<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K

           [  X  ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
                 For the fiscal year ended:  December 31, 1998

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

                       COMMISSION FILE NUMBER: 001-13211

                    INFORMATION MANAGEMENT ASSOCIATES, INC.
            (Exact name of registrant as specified in its charter)

            Connecticut                               06-1289928
  (State or other jurisdiction of                  (I.R.S. Employer
   incorporation or organization)                 Identification No.)
                        One Corporate Drive, Suite 400
                               Shelton, CT 06484
             (Address and Zip Code of principal executive offices)

                                (203) 925-6800
             (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,
           (Title of Class)                                  no par value
                                                             per share
 
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding  12  months  (or for  such shorter period that the registrant was
required  to  file  such  reports),  and  (2)  has  been  subject to such filing
requirements for the past 90 days.
 
                         Yes   / X /         No     /   /
 
Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
 
The  aggregate  market  value of  voting  stock  held by  non-affiliates  of the
registrant as of March 10, 1999:  $13,260,912
 
        Number of shares outstanding as of March 10, 1999:  9,697,088
 
                       DOCUMENTS INCORPORATED BY REFERENCE
Portions  of  the  registrant's  proxy  statement  for  its  Annual  Meeting  of
Stockholders  presently scheduled for May 25, 1999 are incorporated by reference
into Part III of this report.
<PAGE>
 
               TABLE OF CONTENTS

ITEM 1.  BUSINESS                                                3

ITEM 2.  PROPERTIES                                             12

ITEM 3.  LEGAL PROCEEDINGS                                      13

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
         HOLDERS                                                14

ITEM 4A. EXECUTIVE OFFICERS OF REGISTRANT                       14

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND
         RELATED STOCKHOLDER MATTERS                            16

ITEM 6.  SELECTED FINANCIAL DATA                                18

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS          20

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
         MARKET RISK                                            42

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA           F-2

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH
         ACCOUNTANTS ON ACCOUNTING
         AND FINANCIAL DISCLOSURE                             F-24

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
         REGISTRANT                                           F-24

ITEM 11. EXECUTIVE COMPENSATION                               F-24

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
         AND MANAGEMENT                                       F-24

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS       F-24

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
         REPORTS ON FORM 8-K                                  F-24
<PAGE>
 
THE COMPANY

The Company develops, markets and supports customer interaction software
designed to increase the productivity and revenue-generating capabilities of
small, mid-size and large-scale telephone call centers. The Company develops and
markets three primary products: The EDGE TeleBusiness software suite (EDGE), the
TELEMAR software suite (TELEMAR), and the MSM software suite (MSM). EDGE is a
suite of applications and tools that enables businesses to automate telebusiness
activities (telemarketing, telesales, account management, customer service and
customer support) on an enterprise-wide basis. TELEMAR and MSM focus on the
automation of various customer interactive business processes, including
telemarketing, sales and marketing, customer support and remote sales force
automation. The Company complements its software products by offering its
clients professional consulting, technical support and maintenance services. The
Company's software products have been licensed to over 400 customers in a range
of industries, including teleservices outsourcing,telecommunications and
financial services. Customers include Belgacom, S.A., Bose Corporation, ING
Bank, N.V., Humana Inc., Lloyd's Bank Plc, SITEL Corporation, Telefonica de
Espana, Texas Utilities Service Inc., United Parcel Service General Services
Co., United States Cellular Corporation and Wells Fargo Bank, N.A.

The Company's products are designed to provide superior functionality,
flexibility, integration, scalability and speed of deployment. Based upon an
open systems software architecture, EDGE supports multiple hardware platforms,
operating environments, database management systems, network topologies, desktop
standards, and legacy system and computer-telephony middleware. TELEMAR and MSM
support IBM's AS/400 hardware platform and are compatible with industry leading
software and computer telephony integration technologies. The Company's products
and services enable call center agents to effectively manage customer
relationships through the use of the telephone, e-mail, the World Wide Web,
documents and fax. The Company's products provide call center agents with real-
time data and guidance needed to manage increasingly complex processes for
selling products and servicing customers. For example, EDGE offers scripting to
support order-taking, cross-selling and up-selling, enables agents to track and
resolve customer service problems and facilitates the collection of valuable
customer information that can be disseminated on an enterprise-wide basis. The
Company's professional consulting, technical support and maintenance services
include application development, systems integration, systems and database
design and construction and software training. The Company believes that these
services significantly differentiate the Company from its competitors and
complement its products to provide a total solution for small, mid-size and
large-scale call centers.


                                       3
<PAGE>
 
THE IMA SOLUTION

The Company's  software  applications  and tools,  coupled with the  Company's
comprehensive  service offerings,  represent a total solution designed to enable
businesses to increase their productivity and revenue-generating capabilities by
improving  the   effectiveness  of  their  interaction  with  customers  through
telephone call centers.

The IMA solution incorporates five design tenets: functionality, flexibility,
integration, scalability and speed of deployment.

                                       4
<PAGE>
 
Functionality. Customer calls are often three to five minute events which, when
handled effectively, can have a dramatic impact on a business's ability to
acquire and retain customers. The Company's products are designed to enable the
user to more effectively manage the telephone conversation with the customer
before, during and after the call by automating numerous call center activities,
providing real-time access to customer information, and providing features such
as intelligent scripting, contact management, time management, work flow
management, voice/data management and other conversation management aids. In
addition, the Company's products provide comprehensive call center reporting
tools which enable managers and supervisors to efficiently and effectively
manage call center agents and marketing campaigns.

Flexibility. EDGE includes an integrated development environment that enables a
business to rapidly develop or change applications relating to specific sales,
marketing or service activities without disrupting live operations. EDGE allows
a call center manager to tailor scripts, screen displays and workflow processes.
TELEMAR and MSM are provided in source code suitable for customization by 
end-users to accomodate their specific needs. The ability to change applications
allows clients to adapt call center operations quickly in response to changing
business needs such as new product sales or marketing campaigns, special
customer service programs or crisis management events.

Integration. EDGE is designed to integrate seamlessly with other technologies to
improve call center productivity. With its component-based open architecture,
EDGE can be integrated with a wide variety of computer and telephony-based
technologies and products, including telephony devices (voice response units,
predictive dialers, automatic call distributors and private branch exchange
technology), relational databases, legacy systems, other third-party desktop
applications and facsimile technology. Focused on IBM's AS/400 hardware
platform; TELEMAR and MSM are compatible with the industry's leading software
and computer telephony integration technologies.

Scalability.   The  Company's  products  are  scalable  from  small  single-site
departmental networks to multi-site global implementations without significantly
increasing  the risk of system  degradation.  EDGE has been  deployed  in client
configurations consisting of more than 1,000 users handling over 1,000,000 calls
per month.

Speed of Deployment. EDGE's integrated development environment allows businesses
to rapidly develop and deploy call center customer interaction software
solutions on an enterprise-wide basis. The ability to swiftly develop and deploy
applications enables the Company's clients to implement sales, marketing and
service programs quickly in response to changes in the business environment.

PRODUCTS AND SERVICES

EDGE Suite of Products. EDGE is based on a distributed, multi-tier client/server
open architecture which allows for the distinct separation of presentation,
application and database layers. This architecture provides the system
performance and scalability that is critical for mid-size and large-scale call
centers and permits hardware, relational database and operating system
independence to preserve and leverage existing information technology
investments. EDGE currently supports Windows 95, Windows NT workstation clients,
a wide variety of server platforms, including Unix and Windows NT, as well as
database support for Oracle Sybase, Informix and Microsoft SQL Server.

                                       5
<PAGE>
 
EDGE contains numerous development and customization tools that enable the
customer to tailor its solution to meet its business needs, the most common of
these tools are:

  .  Intelligent    Scripting--Provides    dynamic   screen   presentation   and
     navigational  routing  based on defined business rules, historical customer
     data and other input derived from the customer conversation.

  .  Queue  Management--Provides  for  administration,  prioritization, security
     and   processing  of   user  and  system   workflow   activities   such  as
     calling   campaigns,   call   backs,  appointments,   to-do's,  incidents, 
     personal schedules and tasks.

  .  Telephony  Functions--Allows control of all telephone-related functions and
     interfaces  such as automatic call  distributors,  voice response units and
     predictive dialers through the application.

  .  Call List Processing--Provides importing, manipulation,  sorting, selecting
     and loading of calls into prioritized  lists, which can be managed by user,
     group, time of day and quota levels.

  .  Call Center Reporting--Provides  ongoing operational results for management
     analysis of call center  activity in a variety of categories,  including by
     agent, group, department, campaign, list and time period.

  .  Customer  Management--Allows  for  user-defined  searching,  selection  and
     modification  of customer  and company  information,  including  system and
     user-defined data.

                                       6
<PAGE>
 
The Company markets as the AdvantEDGE Application Suite a suite pre-packaged
specific applications that are commonly used by its customers. The AdvantEDGE
Application Suite includes:

  .  Account   Management--Supports   call  center   agents   during   free-form
     conversations   with  customers.   Critical  customer  information  such as
     contacts,  corporate  hierarchy  and  profiles is combined  with  corporate
     information  such as product,  lead source and  objection  handling  and is
     displayed in a timely manner.

  .  Marketing Management--Provides closed-loop lead tracking for users to
     manage leads and prospects through a sales qualification process by
     providing list import and segmentation facilities, lead profiling and
     scoring, results tracking and management reporting.

  .  Telesales/Order Entry--Provides graphical, interactive telephone sales and
     order capture utilizing intelligent prompts for objection handling, cross-
     selling, up-selling, product and service information, campaign based
     pricing and order and inventory file integration.

  .  Customer Service--Allows a user to track and resolve customer inquiries or
     cases in single call or multiple step resolution environments, providing
     closed looped case management with fast path entry, problem determination
     and resolution support, predefined workflows by type and category,
     escalation with proactive alerts and on-line status reports.

  .  Event and Seminar  Management--Allows a user to create, manage and maintain
     the  registration  of  attendees  of  an  event  or  seminar,  track  event
     information by occurrence, schedule, location and mileage proximity.

  .  Campaign Management--Provides full featured campaign cycle tracking that
     enables the management of campaigns through features that direct campaign
     strategy from initial contact through tracking and final outcome while
     enabling the monitoring and effectiveness of overall campaigns.

  .  Dynamic Scripting--Supplies efficient and effective scripting capabilities
     in a simple drag and drop environment, giving customers the tools to
     quickly create branched scripts in an intuitive flow chart presentation.

  .  Workflow--Provides a graphical user interface enabling the customer to
     automatically process cases through pre-defined and/or dynamic steps that
     must be completed before a case can be closed.

   The Company's customers increasingly demand more flexibility in the conduct
of their business, specifically, the Company's customers seek a "virtual" call
center where teleservices representatives have access to the same customer data
without necessarily being in the same location. In response to this demand, the
Company has developed and markets CyberEDGE. CyberEDGE brings real-time web
access to applications built with EDGE, allowing enterprises to build customer
interaction applications that support both Microsoft Windows and Internet
browsers. With CyberEDGE, customers have the ability to develop and deploy self-
service applications that can be used by a call center agent, another company
employee, or a consumer, via the Internet. Web self-service increases
satisfaction of the customer by reducing or eliminating the need to make a
telephone call, allowing customers to receive service in the manner and time
that is most convenient for them. For the call center, CyberEDGE provides the
ability to support remote agents or "virtual" call centers made up of
telecommuters linked to EDGE applications via the Internet or corporate
internets.

   TELEMAR and MSM Suite of Products. The Company's TELEMAR and MSM products
specifically support the AS/400 hardware platform and enable the customer to
automate critical areas within its organization that directly affect customer
relationships, such as sales, marketing, telemarketing, telesales, and customer
support. The Company's enterprise-wide approach permits access to centralized
customer data and allows all groups within an organization to handle accurate,
up to date prospect and customer information. For sales representatives working
remotely, the Company provides a seamless connection to this same data through
its TELEMAR Mobile and MSM Remote products.

   TELEMAR and MSM are architected to provide system performance and scalability
that is critical for small, mid-size and large-scale call centers. TELEMAR and 
MSM are compatible with the industry's leading software and computer telephony 
integration technology including multiple public branch exchanges and predictive
dialers. TELEMAR and MSM can also integrate with back-end systems to allow for 
a complete customer management solution.

   TELEMAR and MSM provide the following functionality: Account Management, Call
Center Automation, Campaign Management, Correspondence Management, Customer
Support, Field Sales Automation, Lead Generation, Literature Fulfillment,
Marketing Research Programs, Opportunity Management, Sales Management,
Telemarketing, Telesales and Territory Management.

PROFESSIONAL SERVICES

   The Company believes that its professional services are a significant
differentiating factor in its target markets and are an important component of
its software deployments. The Company provides consulting and maintenance,
customization and technical support services to its customers. The Company has
developed a comprehensive standard methodology to provide continuity from the
initial sale through the implementation of its applications. The Company's
professional services organization helps to develop and maintain long-term
customer relationships by applying specialized knowledge of industry needs,
business processes and technology to help provide the customer with a highly
functional and flexible solution. The Company's professional service department
works with strategic consulting and systems integration companies to identify
and provide services for large-scale service projects. The Company principally
relies on distributors and remarketers to provide consulting and client support
services to its international customers. As of December 31, 1998, the Company
employed 152 employees in its professional services organization. Services and
maintenance revenues as a percentage of total revenues were 50.4%, 47.4% and
49.3% in 1996, 1997 and 1998, respectively. The Company provides the following
services:

                                       7
<PAGE>
 
Consulting Services.  The Company provides a comprehensive range of professional
services for its customers  including project management,  business  consulting,
application  development,   implementation  and  integration  of  the  Company's
products with the customer's existing systems.  In addition,  the Company offers
training  programs  to meet the  specific  needs of its  customers.  The Company
maintains a large  consulting  services staff with  extensive  experience in the
implementation  and deployment of complex customer  interaction  solutions.  The
demand for the  Company's  consulting  services has  increased as the  Company's
product offerings have been accepted for large-scale  installations.  Consulting
services  fees are  determined on a time and expense basis and training fees are
generally charged on a per class or per student basis.

Maintenance  and  Technical  Support  Services.  The Company's  maintenance  and
technical  support  services staff  provides  clients with telephone and on-line
support of the Company's  products.  These support  services  include  access to
technical support via the Company's  telephone  help-desk,  customer support Web
site and e-mail. The Company offers several product support plans, including a 7
day/24  hour plan,  which are  generally  offered for an annual fee based upon a
percentage  of the license  fee. The Company also  provides its  customers  with
software upgrades,  account management  services,  technical  bulletins,  status
reports and ongoing  communication  regarding  new features  and products  under
development.

CUSTOMERS AND APPLICATIONS

As of December 31, 1998, the Company's software products were licensed to over
400 customers with more than 50,000 total users. In 1998, Texas Utilities
Services Inc. accounted for 12% of the Company's total revenue. In 1997, United
Parcel Service General Services Co. accounted for 10% of the Company's total
revenue. In 1996, no customer accounted for 10% or more of the Company's total
revenue.

SALES AND MARKETING

The Company markets its software and services in the United States through a
direct sales organization and through resellers. The Company's sales
representatives are focused by industry expertise and geographical location. To
support its sales efforts, the Company conducts marketing programs including
advertising, telemarketing, direct mail, seminars, public relations and trade
shows. As of December 31, 1998, the Company's sales and marketing organization
covering the United States consisted of 111 employees.

The Company's direct sales force employs a consultative sales process, working
closely with prospective customers to understand and define their needs and to
determine how those needs are best addressed by the Company's products as well
as complementary technology and services offered by strategic systems
integration and technology companies. In addition to pursuing sales
opportunities with new customers, the Company works closely with its existing
customer base to gain knowledge of their industries, and focuses on selling new
and enhanced products specifically tailored to such existing customers'
requirements, as well as licensing its products to additional users within a
customer. Because customer interaction software applications are highly visible
within an organization, the Company's sales efforts are generally directed to
the senior management of a customer.

                                       8
<PAGE>
 
The Company also works closely with strategic consulting software and systems
integration companies such as American Management Systems, Converse Information
Systems, Deloitte & Touche, FileNET, IBM, ICT Group and PriceWaterhouseCoopers
to increase market awareness and acceptance of the Company's products. The
Company has worked jointly with each of these companies by providing software
and services as part of a total customer software and systems project in which
the consulting or systems integration company also provides services, software
or hardware and may be responsible for the overall coordination of the project.

Through  these relationships   the   Company has been introduced to strategic
accounts,  which has led to increased  account  penetration and reduced sales
cycle length. A key part  of  the  Company's   strategy  is  to  expand  and
enhance  its  existing relationships  with  leading  consulting  and systems
integration  companies to capture additional market share.

The Company markets its software internationally in Europe, the Pacific Rim,
Canada, Mexico and Latin America through remarketing and distribution
relationships which it supplements with a direct sales force in certain regions.
The Company's principal remarketers and distributors include Aspect
Telecommunications Corporation (worldwide), Datapoint (U.K.) Limited (Europe),
TeleDynamics BV (Holland), NCR Corporation (France, Canada, Turkey and Southeast
Asia), Kawasaki Steel Systems R&D Corporation (Japan), Locus Corporation
(Korea), TKM Communications, Inc. (Canada), Communicacoes, Processamento e
Mecanismos de Automacao Ltda. (Brazil), Mitsucon Tecnologia S/A (Brazil) and
Sixtra Chile S.A.(Six Bell) (Chile). As of December 31, 1998, the Company had a
direct sales force consisting of 18 sales and marketing professionals in London,
England, Paris, France, Frankfurt, Germany and Melbourne, Australia offices, and
two sales professionals focused on Mexico and Latin America. The Company is
seeking to expand its existing international distribution network through its
indirect distribution channels and direct sales force in order to take advantage
of international growth opportunities.

PRODUCT DEVELOPMENT

The Company believes that to maintain its competitive  advantage it must enhance
existing applications,  introduce new products and features into the market on a
regular basis to keep pace with technological  advances,  meet changing customer
requirements  and respond to  competitors'  products.  To meet these goals,  the
Company has invested in developing a comprehensive  product  development process
to define and  evaluate  rigorous  requirements  for product  functionality  and
quality. The Company's research and development  engineers work closely with its
marketing and support personnel and its customers to design enhancements and new
products  to  assure  that  product  evolution  reflects   developments  in  the
marketplace and trends in client requirements.

The Company intends to continue its product research and development  efforts in
order to meet the complex and changing requirements of small, mid-size and 
large-scale call centers. The Company is making long-term investments to
enhance the componentization and object orientation of EDGE's underlying
architecture. The Company is utilizing emerging industry standards such as
Microsoft COM/DCOM, CORBA compliant object technology, Java language and
supporting Java technology. The Company believes that these investments will
provide a number of important benefits including the ability to migrate easily
to new components in the future in a "plug and play" mode, to shield business
objects and customer applications from the underlying technology infrastructure,
and to seamlessly integrate with other business applications that adhere to the
same standards.

                                       9
<PAGE>
 
The Company is also developing two new products that it intends to market in
1999: ChannelEDGE and BuyingEDGE.com.  The ChannelEDGE product will allow an
enterprise to manage all channels of entry into the enterprise, via the web, e-
mail, and telephone.  The ChannelEDGE product is targeted for beta and
availability in the second half of 1999.  BuyingEDGE.com is a consumer buying
system that can be accessed through the World Wide Web whereby consumers can
make requests for goods or services and manufacturers and service providers that
have subscribed to the BuyingEDGE.com service would be able to provide bids to
the consumer.  The Company intends to offer this product in the second half of
1999 after a pilot project in the second quarter of this year.

As of December 31, 1998, the Company's product development staff consisted of 70
employees.   In  addition,  the  Company  augments  its  internal  research  and
development  organization  with the services of an outside  consulting firm. The
Company's  total expenses for product  development  for the years ended December
31, 1996,  1997,  and 1998 were $6.4  million,  $6.2  million,  and $9.3 million
respectively,  and represented 24.3%, 16.9% and 18.9% of total revenues in these
periods,  respectively.  The  Company  expects  that it will  continue to commit
substantial resources to product development in the future.

