revenues increase.


  Interest and other income (expense)

    The Company's net interest expense for 1995 was $5,000 and its net interest
income for 1994 and 1996 was $32,000 and $1.4 million, respectively.  Interest
expense consists primarily of interest paid under an equipment lease line.
Interest income consists primarily of interest accrued on the Company's cash
generated from financing and operating activities.  The increase in interest
income in 1996 was primarily due to higher cash and investment balances
resulting from the infusion of cash from the initial public offering partly
offset by a $90,000 expense related to the settlement of a dispute.


  Provision for income taxes

    The Company's provision for income taxes was $144,000 in 1994, $150,000 in 
1995 and $330,000 in 1996. The 1994 and 1995 provision amounts were primarily
due to foreign withholding taxes in connection with product license sales to
Korea. The provision for taxes in 1996 increased as a result of increased net
income before taxes which 

                                       17
<PAGE>
 
resulted in higher federal income taxes after recognizing the benefit of
available net operating loss and credit carryforwards from prior years which
have not been previously utilized. See Note 6 of the Notes to Consolidated
Financial Statements.

Liquidity and Capital Resources

    In May 1996, the Company completed its initial public offering, and its 
common stock began trading on the NASDAQ National Market System under the symbol
ASDV. Through the offering, the Company sold 2,322,500 new shares of its common
stock which generated approximately $42.3 million of cash, net of underwriting
discounts, commissions and other offering costs.

    In 1994, $10,000 of cash was used in operations.  In 1995 and 1996, 
$1,640,000 and $4,874,000, respectively, was generated from operations to
support the Company's ongoing capital requirements.

    In 1994, 1995 and 1996 the Company's investing activities consisted 
primarily of purchases of property and equipment. In those periods, the Company
used approximately $159,000, $194,000 and $2.7 million, respectively, of cash to
purchase property and equipment, primarily for personal computers and for
furniture and other office equipment. Net purchases of short term investments
was $38.2 million in 1996. The Company expects that the rate of purchases of
property and equipment will increase as the Company's employee base grows. As of
December 31, 1996, the Company's principal commitments consisted primarily of a
lease line of credit for equipment and software purchases and leases for office
facilities. See Note 2 of Notes to Consolidated Financial Statements.

    To date, the Company has not invested in derivative securities or any other
financial instruments that involve a high level of complexity or risk. The
Company expects that, in the future, cash in excess of current requirements will
be invested in investment grade, interest-bearing securities.

    At December 31, 1996, the Company had $9.6 million in cash and cash 
equivalents, $38.2 million in short-term investments and $45.5 million of
working capital. The Company also had available a $2.0 million bank line of
credit agreement, secured by certain tangible and intangible assets of the
Company, that permits borrowings of the lesser of $2 million or 80% of domestic
accounts receivable. Eligible accounts receivable are defined as those
outstanding less than 90 days from the date of invoice. Borrowings bear interest
at the bank's prime rate plus 0.5% (8.75% as of December 31, 1996). There were
no borrowings outstanding under this line of credit as of December 31, 1996. See
Note 5 of Notes to Consolidated Financial Statements.

    The Company believes that its current cash balances and cash available 
under its lines of credit, will be sufficient to meet its working capital and
capital expenditure requirements for at least the next 12 months. Although
operating activities may provide cash in certain periods, to the extent that the
Company experiences growth in the future, the Company anticipates that its
operating and investing activities may use cash. Consequently, any such growth
may require the Company to obtain additional equity or debt financing. In
addition, although there are no present understandings, commitments or
agreements with respect to any acquisition of other businesses, products or
technologies, the Company from time to time evaluates potential acquisitions of
businesses, products and technologies and may in the future require additional
equity or debt financings to consummate such potential acquisitions.

Business Factors

    Investors in the Company should be aware of the following risks and
uncertainties that could materially and adversely affect the Company and the
market for the Company's securities.

    The Company's revenues and results of operations are difficult to forecast 
and could be materially adversely affected by many factors, some of which are
outside the control of the Company, including, among others, the relatively long
sales and implementation cycles for the Company's products; the size and timing
of individual license transactions; seasonality of revenues; changes in the
Company's operating expenses; changes in the mix of products and services sold;
timing of introduction or enhancement of products by the Company or its
competitors; market acceptance of new products; technological changes in
software or database technology; personnel changes and difficulties in
attracting and retaining qualified sales, marketing, technical and consulting
personnel; changes in customers' budgeting cycles; foreign currency exchange
rates; quality control of products sold; and economic conditions generally and
in specific industry segments.

                                       18
<PAGE>
 
    The Company's business has experienced and is expected to continue to 
experience seasonality, in part due to customer buying patterns and the
Company's expense patterns. In recent years, the Company has generally had
stronger demand for its products during the quarter ending December 31 and has
incurred higher personnel costs in the quarter ending March 31. The Company
believes that these patterns will continue for the foreseeable future.

    Licenses of the Company's client/server software and reference data products
have historically accounted for the substantial majority of the Company's
revenues, and the Company anticipates that this trend will continue for the
foreseeable future. The Company generally ships its products within a short
period of time after execution of a license. As a result, the Company typically
does not have a material backlog of unfilled license orders, and revenues in any
quarter are substantially dependent on license revenues recognized in 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 in the short term.
Accordingly, the Company may be unable to adjust spending in a timely manner to
compensate for any unexpected shortfall in revenues, and any significant
shortfall of demand in relation to the Company's expectations or any material
delay of customer orders would have an almost immediate material adverse effect
on the Company's business, financial condition or results of operations.

    As a result, it is likely that in some future period the Company's results 
of operations could fail to meet the expectations of public market analysts or
investors. In such event, or in the event that adverse conditions prevail or are
perceived to prevail generally or with respect to the Company's business, the
price of the Company's Common Stock would likely drop significantly.

    The license of the Company's client/server software and reference data
products generally requires the Company to engage in a sales cycle lasting six
to twelve months or longer, during which the Company typically provides a
significant level of education to prospective customers regarding the use and
benefits of the Company's products. In addition, the implementation of the
Company's standard products typically involves a significant commitment of
resources by its customers over an extended period of time and is commonly
associated with reengineering of product development and business processes. For
these reasons, sales and customer implementation cycles are subject to delays
over which the Company may have little or no control. Accordingly, any delay in
the sale or customer implementation of a larger license or a number of smaller
licenses would have a material adverse effect on the Company's business,
financial condition or results of operations and cause the Company's operating
results to vary significantly from quarter to quarter.

    The Company currently derives substantially all of its revenues from the
licensing of its Explore client/server software and VIP family of reference
databases and fees from related services. These products and services are
expected to continue to account for substantially all of the Company's revenues
for the foreseeable future.  While the Company believes that to date its
customers have not experienced significant problems with such products, if the
Company's customers were to do so in the future or if they were dissatisfied
with product functionality or performance, the Company's business, financial
condition or results of operations could be materially adversely affected.

    There can be no assurance that the Company's products will achieve broader
market acceptance or that the Company will be successful in marketing its
products or enhancements thereto. In the event that the Company's current or
future competitors release new products that have more advanced features, offer
better performance or are more price competitive than the Company's products,
demand for the Company's products would decline. A decline in demand for, or
market acceptance of, the Explore client/server software or the VIP family of
reference databases as a result of competition, technological change, evolution
of the Internet or other factors would have a material adverse effect on the
Company's business, financial condition or results of operations.

