<PAGE>
 
                            FORM 10-QSB - Quarterly
    Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

FORM 10-QSB

[X]  Quarterly Report pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of l934.

For the period ended March 31, 1999.
                     ---------------

[_]  Transition Report Pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of 1934.

For the transition period from                      to                     .
                               ---------------------  ---------------------

Commission File Number    0-28462.
                      ------------  

ONLINE SYSTEM SERVICES, INC.
----------------------------
(Exact name of registrant as specified in its charter)

COLORADO                              84-1293864
-----------------------------------------------------
(State or other jurisdiction       I.R.S. Employer
of incorporation or organization  Identification No.)

1800 GLENARM PLACE, SUITE 700, DENVER, CO     80202
-----------------------------------------------------
(Address of principal executive offices)    (Zipcode)

(303) 296-9200
--------------
(Registrant's telephone number, including area code)

Not Applicable
--------------
Former name, former address and former fiscal year, if changed since last
report.)

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.

[X]  YES  [_]  NO

APPLICABLE ONLY TO CORPORATE ISSUERS:
<TABLE> 
<CAPTION> 
<S><C>  
     As of May 13, 1999, Registrant had 5,660,473 shares of common stock outstanding.
</TABLE> 

                                       1
<PAGE>
 
                  ONLINE SYSTEM SERVICES, INC. AND SUBSIDIARY
                                     Index
                                     -----
<TABLE>
<CAPTION>
                                                                                                             Page
                                                                                                           ----------
<S>                                                                                                      <C> 
Part I.  Financial Information
        
         Item 1.  Unaudited Financial Statements

         Consolidated Balance Sheets as of March 31, 1999  and December 31, 1998                                 3

         Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998                4

         Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998              5-6

         Notes to Consolidated Financial Statements                                                           7-14

        Item 2.   Management's Discussion and Analysis of Financial Condition
                  and Results of Operations                                                                  15-28
                
Part II. Other Information

         Item 1 and 3-5.   Not Applicable                                                                       28

         Item 2.  Changes in Securities and Use of Proceeds                                                     28

         Item 6.  Exhibits and Reports on Form 8-K                                                              29

Signatures                                                                                                      30
</TABLE>

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


This report contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended, and is subject to the safe harbors created
by those sections. These forward-looking statements are subject to significant
risks and uncertainties, including those identified in the section of this Form
10-QSB entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Factors That May Affect Future Operating Results,"
which may cause actual results to differ materially from those discussed in such
forward-looking statements. The forward-looking statements within this Form 10-
QSB are identified by words such as "believes," "anticipates," "expects,"
"intends," "may," "will" and other similar expressions. However, these words are
not the exclusive means of identifying such statements. In addition, any
statements which refer to expectations, projections or other characterizations
of future events or circumstances are forward-looking statements. The Company
undertakes no obligation to publicly release the results of any revisions to
these forward-looking statements which may be made to reflect events or
circumstances occurring subsequent to the filing of this Form 10-QSB with the
Securities and Exchange Commission ("SEC"). Readers are urged to carefully
review and consider the various disclosures made by the Company in this report
and in the Company's other reports filed with the SEC that attempt to advise
interested parties of the risks and factors that may affect the Company's
business.


                                       2
<PAGE>
 
                          PART I FINANCIAL INFORMATION

                          ITEM 1 FINANCIAL STATEMENTS

                  ONLINE SYSTEM SERVICES, INC. AND SUBSIDIARY

                          CONSOLIDATED BALANCE SHEETS

                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                              March 31,      December 31,
                                                                                                1999             1998
                                                                                           -------------    -------------
<S>                                                                                         <C>              <C>
                                      ASSETS
Current assets:
  Cash and cash equivalents                                                                 $  1,651,254     $    698,339
  Accounts receivable, net of allowance for doubtful accounts of $18,000                          90,944          124,912
  Accounts receivable from related party                                                          95,531           22,925
  Note and accrued interest receivable                                                           996,141          896,787
  Inventory, net                                                                                  29,193           55,126
  Prepaid expenses                                                                                39,919           74,179
  Deferred acquisition costs                                                                     230,435          229,404
  Short-term deposits                                                                            101,416          101,441
                                                                                           -------------    -------------
              Total current assets                                                             3,234,833        2,203,113

Investment in subsidiary                                                                           5,671                -

Property and equipment, net of accumulated depreciation
  of $849,738 and $741,552, respectively                                                       1,778,842        1,178,628