COMPETITION

The market  for  telemarketing,  telesales  and  customer  service  software  is
intensely  competitive,  rapidly  evolving  and highly  sensitive to new product
introductions  or enhancements and marketing  efforts by industry  participants.
The Company  competes with a large number of  competitors  ranging from internal
information systems departments to packaged software  application  vendors.  The
Company  believes that as the United States and  international  software markets
continue  to grow,  a number of new vendors  will enter the market and  existing
competitors  and new  market  entrants  will  attempt  to  develop  applications
targeting additional markets.

Management  believes  that it competes in most of its markets  with the internal
information  systems  departments  of potential  customers who desire to develop
their own customer interaction  software  rather than acquire  software  from a
third-party vendor such as the Company.  The Company believes that the principal
software companies with which it competes are The Vantive  Corporation,  Clarify
Inc. and Siebel Systems, Inc. The Company also competes on occasion with systems
integration  firms.  Among the  Company's  current and potential competitors are
also a number of large hardware and software companies that may develop or
acquire  products that compete with the Company's  products. Competitors  have
established  and  may in  the  future  establish  cooperative relationships  or
alliances which may increase their ability to provide superior software
solutions or  services.  In  addition,  consolidation  within the call center
customer  interaction  software  industry  could  create new or stronger
competitors.  Increased  competition  resulting  from new entrants,  call center
customer interaction software industry consolidation,  cooperative relationships
or alliances could result in price reductions,  reduced operating income or loss
of market share,  any of which could  materially  adversely affect the Company's
business,  operating  results  or  financial  condition.  Many of the  Company's
current  and  potential   competitors  have  significantly   greater  financial,
technical,  marketing,  service,  support and other  resources,  generate higher
revenues  and have greater name  recognition  than the Company.  There can be no
assurance that the Company's  current or potential  competitors will not develop
products  comparable or superior to those  developed by it or adapt more quickly
than the  Company to new  technologies,  evolving  industry  trends or  changing

                                       10
<PAGE>
 
client requirements.  There can be no assurance that the Company will be able to
compete  effectively  against current or future  competitors or that competitive
pressures  faced by the Company would not  materially  and adversely  affect its
business, operating results or financial condition.

The Company  believes  that the  principal  competitive  factors in its industry
include  product  performance  and  functionality,  flexibility,  ease  of  use,
adherence to open  standards,  scalability,  ability to integrate  external data
sources,  speed of  deployment,  client  service,  customer  support  and price.
Although the Company believes that it currently  competes favorably with respect
to such factors,  there can be no assurance that it will be able to maintain its
competitive position against current and potential competitors, especially those
with  greater  financial,  technical,  marketing,  service,  support  and  other
resources than the Company,  or that  competitive  pressures will not materially
and adversely  affect the Company's  business,  operating  results and financial
condition.

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

The Company relies  primarily on a combination of copyright and trademark  laws,
trade secrets,  nondisclosure  agreements and technical  measures to protect its
proprietary rights. The Company typically enters into confidentiality or license
agreements with its employees,  distributors, clients and potential clients, and
limits  access to and  distribution  of its  software,  documentation  and other
proprietary  information.  There can be no  assurance  that these  steps will be
adequate to deter misappropriation or independent third-party development of its
technology  or to prevent an  unauthorized  third party from  obtaining or using
information  that the Company regards as proprietary.  In addition,  the laws of
some foreign countries do not protect or enforce  proprietary rights to the same
extent as do the laws of the United  States.  Policing  unauthorized  use of the
Company's  products is difficult  and,  while the Company is unable to determine
the extent to which piracy of its software products exists,  software piracy can
be expected  to be a  persistent  problem.  There can be no  assurance  that the
Company's  means of protecting its  proprietary  rights will be adequate or that
the Company's  competitors will not  independently  develop similar  technology.
Although the Company  believes that its products and  technology do not infringe
on any  existing  proprietary  rights of  others,  the use of patents to protect
software has  increased,  and there can be no assurance  that third parties will
not assert  infringement  claims in the future  or, if  infringement  claims are
asserted,  that such claims will be resolved in the Company's favor. The Company
expects  that  software  product  developers  will  increasingly  be  subject to
infringement  claims as the number of products and  competitors in the Company's
industry segment grows and the  functionality of products in different  industry
segments   overlaps.    Any  such  claims,  with  or  without  merit,  could  be
time-consuming,  result in costly  litigation,  cause product shipment delays or
require the Company to enter into royalty or licensing agreements.  Such royalty
or licensing agreements, if required, may not be available on terms favorable to
the  Company  or at all,  which  could  have a  material  adverse  effect on the
Company's business,  operating results and financial condition. Any infringement
claims  resolved  against the Company could have a material  adverse effect upon
the Company's business,  operating results and financial condition. In addition,
litigation may be necessary in the future to protect the Company's trade secrets
or other intellectual property rights, or to determine the validity and scope of
the proprietary  rights of others.  Such litigation  could result in substantial
costs and diversion of resources and could have a material adverse effect on the
Company's business, operating results and financial condition.

                                       11
<PAGE>
 
The Company has entered into  agreements  with a small  number of its  customers
requiring  the  Company  to  place  its  source  code in  escrow.  These  escrow
agreements typically provide that customers have a limited,  non-exclusive right
to use such  code in the  event  that  there is a  bankruptcy  proceeding  by or
against  the  Company,  if the  Company  ceases to do business or if the Company
fails to meet its support obligations.  The escrow agreements,  and any that the
Company  may  enter  into  in  the  future,  may  increase  the  possibility  of
misappropriation  by  third   parties.  In  addition,  the  Company  utilizes  a
third-party  contractor for selected product development projects which may also
increase the possibility of misappropriation by third parties.
 
 
REGULATORY ENVIRONMENT
 
Certain uses of outbound call processing systems are regulated by federal, state
and foreign  law. The Federal  Telephone  Consumer  Protection  Act required the
Federal  Communications  Commission to create regulations protecting residential
telephone subscribers from unwanted telephone solicitations. Certain states have
enacted  similar laws  limiting  access to telephone  subscribers  who object to
receiving  solicitations.  Although  compliance  with  these  laws may limit the
potential  use  of  the  Company's  products,  the  Company's  products  can  be
programmed  to  operate  in  compliance  with  these  laws  through  the  use of
appropriate calling lists and calling campaign time parameters.  There can be no
assurance,  however,  that  future  legislation  further  restricting  telephone
solicitation  practices,  if enacted,  would not materially adversely affect the
Company.
 
EMPLOYEES
 
As of December 31, 1998, the Company  employed 377  employees,  consisting of 70
employees  in  research  and development,  111 employees in sales and marketing,
123  employees  in  consulting services, 29 employees in client support services
and 44 employees in finance and administration.  Of these, 61 are located in the
United Kingdom, France, Germany and Australia and the  remainder  are located in
the United  States.  None  of  these   employees   is  covered by any collective
bargaining  agreements.  The  Company  believes  that  its relationship with its
employees is good.

ITEM 2.  PROPERTIES

The Company leases its corporate headquarters in Shelton, Connecticut, which
consists of approximately 25,000 square feet of office space. The lease for the
Shelton, Connecticut office has a term ending on March 31, 2004. In addition,
the Company maintains an office in Irvine, California with a lease for
approximately 26,000 square feet of office space. The Company has entered into a
Lease Cancellation Agreement in connection with its current Irvine, California
lease and entered into a new lease for approximately 44,000 square feet in
Irvine. The new lease expires April 30, 2006. In support of its direct sales and
service and support operations, the Company leases offices in three other
locations in the United States, as well as offices in London, England, Paris,
France, Frankfurt Germany and Melbourne Australia. These offices comprise
between 300 and 11,000 square feet each and have lease terms ending through
2006.

                                       12
<PAGE>
 
ITEM 3.  LEGAL PROCEEDINGS

ITEM 1: LEGAL PROCEEDINGS

(a)  In the Company's Form 10-Q for the quarter ended June 30, 1998, the
Company reported that Rockwell International Corporation, Rockwell
Semiconductor Systems, Inc. and Rockwell Telecommunications, Inc. (collectively,
"Rockwell") had filed a two count complaint against the Company.  (Rockwell
International Corporation, et al. v. Information Management Associates, Inc. 97
CH 809).  Rockwell's claims related to the Company's provision of a call center
solution to United States Cellular Corporation ("USCC").  Rockwell had obtained
a preliminary injunction preventing the Company from completing USCC's Call
Center Solution or doing other work for USCC.  Although the Company had
contested any wrongdoing and appealed the preliminary injunction decision, the
Company decided to settle the matter quickly to enable it to resume its
relationship with USCC which included USCC's exercise of its option to license
additional software from the Company during the quarter ended September 30, 1998
for a fee of $1.75 million. Under the terms of the settlement, the litigation
was dismissed and all claims by Rockwell relating to the Company's relationship
with USCC have been released. IMA agreed to pay Rockwell $1.75 million in four
installments over one year, of which $950,000 was paid during 1998.

(b)  On August 20, 1998, the Company filed a two count complaint against APAC
Teleservices, Inc. ("APAC") in the United States District Court for the Northern
District of Illinois asserting claims for breach of contract and unjust
enrichment for APAC's failure to pay $255,772 to the Company for professional
services rendered to APAC (Information Management Associates, Inc. v. APAC
Teleservices, Inc., 98C 5162) (the "Complaint" or the "Federal Action"). On
August 21, 1998, the Company filed a demand for arbitration with the American
Arbitration Association in Chicago, Illinois, asserting that APAC breached its
written agreement with the Company by failing to make payment of $575,983 for
software license and maintenance fees (Information Management Associates, Inc.
v. APAC Teleservices, Inc., No. 51 117 0036498) (the "Demand" or the
"Arbitration"). On October 8, 1998, APAC filed its answer to the Complaint,
denying that it owed the monies claimed by the Company. In connection with the
Demand, APAC also filed a counterclaim seeking an unspecified amount of damages
based on allegations that the Company's software and maintenance services were
deficient (hereinafter referred to as the "Counterclaim"). On October 30, 1998,
the Company responded to the Counterclaim, denying the material allegations,
further denying that APAC had suffered damages, and raising several affirmative
defenses. On November 10, 1998, APAC was granted leave to file a counterclaim in
the Federal Action. On December 9, 1998, APAC filed a counterclaim in the
Federal Action seeking in excess of $400,000 based upon its allegation that the
services performed by the Company were deficient (the "Federal Counterclaim").
The parties have consolidated the Arbitration and the Federal Action and both
matters are scheduled to be arbitrated in May, 1999.  The Company believes that
it will prevail in its claims set forth in the Complaint and the Demand. The
Company believes that APAC's Counterclaim and the Federal Counterclaim are 
without merit and intends to vigorously oppose both the Counterclaim and the
Federal Counterclaim. Nevertheless, the final outcome of any legal proceeding
is subject to a great many variables and cannot be predicted with any degree of
certainty. In the event that the Counterclaim and/or the Federal Counterclaim is
ultimately decided in favor of APAC, damages and associated cost could have a
material adverse effect on results of the Company's operations.

                                       13
<PAGE>
 
From time to time, the Company is involved in litigation in the normal course of
business  relating to claims arising out of its  operations.  The Company is not
currently involved in any litigation except as discussed above which, in
management's opinion,  would have a material  adverse  effect on its  business,
operating  results  or  financial condition.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of 1998.
 
ITEM 4A.  EXECUTIVE OFFICERS OF THE REGISTRANT
 
Name                       Age                  Position
--------------------------------------------------------------------------------
 
Albert R. Subbloie, Jr.    38  President, Chief Executive Officer
 
Gary R. Martino            38  Chairman of the Board, Chief Financial
                               Officer,
                               Treasurer and Assistant Secretary
 
Andrei Poludnewycz         39  Executive Vice President-Technology, Secretary
 
Paul G. Frederick          39  Senior Vice President-Professional Services
 
James E. Anderson          53  Vice President-Worldwide Sales
 
David G. Caldeira          42  Vice President-Products Division
 
Michael P. McGroarty       38  Vice President and General Counsel, Assistant
                               Secretary
 
Paul J. Schmidt            39  Vice President-Application Development
 
Kian Saneii                34  Vice President-Worldwide Marketing
 
Eric Montgomery            44  Vice President-Sales-North America
 
   Each officer serves at the  discretion of the Board of Directors.  There are
no family relationships among any of the executive officers of the Company.
 
   Mr.  Subbloie has been the  President  and  Chief  Executive  Officer  of the
Company since its  incorporation in 1990. Prior to incorporation of the Company,
Mr. Subbloie was a founding  partner of the Company's  predecessor,  Information
Management Associates (the "Partnership") with Messrs.  Martino and Poludnewycz,
which  engaged  in the  business  of  consulting  and  development  of  computer
software.  From 1982 to 1984,  Mr.  Subbloie  was employed  with the  consulting
division  of Arthur  Andersen LLP, a  professional   accounting  firm   ("Arthur
Andersen"), and specialized in distribution and manufacturing consulting.
 
   Mr. Martino has been an officer of the Company since its incorporation in
1990 and has served as Treasurer, Chief Financial Officer and Assistant
Secretary.  Prior to incorporation of the Company, Mr. Martino was also a
founder of the Partnership with Messrs. Subbloie and Poludnewycz. From 1982 to
1984, Mr. Martino was employed with the consulting division of Arthur Andersen
and specialized in financial application consulting.

                                       14
<PAGE>
 
   Mr.  Poludnewycz has been an officer of the Company since its incorporation
in 1990 and has served as Secretary of the Company  since its incorporation  in
1990 until January 1999 when he resigned his position of Executive Vice
President Secretary and Director. From 1992 to 1994, he served as Executive Vice
President-Products Division and  subsequently  served  as  Executive  Vice
President-Technology.  Prior  to incorporation  of the Company,  Mr.
Poludnewycz  was a founding  partner of the Partnership  with  Messrs.
Subbloie  and  Martino.  From  1982  to  1984,  Mr. Poludnewycz  was employed
with the  consulting  division of Arthur  Andersen and specialized  in
developing  computer  applications  for the  mid-range  hardware platforms of
IBM.

   Mr. Frederick has served as Senior Vice  President-Professional   Services of
the Company since 1995.  Prior to joining the Company,  he was employed from
1991 to 1995, most recently as associate partner, with a division of Andersen
Consulting LLP   ("Andersen   Consulting")   which   specialized  in  large
scale  systems integration.  Mr. Frederick's primary  responsibilities with
Andersen Consulting included project and practice management.

   Mr. Anderson was promoted to Vice President Worldwide Sales in November 1998,
with responsibility for all direct and channel sales worldwide through December
31, 1998.  Prior to that he served as Vice  President-Business  Development of
the Company from  1994  to  1995  and    as  Vice  President-International
Operations from 1996 - 1998.  From 1970 to 1994,  Mr.  Anderson was employed by
IBM as a software product  planning  manager,  a branch  sales  manager and the
Worldwide  Market Development Manager for IBM's CallPath product.

   Mr. Caldeira has been employed with the Company in several capacities since
its incorporation 1990. He served as Vice  President-Sales from 1990 to 1992 and
as Vice  President-Business  Development from 1992 to 1994. He has served in his
present  position of Vice  President-Products  Division from 1994 through
December 31, 1998.  Mr. Caldeira joined the  Partnership  in 1989 as a Regional
Sales  Manager and was  formerly employed as a Senior  Manager with the
consulting  division of Arthur  Andersen where he specialized in systems for
mid-size companies.

   Mr. McGroarty joined the Company in 1996 as Vice President and General
Counsel, and also served as an Assistant Secretary through December 31, 1998.
From 1990 to 1996, Mr. McGroarty was an attorney with the law firm of Fulbright
& Jaworski L.L.P.

   Mr. Schmidt has served as an officer of the Company since its incorporation
in 1990. From 1990 to 1994, he served as Vice  President-Client  Services.  From
1995 to 1997 he served as Vice President-Applied  Technologies and since 1997 he
has served as Vice  President-Application  Development.  From 1985 to 1990,  Mr.
Schmidt was employed as a Vice President at the  Partnership  and specialized in
client services.  From 1982 to 1985, Mr. Schmidt worked for Andersen  Consulting
and specialized in financial, distribution and manufacturing consulting.

   Mr.  Saneii has  served as Vice  President-Worldwide  Marketing  from   July
1997 through December 31, 1998.  Prior to  joining  the  Company,  Mr.  Saneii
was  employed  by  FileNet Corporation,  a business  process  automation  firm,
as Marketing  Manager from February  1996 to July 1997.  From February  1995 to
February  1996,  Mr. Saneii served  as  President  of  Business  Process
Innovation,   a  consulting  firm specializing in the application of imaging and
workflow technologies.  From 1987 to 1994, Mr. Saneii was Vice President,

                                       15
<PAGE>
 
Corporate Development at DIS Research, a systems integration firm specializing
in the application of imaging and workflow technologies.

   Mr.  Montgomery  has served as Vice  President-Sales, North America  since
December 1997. Prior to joining the  Company,  Mr.  Montgomery  was employed for
eight years by Hyperion   Software,   a  provider  of   enterprise   software
and   analytical applications, most recently as Senior Sales Director.


                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
Price Range of Common Stock
 
   Since  July 30,  1997,  the  Common  Stock has been  traded  on the  NASDAQ
National Market under the symbol "IMAA." There was no established public trading
market for the Common Stock prior to the Company's  initial  public  offering on
July 30, 1997.
 
   The high and low closing  sales prices of the Company's  common  stock,  as
reported on the NASDAQ National Market for each quarter since the Company's July
30, 1997 initial public offering, are as follows:
 
                                           Common Stock
                                           ------------
                                         High        Low
                                        ------      -----
 
 Fourth Quarter - 1998                $   7.625   $  3.50
 Third Quarter  - 1998                  10.0625     5.625
 Second Quarter - 1998                    14.00    9.6875
 First Quarter  - 1998                    14.00     9.125
 Fourth Quarter - 1997                    14.75     9.375
 Third Quarter  - 1997                    13.50     10.75
 Second Quarter - 1997                     N/A       N/A
 First Quarter  - 1997                     N/A       N/A
 
   The Company believes that there were approximately 101 holders of record for
the Common Stock at March 25, 1999. The Company believes that there are in 
excess of 400 beneficial holders of the Common Stock.
 
Dividend Policy
 
   The Company has never  declared or paid any cash dividends on its capital 
stock. The Company currently intends to retain earnings, if any, to support its
growth strategy and does not anticipate paying cash dividends in the foreseeable
future. Payment of future dividends, if any, will be at the discretion of the
Company's Board of Directors after taking into account various factors,
including the Company's financial condition, operating results, current and
anticipated cash needs and plans for expansion.  The credit agreement for the 
senior secured revolving credit facility of $7.5 million for which the Company 
has obtained a commitment from a bank and which the Company expects to enter 
into would prohibit the payment of cash dividends.  See Item 7.  Management's 
Discussion of Financial Condition and Results of Operations for a description of
the loan commitment. 

                                       16
<PAGE>
 
Use of Proceeds
 
On July 30, 1997,  the Company's  Registration Statement on Form S-1 (File No.
333-22923)  became effective.  The net proceeds  from the offering  were $32.4
million. The Company disclosed the use of proceeds through September 30, 1998 on
the Company's  Form  10-Q for the  period ending September 30, 1998. Except as
noted below, no information has changed with respect to the use
of proceeds. The following table sets forth use of offering proceeds from the
effective date (July 30, 1997) through December 31, 1998:

      Repayment of indebtedness    $ 7,400,000
      Working capital               10,200,000
      One time settlement charge     2,200,000
      Acquisition of Equipment       2,900,000
      Minority Investment            1,700,000
      Acquisition of MIS & TSI       1,600,000
                                   -----------
      Total                        $26,000,000
                                   ===========

                                       17
<PAGE>
 
The Company used $250,000 of the net offering  proceeds to repay in full a note
payable to Wand/IMA  Investments, L.P., a beneficial owner of more than the ten
percent of the issued and outstanding shares of common stock of the Company.
 