    The Company's business has grown rapidly in recent periods. In addition, the
Company has experienced significant growth in the number of its employees, the
scope of its operating and financial systems and the geographic area of its
operations, which has placed a significant strain on the Company's management.
The Company's future results of operations will depend in part on the ability of
its officers and other key employees to continue to implement and expand its
operational, customer support and financial control systems and to expand, train
and manage its employee base. In addition, the Company believes that its future
success will also depend to a significant extent upon its ability to attract,
train and retain highly skilled technical, management, sales, marketing and
consulting personnel. Competition for such personnel is intense, and the Company
expects that such competition will continue for the foreseeable future. The
Company has from time to time experienced difficulty in locating candidates with
appropriate qualifications. There can be no assurance that the Company will be
successful in attracting or retaining such personnel, and the failure to attract
or retain such personnel could have a material adverse effect on the Company's
business, financial condition or results of operations.

                                       19
<PAGE>
 
    The Company has operations in Bangalore, India with 156 employees as of 
December 31, 1996. The Company is dependent to a significant extent upon the
ability of its Indian operations to successfully maintain and upgrade its
reference data products. The Company believes that the success of its Indian
operations will depend in large part upon its ability to attract, train and
retain highly skilled technical and management personnel in India. Competition
for such personnel in India is intense, and there can be no assurance that the
Company will be successful in attracting a sufficient number of qualified
personnel. The Company is directly affected by the political and economic
conditions to which India is subject. In addition, many of the Company's
expenses in India are paid in Indian currency, thereby subjecting the Company to
the risk of foreign currency fluctuations. Any difficulties in coordinating or
managing the Indian operations due to cultural, geographic, communication or
other reasons could have a material adverse effect on the Company's business,
financial condition or results of operations.

                                       20
<PAGE>
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
          -------------------------------------------
 
     1.  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

         The following Financial Statements are filed as part of this Report.


                                                                        Page No.
 
Report of Ernst & Young LLP, Independent Auditors.......................   26
 
Consolidated Balance Sheets as of December 31, 1996 and 1995............   27
 
Consolidated Statements of Operations for each of the three fiscal years
in the period ended December 31, 1996...................................   28
 
Consolidated Statements of Stockholders' Equity for each of the three 
fiscal years in the period ended December 31, 1996......................   29
 
Consolidated Statement of Cash Flows for of the three fiscal years in 
the period ended December 31, 1996......................................   30
 
Notes to the Consolidated Financial Statements..........................   31
 

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

    Not applicable.

                                       21
<PAGE>
 
                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
          -----------------------------------------------

    Information regarding the directors of the Company is incorporated by
reference to the information set forth in the Company's Proxy Statement for the
1997 Annual Meeting of Stockholders to be filed with the Commission within 120
days after the end of the Company's fiscal year ended December 31, 1996 (the
"1997 Proxy Statement").

    The executive officers of the Company who are elected by and serve at the
discretion of the Board of Directors, and their ages as of January 31, 1997, are
as follows:

      Name              Age                    Position
      ----              ---                    --------
Dr. Romesh Wadhwani....  49   Chairman of the Board and Chief Executive Officer 
Joseph A. Prang........  41   President, Chief Operating Officer and Director   
David S. Dury..........  48   Vice President and Chief Financial Officer        
James C. Althoff.......  43   Executive Vice President and Chief Technical      
                              Officer                                           
Jerry J. Templer.......  52   Vice President, North American Operations         
Philip G. Nutburn......  47   Vice President, European Operations               
David Horne............  44   Vice President, Marketing                         
Craig Palmer...........  36   Vice President, Online Services                   
David Burwen...........  52   Vice President, Business Development              
Kenneth B. Belanger....  41   Vice President, Data Operations                   
                                                                                
Other Key Employees:                                                            
-------------------                                                             
                                                                                
William H. Feichtmann..  49   Corporate Controller and Secretary                
Tal G. Ball............  32   Director, Enterprise Consulting                   


    Dr. Wadhwani founded the Company in 1990 and has served as Chairman of the
Board of Directors and Chief Executive Officer of the Company since January
1991. From January 1982 to March 1989, Dr. Wadhwani served as the Chief
Executive Officer of Cimflex Teknowledge, Corp., a provider of factory
automation products and systems. Dr. Wadhwani continued to serve as Chairman of
the Board of Cimflex Teknowledge until July 1990. From 1973 to 1981, Dr.
Wadhwani was Chief Executive Officer of Compuguard Corporation, a provider of
building automation systems. Dr. Wadhwani received his Ph.D. and M.S. in
Electrical Engineering from Carnegie-Mellon University.

    Mr. Prang joined the Company as President and Chief Operating Officer in May
1994. Mr. Prang has also served as a Director of the Company since October 1995.
Prior to joining the Company from January 1986 to May 1994, he served in
numerous capacities at Cadence Design Systems, Inc., an electronic design
automation software developer, including Vice President of Marketing, Vice
President and General Manger of System Design Division and President of Systems
Division. From June 1979 to January 1986, Mr. Prang served as Vice President of
GenRad, a company specializing in simulation and test systems. Mr. Prang holds a
B.S. degree in engineering technology and an M.S.M. degree from Purdue
University. Mr. Prang is also a director of EPIC Design Technology, Inc., an
electronic design automation software developer.

    Mr. Dury joined the Company in April 1996 as Vice President and Chief
Financial Officer. Prior to joining the Company, Mr. Dury served as Chief
Financial Officer of NetFrame Systems, Inc., a network server manufacturer,

                                       22
<PAGE>
 
beginning in March 1992. From August 1991 to February 1992, he served as Senior
Vice President and Chief Financial Officer of Maxtor Corporation, a disk drive
manufacturer. From December 1989 to August 1991, he served as Executive Vice
President and Chief Financial Officer of Boole & Babbage, a software developer.
Previously, Mr. Dury was employed by Priam Corporation from February 1983 to
February 1989, serving first as Vice President and Chief Financial Officer, and
then as President and Chief Operating Officer. Mr. Dury held several financial
and operating management positions at Intel corporation from 1979 to 1983. Mr.
Dury holds a B.A. degree in psychology from Duke University and an M.B.A. from
Cornell University.

    Mr. Althoff joined the Company as Vice President, Software Operations in
December 1991.  He was appointed Senior Vice President and Chief Technical
Officer in January 1997.  Mr. Althoff also served as Secretary of the Company
from March 1993 to September 1995. Prior to joining the Company, from October
1981 to December 1991, Mr. Althoff served as Vice President of Engineering and
General Manager of the Japan Business Unit of VLSI Technology/Compass Design &
Automation, an ASIC developer. Mr. Althoff holds a B.S. degree in mathematics
from Florida State University and an M.S. degree in computer science from
California Institute of Technology.

    Mr. Templer joined the Company as Vice President of Eastern Operations in
October 1991, a capacity in which he served until December 1995. From January
1996 until the present, Mr. Templer has served as Vice President of North
American Operations. Prior to joining the Company Mr. Templer was Vice President
of Sales at ExpertViews, Inc., a component information systems software
provider, from April 1990 to July 1991. Prior to that time, Mr. Templer was Vice
President of Sales at LTX, Inc., a provider of test equipment. Mr. Templer holds
a B.S. degree in electrical engineering from Iowa State University and an M.S.
degree in Business from the University of Missouri.