Other assets                                                                                      21,590            3,535
                                                                                           -------------    -------------
              Total assets                                                                  $  5,040,936     $  3,385,276
                                                                                           =============    =============
                            LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable and accrued liabilities                                                  $    975,682     $    873,901
  Accrued salaries and payroll taxes payable                                                     261,239          329,755
  Current portion of capital leases payable                                                       33,906           21,766
  Customer deposits and deferred revenue                                                         365,000          100,600
                                                                                          -------------------------------
              Total current liabilities                                                        1,635,827        1,326,022

Capital leases payable                                                                            54,232           39,915

Stockholders' equity:
  Preferred stock, no par value, 5,000,000 shares authorized:
     10% redeemable, convertible preferred stock, 10% cumulative return; 85,000 and
      245,000 shares issued and outstanding, respectively,
      including dividends payable of $106,256 and $241,172, respectively                         956,256        2,691,172

     Series C redeemable, convertible preferred stock, 4% cumulative
         return; 500 and none issued and outstanding, respectively,
         including dividends payable of $4,386 and none, respectively                            504,386                -
 
     Series A redeemable, convertible preferred stock, 5% cumulative
         return; none and 1,400 issued and outstanding, respectively,
         including dividends payable of none and $10,164, respectively                                 -        1,410,164
 
  Common stock, no par value, 20,000,000 shares authorized,
    5,590,604 and 4,642,888 shares issued and outstanding, respectively                       27,053,704       16,410,300
  Warrants and options                                                                         2,392,060        2,281,832
  Accumulated deficit                                                                        (27,555,529)     (20,774,129)
                                                                                           -------------    -------------
              Total stockholders' equity                                                       3,350,877        2,019,339
                                                                                           -------------    -------------
              Total liabilities and stockholders' equity                                    $  5,040,936     $  3,385,276
                                                                                           =============     ============
</TABLE>


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


                                       3
<PAGE>
 
                  ONLINE SYSTEM SERVICES, INC. AND SUBSIDIARY

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                                                                                Three Months Ended
                                                                                                     March 31,
                                                                                     ------------------------------------------
                                                                                           1999                      1998
                                                                                     -----------------        -----------------
<S>                                                                                <C>                        <C>
Net sales:
 Transaction fee sales                                                                   $     100,329              $    20,825
 Transaction fee sales to related party                                                          6,000                    2,000
 Service sales                                                                                  39,944                   84,747
 Service sales to related party                                                                 24,500                        -
 Hardware and software sales                                                                    52,173                  533,927
 Hardware and software sales to related party                                                   65,336                   85,740
                                                                                     -----------------        -----------------
                                                                                               288,282                  727,239
                                                                                     -----------------        -----------------
Cost of sales:
 Cost of transaction fee sales                                                                  65,291                    7,947
 Cost of transaction fee sales to related party                                                  2,514                      805
 Cost of services                                                                               19,690                   79,767
 Cost of service sales to related party                                                          6,176                        -
 Cost of hardware and software                                                                  35,868                  424,352
 Cost of hardware and software sales to related party                                           58,287                   48,682
                                                                                     -----------------        -----------------  
                                                                                               187,826                  561,553
                                                                                     -----------------        -----------------
 Gross margin                                                                                  100,456                  165,686
                                                                                     -----------------        -----------------
Operating expenses:
 Sales and marketing expenses                                                                  509,859                  514,315
 Product development expenses                                                                  598,840                  222,368
 General and administrative expenses                                                         1,484,545                  851,474
 Depreciation and amortization                                                                 108,229                   95,377
                                                                                     -----------------        -----------------
                                                                                             2,701,473                1,683,534
                                                                                     -----------------        -----------------
 Loss from operations                                                                       (2,601,017)              (1,517,848)
Loss from investment in subsidiary                                                             (21,949)                       -
Interest income, net                                                                            46,142                   29,139
                                                                                     -----------------        -----------------
Net loss                                                                                    (2,576,824)              (1,488,709)
Preferred stock dividends                                                                      (46,013)                 (62,399)
Accretion of preferred stock to redemption value                                            (3,000,000)                (418,696)
Accretion of preferred stock for guaranteed return in excess
 of redemption value                                                                        (1,158,563)                       -
                                                                                     -----------------        -----------------
Net loss available to common stockholders                                                $  (6,781,400)             $(1,969,804)
                                                                                     =================        =================
Loss per share, basic and diluted                                                               $(1.28)                  $(0.59)
                                                                                     =================        =================
Weighted average shares outstanding                                                          5,313,368                3,335,687
                                                                                     =================        =================
</TABLE>