ITEM 6.  SELECTED FINANCIAL DATA
                                          Year Ended December 31
                                  1994      1995      1996      1997      1998
                                  (in thousands, except per share data)
Consolidated Statements of
Operations:
Revenues:
     License fees                 7,393    10,825    13,022    19,295    24,903
     Total Services
         and maintenance         10,959    12,984    13,255    17,377    24,190
                                -------   -------   -------   -------  --------
            Total revenues       18,352    23,809    26,277    36,672    49,093

   Cost of revenues:
     License fees                   462       700       709       304       356
     Services and
     maintenance                  6,268     8,225     7,191     9,428    17,420
                                -------   -------   -------   -------  --------
         Total cost of            6,730     8,925     7,900     9,732    17,776
                                -------   -------   -------   -------  --------
            revenues
   Gross profit                  11,622    14,884    18,377    26,940    31,317

   Operating expenses:
     Sales and marketing          5,857     6,844     8,055    12,580    21,419
     Product development          6,106     6,802     6,382     6,190     9,266
     General and                                                                
       administrative             2,693     3,824     3,878     4,784    12,120 
     Acquired product                                                           
       development costs              -         -         -         -     6,988 
     One time settlement
       charges                        -         -         -         -     2,163
     Total operating                                                            
       expenses                  14,656    17,470    18,315    23,554    51,956 
   Operating income (loss)       (3,034)   (2,586)       62     3,386   (20,639)
   Other income (expense)          (917)   (1,100)   (1,079)       18       810
                                -------   -------   -------   -------  --------
   Income (loss) before          
     provision for income taxes  (3,951)   (3,686)   (1,017)    3,404   (19,829)
   Provision for income taxes       132       100        30       231       470
                                -------   -------   -------   -------  --------
   Net income (loss)                                                            
     per share                  $(4,083)  $(3,786)  $(1,047)  $ 3,173  $(20,299)
                                =======   =======   =======   =======  ======== 

       Basic                    $ (1.14)  $ (1.18)  $  (.44)  $   .43  $  (2.12)
                                =======   =======   =======   =======  ========
       Diluted                  $ (1.14)  $ (1.18)  $  (.44)  $   .38  $  (2.12)
                                =======   =======   =======   =======  ========
 

                                       18
<PAGE>
 
                                                December 31
                                   1994      1995      1996       1997     1998
                                               (in thousands)

Consolidated Balance Sheet
  Data:
   Cash and cash equivalents    $   446   $ 1,543   $ 3,073   $  4,816  $ 8,558
   Working capital                                                              
     (deficit)                   (3,619)   (1,233)    1,210     34,213   14,295 
   Total assets                  12,150    12,519    17,281     43,922   37,238
   Short-term debt                5,499     3,871     5,444        232       73
   Long-term debt                 1,423     3,042     2,803        136       58
   Senior redeemable                                                            
     convertible preferred
     stock                            -     4,751     9,431          -        - 
   Redeemable common stock                                                      
     warrants                     1,517     2,480     2,865          -        - 
   Total shareholders'                                                          
     equity (deficit)            (4,200)   (9,295)  (10,906)    37,030   20,922 

Results of Operations

The following table sets forth the percentage of total revenues for certain
items in the Company's  consolidated  statement of operations data for the years
ended December 31, 1996, 1997 and 1998.

                                                      Year Ended December 31
                                                    1996       1997       1998
 
Consolidated Statement of Operations Data:
  Revenues:
    License fees:                                   49.6%       52.6%     50.7%
    Services and maintenance:                       50.4        47.4      49.3
                                                   -----       -----     -----
                Total revenues                     100.0       100.0     100.0
                                                   -----       -----     -----
  Cost of revenues:
    License fees                                     2.7         0.8       0.7
    Services and maintenance                        27.4        25.7      35.5
                                                   -----       -----     -----
                Total cost of revenues              30.1        26.5      36.2
                                                   -----       -----     -----
  Gross profit                                      69.9        73.5      63.8
                                                   -----       -----     -----
 
  Operating expenses:
    Sales and marketing                             30.7        34.3      43.6
    Product development                             24.3        16.9      18.9
    General and administrative                      14.8        13.0      24.7
    Acquired product development costs                 -           -      14.2
    One time settlement charges                        -           -       4.4
                                                   -----       -----     -----
                Total operating expenses            69.8        64.2     105.8
                                                   -----       -----     -----
  Operating income (loss)                            0.1         9.3     (42.0)
  Other income (expense)                            (4.1)          -       1.6
                                                   -----       -----     -----
  Income (loss) before provision for income taxes   (4.0)        9.3     (40.4)
  Provision for income taxes                           -         0.6       1.0
  Net income (loss)                                 (4.0)%       8.7%    (41.4)%
                                                   =====       =====     ===== 

                                       19
<PAGE>
 
The following  table sets forth for each component of revenue,  the cost of such
revenue expressed as a percentage of such revenue for the periods indicated.


                                              Year Ended December 31
                                              1996     1997     1998

Cost of license fees                           5.4%     1.6%    1.4%
Cost of service and maintenance:              54.3%    54.3%   72.0%

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS
 
The following  Management's  Discussion and Analysis of Financial  Condition and
Results  of  Operations  should  be read in  conjunction  with the  Consolidated
Financial Statements and the Notes thereto included elsewhere in this Form 10-K.
The following discussion contains  forward-looking  statements and the Company's
actual results could differ  materially from those anticipated in these forward-
looking  statements as a result of certain  factors,  including  those set forth
under "Factors That May Affect Future Results".
 
OVERVIEW
 
The  Company  develops,  markets  and  supports  customer  interaction  software
designed to increase the  productivity  and  revenue-generating  capabilities of
mid-size and large-scale telephone call centers.

The Company generates revenues from licensing the rights to use its software
products directly to end users and indirectly through sublicense fees from
resellers.  The Company also generates revenues from sales of software
maintenance contracts, and from consulting and training services performed for
customers who license its products. As of January 1, 1998, the Company adopted
Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), which was
effective for transactions that the Company entered into after December 31,
1997. The adoption of SOP 97-2 did not have a material adverse affect on the
revenues or earnings of the Company for the year ended December 31, 1998.

Revenues from software license agreements are recognized upon the delivery of
the software to the customer if there are no significant post-delivery
obligations and collection is probable.  Service revenues consist of
professional consulting, implementation and training services performed on a
time-and-materials basis under separate service arrangements related to the
implementation of the Company's software products.  Revenues from consulting and
training services are recognized as services are performed.  The Company enters
into transactions which include both license and service elements.  As such
service elements do not include more than minor alteration of the software, the
license fees are recognized upon delivery and the service revenues are
recognized when performed.

Software maintenance fees are recognized ratably over the term of the
maintenance period.  If software maintenance fees are provided for in the
license fee or at a discount in a license agreement, a portion of the license
fee equal to the fair market value of these amounts is allocated to software
maintenance revenue based on the value established by independent sales of such
maintenance service to customers.

                                       20
<PAGE>

The Company markets its products in the United States through a direct sales
organization and certain resellers. The Company markets its products outside the
United States in Europe, the Pacific Rim, Canada, Mexico and Latin America
through remarketing and distribution relationships which it supplements with a
direct sales force in certain regions. The Company maintains offices in the
United Kingdom, France, Germany and Australia to support its international sales
and service activities. In 1998, United States and international revenues were
approximately 64% and 36% of total revenues, respectively.
 
Although the Company has experienced significant growth in revenues during the
past three years, the Company does not believe prior growth is necessarily
indicative of future operating results. In addition, the Company expects
increased competition and intends to continue to invest in its business. There
can be no assurance that the Company will be profitable on a quarterly or annual
basis. Future operating results will depend on many factors, including demand
for the Company's products, the level of product competition, competitor
pricing, the size and timing of significant orders, changes in pricing policies
by the Company or its competitors, the ability of the Company to develop,
introduce and market new products on a timely basis and changes in levels of
operating expenses.

RESULTS OF OPERATION

Year Ended December 31, 1997 Compared to Year Ended December 31, 1998

Revenues

Total revenues increased 33.9% from $36.7 million in 1997 to $49.1 million in
1998.

   License Fees. License fee revenues consist of revenues from initial licenses
for the Company's software products and license upgrades to existing customers
for additional users or modules. Total license fees increased 29.1% from $19.3
million, or 52.6% of total revenues, in the year ended December 31, 1997 to
$24.9 million, or 50.7% of total revenues, in the year ended December 31, 1998.
The increase in license fees was primarily attributable to an increase in the
number of licenses sold. International license revenue increased approximately
$3.6 million or 56.9% from $6.3 million in 1997 to $9.9 million in 1998. The
Company also generated license fees in 1998 from the products acquired in the
Acquisitions, from which there were no revenues in 1997.

   Services and Maintenance.  Services and maintenance revenues derive from
professional services associated with the implementation and deployment of the
Company's software products and maintenance fees for ongoing customer support.
Services and maintenance revenues increased 39.2% from $17.4 million, or 47.4%
of total revenues, in the year ended December 31, 1997 to $24.2 million, or
49.3% of total revenues, in the year ended December 31, 1998. The increase in
services and maintenance was attributable to the increase in software licenses,
the significant new service revenue attributable to several new major customers
such as Texas Utilities Services Inc., Lloyds TSB Bank and Dai Tokyo Royal
Insurance and continuing professional service work from existing customers such
as United Parcel Service General Services Co., and Humana Inc.

                                       21
<PAGE>
 
Cost of Revenues

   Cost of License Fees. Cost of license fees consists primarily of the costs of
media packaging, documentation, third-party software and software production
personnel. Cost of license fees increased 17.1% from $304,000 or 1.6% of the
related license revenues, in the year ended December 31, 1997 to $356,000, or
1.4% of the related license revenues, in the year ended December 31, 1998. The
fluctuations in the cost of license fees is primarily attributable to the
increase in the amount of third-party products resold by the Company due to the
increase in license fees.

   Cost of Services and Maintenance. Cost of services and maintenance consists
primarily of salaries, bonuses, benefits, third party consulting costs and other
costs related to the installation, implementation, training and maintenance
support of the Company's software products. The cost of services and maintenance
increased 84.8% from $9.4 million, or 54.3% of service and maintenance revenues,
in the year ended December 31, 1997 to $17.4 million, or 72% of service and
maintenance revenues, in the year ended December 31, 1998. The increases in the
dollar amount of costs of services and maintenance and the amount of these costs
as a percentage of revenues were primarily attributable to an increase in third
party consulting costs which are, in certain instances, billed to the customer
on a pass through basis and increases in salary, benefits and overhead related
to the hiring of new client services staff. The increase in third party
consulting costs resulted primarily from the Company's efforts to work more
cooperatively with these third party consultants with the expectation that these
vendors would provide the Company with leads and introductions into larger
software transactions.

Operating Expenses

   Sales and Marketing. Sales and marketing expenses consist primarily of
commissions, salaries, bonuses and other related expenses for sales and
marketing personnel, as well as marketing, advertising and promotional expenses.
Sales and marketing expenses increased 70.3% from $12.6 million, or 34.3% of
revenues, in the year ended December 31, 1997 to $21.4 million, or 43.6% of
revenues, in the year ended December 31, 1998. The increase in sales and
marketing expenses was primarily related to the hiring of 40 additional sales
and marketing personnel, increased commissions as a result of higher license
revenues, increased use of outside third party consultants for sales and
marketing efforts and increased marketing activities, including advertising,
trade shows and promotional expenses. The Company may expand its sales and
marketing staff over the next twelve months. 

   Product Development. Product development expenses consist primarily of
salaries, bonuses, other related personnel expenses and consulting fees, as well
as the cost of facilities and equipment. Product development expenses increased
49.7% from $6.2 million, or 16.9% of revenues, in the year ended December 31,
1997 to $9.3 million, or 18.9% of revenues, in the year ended December 31, 1998.
The increase in product development expense was primarily due to an increase in
salaries and benefits related to the hiring of new software development staff,
an increase in third party consulting expense, the continuing development of the
Company's software products, including spending on the Company's new ChannelEDGE
and BuyingEDGE.com, and further development efforts resulting from the 
in-process development projects acquired from MIS and TSI. Both new hires and
third party outside consultants are working on new product development.

                                       22
<PAGE>
 
   

   General and Administrative. General and administrative expenses represent the
costs of executive, finance and administrative support personnel, the portion of
occupancy expenses all allocable to administration, unallocated corporate
expenses such as fees for legal and auditing services and bad debt expense.
General and administrative expenses increased 153.3% from $4.8 million, or 13.0%
of revenues, in the year ended December 31, 1997 to $12.1 million, or 24.7% of
revenues, in the year ended December 31, 1998. The primary reason for the
increase in general and administrative expenses in the year ended December 31,
1998 was the increase in bad debt reserves of $6.5 million following a
comprehensive review of accounts receivable. This review took into account
continued financial weakness among teleservices outsourcing customers, the
Company's rapid growth in revenues and corresponding growth in accounts
receivable as well as certain economic uncertainties in markets in which the
Company operates, including South America, Asia Pacific. Approximately 80% of
the accounts receivable reserve increase in 1998 was attributable to
teleservices outsourcing customers. The Company has implemented stricter credit
requirements for customers in this industry.

   Acquired Product Development Costs. Acquired product development costs
resulted from the March 30, 1998 acquisitions of the assets of Marketing 
Information Systems, Inc. ("MIS") and Telemar Software International LLC
("TSI"). There was no similar acquisition activity for the year ended December
31, 1997. In connection with the acquisitions of MIS and TSI, the Company
allocated $7.0 million of the purchase price to in process research and
development ("R&D") projects. This allocation represented the estimated fair
value at the date of acquisition based on risk-adjusted cash flows related to
the incomplete products. At the acquisition date, the development of these
projects had not yet reached technological feasibility and the R&D in progress
had no alternative future uses. Accordingly, these costs were expensed as of the
acquisition date.

   The values assigned to these assets were determined by identifying
significant research projects for which technological feasibility had not been
established, including development, engineering and testing activities
associated with the creation of SalesPath, a new product under development by
MIS, and new releases of MSM and Telemar, which were telemarketing products
marketed by MIS and TSI, respectively. Valuation of development efforts in the
future was excluded from the analysis.

   The nature of the efforts to develop the acquired in-process technology
into commercially viable products relate to the completion of all planning,
designing, prototyping, and testing activities that are necessary to establish
that the proposed technologies meet their design specifications including
functional, technical, and economic performance requirements.

   The value assigned to purchased in-process technology was determined by
estimating the contribution of the purchased in-process technology in developing
commercially viable products, estimating the resulting net cash flows from the
expected product sales of such products, and discounting the net cash flows to
their present value using a risk-adjusted discount rate.

                                       23
<PAGE>
 
   Long-term revenue growth was deemed to be reasonable compared to growth
estimates of guideline companies in the same or similar industries facing
similar market risks.  An examination of seven guideline companies indicated
that growth estimates ranged from 29% to 53% with an average long-term growth
estimate of 39%.  The estimated revenue growth rates for MIS and TSI used in
determining the values of the in-process technologies were 38% and 44%,
respectively.  These growth estimates were considered reasonable taking into
consideration the level of sales of the companies in 1997, $4 million and $2.4
million for MIS and TSI, respectively.

   Selling, general and administrative expenses and profitability estimates
were determined based on historical indications, anticipated business changes in
the near term, as well as an analysis of the guideline companies.

   The rates utilized to discount the net cash flows to their present value
were based on cost of capital calculations and several studies of investment
rates of return.  Due to the nature of the forecast and the risks associated
with the projected growth, profitability and developmental projects, a discount
rate of 30% was appropriate for the business enterprises of both MIS and TSI,
25% for the existing products and technology, and 32.5 to 35% for the in-process
R&D. Because the in-process projects were such an integral part of each business
enterprise, only a moderate increase in the discount rate for the in-process
technology was deemed appropriate.

   These discount rates were commensurate with MIS' and TSI's market positions,
the uncertainties in the economic estimates described above, the inherent
uncertainty surrounding the successful development of the purchased in-process
technology, the useful life of such technology, the profitability levels of such
technology, and the uncertainty of technological advances that were unknown at
the time of acquisition.

   Selection of an appropriate discount rate for each project was based on
perceived risk related to each individual project taking into consideration the
nature of the R&D effort and the stage of development. The risk of MIS achieving
the revenue from SalesPath was deemed higher than the risk of achieving revenue
from in-process releases of MSM since the MSM in-process releases were based on
an existing product. While SalesPath inherently had a higher technical risk
since it was a completely new platform, at the date of acquisition the Company
believed that this risk was lessened by the market's move away from an AS/400
based product. Further, at the date of acquisition, SalesPath had been estimated
to be greater than 80% complete, which decreased the risk of not completing the
project successfully.

   The Company believes that the foregoing assumptions used in the forecasts
were reasonable at the time of the acquisition.  No assurance can be given,
however, that the underlying assumptions used to estimate expected project
sales, development costs or profitability, or the events associated with such
projects, will transpire as estimated.  For these reasons, actual results may
vary from the projected results.

   MIS' and TSI's in-process research and development value is comprised of two
individual on-going projects for each company. Completion dates for the projects
in progress were anticipated to occur over the two years after the acquisition
at which dates the Company expected to begin generating the economic benefits
from the technologies. Funding for such projects was expected to be obtained
from internally generated sources.


                                       24
<PAGE>
 
   As of December 31, 1998, development of the new releases of the Telemar
product were approximately on schedule with Telemar 6.1 having been released in
November 1998. 1998 revenues from the Telemar suite of products were not
materially different from the forecast revenues.

   As of December 31, 1998, development of the new version of the MSM product
was approximately on schedule with MSM 400 having been released in September
1998. 1998 revenues from the MSM suite of products were significantly lower than
had been forecast in the valuation model.
 
   The Company believes that the acquired SalesPath technologies are of no 
material value. Although these technologies were believed to be valuable at the 
time of acquisition, following the acquisition, the Company discontinued the 
development of SalesPath as a stand-alone product for several reasons, including
increased demand by the Company's customers for more integrated customer 
interaction software and increases in the projected time and expense to complete
development of SalesPath on a stand-alone basis. Primarily for these reasons, 
the Company instead elected to pursue development of a sales force automation 
component as part of its EDGE suite of products. Although the Company will 
incorporate certain concept and design elements of the SalesPath technologies 
into its EDGE sales force automation product, these elements are not believed to
have significant value because they will not materially reduce development time 
or expense. See Note 3 to the Financial Statements.

   Research and development expenses allocable to the in-process projects
related to the new releases of Telemar and MSM were not materially different
than forecast. Research and development expenses prior to the decision to
discontinue development were also not materially different than forecast.
Research and development for SalesPath as a stand-alone product were
discontinued in early August 1998.

   If Telemar and MSM 400 projects are unsuccessful, the sales and profitability
of the Company may be adversely affected in future periods. Commercial results
will be subject to uncertain market events and risks, which are beyond the
Company's control, such as trends in technology, government regulations, market
size and growth, and product introduction or other actions by competitors.

   One Time Settlement Charge.  The one time settlement charge reflects the
total cost of the settlement of litigation against the Company by Rockwell
International Corporation, including the payment of $1.75 million to Rockwell
and approximately $413,000 in legal fees, court costs, disbursements and
expenses. This one time settlement charge represented 4.4% of revenues for the
year ended December 31, 1998.

   Other Income (Expense).  Other income (expense) was $18,000 for the year
ended December 31, 1997 compared to $810,000 for the year ended December
31, 1998. Other income (expense) consists primarily of interest earned
on short-term investments less interest expense on debt and equipment financing.
Interest income increased by $198,000 from $641,000 in the year ended
December 31, 1997 to $839,000 in the year ended December 31, 1998 while
interest expense decreased by $688,000 from $723,000 in the year ended
December 31, 1997 to $35,000 in the year ended December 31, 1998.