    Mr. Nutburn joined the Company as Director of European Operations in
November 1992. In January 1997, he was appointed as Vice President, European
Operations. Prior to joining the Company, Mr. Nutburn worked as a consultant to
the Company beginning in July 1992. Prior to that time, he served as director of
worldwide sales for the electronics design automation division of GenRad, Inc.
from June 1991 to June 1992. Prior to that time Mr. Nutburn held various
management positions at Silvar-Lisco and a division of Schlumberger
Technologies. Mr. Nutburn holds a B.S. degree in electrical engineering from the
University of Northumberland.

    Mr. Horne joined the Company in September 1996 as Vice president of
Marketing. Before joining Aspect, Mr. Horne was Vice President of Marketing for
Concentra Corporation from July 1994 to September 1996. From February 1989 to
June 1994 he held a variety of sales and marketing management positions at
Computervision, most recently Director of Worldwide Marketing operations. Mr.
Horne holds an MBA from Northeastern University and a B.S. degree from the
University of Massachusetts.

    Mr. Palmer joined the Company as Vice President of Marketing in September
1994. In September 1996 be became Vice President, Online Services. From February
1989 to September 1994, Mr. Palmer worked at Cadence Design Systems, Inc., an
electronic design automation software provider, most recently as Director of
Marketing from January 1993 to August 1994. Mr. Palmer also worked at Hewlett-
Packard where from February 1982 to February 1989, he held several marketing
management positions. Mr. Palmer holds a B.S. degree in electrical engineering
from the University of Wisconsin.

    Mr. Burwen joined the Company as Vice President, Sales and Marketing, in
April 1992 and served in that capacity until December 1993. Mr. Burwen served as
Vice President, Marketing and Business Development, from January 1994 through
December 1994, at which time he assumed his current position as Vice President,
Business Development. Prior to joining the Company, Mr. Burwen was a managing
partner of Echelon Management, a consulting firm, from October 1987 to March
1992. Mr. Burwen holds a B.S. degree in physics from Worcester Polytechnic
Institute and an M.A. degree in physics from Brandeis University.

    Mr. Belanger joined the Company as Vice President, Data Operations in March
1992. Prior to joining the Company, Mr. Belanger served as Director of
Development at ExpertViews, Inc., a component information systems provider, from
September 1989 to October 1991. Mr. Belanger holds a B.S. degree in engineering
technology from the University of Massachusetts.

  Other Key Employees:
  -------------------

    Mr. Feichtmann, a certified public accountant, joined the Company as 
Corporate Controller in February 1995. Mr. Feichtmann has also served as
Secretary of the Company since October 1995. Prior to joining the Company, he
served 

                                       23
<PAGE>
 
as Chief Financial Officer and Controller of Silicon Valley Research, Inc., a
computer aided engineering software developer, from August 1983 to July 1994.

    Mr. Ball joined the Company as Director, Consulting in February 1995. Prior
to joining the Company, Mr. Ball served as a Senior Consulting Services Manager
at Cadence Design Systems, Inc., an EDA Software developer, from January 1994 to
February 1995 and as Consulting Services Manager from May 1991 to December 1993,
where he developed library and component information management solutions. Mr.
Ball holds his B.S. degree in electrical engineering from North Carolina State
University.



ITEM 11.  EXECUTIVE COMPENSATION.
          ----------------------

Information regarding executive compensation is incorporated by reference to the
information set forth in the 1997 Proxy Statement.


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

    Information regarding security ownership of certain beneficial owners and
management is incorporated by reference to the information set forth in the 1997
Proxy Statement.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
          ----------------------------------------------

    Information regarding certain relationships and related transactions is
incorporated by reference to the information set forth in the 1997 Proxy
Statement.

                                       24
<PAGE>
 
                                    PART IV

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

    (a)  The following documents are filed as part of this Report:

         1.  Financial Statements and Financial Statement Schedules -- See 
             ------------------------------------------------------
             Index to Consolidated Financial Statements at Item 8 on Page 21 
             of this Report.

         2.  Exhibits.  The following exhibits are filed as part of, or 
             --------
             incorporated by reference into, this Report:

Exhibit
Number                                Exhibit Title
-------                               -------------


Exhibit
Number                            Description of Document
-------                           -----------------------          
 3.1*    Restated Certificate of Incorporation.       

 3.2*    Form of Restated Certificate of Incorporation to be filed with the 
         Delaware Secretary of State following the closing of this offering.

 3.3*    By-Laws.      

 4.1*    Restated Rights Agreement dated December 3, 1993.    

10.1*    Amended and Restated 1992 Stock Option Plan and forms of agreements
         thereunder.     

10.2*    1996 Employee Stock Purchase Plan.    

10.3*    1996 Outside Directors Stock Option Plan and forms of agreement 
         thereunder.     

10.4*    Sublease Agreement between the Company and Insignia Solutions, Inc., 
         dated December 9, 1995.    

10.5*    Agreement of Lease between the Company and Mareld Company, Inc., 
         dated June 2, 1994.

10.6*    Agreement of Lease between Aspect Development India and M.S. Janardhan
         Corporation, dated September 18, 1995.     

10.7*    Agreement of Lease between Aspect-DCM Pvt. Ltd. and the co-owners of 
         Leo Shopping Complex, dated February 10, 1994.    

10.8*    Master Lease Agreement between the Company and Comdisco, Inc.,
         dated July 2, 1992.     

10.9*    Business Loan Agreement between the Company and Silicon Valley Bank, 
         dated November 14, 1995.  

11.1     Statement regarding computation of earnings per share.   

21.1     List of Subsidiaries.  

23.1     Consent of Ernst & Young LLP, Independent Auditors.

27.1     Financial Data Schedule.

* Incorporated by reference to the Form SB-2 filed on April 19, 1996.

                                       25
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Aspect Development, Inc.

    We have audited the accompanying consolidated balance sheets of Aspect
Development, Inc. as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

    We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Aspect
Development, Inc. at December 31, 1996 and 1995, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.



                                       ERNST & YOUNG LLP

Palo Alto, California
January 23, 1997

                                       26
<PAGE>
 
Consolidated Balance Sheets
(in thousands, except share and per share amounts)

December 31,                                              1996       1995
--------------------------------------------------------------------------
ASSETS
Current assets:
  Cash and cash equivalents                             $ 9,632   $ 3,159
  Short-term investments                                 38,186         - 
  Accounts receivable, net of allowance for doubtful   
    accounts of $250 and $81 in 1996 and 1995, 
    respectively                                          6,570     4,382 
  Employee notes receivable                                  14       170 
  Prepaid expenses and other current assets                 950       524 
--------------------------------------------------------------------------  
    Total current assets                                 55,352     8,235 

Property and equipment, net                               3,278     1,397 
Other assets, net                                           370       347 
--------------------------------------------------------------------------
                                                        $59,000    $9,979 
==========================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                      $   766    $  224 
  Accrued bonus and commissions                             910       650 
  Other accrued liabilities                               1,688       651 
  Deferred revenue                                        5,049     4,338 
  Capital lease obligations - current portion               482       531 
  Third-party royalties and fees                            972       817   
--------------------------------------------------------------------------
    Total current liabilities                             9,867     7,211 

Capital lease obligations                                   379       634 

Commitments

Stockholders' equity:

  Convertible preferred stock, $0.001 par value; 
    2,000,000 and 3,805,118 authorized, respectively,
    issuable in series, no shares issued and 
    outstanding at December 31, 1996 and 3,687,117
    shares issued and outstanding at December 31, 1995        -     4,916 

  Common stock, $0.001 par value; 20,000,000 shares 
    authorized, 12,133,575 and 5,385,312 issued and 
    outstanding at December 31, 1996 and 1995, 
    respectively                                         49,405       653

  Notes receivable from stockholders                       (320)     (320)
  Deferred stock compensation                              (544)     (241)
  Accumulated translation adjustment                         78         - 
  Retained earnings (Accumulated deficit)                   135    (2,874)  
--------------------------------------------------------------------------
    Total stockholders' equity                           48,754     2,134 
--------------------------------------------------------------------------
                                                        $59,000   $ 9,979 
==========================================================================
See accompanying notes.