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

                                       4
<PAGE>
 
                  ONLINE SYSTEM SERVICES, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                                                                Three Months Ended
                                                                                                     March 31,
                                                                                 ----------------------------------------------
                                                                                         1999                       1998
                                                                                 -------------------        -------------------
<S>                                                                                <C>                        <C>
 
Cash flows from operating activities:
    Net loss                                                                             $(2,576,824)               $(1,488,709)
    Adjustments to reconcile net loss to net cash used in operating activities:
        Depreciation and amortization                                                        108,229                     95,377
        Loss from investment in subsidiary                                                    21,949
        Accrued interest income on advances to DCI                                           (22,050)                         -
        Reduction in note receivable for services received from DCI                          272,276                          -
        Stock and stock options issued for services and to customer                          140,229                     11,042
    Changes in operating assets and liabilities:
        Decrease in accounts receivable                                                       33,968                    129,149
        Increase in accounts receivable from related party                                   (72,606)                   (22,925)
        Decrease in accrued revenue receivables                                                    -                     26,400
        Decrease in inventory                                                                 25,933                    194,452
        Decrease (increase) in prepaid expenses                                               34,260                    (20,250)
        (Increase) decrease in short-term deposits and other assets                          (18,072)                    11,010
        Decrease in accounts payable and accrued liabilities                                (346,738)                  (430,145)
        (Decrease) increase in accrued salaries and payroll taxes payable                    (68,516)                    92,412
        Increase (decrease) in customer deposits and deferred revenue                        264,400                     (4,999)
                                                                                 -------------------        -------------------
            Net cash used in operating activities                                         (2,203,562)                (1,407,186)
                                                                                 -------------------        -------------------
Cash flows from investing activities:
    Purchase of property and equipment                                                      (224,883)                  (161,270)
    Capitalized software development costs                                                         -                    (68,672)
    Cash advances to DCI                                                                    (349,579)                  (130,967)
    Payment of acquisition costs                                                              (1,031)                         -
    Investment in subsidiary                                                                 (27,620)                         -
                                                                                 -------------------        -------------------
            Net cash used in investing activities                                           (603,113)                  (360,909)
                                                                                 -------------------        -------------------
Cash flows from financing activities:
    Payments on capital leases                                                                (8,543)                    (6,201)
    Proceeds from issuance of common stock and warrants                                            -                     65,442
    Proceeds from exercise of stock options and warrants                                   1,012,633                     50,410
    Proceeds from issuance of 10% Preferred Stock                                                  -                    159,558
    Proceeds from issuance of Series C Preferred Stock                                     3,000,000                          -
    Stock offering costs                                                                    (244,500)                   (26,764)
                                                                                 -------------------        -------------------
            Net cash provided by financing activities                                      3,759,590                    242,445
                                                                                 -------------------        -------------------
Net increase (decrease) in cash and cash equivalents                                         952,915                 (1,525,650)
Cash and cash equivalents, beginning of period                                               698,339                  3,680,282
                                                                                 -------------------        -------------------
Cash and cash equivalents, end of period                                                 $ 1,651,254                $ 2,154,632
                                                                                 ===================        ===================
</TABLE>



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

                                       5
<PAGE>
 
                          ONLINE SYSTEM SERVICES, INC.

               CONSOLIDATED Statements of Cash Flows (Continued)

                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                                                                                  Three Months Ended
                                                                                                       March 31,
                                                                                    ---------------------------------------------
                                                                                            1999                      1998
                                                                                    -------------------       -------------------
<S>                                                                                 <C>                       <C> 
Supplemental disclosure of cash flow information:
Cash paid for interest                                                                   $        4,159              $      1,784

Supplemental schedule of non-cash investing and financing activities:
   Accretion of preferred stock to redemption value                                      $    3,000,000              $    418,696
   Accretion of preferred stock for guaranteed return in excess of
         redemption value                                                                     1,158,563                         -
   Preferred stock dividends paid or to be paid in common stock                                  46,013                    62,399
   Preferred stock and dividends converted to common stock                                    5,686,707                         -
   Stock and stock options issued for services and to customer                                  140,229                    11,042
   Capital leases for equipment                                                                  35,000                     5,100
   Reduction of note receivable in exchange for services received                               272,276                         -
   Equipment to be paid for with capital leases                                                 427,664                         -
   Purchase of intangible asset                                                                  27,620                         -
</TABLE>