                                       25
<PAGE>
 
   Provision For Income Taxes. Provision for income taxes consists of foreign
and state income and withholding taxes. The provision for income taxes increased
from $231,000 in the year ended December 31, 1997 to $470,000 in year ended
December 31, 1998. At December 31, 1998, the Company had approximately $13.0
million of U.S. Federal net operating loss carryforwards, of which approximately
$4.1 million resulted from the exercise of non-qualified stock options, and
approximately $4.0 million of state net operating loss carryforwards which can
be used, subject to certain limitations, to offset future taxable income, if
any. When realized, the tax benefits of the portion of the net operating losses
attributed to the exercise of stock options will be credited directly to paid in
capital. The U.S. Federal net operating loss carryforwards expire through 2018
and the State net operating loss carryforwards expire through 2003.

   In addition, the Company has United Kingdom net operating loss carryforwards
of approximately $3.5 million, which can be utilized to offset future taxable
income and which have no expiration.

   The Company has recorded a full valuation allowance against its deferred tax
assets, including those resulting from net operating loss carryforwards, as a
result of uncertainties regarding the realization of the asset.  Such
uncertainties result from cumulative losses in recent years and the lack of a
sufficiently quantifiable backlog given the Company's selling cycle and the
industry in which the Company operates.  As the future realization of deferred
tax assets is primarily contingent upon the Company's ability to generate future
taxable income, and given the limited history of generating such taxable income,
the Company does not believe it appropriate to recognize a net deferred tax
asset based on forecasted operating results.

   The IPO resulted in a change of ownership, as defined by Federal income tax
laws and regulations. As a result of this change in ownership, the amount of
U.S. Federal net operating loss carryforwards generated prior to the IPO which
can be utilized to offset Federal taxable income has an annual limitation of
approximately $4.7 million.

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1997
 
Revenues
 
Total revenues increased 39.6% from $26.3 million in 1996 to $36.7 million in
1997.
 
License Fees. Total license fees increased 48.2% from $13.0 million, or 49.6% of
total revenues in 1996 to $19.3 million, or 52.6% of total revenues in 1997.
EDGE license fees increased 58.4% from $12.2 million in 1996 to $19.3 million in
1997. The increase in EDGE license fees was primarily attributable to increases
in both the number of license transactions and the average price per customer
license, which the Company believes was primarily the result of greater market
awareness and acceptance of the EDGE products and expansion of the Company's
sales and marketing organization. Telemar license fees decreased from $842,000
in 1996 to $0 in 1997 due to the sale of the Telemar product line to TSI in
September 1996.
 
Services and Maintenance. Services and maintenance revenues increased 31.1% from
$13.3 million,  or 50.4% of total revenues in 1996 to $17.4 million, or 47.4% of
total revenues in 1997. EDGE services and maintenance  revenues increased 49.2%
from  $11.6  million  in 1996 to $17.4  million in 1997.  The  increase  in EDGE

                                       26
<PAGE>
 
services and maintenance revenues was primarily attributable to increased demand
for services  and maintenance  and the significant  increase in EDGE  software
licenses in 1997. Telemar services and maintenance revenues decreased from $1.6
million  in 1996 to $0 in 1997 due to the sale of the  Telemar  product line in
September 1996.
 
Cost of Revenues
 
Cost of revenues increased  23.2% from $7.9  million in 1996 to $9.7 million in
1997.
 
Cost of License  Fees. Cost of license  fees is comprised of the costs of media
packaging, documentation, third  party  software  and  software  production
personnel.  Cost of license fees decreased 57.1% from $709,000, or 5.4% of total
license fees in 1996 to 304,000,  or 1.6% of total  license fees in 1997. The
higher  cost of  license fees in 1996  was attributable  to the cost of other
vendors'  products  resold by the Company in connection with the Telemar product
line.
 
Cost of Services and Maintenance.  The cost of services and maintenance consists
of  salaries,  wages, benefits  and  other  costs  related  to installation,
implementation, training, and  maintenance  support of the Company's  software
products.  The cost of services  and maintenance  increased 31.1%  from $7.2
million, or 54.3% of services and maintenance revenues in 1996 to $9.4 million,
or 54.3% of services and maintenance  revenues in 1997. The increase in cost of
services and  maintenance was primarily attributable  to additional  personnel
hired to meet customer needs for services.
 
Operating Expenses
 
Sales  and  Marketing. Sales  and  marketing  expenses  consist primarily  of
commissions,  salaries, bonuses  and  other related  expenses  for sales  and
marketing personnel, as well as marketing, advertising and promotional expenses.
Sales and marketing expenses  increased 56.2% from $8.1  million, or 30.7% of
total  revenues in 1996 to $12.6  million,  or 34.3% of total  revenues in 1997.
This increase was primarily  attributable to the hiring of additional  sales and
marketing  personnel, increased print advertisements, participation  in trade
shows, travel expenses and other sales and marketing expenses.
 
Product Development. Product development expenses consist primarily of salaries,
bonuses,  other related personnel  expenses and consulting fees, as well as the
cost of  facilities  and equipment.  Costs related to product  development are
expensed as incurred. Product  development expenses  decreased  3.0% from $6.4
million,  or 24.3% of total revenues in 1996 to $6.2 million,  or 16.9% of total
revenues  in  1997. However,  product development  expenses related  to  EDGE
increased  16.5%  from $5.3  million to $6.2 million.  The  reduction in total
product development expenses was attributable to the sale of the Telemar product
line in September 1996, after which no Telemar product development expenses were
incurred.
 
General and Administrative.  General and administrative expenses represent the
costs of executive, finance and administrative support personnel, the portion of
occupancy expenses allocable to administration, unallocated  corporate expenses
such as fees for legal and auditing services and bad debt expense. The Company's
general and administrative expenses increased 23.4% from $3.9 million, or 14.8%
of total  revenues in 1996 to $4.8 million,  or 13.0% of total revenues in 1997.
This increase was generally attributable to increases in general and

                                       27
<PAGE>
 
administrative costs associated with higher business volume, including the
hiring of administrative personnel, the leasing of additional office space,
higher legal and accounting expenses and an increase in the Company's accounts
receivable reserve.
 
Other Income
 
Interest Expense. Interest expense consists of interest on debt and equipment
financing less interest earned on cash, short term investments, notes receivable
from officers and the promissory note entered into in connection with the sale
of Telemar. Net interest expense decreased 93.0% from $1.2 million in 1996 to
$82,000 in 1997 primarily as a result of the completion of the Company's initial
public offering of Common Stock in August 1997, the repayment of all of the
Company's outstanding indebtedness with the proceeds of the offering and the
investment of the remaining proceeds in interest bearing securities. Interest
income was $641,000 and interest expense was $723,000 in 1997.
 
Other
 
In connection with the sale of Telemar, the Company received a promissory note
from TSI in the principal amount of $650,000 (the "TSI Note") payable in five
equal annual installments commencing October 1997 and which bears interest at
8.0% per annum. At the time of issuance, the Company fully reserved for the TSI
Note because collectibility, based on the start-up nature of TSI operations, was
not ascertainable at the time of sale. This note was paid off in connection with
the aquisition of TSI by the Company in March 1998. The Company had other income
of $100,000 in 1997 due to the receipt of a payment of $100,000 on the
promissory note received in connection with the sale of Telemar, compared with
other income of $92,000 in 1996, which was attributable to a gain on the sale of
Telemar assets.
 
Provision for Income Taxes. The increase in provision for income taxes is
primarily attributable to an increase in international withholding taxes. At
December 31, 1997, the Company had approximately 8.6 million of U.S. Federal net
operating loss carryforwards of which approximately 3.4 million resulted from
the exercise of nonqualified stock options, and approximately $2.5 million of
state net operating loss carryforwards.

Liquidity and Capital Resources

   At December 31, 1998, the Company had $11.6 million in cash and cash
equivalents and $16.5 million in accounts receivable. For the year ended
December 31, 1998, the Company used net cash of $7.5 million from operating
activities. The net cash of $7.5 million used in operations resulted primarily
from the net loss of $20.3 million, offset by the $7.0 million non-cash charge
for acquired product development costs related to the acquisitions of MIS and

                                       28
<PAGE>
 
TSI, depreciation and amortization of $1.8 million and an increase of $3.1
million in accounts payable and accrued liabilities and reduced by an increase
of $975,000 in accounts receivable. The fluctuations in operating assets and
liabilities were primarily due to increases in accounts receivable reserves by 
approximately $6.5 million in 1998, the timing of orders, collections of
accounts receivable and the payment of accounts payable.

   For the year ended December 31, 1998, the Company's primary investing
activities consisted of net proceeds from short term investments of
approximately $16.4, use of $2.3 million for purchases of computer and
office equipment to support the Company's expanding employee base, use of $1.7
million related to a minority equity investment and $1.6 million of cash paid in
connection with the acquisitions of MIS and TSI and related deal costs.

   For the year ended December 31, 1998, the Company's primary financing
activities consisted of the exercise of employee stock options which provided
cash proceeds of $665,000.

   In March 1999, the Company obtained a commitment from a commercial bank to
provide a $7.5 million senior secured revolving credit facility bearing interest
at a floating rate based on several rate alternatives (the "Credit Facility").
Borrowings will be limited to the lesser of $7.5 million or 80% of eligible
accounts receivable. The Credit Facility will mature two years after the closing
date and will be secured by all of the Company's assets. The Credit Facility
will contain certain affirmative and negative financial covenants. The closing
of the Credit Facility is subject to execution of a definitive credit agreement
and other customary conditions. The Company expects to formalize the Credit 
Facility with the bank in April 1999.

   The Company anticipates that its current cash and cash equivalents together
with cash provided by operations and borrowings under the Credit Facility will
be sufficient to meet the Company's projected working capital and other cash
requirements for the foreseeable future but there can be no assurance that the
Company will be able to generate sufficient cash to meet its requirements from
these sources. The Company's future operating and capital requirements will
depend on numerous factors, including the collection of accounts receivable, the
level of resources the Company devotes to marketing and sales activities and
internal research and development programs, advances in technology, the
successful development and introduction of new products and any acquisitions or
strategic alliances or investments which the Company may consider. In the event
that the Company were unable to meet its needs for cash from the sources
described above, the Company would need to obtain equity or debt financing or
reduce its operating expenses and capital expenditures. There can be no
assurance that equity or debt financing would be available to the Company on
favorable terms.


                                       29
<PAGE>
 

Year 2000 Compliance

   The following Year 2000 discussion contains various forward-looking
statements which represent the Company's beliefs or expectations regarding
future events.  When used in the Year 2000 discussion, the words "believe",
"expects", "estimates" and other similar expressions are intended to identify
forward-looking statements.  Forward-looking statements include, without
limitation, the Company's expectations as to when it and its significant
distributors, customers and suppliers will complete the implementation and
compliance phases of the Year 2000 Plan, as well as its Year 2000 contingency
plans; its estimated costs related to the Year 2000 Plan; and the Company's
belief that its internal systems and equipment will be Year 2000 compliant in a
timely manner.  All forward-looking statements involve a number of risks and
uncertainties that could cause the actual results to differ materially from the
projected results.  Factors that may cause these differences include, but are
not limited to, the availability of qualified personnel and other information
technology resources; the ability to identify and remediate all date sensitive
lines of code or to replace embedded chips in affected systems or equipment;
unanticipated delays or expenses related to remediation; and the actions of
independent third-parties with respect to Year 2000 problems.

   The statements in the following section include "Year 2000 Readiness
Disclosure" within the meaning of the Year 2000 Information and Readiness
Disclosure Act of 1998.

   The Year 2000 problem refers to the inability of software to process date
information later than December 31, 1999.  Date codes in many software programs
are abbreviated to allow only two digits for the year.  Software with date-
sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000.  When that happens, some
software will not work at all and other software will suffer critical
calculation and other processing errors. Hardware and other products with
embedded chips may also experience problems.

   The Company believes that its current version of EDGE, TELEMAR and MSM
products are Year 2000 compliant. In addition, the Company tracks the version of
its products that each of its customers uses. The Company has sent a letter to 
all customers advising them of the availability of its Year 2000 compliant 
products.


                                       30
<PAGE>
 
   The Company believes that all current versions of its products will meet
basic functionality requirements, however, because all specific customer
situations and uses cannot be anticipated, IMA may be faced with warranty and
other claims as a result of the Year 2000 transition. The impact of such
customer claims could have a material adverse impact on the Company's results of
operations and financial condition.

   Some customers may have written applications using the Company's products.
The Company, in its consulting capacity, also has written such applications. The
Company believes that most applications written by it are Year 2000 compliant.
The Company does not know, and has no meaningful way of determining, whether the
applications written by customers are Year 2000 compliant.

   The Company is in the process of completing a comprehensive evaluation of its
internal systems and equipment that addresses both information technology
systems ("IT") (i.e. business systems and the software development environment)
and non-IT systems, (i.e. elevators, building security and HVAC systems)
including hardware, software and firmware. The Company has begun to upgrade
certain critical systems to meet with Year 2000 requirements. The Company will
be conducting transaction testing in the first half of 1999 to evaluate
compliance of the overall system infrastructure. The Company will consider the
need for remediation plans as it continues to assess the Year 2000 risk. The
Company expects to complete its evaluation by the end of the second quarter of
1999. The Company's inability to remediate non-compliant systems in its
infrastructure could have a material adverse affect on the Company's results of
operations and financial condition.

   The costs incurred to date related to upgrading the Company's products to be
Year 2000 compliant were approximately $200,000 and have been funded from
operating cash flows and have not been separately accounted for partly because
the responsibilities and costs were distributed throughout the organization and
represent a small percentage of total operating costs. Expenses associated with
evaluation of the Company's internal systems for Year 2000 problems have been
approximately $100,000. The Company originally had expected to complete its
evaluation by the end of the first quarter of 1999. Staff reorganization and
relocation of the Company's Irvine office, has caused the Company to revise
this estimate. The Company now expects to complete an estimate of the
anticipated cost of upgrading internal systems by the end of the second quarter
of 1999. While the Company expects to incur additional expenses to complete
these upgrades, it does not believe the implementation of the Year 2000 programs
discussed above will have a material adverse impact on the Company's financial
condition or results of operations. The Company believes that it has sufficient
funds to satisfy costs incurred to date and future Year 2000 compliance costs.

   The Company has initiated the development of a comprehensive Year 2000
contingency plan to address situations that may result if the Company is unable
to achieve Year 2000 readiness of its critical systems.  The contingency plan is
expected to be completed during the second quarter of 1999.

   The Company also is in the process of conducting a review of its critical
suppliers to determine that the suppliers' operations and the products and
services they provide are Year 2000 compliant or that an alternative source for
this critical product or service is available. The Company originally estimated
that this review would be completed in the first quarter of 1999. Slower than
expected responses from its critical suppliers, however, has caused the Company
to revise this estimate. The Company now believes the review of its suppliers
will be complete during the second quarter of 1999. The Company has no practical
means to verify the information provided by these independent third parties and
is still pursuing those key distributors and vendors who may not yet have
responded. Based upon this assessment and where practicable, the Company will
attempt to mitigate its risks with respect to any suppliers that may not meet
the requirements, including seeking alternative suppliers. However, there can be
no assurance that the Company will not experience disruptions in

                                       31
<PAGE>
 
its ability to conduct business because of Year 2000 problems experienced by the
Company's distributors or vendors, such problems remain a possibility and could
have an adverse impact on the Company's results of operations and financial
condition.

   Some commentators have predicted significant litigation regarding Year 2000
compliance issues, and the Company is aware of such lawsuits against other
software vendors.  Because of the unprecedented nature of such litigation, it is
uncertain whether, or to what extent, the Company may be affected.  However, at
this time the Company believes that the existence of earlier versions of its
products that are not Year 2000 compliant is not likely to have a material
adverse effect on the Company or its operations. To the extent that its key
distributors or vendors experience problems relative to achieving Year 2000
compliance, the Company could suffer unanticipated revenue losses.

   In addition, the Company does not currently have meaningful information
concerning the Year 2000 compliance status of its customers.  As is the case
with other software companies, if significant numbers of the Company's current
or future customers fail to achieve Year 2000 compliance it could have a
material adverse effect on the Company.

Factors That May Affect Future Results

   References in this section to the "Company," "Information Management
Associates, Inc.," "IMA," "we," "us," and "our" refer to Information Management
Associates, Inc.

   Statements in this Form 10-K which express "belief", "anticipation" or
"expectation", as well as other statements which are not historical fact, and
statements as to product compatibility, design, features, functionality and
performance insofar as they may apply prospectively, are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 and the Company's actual results could differ materially from those
expressed in these forward-looking statements as a result of numerous factors,
including those set forth below, and elsewhere in this Form 10-K.

   History of Operating Losses; Uncertainty of Future Operating Results. We
incurred significant net operating losses in each of 1992, 1993, 1994, 1995 and
1998. As of December 31, 1998, we had an accumulated deficit of $34.3 million.
Given our operating history, we cannot predict our future operating results with
any certainty. You should not consider our recent revenue growth as indicative
of future revenue growth or operating results. We cannot assure you that our
business strategies will be successful, nor can we assure you that we will
achieve or sustain profitability on a quarterly or annual basis.

   Fluctuations in Quarterly Performance.  Our quarterly operating results
have varied significantly in the past and may continue to do so depending on
several factors, many of which are beyond our control.  These factors include,
among others:

  .  our ability to develop, introduce and market new and enhanced versions
  .  of our products on a timely basis;
  .  demand for our products;
  .  the lengthy sales cycle for full implementation of our products;
  .  the size, timing and contractual terms of significant orders;
  .  the timing and significance of product enhancements and new product

                                       32
<PAGE>
 
     announcements by us or our competitors;
  .  changes in our business strategies;
  .  the budgeting cycles of our potential customers;
  .  customer order deferrals in anticipation of enhancements or new
     products;
     changes in the mix of products and services we sell;
  .  changes in the amount of our revenue attributable to domestic and
     international sales;
  .  changes in foreign currency exchange rates;
  .  product and price competition;
  .  cancellations or non-renewals of licenses or maintenance agreements;
     investments to develop marketing and distribution channels; and
  .  changes in the level of our operating expenses.

To achieve our quarterly revenue objectives, we depend upon obtaining orders in
that quarter for delivery in that quarter. The timing of our revenue recognition
is affected by the amount of contracts executed and delivered, whether the
contract contains post delivery obligations and when our customers accept the
product. We derive a significant portion of our revenues in any quarter from
non-recurring, large license fees paid to us by a relatively small number of
customers. We expect this trend to continue for the foreseeable future.
Therefore, if a customer defers, cancels or fails to honor its contractual
obligations, our operating results could be materially adversely affected in a
given quarter. On the other hand, significant sales occurring earlier than
expected may adversely affect subsequent quarters. In addition, we have
experienced and expect to continue to experience stronger demand during the
quarters ending in June and December than during the quarters ending in March
and September. We receive a substantial portion of our orders in the last months
or weeks of any given quarter.

   Because of the factors stated above, we are not able to predict our
quarterly revenues and operating results with any significant degree of
accuracy.  If revenue levels fall below expectations, the shortfall would likely
materially adversely affect our business, operating results and financial
condition.  As a result, we believe that you should not rely on period-to-period
comparisons of our results of operations as meaningful indicators of future
performance.  We cannot assure you that we will be able to achieve or sustain
profitability on a quarterly or annual basis.  We expect that in some future
quarter or quarters our total revenues or operating results will not meet the
expectations of public market analysts and investors.  Our failure to meet
expectations or adverse conditions prevailing or appearing to prevail generally
or with respect to our business will likely materially adversely affect our
Common Stock price.

   Ability to Integrate Acquisitions.  We completed the acquisitions of
substantially all of the assets of Marketing Information Systems, Inc. ("MIS")
and Telemar Software International, LLC ("TSI") on March 30, 1998 for an
aggregate purchase price of $8.6 million.  Each has product lines that focused
on the IBM AS/400 market, a platform to which IMA's flagship product EDGE has
only recently been introduced. Failure to successfully integrate the acquired
product lines, and the employees, distributors, and customers of the acquired
businesses could have a material adverse effect on our business, operating
results and financial condition.