                                       27
<PAGE>
 
Consolidated Statements of Operations
(in thousands, except per share amounts)

Year ended December 31,                              1996      1995      1994
-------------------------------------------------------------------------------
Revenues
  Licenses                                         $12,263    $7,143    $3,478
  Subscription and maintenance                       8,943     4,964     2,962 
  Service and other                                  3,029     1,586     2,044
-------------------------------------------------------------------------------
    Total revenues                                  24,235    13,693     8,484 

Cost of revenues
  Cost of license revenues                             612       298       197 
  Cost of subscription and maintenance revenues      1,116       938       735 
  Cost of service and other revenues                 1,679       612     1,333 
-------------------------------------------------------------------------------
    Total cost of revenues                           3,407     1,848     2,265
-------------------------------------------------------------------------------
Gross profit                                        20,828    11,845     6,219 
-------------------------------------------------------------------------------

Operating expenses:
  Research and development                           7,052     4,859     3,096 
  Sales and marketing                                8,819     4,490     3,047 
  General and administrative                         2,975     1,660     1,084 
-------------------------------------------------------------------------------
Total operating expenses                            18,846    11,009     7,227
-------------------------------------------------------------------------------

Operating income (loss)                              1,982       836    (1,008)
Interest and other income, net                       1,566        78        78 
Interest expense                                      (209)      (83)      (46)
-------------------------------------------------------------------------------
Income (loss) before income taxes                    3,339       831      (976)
Provision for income taxes                             330       150       144 
-------------------------------------------------------------------------------
Net income (loss)                                  $ 3,009   $   681   $(1,120)
===============================================================================
Net income (loss) per share                        $  0.24   $  0.06   $ (0.23)
===============================================================================
Number of shares used in computing 
  per share amounts                                 12,719    10,912     4,936 
===============================================================================
See accompanying notes.

                                       28
<PAGE>
 
Consolidated Statement of Stockholders' Equity
(in thousands)
<TABLE>
                                                                         Notes
                                                                         Receiv-
                                       Convertible                        able                                  Earnings  Total
                                     Preferred Stock     Common Stock      From      Deferred    Accumulated    (Accumu-  Stock
                                   ------------------   --------------    Stock-      Compen-    Translation     lated    holders'
                                   Shares     Amount    Shares  Amount    holders     sation     Adjustment     Defict)   Equity
                                   ------     -------   ------  ------    --------   --------    -----------    -------   -------
<S>                                <C>        <C>       <C>     <C>       <C>        <C>         <C>            <C>       <C> 
Balance at December 31, 1993        3,687     $ 4,916    4,079    $   9    $   -        $   -        $    -     $ (2,435)   $ 2,490
  Issuance of common stock
    for note receivable                 -           -      550      110     (110)           -             -            -          -
  Issuance of common stock
    upon exercise of options            -           -       51        5        -            -             -            -          5
  Net loss                              -           -        -        -        -            -             -       (1,120)    (1,120)
                                    -----     -------   ------  -------    -----        -----        ------     --------   -------

Balance at December 31, 1994        3,687       4,916    4,680      124     (110)           -             -       (3,555)     1,375
  Issuance of common stock
    upon exercise of options            -           -      405       64        -            -             -            -         64
  Issuance of common stock for
    note receivable                     -           -      300      210     (210)           -             -            -          -
  Deferred compensation related
    to grant of stock options           -           -        -      255        -         (255)            -            -          -
  Amortization of deferred
    compensation                        -           -        -        -        -           14             -            -         14
  Net income                            -           -        -        -        -            -             -          681        681
                                    -----     -------   ------  -------    -----        -----        ------     --------   -------

Balance at December 31, 1995        3,687       4,916    5,385      653     (320)        (241)            -       (2,874)     2,134
  Conversion of preferred stock    (3,687)     (4,916)   3,687    4,916        -            -             -            -          -
  Issuance of common stock upon
    exercise of options                 -           -      569      157        -            -             -            -        157
  Deferred compensation related
    to grant of stock options           -           -        -      441        -         (441)            -            -          -
  Amortization of deferred
    compensation                        -           -        -        -        -          138             -            -        138
  Tax benefit from stock options        -           -        -      250        -            -             -            -        250
  Issuance of common stock through
    Initial Public Offering net of
    issuance costs of $938              -           -    2,323   42,261        -            -             -            -     42,261
  Issuance of common stock upon
    exercise of warrants                -           -       95       30        -            -             -            -         30
  Option granted for dispute
    settlement                          -           -        -       90        -            -             -            -         90
  Issuance of common stock upon
    exercise of options from
    settlement                          -           -       75      607        -            -             -            -        607
  Foreign currency translation
    adjustments                         -           -        -        -        -            -            78            -         78
  Net income                            -           -        -        -        -            -             -        3,009      3,009
                                    -----     -------   ------  -------    -----        -----        ------     --------   -------
Balance at December 31, 1996            -     $     -   12,134  $49,405    $(320)       $(544)       $   78     $    135   $48,754
                                    =====     =======   ======  =======    =====        =====        ======     ========   =======
</TABLE>
See accompanying notes.

                                       29
<PAGE>
 
Consolidated Statements of Cash Flows
Increase (Decrease) in Cash and cash equivalents
(in thousands)

Year ended December 31,                                1996     1995     1994
-------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss)                                    $3,009   $  681   $(1,120)
Adjustments to reconcile net income (loss) 
  to net cash from operating activities:
    Depreciation and amortization                     1,356      454       348
    Compensation related to options granted for 
      dispute settlement                                 90        -         -
    Changes in items affecting operations:
      Accounts receivable                            (2,188)  (2,717)     (448)
      Prepaid expenses and other current assets        (426)     (18)     (274)
      Accounts payable and accruals                   2,244      891       872
      Deferred revenue                                  711    2,349       612 
      Other, net                                         78        -         -
                                                    -------  -------   ------- 
Net cash provided by (used for) operating 
  activities                                          4,874    1,640       (10)
                                                    -------  -------   -------

Cash flows from investing activities
  Capital expenditures                               (2,698)    (194)     (159)
  Payment for acquisition of Aspect 
    Development India, net of cash acquired               -      (90)        - 
  Increase (decrease) in employee notes receivable      156     (170)        -
  Proceeds from short term investments               22,229        -         -
  Purchase of short term investments                (60,415)       -         -
  Increase in other assets                              (23)    (115)       (3)
                                                    -------  -------   -------