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

                                       6
<PAGE>
 
                  ONLINE SYSTEM SERVICES, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                      MARCH 31, 1999 AND DECEMBER 31, 1998

                                  (UNAUDITIED)

NOTE 1 - BASIS OF PRESENTATION

     The accompanying unaudited interim consolidated financial statements
include the accounts of Online System Services and its wholly owned subsidiary
(collectively the "Company").  The Company's investment in NetIgnite is
accounted for using the equity method.  The consolidated financial statements
have been prepared without audit pursuant to rules and regulations of the
Securities and Exchange Commission and reflect, in the opinion of management,
all adjustments, which are of a normal and recurring nature, necessary for a
fair presentation of the financial position and results of operations for the
periods presented.  The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions.  Such estimates and assumptions affect the reported amounts of
assets and liabilities as well as disclosure of contingent assets and
liabilities at the date of the accompanying financial statements, and the
reported amounts of revenue and expenses during the reporting period.  Actual
results could differ from those estimates.  The results of operations for the
interim periods are not necessarily indicative of the results for the entire
year.  The interim financial statements should be read in connection with the
financial statements included in the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1998 filed with the Securities and Exchange
Commission.

     The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern.  Among other
factors, the Company has incurred significant and recurring losses from
operations, and such losses are expected to continue in the near future, which
raises substantial doubt about the ability of the Company to continue as a going
concern.  Management's plans in regard to these matters are described in
Management's Discussion and Analysis of Financial Condition and Results of
Operations.  The accompanying financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern.

     The continued viability of the Company depends upon, in part, its ability
to obtain additional profitable customer contracts and to obtain additional
capital through debt or equity financing. The Company believes that its cash and
cash equivalents and working capital as of March 31, 1999 plus the anticipated
proceeds from the sale of 2,000 shares of the Company's Series C Preferred Stock
(See Note 7) will be adequate to sustain operations through July 1999. The
Company estimates that it will need to raise approximately $25,000,000 through
equity, debt or other external financing, to implement its business development
plan (approximately $6,000,000 of which is required to sustain operations for
the remainder of 1999). The Company's plan to fund its operations for the next
twelve months is to obtain equity financing through a combination of strategic
partner investments, proceeds from the exercise of initial public offering
("IPO") common stock warrants (if any, see below), additional private placements
of its securities, and may include a secondary public offering of its common
stock. The Company is engaged in ongoing discussions with certain potential
strategic partners, which if successful, could result in significant additional
equity funding for the Company. In connection with the Company's IPO during May
1996, warrants representing the right to acquire 632,500 shares of common stock
at $9.00 per share were issued to investors. These warrants expire on May 24,
1999, if not exercised prior thereto. In the event that all of the warrants were
exercised for cash, the Company would receive in excess of $5.6 million in net
proceeds. In lieu of exercising the warrants for cash, holders may utilize a
"cashless exercise" option whereby they may apply the value of a portion of
their warrants (i.e., the difference between the market value for our common
stock and $9.00, the exercise price of the warrants) to pay the exercise price
for the balance of the warrants to be exercised. Therefore, the Company is
unable to predict the amount of net proceeds, if any, which it may receive upon
exercise of the warrants. Further, the Company believes that it would be
possible to continue to raise additional working capital through the sale of
securities similar to the transaction described in Note 7 and has initiated
discussions with various potential private investors which could result in
additional debt or equity investments. The Company has begun discussions
regarding a possible secondary offering of its securities during the fall of
1999. However, the Company


                                       7
<PAGE>
 
has no commitments for any such funding and there can be no assurances that
these discussions will be successful, or if successful, that the terms of any
such fundings will be acceptable to the Company. If the Company is not
successful in obtaining funding in appropriate amounts or at appropriate terms,
management would consider significant reductions in activity and operations.

NOTE 2 - REVENUE RECOGNITION

     Transaction fee sales include revenue from e-banking service bureau fees,
online subscription fees, and Internet access and e-commerce royalties.  The
Company recognizes revenue in the period the services are provided or earned by
the Company.