   Product Concentration.  Although we now receive some revenues from MIS and
TSI products, licensing of EDGE and the provision of professional consulting,
technical support and maintenance services relating to EDGE account for

                                       33
<PAGE>
 
substantially all of our revenues.  We do not expect this to change in the
foreseeable future.  Accordingly, factors adversely affecting the pricing of or
demand for EDGE products and services, such as competition or technological
changes, could have a material adverse effect on our business, operating results
and financial condition. Our future financial performance will depend, in
significant part, on the continued market acceptance of our EDGE products
including its new and enhanced versions. We cannot assure you that we will
continue to successfully develop and market EDGE.

   Lengthy Sales and Implementation Cycles; Post-Delivery Obligations.  The
following factors over which we may have little or no control may significantly
delay our sales cycle:

  . significant commitment of customer resources for licensing and
    implementing our products;
  . significant level of education required by prospective customers
    regarding the use of our products;
  . lengthy customer approval process typically associated with
    significant capital expenditures; and
  . implementation of our products generally extends for several months
    and for larger, more complex implementations, multiple quarters.

  We recognize licensing fees upon delivery of the product if:

  . we have no significant post-delivery obligations;
  . our customer has no acceptance conditions; and
    we believe that we can collect the resulting receivable.

If any of the above conditions do not exist, we will defer the revenue until all
of the conditions are satisfied.

   Previously, when we have provided consulting services to implement certain
larger projects, some customers have not honored their obligations by delaying
payments of a portion of license fees until we completed implementation or
disputing the consulting fees charged for implementation.  We may experience
delays, cancellations or disputes in the future.  If these occur, they could
have a material adverse effect on our business, operating results and financial
condition.  They could also cause our quarterly operating results to vary
significantly.

   Dependence on Proprietary Technology.  Our success and ability to compete
depends in part upon proprietary technology.  We rely primarily on a combination
of copyright and trademark laws, trade secrets, nondisclosure agreements and
technical measures to protect our proprietary rights.  We typically enter into
confidentiality or license agreements with our employees, distributors, clients
and potential clients and limit access to and distribution of our software,
documentation and other proprietary information.  We cannot assure you that
these steps will adequately deter misappropriation or independent third-party
development of our technology.  Also, the laws of some foreign countries do not
protect proprietary rights to the same extent as the laws of the United States.

   We have placed, and may continue to place, our source code in escrow for
the benefit of a small number of our customers.  The escrow agreements permit
these customers to use the source code on a limited, non-exclusive basis if:
(i) we initiate bankruptcy proceedings or bankruptcy proceedings are initiated
against us; (ii) we cease to do business; or (iii) we fail to meet our support
obligations.  In addition, we use third-party contractors for selected product

                                       34
<PAGE>
 
development projects.  The escrow of source code and the use of a third-party
contractor may increase the possibility of misappropriation by third parties.

   As the number of products and competitors in our industry segment grows and
the functionality of products in different segments overlaps, we expect that
software product developers increasingly will be subject to infringement claims.
The use of patents to protect software has increased.  We believe that our
products and technology do not infringe on any existing proprietary rights.
Nevertheless, we cannot assure you that third parties will not assert successful
infringement claims.  The following could have a material adverse effect upon
our business, operating results and financial condition:

  . any infringement claim against us, even if unfounded, resulting in
    diversion of our time and resources, costly litigation and product
    shipment delays;
  . any infringement claim that results in the necessity that we enter
    into a royalty or licensing agreements which may not be available on
    terms favorable to us;
  . any infringement claim resolved against us;
  . litigation to protect our trade secrets or other intellectual property
    rights or to determine the validity and scope of the proprietary
    rights of others resulting in substantial costs and diversion of
    resources.

   Dependence on Indirect Marketing and Distribution Channels; Potential
Conflicts.  In addition to our own marketing efforts, we maintain relationships
with consulting and systems integration companies to increase our domestic and
international visibility.  In addition to our direct sales force, we distribute
our products domestically and internationally through remarketers and
distributors.  We do not maintain exclusive relationships with any of the
consultants, systems integration companies, remarketers or distributors.  They
are not under our direct control. They have no minimum purchase obligations and
they may terminate their relationship with us at any time without cause.  In
addition, they are free to co-market and distribute potentially competitive
products.  Accordingly, we must compete for the focus and sales efforts of these
third party entities.  Also, selling through indirect channels may limit our
contacts with our customers, hindering our ability to accurately forecast sales
and revenue, determine contract terms, evaluate customer credit, evaluate
customer satisfaction and recognize emerging customer needs.  We cannot assure
you that co-marketers, remarketers and distributors will continue successfully
to distribute or recommend the Company's products.  We may not continue to
succeed in increasing the use of these indirect channels profitably.  Also, one
or more of these companies may begin to market products in competition with us,
which may adversely affect our business, operating results and financial
condition.

   Our strategy of marketing our products directly to end-users and indirectly
through remarketers and distributors may result in conflicts between our direct
sales efforts and third party indirect sales efforts; and conflicts between and
among some of our resellers targeting the same customers.  These conflicts could
materially adversely affect our relationships with existing remarketers and
distributors and may adversely affect our ability to attract new remarketers and
distributors.

                                       35
<PAGE>
 
   Need to Expand Marketing and Distribution Channels.  As part of our
international strategy, we intend to increase our use of remarketers and
distributors and to expand our existing co-marketing relationships and
establish new relationships with other consulting and systems integration
companies. Also, we seek to expand our international direct sales force
to take advantage of international growth opportunities. Our ability to
achieve revenue growth depends on successful implementation of this
strategy. We have experienced, and continue to experience, difficulty in
recruiting and retaining qualified personnel. We cannot assure you that we will
successfully expand our direct or indirect sales force. Even if we are
successful, we cannot assure you that such sales force expansion will result in
increased revenues. Failure to expand our sales force could materially and
adversely affect our business, operating results and financial condition.

   Emerging Markets for Call Center Customer Interaction Software; Dependence
on Increased Use of Products by Existing Customers.  The market for call center
customer interaction software is relatively new.  It is characterized by:

  . ongoing technological developments;
  . frequent new product announcements and introductions;
    evolving industry standards; and
  . changing customer requirements.

Our future financial performance depends in large part on continued growth in
the number of organizations adopting call center customer interaction software
products on an enterprise-wide basis and on the number of applications and
software components developed for such use.  We cannot assure you that the call
center customer interaction software market will continue to grow.  Failure of
this market to grow, or market growth slower than our current expectations could
materially adversely affect our business, operating results and financial
condition.

   Also, some of our larger customers have licensed our software on an
incremental basis and we cannot assure you that these customers will expand
their use of our software on an enterprise-wide basis or license new or enhanced
software products as we introduce them to the market.  If our customers do not
deploy our software on an enterprise-wide basis because the software has not met
their expectations or for other reasons, our business, operating results and
financial condition could be materially and adversely affected.

   Rapid Technological Change.  Any of the following factors which are present
in the call center customer interaction software market could render our
existing products obsolete and unmarketable:


  . rapid technological change;
  . frequent introductions of new products;
  . changes in customer demands; and
  . evolving industry standards.

These factors could rapidly diminish our position in existing and future
markets.  We expect to make substantial investments from time to time in our
product development and testing although we cannot assure you that we will have
sufficient resources to make the necessary investments.

                                       36
<PAGE>
 
   Our customers have adopted a wide variety of hardware, software, database
and networking platforms.  To gain broad market acceptance, we must continue to
support and maintain our products on a variety of such platforms and develop and
introduce enhancements to our existing products and new products on pace with
technological developments, changing customer requirements and evolving industry
standards.  Our future success depends on our ability to address the
increasingly sophisticated needs of our customers.  Our success may also depend,
in part, on our ability to introduce products that are compatible with the
Internet, and on the broad acceptance of the Internet as a viable customer
interaction channel.  We cannot assure you that the Internet will become a
viable customer interaction channel or that the demand for Internet-related
products and services will increase in the future.

   We also cannot assure you that we will be successful in developing and
marketing enhancements to our products that respond to technological
developments, changing customer requirements or evolving industry standards.  We
may experience difficulties that could delay or prevent the successful
development, introduction and sale of such enhancements.  Our enhancements may
not adequately meet the requirements of the marketplace and achieve any
significant degree of market acceptance.  Product enhancement and new product
delays or failure to achieve market acceptance when released could materially
and adversely affect our business, operating results or financial condition.  In
addition, the introduction or announcement of new product offerings or
enhancements by us, our competitors or major hardware, systems or software
vendors may cause customers to defer or forego licensing of our products, which
could have a material adverse effect on our business, operating results and
financial condition.

   We also cannot assure you that we will be successful in the development and
implementation of any of our new software products, specifically our
BuyingEDGE.com product for purchasing goods and services over the Internet.  Our
strategy regarding the BuyingEDGE.com system will rely on several sources of
revenue.  We can not assure you that the BuyingEDGE.com product will achieve any
degree of market acceptance among consumers or manufacturers and service
providers.  Internet purchasing is a rapidly evolving area of commerce with
rapid technological changes and the frequent introduction of new products and
services.  These technological changes and increased competition in the Internet
commerce area could render the BuyingEDGE.com product obsolete and rapidly
diminish the Company's ability to establish a position in existing or future
markets.   We can not assure you that competitors will not develop products
comparable or superior to ours or adapt more quickly than we do to new
technologies, evolving industry trends or the changing needs of consumers.
Though the Company intends to make substantial investments form time to time in
the development and testing of BuyingEDGE.com, we cannot assure you that we will
have sufficient resources to make the necessary investments.  We may experience
difficulties that could delay or prevent the successful development,
introduction, and sale of the BuyingEDGE.com product.  We can not assure you
that BuyingEDGE.com will adequately meet the requirements of the marketplace and
achieve any degree of market acceptance.  BuyingEDGE.com product delays, the
failure to achieve market acceptance could materially and adversely affect our
business, operating results or financial condition.

   We depend upon the products of other software vendors, including certain
system software vendors, such as Microsoft Corporation, and relational database
software vendors to remain competitive and respond to technological change.

                                       37
<PAGE>
 
Design defects in such products or unexpected delays in their introduction,
could materially and adversely affect our business, operating results and
financial condition.

   Management of Growth.  We recently have experienced rapid growth.  This
growth could place a significant strain on our management and other resources.
We anticipate that the growth of our company, if any, will require us to
recruit, hire, train and retain a substantial number of new and highly skilled
product development, managerial, finance, sales and marketing and support
personnel. The market for such personnel is intensely competitive and we expect
that such competition will continue for the foreseeable future. We cannot assure
you that we will be able to hire or retain such personnel.

   Our ability to compete effectively and to manage future growth, if any,
depends on our ability to continue to implement and improve operational,
financial and management information systems on a timely basis and to expand,
train, motivate and manage our work force.  We cannot assure you of the future
adequacy of our personnel, systems, procedures and controls.  Inability to
effectively manage growth and the quality of our products could materially and
adversely affect our business, operating results and financial condition.

   Competition.  The market for telemarketing, telesales and customer service
software is:

  . intensely competitive;
  . rapidly evolving; and
  . highly sensitive to new product introductions or enhancements and
    marketing efforts by industry participants.

Our competitors range from internal information systems departments to packaged
software application vendors.  We believe that as the United States and
international software markets continue to grow, a number of new vendors will
enter the market and existing competitors and new market entrants will attempt
to develop applications targeting additional markets. Our segment of the
software industry has experienced consolidation as certain of our larger
competitors have recently acquired other smaller competitors. In addition,
competitors have established and may in the future establish cooperative
relationships or alliances that may increase their ability to provide superior
software solutions or services.

   Increased competition resulting from new entrants, consolidation of the
call center customer interaction software industry, cooperative relationships or
alliances could result in new or stronger competitors, price reductions, reduced
operating income or loss of market share, any of which could materially
adversely affect our business, operating results or financial condition. Many of
our current and potential competitors have significantly greater financial,
technical, marketing, service, support and other resources. They generate higher
revenues and have greater name recognition. We cannot assure you that our
competitors will not develop products comparable or superior to ours or adapt
more quickly than we do to new technologies, evolving industry trends or
changing client requirements. We cannot assure you that we will compete
effectively against competitors or that competitive pressures will not
materially and adversely affect our business, operating results or financial
condition.

                                       38
<PAGE>
 
   Dependence on Key Personnel.  Our business involves the development,
marketing and installation of complex software products and the delivery of
professional services.  Our success will depend in large part upon our ability
to attract, retain and motivate highly skilled employees.  The market for such
employees is intense and we expect that such competition will continue for the
foreseeable future.  We cannot assure you that we will hire or retain such
personnel.  Failure to hire and retain sufficient numbers of highly skilled
employees could materially and adversely affect our business, operating results
and financial condition.  In addition, the loss of Albert R. Subbloie, Jr., the
President and Chief Executive Officer, or Gary R. Martino, Chairman of the Board
and Chief Financial Officer, or some of our other key personnel could have a
material adverse effect on our business, operating results or financial
condition, including our ability to attract employees and secure and complete
engagements.  We maintain key-man life insurance policies with respect to
certain of our executive officers, including Mr. Subbloie and Mr. Martino.

   Risk of Product Defects.  Software products, particularly new versions,
frequently contain errors, especially when first introduced.  We conduct
extensive product testing during product development.  Nevertheless, we have at
times delayed commercial release of software until we corrected problems.  In
some cases, we have provided enhancements to correct errors in released
software.  We could, in the future, lose revenues as a result of software errors
or defects. Despite testing by us and by current and potential customers, future
software or releases after commencement of commercial shipments may include
errors, resulting in

   . loss or delay of revenue;
   . delay in market acceptance;
   . diversion of development resources;
   . damage to our reputation; or
     increased service and warranty costs.
   Any of these results could materially and adversely affect our business,
operating results and financial condition.

   Risks Associated with International Operations.  International operations
account for a significant portion of our total revenues and we intend to
continue and expand our international sales activity. Continuation and expansion
of international operations will require significant management attention and
financial resources and will require us to establish additional foreign
operations and hire additional personnel. We may not be able to maintain or
increase international market demand for our products and failure to do so could
materially and adversely affect our business, operating results or financial
condition.

   International Currency Risks.  We currently denominate our international
sales in U.S. dollars with respect to sales outside of the United Kingdom,
Europe and Australia, and generally in pounds sterling with respect to sales in
the United Kingdom and Europe. An increase in the value of the U.S. dollar or
pound sterling relative to other currencies could make our products more
expensive and, therefore, potentially less competitive in foreign markets.
Currently, we have not employed currency hedging strategies to reduce this risk
although we may consider employing hedging strategies in the future based on our
assessment of exposure to fluctuations in foreign currency exchange rates. We
cannot assure you that our assessments of exposure to fluctuations in foreign
currency exchange rates will be accurate or that any hedging strategies we may
use in the future will be effective.

                                       39
<PAGE>
 
   International Operation and Collection Risks.  The following risk factors
associated with our international business may have a material adverse effect on
our future international sales and, consequently, on our business, operating
results or financial condition:

  . potentially longer payment cycles;
  . difficulties in collecting international accounts receivable;
  . difficulties in enforcement of contractual obligations and
    intellectual property rights;
  . potentially adverse tax consequences;
  . increased costs associated with maintaining international marketing
    efforts;
  . increased costs of localizing products for foreign markets;
  . tariffs, duties and other trade barriers;
  . adverse changes in regulatory requirements;
  . possible recessionary economies outside of the United States; and
  . political and economic instability.

   Dependence on Licensed Technology.  We license, and expect to license in
the future, technology from other companies for use in and with our products.
Our inability to license these products or other necessary products for use in
or with our products could have a material adverse effect on our business,
operating results or financial condition.  In addition, the effective
implementation of our products may depend in the future upon the successful
operation of licensed products as an integrated part of, or in conjunction with,
our products.  Any undetected errors in such licensed products could impair the
functionality of our products or otherwise delay or prevent the implementation
of an installation or the introduction of new products, and injure our
reputation, which could have a material adverse effect on our business,
operating results or financial condition.

   Increased Use of Third-Party Development Tools.  Our EDGE products include
application development tools produced by third parties used to build and modify
our applications.  Third-party application development tools may become more
widely used as a result of technological advances or customer requirements.
Wider use of third-party applications could require us to make greater use of
third-party tools in the future.  This increased use would require us to enter
into license arrangements with such third parties resulting in higher royalty
payments, a loss of product differentiation and delays.  Such effects or our
inability to enter into commercially reasonable licenses could have a material
adverse effect on our business, operating results or financial condition.

   Dependence on Growth of Client/Server Computing Environment.  We market our
products to customers:

  . committed or committing their call center systems to client/server
    computing environments; or
  . converting legacy systems, in part or in whole, to a client/server
    computing environment.

Our success will depend on further growth in the number of organizations
adopting client/server computing environments.  We cannot  assure you that the
anticipated client/server computing trends will occur or that we will respond
effectively to the evolving requirements of this market.  Failure of the
client/server market to grow, or growth at a rate slower than experienced in the
past, could materially and adversely affect our business, operating results or
financial condition.

                                       40
<PAGE>
 
   Industry Concentration.  We derive a substantial portion of our revenues
from customers in the teleservices outsourcing, telecommunications and financial
services industries.  We intend to further develop our knowledge of the business
processes and requirements of other industries in order to establish additional
market opportunities. We may not successfully do so.  Our failure to increase
our customers among a broader base of varied industries, or a downturn in one or
more of the teleservices outsourcing, telecommunications or financial services
industries could have a material adverse effect on our revenues from that
industry or the collectibility of customer obligations from that industry or
other aspects of our business, operating results or financial condition.

   Product Liability.  The risk of product liability claims is inherent in the
sale and support of products.  Our license agreements with our customers
typically contain provisions designed to limit our exposure to potential product
liability claims.  The laws of certain jurisdictions, however, may not enforce
the limitation of liability provisions contained in our license agreements.  A
party could bring a successful product liability claim against us, which could
result in a material adverse effect on our business, operating results and
financial condition.

   Regulatory Environment.  Federal, state and foreign law regulates certain
uses of outbound call processing systems.  Our systems can be programmed to
operate in compliance with these laws through the use of appropriate calling
lists and calling campaign time parameters.   Compliance with these laws,
however, may limit the potential use of our products.  In addition,
future legislation further restricting telephone solicitation practices, if
enacted, could adversely affect us.

   Year 2000 Risks. Many computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with such Year 2000
requirements. Our failure or inability to identify and correct Year 2000
problems in our products, internal information or other systems, software,
hardware or firmware could have a material, adverse effect on our business,
operating results, and financial condition. We are still reviewing the impact
the Year 2000 issue will have on our internal information systems. We plan to
take necessary actions based on the results of such analyses. If costs related
to Year 2000 are material, our business, operating results, and financial
condition could be materially adversely affected.

   In certain cases, we have warranted that the use or occurrence of dates on
or after January 1, 2000 will not adversely affect the performance of our
products with respect to four digit date dependent data or the ability to
create, store, process, and output information related to such data. If any of
our licensees experience Year 2000 problems, those licensees could assert claims
for damages. Such claims, whether or not successful, could materially and
adversely affect our business, operating results and financial condition.

   In addition, the purchasing patterns of our customers and potential
customers may be affected by Year 2000 issues.  Many companies are expending
significant resources to correct their current software systems for Year 2000
compliance.  These expenditures may result in reduced funds available to
purchase software products such as those offered by us.  This may adversely
affect on our business, operating results, and financial condition.