Net cash used for investing activities              (40,751)    (569)     (162)
                                                    -------  -------   -------

Cash flows from financing activities:
  Principal payments on advance from customer             -        -      (110)
  Principal payments on capital lease obligations      (705)    (413)     (241)
  Proceeds from Initial Public Offering              42,261        -         - 
  Proceeds from other issuance of common stock          794       64         5
                                                    -------  -------   ------- 
Net cash provided by (used for) financing 
  activities                                         42,350     (349)     (346)
                                                    =======  =======   =======
Net increase (decrease) in cash and cash
  equivalents                                         6,473      722      (518)
Cash and cash equivalents at the
  beginning of the period                             3,159    2,437     2,955 
                                                    -------  -------   -------
Cash and cash equivalents at the end of the 
  period                                            $ 9,632  $ 3,159   $ 2,437
                                                    =======  =======   =======

Supplemental disclosure of cash flow information
  Cash paid during the period for interest          $   116  $    83   $    46
                                                    =======  =======   ======= 
  Income taxes paid                                 $    67  $    51   $   146
                                                    =======  =======   =======

Supplemental schedule of noncash financing
activities
  Equipment acquired under capital lease 
    obligations                                     $   401  $   953   $   431
                                                    =======  =======   ======= 
  Conversion of preferred stock to common 
    stock                                           $ 4,916  $     -   $     -
                                                    =======  =======   ======= 
  Issuance of common stock for note receivable      $     -  $   210   $   110
                                                    =======  =======   ======= 
  Tax benefits from stock options                   $   250  $     -   $     - 
                                                    =======  =======   =======
See accompanying notes.

                                       30
<PAGE>
 
                  Notes to Consolidated Financial Statements


1.        Organization and Summary of Significant Accounting Policies

Description of Business and Principles of Consolidation
-------------------------------------------------------

    Aspect Development Inc. ("the Company") develops, markets and supports
enterprise client/server software and reference data products that enable
manufacturers to improve product development and business processes through
component and supplier management. The Company sells licensed software and
reference data products to customers and provides software and data services for
customers both within and outside the United States.

    The consolidated financial statements comprise the accounts of the Company
and its wholly owned subsidiaries, Aspect Development India Private Limited,
which was acquired in June 1995, and Aspect Development Europe Limited, after
elimination of all significant intercompany balances and transactions.

Foreign Exchange
----------------

    Assets and liabilities of the Company and its wholly owned foreign
subsidiaries are translated from the local currency to United States dollars at
year-end exchange rates. Income and expense items are translated on a quarterly
basis at the average rates of exchange prevailing during the quarter. The
adjustment resulting from translating the financial statements of the Company
and its foreign subsidiaries is reflected as an accumulated translation
adjustment in stockholders' equity. Foreign currency transaction gains and
losses are included in results of operations and were immaterial for all periods
presented.

Use of Estimates
----------------

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

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

    Licenses are comprised of perpetual license fees, which are recognized as
revenue after execution of a license agreement or receipt of a definitive
purchase order, and shipment of the product if no significant vendor obligations
remain and collection of the resulting receivables is deemed probable.  Where
delivery involves significant installation obligations at multiple sites,
revenues are recognized on a per-site basis upon completion of installation.
Product returns and allowances (which were not significant through December 31,
1996) are estimated and provided for at the time of sale.

    Revenue from subscription and maintenance agreements is deferred and
recognized on a straight-line basis over the life of the related agreement,
typically one year.

    Service and other revenues are comprised of service, consulting and
development fees. Service revenues from training and consulting are recognized
upon completion of the work to be performed. Development fees are recognized as
revenue in accordance with the terms of the agreements, generally when related
costs have been incurred. Generally, the Company retains complete ownership of
technology developed under these agreements. The related costs are charged as
incurred. Under these development agreements, costs totaled approximately
$1,019,000, $167,000 and none for fiscal 1994, 1995 and 1996, respectively.

Per Share Amounts
-----------------

    Net income (loss) per share is computed using the weighted average number of
common and dilutive common equivalent shares outstanding during the period.
Dilutive common equivalent shares consists of  shares issuable upon the exercise
of stock options (using the treasury stock method).  Pursuant to the Securities
and Exchange Commission Staff Accounting Bulletins and staff policy, such
computations prior to the Company's Initial Public Offering ("IPO") include all
common and common equivalent shares issued within 12 months of the Company's IPO
as if they were outstanding for all periods presented using the treasury stock
method.

                                       31
<PAGE>
 
                  Notes to Consolidated Financial Statements


Concentration of Credit Risk and Significant Customers
------------------------------------------------------

    The Company's revenues consist primarily of license and subscription fees
for its applications software and reference data products from large
manufacturers in the United States, Europe and Asia. The Company has
historically sold primarily to large financially stable institutions and has not
obtained collateral. The Company has not incurred significant credit losses
during any of the periods presented.

    One customer accounted for 13% of revenues during 1996, three customers each
accounted for 11% of revenues during 1995 and three customers accounted for 12%,
11%, and 10% of revenues during 1994.  No other customer accounted for more than
10% of revenues during any of the periods presented.

Product Concentration
---------------------

    The Company currently derives substantially all of its revenues from the
licensing of its Explore client/server software and VIP family of reference
databases and fees from related services. These products and services are
expected to continue to account for substantially all of the Company's revenues
for the foreseeable future.  While the Company believes that to date its
customers have not experienced significant problems with such products, if the
Company's customers were to do so in the future or if they were dissatisfied
with product functionality or performance, the Company's business, financial
condition or results of operations could be materially adversely affected.

Cash, Cash Equivalents and Short-Term Investments
-------------------------------------------------

    The Company considers all highly liquid investments with minimum yield risks
and maturities of less than 90 days at time of purchase to be cash equivalents.

    The Company accounts for its cash equivalents and short term investments
under Statement of Financial Accounting Standards No. 115 ("SFAS 115")
"Accounting for Certain Investments in Debt and Equity Securities." Management
determines the appropriate classification of debt securities at the time of
purchase and reevaluates such designation as of each subsequent balance sheet
date. The Company's policy is to protect the value of its investment portfolio
and to minimize principal risk by earning returns based on current interest
rates. At December 31, 1996 all of the Company's cash equivalents and short term
investments were designated as "available-for-sale" and , in accordance with
SFAS 115, are recorded at fair value. As the difference between cost and fair
value was immaterial at December 31, 1996, no adjustment has been made to the
historical carrying value of the investments and no unrealized gains or losses
have been recorded as a separate component of stockholders' equity. Realized
gains and losses to date have not been material. The cost of securities sold is
based on specific identification.

    At December 31, 1995, the Company had no debt securities. At December 31,
1996, the Company's debt securities include $10.7 million in obligations of U.S.
government agencies and $32.9 million of corporate debt, all of which mature
within one year. At December 31, 1996, $5.4 million of debt securities were
included in cash equivalents.