                                       41
<PAGE>
 
   In addition to the "Factors That May Affect Future Results" mentioned above,
the Company's business entails a variety of additional risks, which are set
forth in the Company's filings with the Securities and Exchange Commission.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   Foreign currency risk. The Company's exposure to foreign currency risks has
been relatively low because of the way the Company conducts its international
business. The primary reason for the low level of exposure to foreign currency
fluctuations is that the Company generally requires payment from its
international customers outside the United Kingdom, Europe and Australia in U.S.
dollars. In the United Kingdom and Europe, the Company generally requires
payment from its international customers in pounds sterling. In addition, the
Company has no debt denominated in any foreign currency although it has entered
into equipment and real estate leases that are payable in local currency. For
the year ended December 31, 1998, the Company derived 36% of its revenues from
international operations. Approximately 73% of international revenues were from
transactions denominated in pounds sterling with substantially all of the
remaining percentage denominated in U.S. dollars. Gains and losses on
translation into U.S. dollars of foreign currency are recorded as a separate
component of shareholders' equity and do not affect results of operations.

   Because of the historically low level of currency risks, the Company has not
previously engaged in foreign currency hedging programs. However, as revenues
from international operations have grown, the Company has been monitoring its
foreign exchange exposures to assess risks of fluctuations in foreign currency
exchange rates. As part of our monitoring of currency risks, the Company will
consider using foreign currency option contracts and forward contracts in the
future to hedge a portion of our exposure on anticipated transactions and firm
commitment transactions if we determine that such actions are appropriate and
cost-effective. There can be no assurance that the Company's monitoring of
foreign currency exposures or future hedging activities, if any, will
substantially reduce the impact of fluctuations in currency exchange rates on
its results of operations and financial position.

   On January 1, 1999, certain member states of the European Economic Community
fixed their respective currencies to a new currency, the Single European
Currency ("Euro"). On that day the Euro became a functional legal currency
within these countries. During the three years beginning on January 1, 1999,
business in these countries will be conducted both in the existing national
currency, such as the French Franc or the Deutsche Mark, as well as the Euro.
Although we will continue to evaluate the impact of the Euro introduction over
time, based on presently available information we do not presently expect that
introduction and use of the Euro will materially increase our exposure to
foreign currency risks.

   Interest Rates.  The Company invests its cash in a variety of financial 
instruments, including bank time deposits and taxable fixed rate obligations of 
corporations.  These investments are denominated in U.S. dollars.  Cash balances
in foreign currencies overseas are operating balances and are invested in 
short-term time deposits of the local operating bank.

   Interest income on the Company's investments is carried in "Other income 
(expense)."  The Company accounts for its investment instruments in accordance 
with Statement of Financial Accounting Standards No. 115, "Accounting for 
Certain Investments in Debt and Equity Securities" ("SFAS 115").  All of the 
cash equivalents and short-term investments are treated as available-for-sale 
under SFAS 115.

   Investments in fixed rate interest earning instruments carry a degree of 
interest rate risk.  Fixed rate securities may have their fair market value 
adversely impacted due to a rise in interest rates.  Due in part to these 
factors, the Company's future investment income may fall short of expectations 
due to changes in interest rates or the Company may suffer losses in principal 
if forced to sell securities which have seen a decline in market value due to 
changes in interest rates.  The Company's investment securities are held for 
purposes other than trading.  The investment securities had maturities of less 
than one year.  The weighted-average interest rate on investment securities at 
December 31, 1998 was 4.5%.  The fair value of securities held at December 31, 
1998 was $3.1 million.

                                       42
<PAGE>
 
PART II:  OTHER INFORMATION

ITEM 8:  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


INFORMATION MANAGEMENT ASSOCIATES, INC. AND SUBSIDIARIES
--------------------------------------------------------

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------

                                                               Page
                                                               ----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS                       F-2
 
  Consolidated Balance Sheets as of December 31, 1997
    and 1998                                                   F-3
 
  Consolidated Statements of Operations for the Years Ended
   December 31, 1996, 1997 and 1998                            F-4
 
  Consolidated Statements of Cash Flows for the Years
    Ended December 31, 1996, 1997 and 1998                     F-5
 
  Consolidated Statements of Shareholders' Equity
    for the Years Ended December 31, 1996, 1997 and 1998       F-6
 
  Notes to Consolidated Financial Statements                   F-7
<PAGE>
 
                        
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS      
                   ----------------------------------------


To the Board of Directors and Shareholders of

          Information Management Associates, Inc.:

    
We have audited the accompanying consolidated balance sheets of Information
Management Associates, Inc. (a Connecticut corporation) and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1998.  These consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Information
Management Associates, Inc. and subsidiaries as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.


                                                             Arthur Andersen LLP
Hartford, Connecticut
March 3, 1999


                                      F-2
<PAGE>
 
           INFORMATION MANAGEMENT ASSOCIATES, INC. AND SUBSIDIARIES
           --------------------------------------------------------
                          CONSOLIDATED BALANCE SHEETS
                          ---------------------------
                     (in thousands, except share amounts)
 
                                                  1997     1998
                                                --------  -------
                   ASSETS
                   ------
 
CURRENT ASSETS:
  Cash and cash equivalents                      $ 4,816  $ 8,558
  Short-term investments                          19,455    3,091
  Accounts receivable, net of allowance
   for doubtful accounts of $630 in
   1997 and $3,408 in 1998                        14,815   16,487
  Other current assets                             1,420    1,985
                                                 -------  -------
             Total current assets                 40,506   30,121
 
EQUIPMENT, net                                     2,279    3,134
 
NOTES RECEIVABLE FROM OFFICERS AND EMPLOYEES          24        -
 
OTHER ASSETS, net                                  1,113    3,983
                                                 -------  -------
                                                 $43,922  $37,238
                                                 =======  =======

  LIABILITIES AND SHAREHOLDERS' EQUITY
  ------------------------------------

CURRENT LIABILITIES:

  Current maturities of obligations 
   under capital leases                          $   232  $    73
  Accounts payable                                 1,738    6,985
  Accrued compensation                             1,597    2,025
  Other accrued liabilities                        1,040    2,402
  Deferred revenues                                1,686    4,341
                                                -------- --------
             Total current liabilities             6,293   15,826
                                                -------- --------
OBLIGATIONS UNDER CAPITAL LEASES, less 
  current maturities included above                  136       58
                                                -------- --------
OTHER LONG-TERM LIABILITIES                          463      432
                                                -------- --------
 
COMMITMENTS AND CONTINGENCIES (NOTE 10)
 
SHAREHOLDERS' EQUITY:
  Common stock, no par value; 20,000,000 
   authorized shares, 9,236,035 and 9,697,088 
   shares issued and outstanding at December 31, 
   1997 and 1998                                  51,102   54,691
  Shares to be issued in connection with 
   acquisition                                         -      564
  Cumulative translation adjustment                 (101)     (63)
  Accumulated deficit                            (13,971) (34,270)
                                                -------- --------
             Total shareholders' equity           37,030   20,922
                                                -------- --------
                                                $ 43,922 $ 37,238
                                                ======== ========

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


                                      F-3

<PAGE>
 
           INFORMATION MANAGEMENT ASSOCIATES, INC. AND SUBSIDIARIES
           --------------------------------------------------------
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     -------------------------------------
                       
                   (in thousands, except per share amounts)      
 
                                                   1996      1997      1998
                                                 --------  --------  ---------
Revenues:
  License fees                                    $13,022   $19,295  $ 24,903
  Services and maintenance                         13,255    17,377    24,190
                                                  -------   -------  --------
             Total revenues                        26,277    36,672    49,093
                                                  -------   -------  --------
Cost of revenues:
  Cost of license fees                                709       304       356
  Cost of services and maintenance                  7,191     9,428    17,420
                                                  -------   -------  --------
             Total cost of revenues                 7,900     9,732    17,776
                                                  -------   -------  --------
 
Gross profit                                       18,377    26,940    31,317
                                                  -------   -------  --------
Operating expenses:
  Sales and marketing                               8,055    12,580    21,419
  Product development                               6,382     6,190     9,266
  General and administrative                        3,878     4,784    12,120
  Acquired product development costs                    -         -     6,988
  One time settlement charges                           -         -     2,163
                                                  -------   -------  --------
             Total operating expenses              18,315    23,554    51,956
                                                  -------   -------  --------
 
Operating income (loss)                                62     3,386   (20,639)
                                                  -------   -------  --------
Other income (expense):
  Interest expense                                 (1,219)     (723)      (35)
  Interest income                                      48       641       839
  Other                                                92       100         6
                                                  -------   -------  --------
             Total other income (expense)          (1,079)       18       810
                                                  -------   -------  --------
Income (loss) before provision for
  income taxes                                     (1,017)    3,404   (19,829)
Provision for income taxes                             30       231       470
                                                  -------   -------  --------
Net income (loss)                                  (1,047)    3,173   (20,299)

Accretion of preferred stock dividends               (452)     (452)        -
Increase in fair market value of
  redeemable common stock warrants                   (385)        -         -
                                                  -------   -------  --------
Net income (loss) available to common
  shareholders'                                   $(1,884)  $ 2,721  $(20,299)
                                                  =======   =======  ========
Net income (loss) per share:
  Basic                                             $(.44)     $.43  $  (2.12)
                                                  =======   =======  ========
 
  Diluted                                           $(.44)     $.38  $  (2.12)
                                                  =======   =======  ========
Weighted average shares used in computing net
  income (loss) per share:
    Basic                                           4,258     6,371     9,588
                                                  =======   =======  ========
    Diluted                                         4,258     7,714     9,588
                                                  =======   =======  ========
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      F-4
<PAGE>
 
           INFORMATION MANAGEMENT ASSOCIATES, INC. AND SUBSIDIARIES
           --------------------------------------------------------
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                     -------------------------------------
                                    
                                (in thousands)      

<TABLE>     
<CAPTION>
                                                       1996        1997        1998
                                                       ----        ----        ----
<S>                                                  <C>       <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net income (loss)                                   $ (1,047) $   3,173    $(20,299)
 Adjustments to reconcile net income (loss)
   to net cash used in operations:
 Depreciation and amortization                         1,155       1,404       1,784
 Charge for acquired product development costs             -           -       6,988
 Gain on sale of product line                            (92)          -           -
 Amortization of restricted stock awards                  10          10           -
 Changes in operating assets and liabilities:
   Accounts receivable                                (3,001)     (4,342)       (975)
   Other current assets                                  143      (1,188)        564
   Notes receivable from officers and employees         (378)        548           -
   Other assets, net                                    (502)       (492)        956
   Accounts payable                                     (480)       (570)      5,247
   Accrued compensation                                  109         431         428
   Other accrued liabilities                             973        (905)     (2,592)
   Deferred revenues                                    (128)        (19)        407
   Other long-term liabilities                           (52)        (57)        (31)
                                                     -------   ---------    --------
    Net Cash Used in Operations                       (3,290)     (2,007)     (7,523)
                                                     -------   ---------    --------
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 Acquisition of equipment                             (1,001)     (1,419)     (2,323)
 Cash paid in connection with acquisition                  -           -      (1,632)
   and related deal costs
 Minority equity investment                                -           -      (1,715)
 Proceeds from short-term investing maturities             -     352,106      83,784
 Purchases of short-term investments                       -    (371,515)    (67,420)
                                                     -------   ---------    --------
    Net Cash Provided by (Used in) 
     Investing Activities                             (1,001)    (20,828)     10,694
                                                     -------   ---------    --------
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 Proceeds from sale of common stock, net of
   issuance costs $4,049                                 231      32,350           -
 Proceeds from exercise of stock options                   -         151         665
 Proceeds from employee stock purchase plan                -          48         105
 Net proceeds from sale of preferred stock             4,228           -           -
 Repayment of bank term loan                               -      (2,500)          -
 Net proceeds from (repayment of) bank line
   of credit                                           1,860      (4,860)          -
 Repayment of obligations under capital leases          (539)       (269)       (237)
 Proceeds from sale leaseback                            509           -           -
 Repayment of subordinated note payable to
   shareholder                                          (500)       (250)          -
                                                     -------   ---------    --------
    Net Cash Provided by Financing Activities          5,789      24,670         533
                                                     -------   ---------    --------
Effect of exchange rate changes                           32         (92)         38
                                                     -------   ---------    --------
NET INCREASE IN CASH AND CASH EQUIVALENTS              1,530       1,743       3,742
 
CASH AND CASH EQUIVALENTS, beginning of period         1,543       3,073       4,816
                                                     -------   ---------    --------
CASH AND CASH EQUIVALENTS, end of period             $ 3,073   $   4,816    $  8,558
                                                     =======   =========    ========

<PAGE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 Cash paid during the period for interest            $   877   $     671     $    24
 Cash paid during the period for income taxes             16          90         134
 
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
 Accretion of Series A preferred stock in
   lieu of dividends                                     394         244           -
 Accretion of Series B preferred stock in
   lieu of dividends                                      58         208           -
 Increase in fair market value of redeemable
   common stock warrants                                 385           -           -
 Issuance of common stock in connection with               -           -       3,383
   acquisitions
</TABLE>      

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

                                      F-5
<PAGE>
 
           INFORMATION MANAGEMENT ASSOCIATES, INC. AND SUBSIDIARIES
           --------------------------------------------------------
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                -----------------------------------------------
                     (in thousands, except share amounts)
<TABLE>    
<CAPTION>
                                                               Cumulative
                                       Common Stock           Translation   Accumulated                   Comprehensive
                                          Shares     Amount    Adjustment     Deficit           Total        Income
                                       ------------  ------    ----------     -------           -----     -----------
<S>                                    <C>          <C>        <C>          <C>            <C>              <C>
Balance, January 1, 1996                4,255,195   $ 5,554    $    (41)     $(14,808)        $(9,295)    $  --
 
 Sale of common stock                      32,400       231        -             -                231
 Exercise of common stock options           5,782      -           -             -               -
 Amortization of restricted stock
   awards                                    -           10        -             -                 10
 Change in fair market value of
   redeemable common stock warrants          -         -           -             (385)           (385)
 Accretion of Series A preferred
   stock dividends                           -         -           -             (394)           (394)
 Accretion of Series B preferred
   stock dividends                           -         -           -              (58)            (58)
 Equity adjustment from foreign
   currency translation                      -         -             32          -                 32           32
 Net loss                                    -         -           -           (1,047)         (1,047)      (1,047)
                                                                                                          --------
 Comprehensive loss                          -         -           -             -               -        $ (1,015)
                                       ----------   -------    --------     ---------       ---------     ========
Balance, December 31, 1996              4,293,377     5,795          (9)      (16,692)        (10,906)
 
 Sale of common stock, net of
   issuance costs of $4,049             2,800,000    32,350        -             -             32,350
 Exercise of common stock options         187,957       151        -             -                151
 Employee stock purchase plan               5,841        48        -             -                 48
 Amortization of restricted stock
   awards                                    -           10        -             -                 10
 Conversion of redeemable common
   stock warrants                         416,699     2,865        -             -              2,865
 Conversion of Series A preferred
   stock                                  920,433     5,389        -             -              5,389
 Conversion of Series B preferred
   stock                                  611,728     4,494        -             -              4,494
 Accretion of Series A preferred
   stock dividends                           -         -           -             (244)           (244)
 Accretion of Series B preferred
   stock dividends                           -         -           -             (208)           (208)
 Equity adjustment from foreign
   currency translation                      -         -            (92)         -                (92)         (92)
 Net income                                  -         -           -            3,173           3,173        3,173
                                                                                                          --------
 Comprehensive income                        -         -           -             -               -        $  3,081
                                       ----------   -------    --------     ---------       ---------     ========
Balance, December 31, 1997              9,236,035    51,102        (101)      (13,971)         37,030
 Exercise of common stock options         185,295       665        -             -                665
 Employee stock purchase plan              20,917       105        -             -                105
 Issuance of Common Stock in
  connection with acquisitions,           254,841     3,383        -             -              3,383
  including 42,508 shares valued
  at $564 to be issued 
 Equity adjustment from foreign
   currency translation                       -        -             38          -                 38           38
 Net loss                                     -        -           -          (20,299)        (20,299)     (20,299)
                                                                                                          --------
 Comprehensive loss                           -        -           -             -               -        $(20,261)
                                       ----------   -------    --------     ---------       ---------     ========
Balance, December 31, 1998              9,697,088   $55,255    $    (63)     $(34,270)      $  20,922
                                       ==========   =======    ========     =========       =========     
</TABLE>     
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      F-6
<PAGE>
 
INFORMATION MANAGEMENT ASSOCIATES, INC. AND SUBSIDIARIES
--------------------------------------------------------

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

1.  Nature of Operations:
    -------------------- 

    Information Management Associates, Inc. and subsidiaries (collectively, the
    Company) are primarily engaged in the development, marketing and support of
    software that automates customer interaction including telemarketing,
    telesales, contact management, sales, marketing and customer service
    functions of business organizations in a variety of industries.  The Company
    markets its software products in North and South America as well as Western
    Europe, Asia, Australia and New Zealand.

    In July 1997, the Company completed its initial public offering of its
    common stock which provided proceeds of $32.4 million, net of related
    underwriting discounts and expenses (see Note 5).
    
    The Company incurred a net loss of approximately $20,300,000 for the year
    ended December 31, 1998, and has an accumulated deficit of approximately
    $34,270,000 as of December 31, 1998. The market for telemarketing, telesales
    and customer service software is intensely competitive, rapidly evolving and
    highly sensitive to new product introductions or enhancements and marketing
    efforts by industry participants. The Company competes with a large number
    of competitors ranging from internal information systems departments to
    packaged software application vendors. Future operating results will depend
    on many factors, including demand for the Company's products, the level of
    product competition, competitor pricing, the size and timing of significant
    orders, changes in pricing policies by the Company or its competitors, the
    ability of the Company to develop, introduce and market new products on a
    timely basis and management's ability to acheive profitable operations and
    positive cash flow. Management's plans to address these risks include
    marketing and sales efforts to increase revenues, focused research and
    development investments and strict controls over discretionary expenditures.
    In addition, the Company expects to formalize a line of credit agreement
    with a bank in April 1999 to provide for additional liquidity (see Note 15).
    The accompanying financial statements do not reflect any adjustments
    resulting from the risks noted above.     

2.  Summary of Significant Accounting Policies:
    ------------------------------------------ 

    Principles of consolidation -
    ---------------------------

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

    Foreign currency transactions -
    -----------------------------
    
    The functional currency of the Company's subsidiaries is the local currency.
    Accordingly, the Company applies the current rate method to translate the
    subsidiaries' financial statements into U.S. dollars. Translation
    adjustments are included as a separate component of shareholders' equity in
    the accompanying consolidated financial statements.

    Cash and cash equivalents -
    -------------------------

                                      F-7

<PAGE>
 
    
    The Company considers all highly liquid investments with original maturities
    of three months or less to be cash equivalents.  As of December 31, 1997 and
    1998, the Company's cash and cash equivalents are primarily deposited with 
    two financial institutions.     

    Short-term investments -
    ----------------------

    The Company accounts for investments in accordance with Statement of
    Financial Accounting Standards No. 115, Accounting for Certain Investments
    in Debt and Equity Securities.  This statement requires that securities be
    classified as "held to maturity," "available for sale" or "trading", and the
    securities in each classification be accounted for at either amortized cost
    or fair market value, depending upon their classification.  Included in the
    accompanying 1997 and 1998 balance sheets are short-term corporate bonds
    that have original maturities of less than six months, and which are
    recorded at amortized cost plus accrued interest which approximates fair
    value.

    Equipment -
    ---------

    Equipment is recorded at cost and is depreciated or amortized, using the
    straight-line method, over their estimated useful lives of three to seven
    years.

    At December 31, 1997 and 1998, property and equipment, net, consisted of the
    following (in thousands):
 
                                               December 31,
                                              ---------------
                                               1997    1998
                                              ------  -------
        Equipment                             $4,890  $ 7,235
        Furniture and fixtures                 1,676    2,280
        Leasehold improvements                   595      487
                                              ------  -------
                                               7,161   10,002
        Less  Accumulated depreciation and
          amortization                         4,882    6,868
                                              ------  -------
                                              $2,279  $ 3,134
                                              ======  =======

    Expenditures for repairs and maintenance are charged against income as
    incurred while renewals and betterments are capitalized.

    Software development costs -
    --------------------------

    The Company expenses research and development costs as incurred.  The
    Company has evaluated the establishment of technological feasibility of its
    products in accordance with Statement of Financial Accounting Standards No.
    86, Accounting for the Costs of Computer Software To Be Sold, Leased or
    Otherwise Marketed.  The Company defines technological feasibility as the
    completion of a working model.  The Company sells products in a market that
    is subject to rapid technological change, new product development and
    changing customer needs.  The Company has concluded that technological
    feasibility is not established until the development stage of the product is
    nearly complete.  The time period during which costs could be capitalized
    from the point of reaching technological feasibility until the time of
    general product release 


                                      F-8
<PAGE>
 
    is very short and, consequently, the amounts that could be capitalized are
    not material to the Company's financial position or results of operations.
    Therefore, the Company has charged all such costs to research and
    development in the period incurred.

    Revenue recognition -
    -------------------  

    The Company generates revenues from licensing the rights to use its software
    products directly to end users and indirectly through sublicense fees from
    resellers.  The Company also generates revenues from sales of software
    maintenance contracts, and from consulting and training services performed
    for customers who license its products. As of January 1, 1998, the Company
    adopted Statement of Position 97-2, Software Revenue Recognition (SOP 97-2),
    which was effective for transactions that the Company entered into after
    December 31, 1997. The adoption of SOP 97-2 did not have a material adverse
    affect on the revenues or earnings of the Company for the year ended
    December 31, 1998.

    Revenues from software license agreements are recognized upon the delivery
    of the software to the customer if there are no significant post-delivery
    obligations and collection is probable.  Service revenues consist of
    professional consulting, implementation and training services performed on a
    time-and-materials basis under separate service arrangements related to the
    implementation of the Company's software products.  Revenues from consulting
    and training services are recognized as services are performed.  The Company
    enters into transactions which include both license and service elements.
    As such service elements do not include more than minor alteration of the
    software, the license fees are recognized upon delivery and the service
    revenues are recognized when performed.

    Software maintenance fees are recognized ratably over the term of the
    maintenance period.  If software maintenance fees are provided for in the
    license fee or at a discount in a license agreement, a portion of the
    license fee equal to the fair market value of these amounts is allocated to
    software maintenance revenue based on the value established by independent
    sales of such maintenance service to customers.

    Cost of license revenues consists primarily of the cost of media on which
    the product is delivered and third party software products which are resold
    by the Company.  Cost of service and maintenance revenues consists primarily
    of salaries, benefits, subcontracted consulting costs and allocated overhead
    costs related to consulting personnel and the customer support group.

    Deferred revenues primarily relate to post-contract customer support which
    has been paid by customers prior to the performance of the services.

    Earnings per share -
    ------------------

    Statement of Financial Accounting Standards No. 128, Earnings Per Share
    (SFAS 128) establishes standards for computing and presenting earnings per
    share. Under SFAS 128, earnings per share is computed both under the basic
    and dilutive methods. Basic earnings per share is computed by dividing
    income available to common shareholders by the weighted average number of
    common shares outstanding; dilutive earnings per share is computed by giving
    effect to all dilutive potential common share equivalents that were
    outstanding


                                      F-9
<PAGE>
 
    during the period. Dilutive common share equivalents include stock options,
    warrants and convertible preferred stock. 

    The calculation of basic and diluted earnings per share is as follows (in
    thousands, except per share amounts):
 
                                                     1996      1997      1998
                                                   --------  --------  ---------
             Basic earnings (loss) per share:
             -------------------------------
             Net income (loss) applicable
              to common shareholders               $(1,884)   $2,721   $(20,299)
                                                   =======    ======   ========

             Weighted average shares outstanding     4,258     6,371      9,588
                                                   =======    ======   ========
             Basic earnings (loss) per share       $  (.44)   $  .43   $  (2.12)
                                                   =======    ======   ========

             Diluted earnings (loss) per shares:
             ----------------------------------
             Net income (loss)                     $(1,047)   $3,173   $(20,299)
             Accretion of Series A preferred
              stock dividends                         (394)        -          -
             Accretion of Series B preferred
              stock dividends                          (58)     (208)         -
             Increase in fair market value of
              redeemable common stock warrants        (385)        -          -
                                                    -------    ------   --------
                                                   $(1,884)   $2,965   $(20,299)
                                                   =======    ======   ========

             Weighted average shares outstanding     4,258     6,371      9,588
             Weighted average shares resulting
              from exercise of options,
              calculated in accordance with the
              treasury stock method                      -       397          -
             Weighted average shares resulting
              from conversion of redeemable
              common stock warrants                      -       409          -
             Weighted average shares resulting
              from conversion of
              Series A preferred stock                   -       537          -
                                                   -------    ------   --------
                                                     4,258     7,714      9,588
                                                   =======    ======   ========
             Diluted earnings (loss) per share     $  (.44)   $  .38   $  (2.12)
                                                   =======    ======   ========
    
    The 1996 calculation of diluted earnings (loss) per share does not include
    the exercise of stock options (see Note 5), the conversion of Series A and
    Series B preferred stock (see Note 6) or the conversion of the redeemable
    common stock warrants (see Note 7), as the effect on diluted earnings loss
    per share would have been antidilutive. The 1997 calculation of diluted
    earnings (loss)     
                                     F-10
<PAGE>
 
    per share does not include the conversion of the Series B preferred stock as
    the effect on diluted earnings (loss) per share would have been
    antidilutive. The 1998 calculation of diluted earnings (loss) per share does
    not include the exercise of stock options as the effect on diluted earnings
    (loss) per share would have been antidilutive.

    Comprehensive income -
    --------------------
    
    Effective January 1, 1998, the Company adopted Statement of Financial
    Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130).
    SFAS 130 requires disclosure of all components of comprehensive income on an
    annual and interim basis.  Comprehensive income is defined as the change in
    stockholders' equity of a business enterprise during a period from
    transactions and other events and circumstances from non-owner sources.  The
    Company has disclosed comprehensive income for all periods presented in the
    accompanying consolidated statements of shareholder's equity.     

    Income taxes -
    ------------

    The Company accounts for income taxes in accordance with Statement of
    Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS
    109). SFAS 109 requires the Company to recognize deferred tax liabilities
    and assets for the expected future tax consequences of events that have been
    recognized in the Company's financial statements or tax returns. Under this
    method, deferred tax liabilities and assets are determined based on the
    difference between the financial statement carrying amounts and the tax
    basis of the assets and liabilities and the net operating loss carryforwards
    available for tax reporting purposes, using applicable tax rates for the
    years in which the differences are expected to reverse.

    Long-lived assets -
    -----------------

    Statement of Financial Accounting Standards No. 121, Accounting for the
    Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
    requires a company to review long-lived assets for impairment whenever
    events or changes in circumstances indicate that the carrying amount of an
    asset may not be recoverable.  As of December 31, 1998, the Company has
    determined that no material adjustment to the carrying value of its long
    lived assets is required.

    Concentration of credit risk -
    ----------------------------

    Financial instruments which potentially subject the Company to concentration
    of credit risk consists principally of cash, short term investments and
    trade receivables. As of December 31, 1998, one customer accounted for 11%
    of accounts receivables. No one customer accounted for greater than 10% of
    accounts receivable as of December 31, 1997.



    Use of estimates in the preparation of financial statements -
    -----------------------------------------------------------

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



                                     F-11
<PAGE>
 
    Reclassifications -
    -----------------

    Certain reclassifications have been made to the 1996 and 1997 consolidated
    financial statements in order for them to be presented in conformity with
    the 1998 consolidated financial statements.


    Recently Issued Accounting Standards  -
    ------------------------------------
        
    The Company is required to adopt Statement of Financial Accounting
    Standards No. 133, Accounting for Derivative Instruments and Hedging
    Activities (SFAS 133) for the year ending December 31, 1999.  SFAS 133
    establishes methods of accounting for derivative financial instruments and
    hedging activities related to those instruments as well as other hedging
    activities.  Because the Company currently holds no derivative financial
    instruments and does not currently engage in hedging activities, adoption of
    SFAS 133 is not expected to have any material impact on the Company's
    financial condition or results of operations.      

    In March 1998, the American Institute of Certified Public Accountants issued
    Statement of Position 98-1, Accounting for the Costs of Computer Software
    Developed or Obtained for Internal Use (SOP 98-1). SOP 98-1 requires that
    entities capitalize certain costs related to internal-use software once
    certain criteria have been met. The Company is required to implement SOP 
    98-1 for the year ending December 31, 1999. Adoption of SOP 98-1 is not
    expected to have any material impact on The Company's financial condition or
    results of operations.

3.  Business Acquisitions and Investments:
    ------------------------------------- 

    On March 30, 1998, the Company acquired substantially all of the net assets
    of Marketing Information Systems, Inc. ("MIS") and Telemar Software
    International, LLC ("TSI") ("the Acquisitions"), each of which markets
    proprietary call center software focused on the IBM AS/400 user market.
        
    The final adjusted aggregate purchase price of $8,656,000 consisted of
    $1,247,000 of cash, 254,841 shares of common stock valued at $3,383,000,
    $3,641,000 of net assumed liabilities and $385,000 of transaction costs. Of
    the 254,841 shares, 42,508 shares (valued at $564,000) have been placed in
    escrow and will be released from escrow no later than March 30, 1999,
    subject to the satisfactory collection of accounts receivable and the
    absence of any indemnification claims. The value of the common stock was
    determined based on the average trading price of the Company's common stock
    for the two days prior to, the day of, and the two days after, the date that
    the terms of the Acquisitions were announced.      


    The Acquisitions have been accounted for under the purchase method of
    accounting and the aggregate purchase price was allocated to the acquired

                                     F-12
<PAGE>
 
    assets and assumed liabilities based on their estimated fair value. Of the
    aggregate purchase price, $6,988,000 was allocated to acquired product
    development costs and charged to operations at the date of acquisition,
    $1,389,000 was allocated to purchased software and will be amortized over
    three years and $279,000 was allocated to goodwill and will be amortized
    over seven years.
        
    Of the $6,988,000 allocated to acquired product development costs,
    approximately $5,180,000 related to MIS technologies and $1,808,000 related
    to TSI technologies. The Company had originally allocated $2,478,000 to
    the TSI acquired product development costs based on its initial valuation at
    the time of acquisition. However, the Company subsequently adjusted its
    initial valuation and reduced the amount allocated to the TSI acquired
    product development costs by $670,000 to reflect certain adjustments in the
    valuation methodology resulting from a reallocation of a portion of future
    cash flows from the TSI acquired product development to the TSI purchased
    software. The adjustment to increase the value of the TSI purchased software
    and decrease the value of the TSI acquired product development costs was
    recorded by the Company during its fiscal quarter ended December 31, 1998.

    The MIS technologies were comprised of two separate projects: SalesPath, a
    sales force automation tool valued at approximately $4,860,000 and MSM, a
    telemarketing tool valued at approximately $320,000. Subsequent to the
    acquisition date, the Company determined that the acquired SalesPath
    technologies were of no material value. Although the SalesPath technologies
    were believed to be valuable at the time of acquisition, subsequently, the
    Company discontinued the development of SalesPath as a standalone product
    and decided to pursue development of a sales force automation component as
    part of its current suite of products.

    The operating results of the Acquisitions have been included in the
    consolidated statement of operations from the date of acquisition. The
    unaudited pro forma results below assume the acquisition occurred on January
    1 of each year:
                                          (Unaudited)
                                          -----------
                                      1997          1998
                                      ----          ----
    Revenues                         $42,975       $ 50,359
    Operating income (loss)          $(4,876)      $(21,089)
    Net Income (loss)                $(5,155)      $(20,320)
        
    Net income per share:
     Basic                           $ (0.85)      $  (2.11)
     Diluted                         $ (0.85)      $  (2.11)      

    In management's opinion, the unaudited pro forma combined results of
    operations are not indicative of the actual results that would have occurred
    had the acquisition been consummated at the beginning of fiscal 1997 or 1998
    or of future operations of the combined companies under the ownership and
    management of the Company.

4.  Equity Investment:
    -----------------
        
    During 1998, the Company acquired 19.8% of the common stock of Mitsucon
    Tecnologia S/A., a Brazilian software and services company that acts as a
    distributor for the Company, for a purchase price of approximately
    $1,715,000 in cash, including transaction costs. This investment is being
    accounted for under the cost method of accounting and is included in other
    assets in the accompanying 1998 consolidated balance sheet.      


                                     F-13

<PAGE>
 
5.  Shareholders' Equity
    --------------------

    Common stock -
    ------------

    In connection with its initial public offering (see below), the Company
    amended its Certificate of Incorporation to increase the number of
    authorized shares of common stock from 5,000,000 to 20,000,000 and to give
    effect to a 2.25-for-1 split of the Company's common stock.  The
    accompanying financial statements have been restated to reflect this stock
    split and change in authorized shares.

    In July 1997, the Company completed its initial public offering (IPO) of
    3,900,000 shares of its common stock, of which 2,800,000 shares were issued
    and sold by the Company and 1,100,000 shares were issued and sold by certain
    selling shareholders. As a result of this offering, the Company recorded
    proceeds of $32,400,000, net of related underwriting discounts and offering
    expenses of $4,100,000. In connection with the offering, the Company's
    Series A and Series B preferred stock were converted into 1,532,161 shares
    of common stock (see Note 6), 416,669 shares of common stock were issued in
    connection with the exercise of the redeemable common stock warrants (see
    Note 7) and 154,934 stock options were exercised.

    Restricted stock awards -
    -----------------------
        
    During 1990, the Company granted 160,875 shares of common stock to certain
    key employees in consideration of future services to be performed.  The
    awards required the recipients to be employed or engaged as a consultant by
    the Company for seven years in order to retain ownership of the stock.  The
    related compensation was recognized ratably over the 7-year vesting period.
    During each of 1996 and 1997, $10,000 of compensation expense was recognized
    in connection with these restricted stock awards.  These shares became fully
    vested in 1997.      

    Stock option plans -
    ------------------

    The Company has stock option plans which provide for the issuance of both
    incentive and nonqualified stock options. In March 1998, the Company adopted
    the 1998 Employee and Consultant Stock Option Plan, (The 1998 Plan) which
    provides for the issuance of up to 800,000 shares of common shares for both
    incentive and nonqualified stock options. In March 1996, the Company adopted
    both the 1996 Employee and Consultant Stock Option Plan, which provides for
    the issuance of up to 900,000 shares of common shares for both incentive and
    nonqualified stock options, and the 1996 Non-Employee Directors' Stock
    Option Plan, which provides for the issuance of up to 135,000 shares of
    common stock (collectively, The 1996 Plans). Under the provisions of The
    1998 and 1996 Plans, the exercise price of each option shall not be less
    than 100% of the fair market value of a share of common stock at the time of
    grant, as defined, and the options may vest immediately or over time. The
    1998 and 1996 Plans shall be adjusted for future changes in the
    capitalization of the Company or as designated by the Board of Directors.


    Previous to The 1996 Plans, the Company had established a stock option plan
    which provided for the issuance of up to 900,000 shares of common stock for
    both incentive and nonqualified stock options.  Under the provisions of this
    plan, the exercise price of each option was not to be less than 100% of the
    fair market value of a share of common stock, as defined, and the options
    could vest immediately or over time.

                                     F-14
<PAGE>
 
    Statement of Financial Accounting Standards No. 123, Accounting for Stock-
    Based Compensation (SFAS No. 123), requires the measurement of the fair
    value of stock options or warrants to be included in the statement of
    operations or disclosed in the notes to financial statements. The Company
    has determined that it will continue to account for stock-based compensation
    for employees under Accounting Principles Board Opinion No. 25 and elect the
    disclosure-only alternative under SFAS 123. The Company has computed the Pro
    forma disclosures required under SFAS 123 for options granted in 1996, 1997
    and 1998 using the Black-Scholes option pricing model prescribed by SFAS
    123. The weighted average assumptions used are as follows: 

                                  1996          1997           1998
                                  ----          ----           ----
    Risk free interest rate    6.15-6.94%    5.77%-6.30%    4.65%-5.56%
    Expected dividend yield         None           None           None
    Expected lives               8 years        5 years        5 years
    Expected volatility               72%            56%            78%

    Had compensation cost for the Company's stock option plans been determined
    based on the fair value at the grant dates of awards under these plans
    consistent with the method of SFAS 123, the Company's net income (loss) and
    net income (loss) per share would have been as follows (in thousands except
    for per share data):
 
                                                      1996     1997     1998
                                                    --------  ------  ---------
    Net income (loss):
      As reported                                   $(1,047)  $3,173  $(20,299)
      Pro forma                                     $(2,563)  $2,215  $(20,745)

    Basic net income (loss) per common share:
      As reported                                   $  (.44)  $  .43   $ (2.12)
      Pro forma                                     $  (.80)  $  .28   $ (2.16)
 
    Diluted net income (loss) per common share:
      As reported                                   $  (.44)  $  .38   $ (2.12)
      Pro forma                                     $  (.80)  $  .23   $ (2.16)


                                     F-15
<PAGE>
 
    A summary of the status of the Company's stock option plans at December 31,
    1996, 1997 and 1998 and changes during the years then ended is presented in
    the table and narrative below :
<TABLE>
<CAPTION>
                                                    1996                  1997                  1998
                                                    ------------------------------------------------
                                                  Weighted              Weighted              Weighted
                                                  Average               Average               Average
                                                  Exercise              Exercise              Exercise
                                        Shares     Price      Shares     Price      Shares     Price
                                      ----------  --------  ----------  --------  ----------  --------
<S>                                   <C>         <C>       <C>         <C>       <C>         <C>
    Outstanding, beginning of year      894,606      $2.97  1,336,349      $4.62  1,509,548      $6.23
      Granted                           502,875       7.51    409,626       9.56    966,185       7.55
      Exercised                          (5,782)       .04   (187,957)      1.13   (185,295)      3.41
      Expired                           (55,350)      4.61    (48,470)      9.81   (682,067)      9.73
                                      ---------             ---------             ---------      
    Outstanding, end of year          1,336,349       4.62  1,509,548       6.23  1,608,371       5.87
                                      =========             =========             =========      
    Exercisable, end of year            854,282       3.42    896,335       4.74    739,971       5.22
                                      =========             =========             =========      
    Weighted average fair value
      of options granted                             $5.80                 $6.27                 $5.90
                                                     =====                 =====                 =====
</TABLE>

    The following table presents weighted average price and life information for
    significant option groups outstanding at December 31, 1998:

<TABLE>
<CAPTION>                                          Weighted-  
                                                   Average     
                                                   Remaining       Weighted-            
                                 Number            Contractual     Average       Number          Weighted-
                                 Outstanding       Life            Exercise      Exercisable     Average
    Range of Exercise Prices     at 12/31/98       (Years)         Price         at 12/31/98     Exercise Price
    ------------------------     -----------       -------         -----         -----------     --------------
    <S>              <C>       <C>                 <C>             <C>           <C>             <C>
                     0.04         32,447              2.8          $ 0.04         32,447         $ 0.04
    $2.25-           2.94         61,274              3.9          $ 2.62         61,274         $ 2.62
    $4.00-           5.75        959,952              6.3          $ 5.17        348,792         $ 4.16
    $6.06-           8.00        474,998              7.5          $ 7.41        281,083         $ 7.40
    $10.00-         11.75         79,700              8.0          $10.67         16,375         $10.47
                               ---------                                         -------                  
                               1,608,371                                         739,971                  
                               =========                                         =======
    </TABLE>

    Stock Purchase plan -
    -------------------

    On March 1, 1997, the Board of Directors approved the adoption of an
    employee stock purchase plan designed to allow eligible employees of the
    Company to purchase shares of common stock.  The Board of Directors has
    reserved 450,000 shares of Common Stock to be available under this plan.
    The stock purchase plan allows eligible employees the right to purchase
    common stock on a quarterly basis at the lower of 85% of the market price at
    the beginning or end of each offering period.  During 1998 and 1997
    employees purchased 20,917 and 5,841 shares of common stock for an aggregate
    purchase price of approximately $105,000 and $48,000, respectively.