Property and Equipment
----------------------

    Office and computer equipment are recorded at cost and depreciated on a
straight-line basis over their estimated useful lives (generally two to five
years).  Equipment under capital lease obligations is recorded at cost and
amortized on a straight-line basis over the shorter of its estimated life or the
term of the lease (generally three years).  Accumulated depreciation of assets
under capital leases was approximately, $1,268,000 at December 31, 1996
($660,000 at December 31, 1995).  Property and equipment consists of the
following (in thousands):
<TABLE>
<CAPTION>
 
                                                           December 31,
                                                        ------------------
                                                         1996       1995
                                                        -------    -------
<S>                                                     <C>        <C>
 
Office and computer equipment                           $ 3,208    $   510
Computer equipment under capital lease obligations        2,295      1,894
                                                        -------    -------
                                                          5,503      2,404
Accumulated depreciation and amortization                (2,225)    (1,007)
                                                        -------    -------
Property and equipment, net                             $ 3,278    $ 1,397
                                                        =======    =======
</TABLE>

                                       32
<PAGE>
 
                  Notes to Consolidated Financial Statements


    On January 1, 1996 the Company adopted Statement of Financial Accounting
Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of."  SFAS 121 requires
recognition of impairment of long-lived assets in the event the net book value
of such assets exceeds the future undiscounted cash flows attributable to such
assets. The effect of adopting this statement was immaterial to the Company's
consolidated financial position or operating results.

Research and Development
------------------------

    Research and development expenditures are generally charged to operations as
incurred. Statement of Financial Accounting Standards No. 86, "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,"
requires the capitalization of certain software development costs subsequent to
the establishment of technological feasibility.  Based on the Company's product
development process, technological feasibility is established upon completion of
a working model.  Costs incurred by the Company between completion of the
working model and the point at which the product is ready for general release
have been insignificant.  Through December 31, 1996, all research and
development costs had been expensed.

Reclassification
----------------

    The Company has reclassified certain prior year balances to conform with
current year's presentation.

2.   Lease Obligations

    The Company had a lease line of credit for the funding of equipment and
software purchases of $2,200,000 at December 31, 1995 which was terminated
during 1996.

    The Company leases seven office facilities under noncancelable operating
leases which expire at various dates through September 2004. The Company also
rents certain property and equipment under operating leases. Rental expense for
all operating leases was $665,908, $386,472 and $262,971 for 1996, 1995 and 1994
respectively.

    Future minimum lease payments under operating and capital lease obligations
which have initial or remaining noncancelable lease terms in excess of one year
as of December 31, 1996 are as follows (in thousands):

                                               Operating   Capital
                                                Leases      Leases
                                                ------      ------     
Year ending December 31, 
      1997                                        $537       $540
      1998                                         265        345
      1999                                         108         34
      2000                                          89          -
      2001                                          89          -
  Thereafter                                       302          - 
                                                ------       ----     
Total minimum lease payments                    $1,390        919
Less amount representing interest                              58
                                                             ---- 
Present value of net minimum lease payments                   861
Less current portion                                          482
                                                             ----
Noncurrent portion                                           $379
                                                             ====

                                       33
<PAGE>
 
                  Notes to Consolidated Financial Statements


3.   Stockholder's Equity

Initial Public Offering

    In May 1996, the Company completed the Initial Public Offering ("IPO") of
its common stock. The Company sold 2,322,500 shares for net proceeds of $42.3
million.

Convertible Preferred Stock

    Each aggregate share of  Series A, B and C preferred stock outstanding was
automatically converted into one share of  common stock upon the  initial public
offering  of the Company's common stock on May 24, 1996 (a total of 3,687,117
shares).  In 1996 the Board approved the authorization of 2,000,000 shares of
undesignated preferred stock and 20,000,000 shares of common stock.

Common Stock Subject to Repurchase

    The Company has previously issued shares of common stock which are subject
to the Company's right to repurchase at the original issuance price upon the
occurrence of certain events, as defined in the agreement relating to the sales
of such stock. At December 31, 1995 and December 31, 1996, approximately 564,000
and 351,000 shares, respectively, were subject to repurchase. In the event that
a stockholder negotiates to sell all or part of the stock to a third party, the
Company has a right of first refusal to repurchase that stock at the negotiated
price.

Stock Options

    Amended and Restated 1992 Stock Option Plan.  
    -------------------------------------------

    During 1996, the Company adopted its Amended and Restated 1992 Stock Option
Plan (the "Plan") which authorizes the board of directors to grant incentive
stock options or nonqualified stock options to purchase up to 3,930,000 shares
of common stock to employees, officers and directors of the Company. The Plan
allows for the grant of incentive stock options to employees and the grant of
nonstatutory stock options to eligible participants.

    The option price shall be at least 100% and 85% of the fair value on the 
date of the grant as determined by the board of directors for incentive stock
options and nonqualified stock options, respectively, except for options granted
to a person owning greater than 10% of the total voting power of the Company,
for which the exercise price of the options must not be less than 110% of the
fair market value at the time of grant. Options generally become exercisable
upon grant subject to repurchase rights in favor of the Company until vested. At
December 31, 1995 and December 31, 1996, 29,999 and 47,872 shares of common
stock, respectively, previously exercised under the plan were subject to
repurchase. Shares generally vest over a period of four years, with 1/8 of the
shares subject to option vesting at the end of the six months after commencement
of employment, and the remainder vesting ratably over the next 42 months.
Options may be granted with different vesting terms. Options are exercisable for
a term of ten years after the date of grant except those options granted to a
person owning greater than 10% of the total vesting power of stock of the
Company, which are exercisable for a term of five years after the date of grant.

    In the event of a sale or merger of the Company, the board may arrange with
the acquiring corporation for such corporation either to assume the Company's
rights and obligations under the outstanding options or to substitute new
options for the acquiring corporation's stock for such outstanding options.
Options that are neither assumed nor substituted by the acquiring corporation,
nor exercised as of the date of the sale or merger, terminate and cease to be
outstanding as of the date of the transaction.

    1996 Outside Directors Stock Option Plan.   
    ----------------------------------------

    During 1996 the Company adopted its 1996 Outside Directors Stock Option Plan
("the Directors Plan") and reserved for issuance a total of 100,000 shares of
common stock. The Directors Plan provides for the automatic grant of
nonstatutory stock options to directors of the Company who are not employees of
the Company or any parent or subsidiary corporation of the Company ("Outside
Directors.") Under the Directors Plan, each present Outside director who has not
previously been granted an option under a stock option plan of the Company was
granted automatically on the effective date of the IPO an option to purchase
5,000 shares of Common Stock. Each new Outside Director elected after the date
of the IPO will be granted automatically on the date of election an option to
purchase 15,000 shares of Common Stock. Such options will become vested in three
annual installments on the anniversaries of the date of grant. In addition, each
Outside Director previously granted an option under the Directors Plan will be
granted automatically on the date of each annual meeting of the stockholders
after

                                       34
<PAGE>
 
                  Notes to Consolidated Financial Statements

1996 an option to purchase 5,000 shares of Common Stock. Each such subsequent
option will become vested in full on the third anniversary of the date of grant.
The exercise price of each option granted under the Directors Plan will equal
the fair market value of the Common Stock on the date of grant, and the term of
each option is ten years. Options granted under the Directors plan are
nontransferable.

    Information with respect to activity under the plans is as follows (shares
in thousands):
                                               Out-
                                     Options  standing               Weighted
                                    Available  Number   Options      Average
                                      for        of      Price       Exercise
                                     Grant     Shares  Per Share      Price
                                     ------    -----   ------------   ------
Balance at December 31, 1993             20    1,515   $0.05-$0.20     $0.15   
  Additional Shares Authorized          780        -             -     
  Options Granted                      (451)     451   $0.20-$0.70     $0.24
  Exercised                               -      (52)  $0.05-$0.20     $0.10    
  Canceled                              108     (108)  $0.05-$0.20     $0.19
                                     ------    -----   ------------   ------

Balance at December 31, 1994            457    1,806   $0.05-$0.70     $0.17    
  Options Granted                      (552)     552      $0.70        $0.70
  Exercised                               -     (404)  $0.05-$0.70     $0.16    
  Canceled                              176     (176)  $0.05-$0.70     $0.25
                                     ------    -----   ------------   ------

Balance at December 31, 1995             81    1,778   $0.05-$0.70     $0.33   
  Additional Shares Authorized        1,700        -        -     
  Options Granted                    (1,027)   1,027   $0.70-$26.75   $10.72    
  Exercised                               -     (567)  $0.05-$8.10    $0.28    
  Canceled                               87      (87)  $0.20-$8.10    $1.12
                                     ------    -----   ------------   ------

Balance at December 31, 1996            841    2,151   $0.05-$26.75   $5.27
                                     ======    =====   ============   ======


    At December 31, 1996, options to purchase 2,151,379 shares were exercisable
(1,777,651 shares at December 31, 1995.)

    The company has recorded for financial statement purposes deferred
compensation expense of $695,000 for the difference between the exercise price
and the deemed fair value of the common stock with respect to certain options
granted in 1995 and 1996. This amount is being amortized over the vesting period
of the individual options, generally four years. Compensation expense recognized
in fiscal 1996 and 1995 total $138,000 and $14,000 respectively. At December 31,
1996, deferred compensation totaled $543,000.

    1996 Employee Stock Purchase Plan.   
    ---------------------------------

    During 1996 the Company adopted its 1996 Employee Stock Purchase Plan
(the"Purchase Plan") and reserved for issuance a total of 300,000 shares, none
of which have yet been issued. The Purchase Plan permits eligible employees to
purchase Common Stock at a discount, but only through payroll deductions, during
concurrent 24-month offering periods. Each offering period will be divided into
four consecutive six-month purchase periods. The price at which stock is
purchased under the Purchase Plan is equal to 85% of the fair market value of
the Common Stock on the first day of the offering period or the last day of the
purchase period, whichever is lower. The initial offering period commenced
approximately two weeks prior to the effective date of the IPO.


Common Stock Issued Outside of the 1992 Stock Option Plan
---------------------------------------------------------

    During 1991, the Company granted an employee and a director options to
purchase a total of 172,500 shares of common stock at exercise prices of $0.05
to $0.15, of which 64,350 shares were issued in 1993 and 2,500 shares were

                                       35
<PAGE>
 
                  Notes to Consolidated Financial Statements


issued in the quarter ended March 31, 1996. The remaining 105,650 shares were
canceled upon the employee's termination in 1993.

Stock Warrants
--------------

    During 1992, warrants to purchase 55,970 shares of Series A preferred stock
at an exercise price of $0.67, were issued in connection with equipment lease
arrangements. During 1993, warrants to purchase an additional 8,333 shares of
Series A preferred stock at an exercise price of $1.50 and 29,412 shares of
Series C preferred stock at an exercise price of $1.85, were issued in
connection with an extension of the equipment lease arrangements. During 1995,
warrants to purchase an additional 14,286 shares of Series C preferred stock at
an exercise price of $3.50 per share, were issued in connection with the further
extension of the lease line. All outstanding warrants were exercised in May 1996
in connection with the Company's IPO. As of December 31, 1996, there were no
outstanding warrants.

Option Issued as Settlement
---------------------------

    During 1996, the board of directors approved the issuance of an option to a
third party to purchase up to 100,000 shares of common stock at a price of $8.10
per share to obtain the release of all claims arising from a dispute with such
party.  The Company recorded an expense of $90,000 in connection with this
grant.  75,000 of these options were exercised in 1996, for proceeds of $607,000
and the remaining 25,000 options were exercised in January 1997.

Stock Compensation
------------------

    The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," ("Statement 123")
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.

    Pro forma information regarding net income and earnings per share is
required by Statement 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options
granted subsequent to December 31, 1994 under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using the Minimum Value Method for 1995 and the Black-Scholes option pricing
model for 1996 with the following weighted-average assumptions for 1995 and
1996, respectively: risk-free interest rates of 6.22% and 5.64%; a dividend
yield of 0.0%; volatility factors of the expected market price of the Company's
common stock of .0 and .75; and a weighted-average expected life of the option
of 1 and 2 years beyond each respective vesting period. The weighted average
fair value of options granted during 1996 and 1995 was $4.65 and $0.12,
respectively.

    The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

    For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands except for earnings per share
information):

                                            1996                1995
                                           ------               -----
Pro forma net income                       $2,400               $ 663
Pro forma earnings per share               $ 0.19               $0.06


    Because Statement 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1998.

                                       36
<PAGE>
 
                  Notes to Consolidated Financial Statements

    The following table summarizes information regarding stock options
outstanding at December 31, 1996:

                               Options Outstanding and Exercisable
                        ------------------------------------------------ 
                             Number            Weighted
     Range                 Outstanding          Average         Weighted
      of                        at             Remaining        Average
   Exercise             December 31, 1996     Contractual      Exercise
    Prices                (in thousands)         Life            Price
---------------         -----------------    -----------       ---------
$ 0.05 - $ 0.20                  689              4.5              $0.15
  0.70 -   0.70                  581              8.6                0.7
  3.00 -   7.00                  308              8.1               6.24
  7.15 -   8.10                  261              8.4               7.52
 10.00 -  19.75                   62              9.7              18.56
$20.50 - $26.75                  275              9.1             $20.68 
                               -----              ---
                               2,176              7.3
                               =====              ===

4.   Notes Receivable from Stockholders

    During 1994 the Company issued 550,000 shares of common stock at a purchase
price of $0.20 per share to an officer secured by a note receivable.  The note
was a nonrecourse promissory note bearing interest at 6.43%.  During 1995, the
note was amended to become a recourse note bearing interest at 6.31%.  Interest
is payable annually and the principal is due in 2003.

    During 1995, the Company issued 300,000 shares of common stock to an 
officer, at a purchase price of $0.70 per share, also secured by a note
receivable. The note is a recourse promissory note bearing interest at 6.31%,
and the principal is due in 2004.

5.   Lines of Credit

    At December 31,1996, the Company had a revolving line of credit with a bank
totaling $2,000,000, secured by certain tangible and intangible assets of the
Company. The Company may utilize up to $2,000,000 of this line for spot and
future foreign exchange contracts. The line expires in April 1997.  The rate of
interest payable by the Company on the line is the bank's prime rate plus 0.5%.
There were no borrowings outstanding under the line at December 31, 1996 and
1995.

    Under this agreement the Company is required, among other things, to meet
certain financial covenants including specified amounts of tangible net worth
and specified ratios including ''quick'' ratio, liabilities to tangible net
worth and debt service coverage. Prior to declaring dividends, the Company must
obtain written consent from the bank. The Company was in compliance with all
covenants as of December 31, 1996.