                                     F-16
<PAGE>
 
6.  Redeemable Convertible Preferred Stock:
    -------------------------------------- 

    In March 1995, the Company issued Series A preferred stock, with a stated
    value of $1,000, to certain common shareholders for proceeds of
    approximately $4,475,000.  In November 1996, the Company issued Series B
    preferred, with a stated value of $1,000, to certain common shareholders for
    proceeds of approximately $4,228,000.  In connection with the initial public
    offering the Series A and Series B Preferred Stock, plus accrued dividends,
    were converted into shares of common stock (see Note 5).


7.  Redeemable Common Stock Warrants:
    -------------------------------- 

    The Company issued redeemable warrants to purchase 433,372, shares of
    commons stock, with exercise prices ranging from $.40 per share to $1.33 per
    share.  In connection with the initial public offering the redeemable common
    stock warrants were converted into 416,699 shares of common stock (see Note
    5). The Company accounted for the initial value of the warrants based on
    their fair market values at the time the warrants were originally issued.
    Subsequent increases in the fair market value of the warrants, as determined
    by sales of the Company's common stock, resulted in adjustments to the
    carrying value of the warrants through direct charges to accumulated
    deficit.

8.  Income Taxes:
    ------------ 
        
    Income (loss) from operations before provision for income taxes consisted
    of (in thousands):      

                                              1996       1997        1998
                                              ----       ----        ----
     U.S.                                  $  (374)   $ 4,249   $ (17,481)
     International                            (643)      (845)     (2,348)
                                            ------     ------    --------
                                           $(1,017)   $ 3,404   $ (19,829)
                                            ======     ======     =======

    The provision for income taxes for the years ended December 31, 1996, 1997
    and 1998 is as follows (in thousands):

        
                                       Year Ended December 31,
                                       -----------------------
                                  1996          1997         1998
                                  ----          ----         ----
    Current:
      Foreign                    $   -         $ 199        $ 380
      Federal                        -             -            -
      State                         30            32           90
                                 -----         -----        -----
                                 $  30         $ 231        $ 470
                                 =====         =====        =====
         
    Deferred income taxes reflect the net tax effects of temporary differences
    between the basis of assets and liabilities for financial reporting and
    income 

                                     F-17
<PAGE>
 
    tax purposes.   A valuation allowance has been recorded for the
    deferred tax assets as a result of uncertainties regarding the realization
    of the asset.

    The approximate tax effects of temporary differences which give rise to
    deferred tax assets and liabilities is as follows (in thousands):
 
                                                     December 31,
                                               1996      1997      1998
                                             --------  --------  --------
    Current:
      Allowance for doubtful accounts        $   178   $   243   $   943
      Accrued vacation and payroll                57        65        81
      Other                                      216        76       187
      Valuation allowance                       (451)     (384)   (1,211)
                                             -------   -------   -------
                                             $     -   $     -   $     -
                                             =======   =======   =======
     
    Non-current:
      Purchased software                     $     -   $     -   $   510
      Depreciation                                51        71        91
      Deferred compensation                       23         -         -
      Rental obligations                         154       145       155
      Tax effect of net operating losses,
        excluding amounts related to
        stock option exercises                 3,265     2,053     3,608
      Valuation allowance                     (3,493)   (2,269)   (4,364)
                                             -------   -------   -------
                                             $     -   $     -   $     -
                                             =======   =======   =======
         
    The exercise price of non-qualified stock options gives rise to compensation
    which is included in the taxable income of the applicable employees and
    deducted by the Company for federal and state income tax purposes. As a
    result of the exercise of nonqualified stock options during 1997 and 1998,
    the Company has related net operating loss carryforwards of $4,051,000 which
    can be used to offset future taxable income, if any. When realized, the
    related tax benefits of these net operating loss carryforwards will be
    credited directly to paid in capital.     


                                     F-18
<PAGE>
 
    The Company's effective tax rate differs from the statutory federal income
    tax rate as shown in the following schedule:
 
                                            December 31,
                                         1996   1997   1998
                                         -----  -----  -----
    Income tax at statutory rate         (34)%    34%   (34)%
    Other                                 (3)      1      1
    Net operating loss not benefited      37       -     33
    Utilization of net operating loss
      carryforwards                        -     (35)     -
                                        ----    ----   ----
                                           0%      0%     0%
                                        ====    ====   ====

    At December 31, 1998, the Company had approximately $13,000,000 of U.S.
    Federal net operating loss carryforwards, of which approximately $4,051,000
    resulted from the exercise of nonqualified stock options (see above), and
    approximately $4,000,000 of state net operating loss carryforwards which can
    be used, subject to certain limitations, to offset future taxable income, if
    any.  These U.S. Federal net operating loss carryforwards expire through
    2018 and the state net operating loss carryforwards expire through 2003.

    In addition, the Company has United Kingdom net operating loss carryforwards
    of approximately $3,500,000 which can be utilized to offset future taxable
    income and which have no expiration.

    The Company's IPO (see Note 5) resulted in a change in ownership, as defined
    by Federal income tax laws and regulations. As a result of this change in
    ownership, the amount of pre IPO U.S. Federal net operating loss
    carryforwards which can be utilized to offset Federal taxable income has an
    annual limitation of approximately $4,700,000.

9.  Related Party Transactions:
    -------------------------- 

    Notes receivable from related parties consists of net advances to
    shareholders of $24,000 at December 31, 1997 which were repaid to the
    Company during 1998.

10. Commitments and Contingencies:
    ----------------------------- 

    Leases -
    ------

    The Company has entered into an agreement to lease its corporate
    headquarters.  This lease commenced April 1, 1994, and has a term of 10
    years.  Total aggregate lease payments of approximately $2,176,000 are being
    amortized on a straight-line basis over the term of the operating lease,
    beginning in April 1994.  Accordingly, approximately $28,000 of deferred
    rent expense was recorded during 1997 and 1998, respectively, related to
    this lease and is included in other accrued liabilities and other long-term
    liabilities in the accompanying consolidated balance sheets.

    In November 1998, the Company entered into an agreement to lease office
    space in Irvine, California, which is to be used as a sales, service and
    product development facility.  The lease will commence May 1, 1999 and has a
    term of 7 

                                     F-19
<PAGE>
 
    years.  Under the terms of the lease, the Company is committed to
    pay aggregate lease payments of approximately $5,860,000.  In connection
    with entering into this lease, the Company terminated the lease for its
    previous California facility.  As a result of the termination of such lease,
    the Company incurred a $250,000 lease termination cost and $77,000 of
    expense associated with the write off of leasehold improvements which are
    reflected as a general and administrative expense in the accompanying 1998
    consolidated statement of operations. Of the total lease termination charge,
    $125,000 was paid by the Company upon execution of the lease and the
    remaining $125,000, which will be paid when the Company vacates the current
    premises in April 1999.

    The Company leases other property and equipment under a number of operating
    leases extended for varying periods of time. Operating lease rental expense
    approximated $858,000, $1,255,000 and $1,426,000 for the years ended
    December 31, 1996, 1997 and 1998, respectively. Minimum future rental
    commitments under all operating leases for each of the succeeding five years
    subsequent to December 31, 1998, and thereafter, are as follows (in
    thousands):

                    Year Ending
                    December 31,                  Amount
                    ------------                  ------
                       1999                       $1,893
                       2000                        1,835
                       2001                        1,785
                       2002                        1,835
                       2003                        1,867
                       Thereafter                  2,060

    Litigation -
    ----------
        
    During 1998, the Company entered into a settlement agreement with Rockwell
    International Corporation, Rockwell Semiconductor Systems, Inc. and Rockwell
    Telecommunications, Inc. (collectively, "Rockwell") resulting from
    Rockwell's claims related to the Company's provision of a call center
    solution to United States Cellular Corporation ("USCC"). The Company decided
    to settle the matter to enable it to resume its relationship with USCC which
    included USCC's exercise of its option to license additional software from
    the Company during the quarter ended September 30, 1998 for a fee of
    $1,750,000. Under the terms of the settlement, the litigation was dismissed
    and all claims by Rockwell relating to the Company's relationship with USCC
    have been released. IMA agreed to pay Rockwell $1,750,000 in four
    installments over one year, of which $950,000 was paid during 1998.     
        
    The Company is currently a party to other litigation arising in the normal
    course of business. In the opinion of management, no claims are expected to
    have a material adverse effect on the Company's operations or financial
    position.     

11. Employee Benefit Plan:
    --------------------- 

    The Company has a voluntary 401(k) plan.  All full-time employees who have
    completed six months of service are eligible to participate in the plan.
    The plan provides for matching contributions and an annual profit sharing
    contribution made at the discretion of the Company's Board of Directors.
    During 1996, 1997 and 1998, $33,000, $57,000 and $104,000, respectively, of
    matching contributions were made to the plan by the Company.

12. Disclosures about Fair Value of Financial Instruments:
    ----------------------------------------------------- 

    The carrying value of certain of the Company's financial instruments
    including cash and cash equivalents, short-term investments, accounts
    receivable, 

                                     F-20
<PAGE>
 
    accounts payable and other accrued liabilities approximate fair value due to
    their short maturities. Based on borrowing rates currently available to the
    Company for loans with similar terms, the carrying value of its capital
    lease obligations also approximates fair value.

13. Business Segment Information:
    ---------------------------- 

    Effective for the year ended December 31, 1998, the Company adopted
    Statement of Financial Accounting Standards No. 131, Disclosures about
    Segments of an Enterprise and Related Information  which requires disclosure
    of financial and descriptive information about the Company's reportable
    operating segments.  The operating segments reported below are the segments
    for which separate financial information is available and for which
    operating profit (loss) amounts are evaluated regularly by senior management
    in deciding how to allocate resources and in assessing performance.

    The Company operates  two reportable segments:  enterprise call center
    software solutions and professional services.  The Company's reportable
    segments are strategic business units that offer different products and
    services.  They are managed separately, based on the fundamental differences
    in their operations.  The enterprise call center software solution provides
    software licenses of the Company's software products.  The professional
    services provides the professional consulting services, implementation,
    training and maintenance related to the Company's enterprise call center
    software solutions.  The accounting policies of the segments are the same as
    those described in the summary of significant accounting policies.  Expenses
    related to general corporate functions such as Information Technology,
    Finance and Human Resources, and general and administrative costs such as
    depreciation, rent and utilities are allocated to the reportable segments
    based on relative headcount or relative usage. Income tax provision
    (benefit) is allocated to the reportable segments in deriving segment profit
    (loss) based on each segment's pro rata income or loss before income tax
    provision (benefit). The Company has no intersegment sales and transfers,
    and does not allocate assets to the operating segments.
        
    For The Year Ended December 31, 1998
    --------------------------------------
    (in thousands)
 
                                 Enterprise Call   Professional
                                 Center Software       Services   Consolidated
                                 ---------------   ------------   ------------
    Revenues                            $ 24,903        $24,190       $ 49,093
    Cost of Sales                            356         17,420         17,776
    Product Development                    9,266              -          9,266
    Depreciation & Amortization            1,085            911          1,996
    Other Income(Expense), net               440            370            810 
                                        --------        -------       --------
    Segment Loss                        $(11,915)       $(8,384)      $(20,299)
                                        ========        =======       ========
         
                                     F-21
<PAGE>
 
    For The Year Ended December 31, 1997
    ------------------------------------------
    (in thousands)
                                 Enterprise Call   Professional
                                 Center Software   Services       Consolidated
                                 ---------------   ------------   ------------
    Revenues                            $ 19,295       $ 17,377       $ 36,672
    Cost of Sales                            304          9,428          9,732
    Product Development                    6,190              -          6,190
    Depreciation & Amortization              804            602          1,406
    Other Income(Expense), net                10              8             18 
                                         -------        -------        -------
    Segment Profit                      $  2,745       $    428       $  3,173
                                         =======        =======        =======
 
    For The Year Ended December 31, 1996
    ------------------------------------
    (in thousands)
                                 Enterprise Call   Professional
                                 Center Software   Services       Consolidated
                                 ---------------   ------------   ------------
    Revenues                            $ 13,022       $ 13,255       $ 26,277
    Cost of Sales                            709          7,191          7,900
    Product Development                    6,382              -          6,382
    Depreciation & Amortization              493            728          1,221
    Other Income(Expense), net              (435)          (644)        (1,079)
                                         -------        -------        -------
    Segment Profit (Loss)               $    670       $ (1,717)      $ (1,047)
                                         =======        =======        =======

The Company also operates in two major geographic areas:  United States and
International. The United States charges the International segment a 50% royalty
on license fees recognized, which approximates the royalty fee charged to
unaffiliated resellers. In addition, certain direct costs incurred by the United
States segment, primarily related to research and development and customer
support costs, are charged to the International segment. The elimination in the
identifiable assets is for intercompany receivables (in thousands).

<TABLE>     
<CAPTION>
 
                                      UNITED STATES    INTERNATIONAL    ELIMINATION    CONSOLIDATED
                                      -------------    -------------    -----------    ------------
<S>                                   <C>              <C>              <C>            <C>
Year Ended December 31, 1998
Revenues.                               $ 39,981         $ 12,695       $ (3,583)       $ 49,093
                                        ========         ========       ========        ========
Loss from operations                     (18,263)          (2,376)             -         (20,639)
                                        ========         ========       ========        ========
Identifiable assets                       38,727            8,153         (9,642)         37,238
                                        ========         ========       ========        ========
Year Ended December 31, 1997
Revenues                                  32,345            6,086         (1,759)         36,672
                                        ========         ========       ========        ========
Income (loss) from operations              4,239             (853)             -           3,386
                                        ========         ========       ========        ========
Identifiable assets                       44,774            3,620         (4,472)         43,922
                                        ========         ========       ========        ========
Year Ended December 31, 1996
Revenues                                  22,762            4,680         (1,165)         26,277
                                        ========         ========       ========        ========
Income (loss) from operations                802             (740)             -              62
                                        ========         ========       ========        ========
Identifiable assets                       17,483            2,648         (2,850)         17,281
                                        ========         ========       ========        ========
</TABLE>      

                                     F-22
<PAGE>
 
    The following table summarizes the Company's revenues by major worldwide
    regions (in thousands):

       
                                         FOR THE YEAR ENDED DECEMBER 31,
                                         ------------------------------
                                        1996          1997           1998
                                      -------       -------       --------
    United States                     $19,483       $26,887       $ 31,622
    Canada                                546           833            394
    Mexico and Latin America              277         1,903          2,145
    Europe                              4,798         5,552         12,692
    Pacific Rim                         1,173         1,497          2,240
                                      -------       -------       --------
                                      $26,277       $36,672       $ 49,093
                                      =======       =======       ========
     
14. Significant Customers:
    --------------------- 

    For the years ended December 31, 1996, 1997 and 1998, approximately 8%, 10%
    and 12%, respectively, of the Company's revenues resulted from sales to a
    single customer.
    
15. Subsequent Event:
    ----------------

    In March 1999, the Company obtained a commitment letter from a bank for a
    line of credit facility (Line of Credit).  Borrowing under the Line of
    Credit will be limited to the greater of $7,500,000 or 80% of eligible
    accounts receivable, as defined.  The Line of Credit, which will mature two
    years from the final execution date, will contain certain financial
    covenants including, but not limited to, minimum net worth, minimum working
    capital, and minimum interest coverage ratios, as defined.  The Company
    expects to execute the Line of Credit in April 1999.      

                                     F-23
<PAGE>
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         Not applicable.

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

    The information required by Item 401 of Regulation S-K with respect to the
executive officers of the Company is included in Item 4A of this Form 10-K.  The
information required by Item 401 of Regulation S-k with respect to directors of
the Company and information required by Item 405 of Regulation S-K is
incorporated by reference by the Company's definitive proxy statement (the
"Definitive Proxy Statement") which will be filed with the Securities and
Exchange Commission pursuant to Regulation 14A within 120 days after the end of
the fiscal year covered by this Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

    The information required by Item 402 of Regulation S-K is incorporated by
reference to the Definitive Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    The information required by Item 403 of Regulation S-K is incorporated by
reference to the Definitive Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AN RELATED TRANSACTIONS

    The information required by Item 404 of Regulation S-K is incorporated by
reference to the Definitive Proxy Statement.

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

     (a) 1.  FINANCIAL STATEMENTS

             See Item 8 of this Report

         2.  FINANCIAL STATEMENT SCHEDULES

             See Item 8 of this Report

     (b) Reports on Form 8-K

         1.  A Report on Form 8-K was filed by the Company on November 3, 1998 
             to report under Item 5 the Company's third quarter earnings.

         2.  A Report on Form 8-K was filed by the Company on October 7, 1998 
             announcing the Company's preliminary earnings and announcing the
             settlement of litigation.

     (c) Exhibits

         Please see the Exhibit Index to this Report which is incorporated 
         herein by reference.

     (d) Financial Statements Excluded From Annual Report to Shareholders

         Not Applicable
 
                                    F-24
<PAGE>
 
SIGNATURES

Pursuant to the requirements 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.

<TABLE>
<S>                              <C>                                  <C>
Dated: March 30, 1999            /s/ Albert R. Subbloie, Jr.           President, Chief Executive
                                ------------------------------         Officer and Director
                                Albert R. Subbloie, Jr.                (Principal Executive Officer)


Dated: March 30, 1999           /s/ Gary R. Martino                    Chairman of the
                                ---------------------------            Board of Directors,
                                Gary R. Martino                        Chief Financial Officer, Treasurer
                                                                       and Director (Principal Financial
                                                                       Accounting Officer)
</TABLE>

       No reports on Form 8-K were filed by the Registrant during the
       fourth quarter of the fiscal year covered by this report.

                                  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.

                                  INFORMATION MANAGEMENT ASSOCIATES, INC.
 

                               By:        /s/  Albert R. Subbloie, Jr.
                                     -------------------------------------  
                                     Albert R. Subbloie, Jr.
                                     President and Chief Executive Officer
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
 
     SIGNATURE                             TITLE                  DATE
 

     /s/  Albert R. Subbloie, Jr.          President, Chief       March 30, 1999
     ------------------------------
     ALBERT R. SUBBLOIE, JR.               Executive Officer
                                           and Director
                                           (Principal
                                           Executive Officer)
<PAGE>
 
    /s/  Gary R. Martino                   Chairman of the        March 30, 1999
    ------------------------------         Board of
    GARY R. MARTINO                        Directors, Chief
                                           Financial Officer,
                                           Treasurer and
                                           Director (Principal
                                           Financial and
                                           Accounting Officer)


    /s/  Paul J. Schmidt                   Director               
    --------------------------------
    PAUL J. SCHMIDT


    /s/ Thomas F. Hill                     Director               
    --------------------------------
    THOMAS F. HILL



    /s/  Donald P. Miller                  Director               
    --------------------------------
    DONALD P. MILLER


    /s/  David J. Callard                  Director               
    --------------------------------
    DAVID J. CALLARD


                                 EXHIBIT INDEX

    Exhibit 10.1   Lease Agreement
    Exhibit 10.2   Amendment to Lease
    Exhibit 23.1   Report of Independent Public Accountants on Schedule  
    Exhibit 23.2   Consent of Independent Public Accountants
    Exhibit 27.1   Financial Data Schedule                              

    

                   CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation of our
reports  included  in this  Form  10-K,  into  the  Company's  previously  filed
Registration Statement File No. 333-32417.

                                                         Arthur Andersen LLP /s/
Hartford, Connecticut
March 31, 1998

<PAGE>
 
SCHEDULE II

INFORMATION MANAGEMENT ASSOCIATES, INC.

VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                           Balance At        Charge to                     Balance At
                                           Beginning         Cost and                        End of
                                           Of Period         Expenses     Deductions         Period
<S>                                        <C>             <C>            <C>              <C>
January 1, 1996-December 31, 1996          $425,328        $  390,224     $  (333,578)     $  481,974
January 1, 1997-December 31, 1997          $481,974        $1,138,614     $  (990,511)     $  630,077
January 1, 1998-December 31, 1998          $630,077        $6,721,995     $(3,943,936)     $3,408,136
</TABLE>