6.   Income Taxes

    The provision for taxes consists of the following (in thousands):

                                    Years ended December 31,
                            ---------------------------------------
                              1996            1995           1994     
                            --------         -------       --------
Current:
  Federal                   $    353         $    36       $     --    
  State                           53               1             --    
  Foreign                         33             113            144
                            --------         -------       --------
                            $    439         $   150       $    144
Deferred:       
  Federal                   $   (109)        $    --       $     --
                            --------         -------       --------
                            $    330         $   150       $    144
                            ========         =======       ========

                                       37
<PAGE>
 
                  Notes to Consolidated Financial Statements

 
        Tax benefits resulting from the exercise of nonqualified stock options
and the disqualifying disposition of shares acquired under the Company's
incentive stock option and stock purchase plans reduced taxes currently payable
as shown above by approximately $359,000 for the year ended December 31, 1996.
Such benefits were credited to common stock.

        The Company's effective income tax provision differs from the Federal
statutory rate of 34% due to the following (in thousands):

<TABLE> 
<CAPTION> 
                                                                      Years ended December 31,
                                                                ----------------------------------
                                                                 1996           1995         1994     
                                                                ------         ------       ------    
<S>                                                             <C>            <C>          <C> 
Expected tax provision (benefit) at federal statutory rate      $ 1,135        $ 283        $(332)    
State taxes (net of federal benefit)                                 35           51          (30)    
Foreign taxes                                                        --          113          144     
Research credits                                                     --         (278)        (253)    
Foreign tax credits                                                  --         (158)        (100)    
Other                                                                49           39           15     
Change in valuation allowance                                      (889)         100          700     
                                                                  ------       -----        -----     
Provision for income taxes                                        $  330       $ 150        $ 144     
                                                                  ======       =====        =====     
Effective tax rate                                                   9.9%       18.0%       (14.8)%    
</TABLE> 

        As of December 31, 1996, the Company had federal net operating loss
carryforwards of approximately $3,000,000. The Company also had federal research
and development tax credit carryforwards of approximately $450,000. The federal
net operating loss and credit carryforwards will expire between 2007 and 2011,
if not utilized.

        Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.

        Significant components of the Company's deferred tax assets are as
follows:

<TABLE>
<CAPTION> 
                                                         December 31,                 
                                           --------------------------------------
                                              1996          1995         1994
                                           -----------  -----------   ----------- 
<S>                                        <C>           <C>          <C> 
Deferred tax assets:
    Net operating loss carryforwards       $ 1,100,000   $  200,000   $ 1,000,000      
    Research credit carryforwards              700,000      500,000       400,000
    Foreign tax credits                        300,000      300,000            --
    Other timing differences                   400,000      600,000       100,000
                                           -----------  -----------   ----------- 
Total deferred tax assets                    2,500,000    1,600,000     1,500,000
Valuation allowance                         (2,500,000)  (1,600,000)   (1,500,000)
                                           -----------  -----------   ----------- 
Net deferred tax assets                    $        --  $        --   $        --
                                           ===========  ===========   =========== 
</TABLE> 

        The valuation allowance increased by $700,000 during the year ended
December 31, 1994. Approximately $1,789,000 of the valuation allowance for
deferred tax assets relates to benefits of stock option deductions which, when
recognized, will be allocated directly to common stock.

7.      JOINT VENTURE

        The Company entered into a joint venture agreement with DCM Ltd. ("DCM")
dated August 6, 1990. The joint venture was established for the innovation and
development of component databases for electronic design automation. The equity
ownership of this joint venture was split 80% to DCM and 20% to the Company. On
March 6, 1995, the Company entered into an agreement to purchase DCM's rights
and interest in the joint venture. Under the terms of the agreement, The Company
paid DCM a total of $90,000 and DCM relinquished its rights to certain
liabilities owed DCM at December 31, 1994. Upon completion of the buyout of
DCM's interest, the joint venture became a wholly owned subsidiary of the
Company, Aspect Development India Private Limited.

                                       38
<PAGE>
 
                  Notes to Consolidated Financial Statements

8.   Industry Segment and Geographic Information

    The Company develops, markets and supports enterprise client/server software
and reference data products that enable manufacturers to improve product
development and business processes through component and supplier management.
The Company operates in a single industry segment.

    The Company's foreign operations consist of sales, marketing, and support
activities in subsidiaries and distributors throughout the world and development
and support activities in India. The Company's export sales were as follows (in
thousands):

                                                  Year Ended December 31,
                                               ----------------------------
                                                 1996      1995       1994
                                               -------    -------    ------
Net Revenues from unaffiliated customers:
  Europe                                       $ 2,398    $ 2,189    $  495
  Asia                                             229        748       668
                                               -------    -------    ------
     Total export sales                        $ 2,627    $ 2,937    $1,163
                                               =======    =======    ======
 
    Operating income generated by the foreign operations of the Company and
 their corresponding identifiable assets were not material in 1994. Revenue,
 operating income, and identifiable assets classified by major geographic area
 were as follows (in thousands):

                                                 Year Ended December 31,
                                              ----------------------------
                                                1996      1995       1994
                                              -------    -------    ------
Net Revenues from unaffiliated customers:
  North America                               $18,059    $10,756    $7,321
  Europe                                        5,947      2,189       495
  Other international operations                  229        748       668
                                              -------    -------    ------
    Total net revenues                        $24,235    $13,693    $8,484
                                              =======    =======    ======

Income (loss) from operations:
  North America                               $(2,157)   $(1,395)
  Europe                                        4,789      1,823
  Other international operations                 (650)       408
                                              -------    -------
    Income from operations                    $ 1,982    $   836
                                              =======    =======

Identifiable assets:
  North America                               $54,623    $ 9,216
  Europe                                        3,425        587
  Other international operations                  952        176
                                              -------    -------
    Total identifiable assets                 $59,000    $ 9,979
                                              =======    =======

9.   401 (k) Plan

    Under the Company's 401(k) Plan, an employee may defer and invest up to 20%
of his or her compensation, subject to an annual limitation. As of December 31,
1996, the Company had not elected to make any matching contributions under the
Plan.

                                       39
<PAGE>
 
                                  SIGNATURES

  Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized on this nineteenth day of
March, 1996.

                                  Aspect Development, Inc.


                                  By:      /s/ ROMESH WADHWANI
                                     ---------------------------------------
                                      Romesh Wadhwani
                                      Chief Executive Officer and Director
                                      (Principal Executive Officer)


  Pursuant to the requirements of the Securities Act, this Amendment to this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:

<TABLE>
<CAPTION>
 
SIGNATURE                            TITLE                          DATE
------------------------   --------------------------   -----------------------------
<S>                        <C>                          <C>
 
/s/ ROMESH WADHWANI        Chairman of the Board of     March 19, 1997
------------------------   Directors and Chief
Romesh Wadhwani            Executive Officer (Principal
                           Executive Officer)
 
/s/ JOSEPH PRANG           President, Chief Operating   March 19, 1997
------------------------   Officer and Director
Joseph Prang
 
/s/ DAVID S. DURY          Vice President and Chief     March 19, 1997
------------------------   Financial Officer
David S. Dury              (Principal Financial and
                           Accounting Officer)
 
/s/ MARK A. STEVENS        Director                     March 19, 1997
------------------------ 
Mark A. Stevens
 
/s/ DENNIS SISCO           Director                     March 19, 1997
------------------------ 
Dennis Sisco
 
/s/ STEVEN GOLDBY          Director                     March 19, 1997
------------------------
Steven Goldby

</TABLE>

                                      40