NOTE 3 - INVESTMENT IN NETIGNITE

     On March 10, 1999, the Company acquired a controlling interest in a newly
formed company, NetIgnite 2, LLC ("NetIgnite").  NetIgnite is a development
stage company which the Company formed with a predecessor company by the name of
NetIgnite, Inc. ("NI"), the sole shareholder and founder of which was Perry
Evans, the founder and past President of MapQuest.com.  In connection with the
formation of NetIgnite, NI contributed all of its rights to certain technology
to NetIgnite and the Company agreed to provide funding totaling $1,500,000 which
the Company believes will be required to implement NetIgnite's business plan,
such funding will occur over the  next 12 to 18 months, and on March 31,
1999, the Company had funded $27,620.  The Company is entitled to 99.5% of
NetIgnite's operating income and approximately 60% of any proceeds upon the sale
of NetIgnite.  NI is entitled to .5% of NetIgnite's operating income and
approximately 40% of any proceeds upon the sale of NetIgnite.  The Company has
entered into a Buy-Sell Agreement with NI pursuant to which either the Company
or NI could, subject to certain conditions, acquire all of the other's interest
in NetIgnite.  In the event that the Company sold its interest to NetIgnite in
accordance with the Buy-Sell Agreement, the Company would be entitled to retain
a limited non-exclusive license to utilize the technology developed by
NetIgnite.  Mr. Evans has entered into an Employment Agreement with the Company
and NetIgnite which has an initial term of two years, provides for a minimum
annual salary of $190,000 and the granting of stock options to purchase 80,000
shares of common stock at an exercise price of $12.25, one-third of such option
shares to vest annually during the next three years subject to Mr. Evans'
continuous employment by the Company.

     The Company utilizes the equity method of accounting for this subsidiary.

NOTE 4 - NOTE RECEIVABLE

     In connection with the Merger Agreement (See Note 13) between the Company
and DCI, the Company agreed to fund DCI's working capital requirements through
the consummation of the merger and executed an unsecured working capital note
with a stated interest rate of 10%.  As of March 31, 1999, the Company had
loaned DCI $1,737,434 and recorded $71,354 of accrued interest receivable.  In
addition, the Company paid DCI $812,648 for services rendered in connection with
the integration of DCI's CommunityWare(R) with the Company's WEBBbuilder
product offerings, the payment for such services was effected as a reduction in
the note receivable and as product development expenses in the accompanying 1999
consolidated statement of operations.  The Company believes that the merger will
be consummated during the second quarter of 1999.  If the merger is not
completed, no assurances can be made that any amounts due from DCI will be
collected.  The note receivable is secured by a license to DCI's technology.  It
is the Company's intent to continue to fund DCI until the business combination
is complete.

NOTE 5 - INCOME TAXES

     As a result of net losses and the Company's inability to recognize a
benefit for its deferred tax assets, the Company did not record a provision for
income taxes in the three months ended March 31, 1999 and 1998.

NOTE 6 - NET LOSS PER SHARE

     Net loss per share is calculated in accordance with SFAS No. 128, "Earnings
Per Share" ("SFAS 128"), and Securities and Exchange Commission Staff Accounting
Bulletin No. 98 ("SAB 98").  Under the provisions of 


                                       8
<PAGE>
 
SFAS 128 and SAB 98, basic net loss per share is computed by dividing net loss
available to common shareholders for the period by the weighted average number
of common shares outstanding for the period. Diluted net loss per share is
computed by dividing the net loss for the period by the weighted average number
of common and potential common shares outstanding during the period if the
effect of the potential common shares is dilutive. As a result of the Company's
net losses, all potentially dilutive securities, as indicated in the table
below, would be anti-dilutive and are excluded from the computation of diluted
loss per share.

                                                     March 31,
                                        ------------------------------------
                                              1999                1998
                                        ----------------     ---------------

Stock options                                 1,755,015           1,313,600
Warrants and underwriter options              1,190,612             878,100
10% Preferred Stock                              95,596             358,450
Series C Preferred Stock                         40,651                   -
                                        ----------------     ---------------
Total                                         3,081,874           2,550,150
                                        ================     ===============

     The number of shares excluded from the earning per share calculation
because they are anti-dilutive, using the treasury stock method, were 6,499,093
and 4,118,591 for the three months ended March 31, 1999 and 1998, respectively.

NOTE 7 - SERIES C PREFERRED STOCK

     On January 11, 1999, the Company completed a private placement for gross
proceeds of $3,000,000.  The Company sold 3,000 shares of Series C cumulative,
convertible, redeemable preferred stock (the "Series C Preferred Stock").  Net
proceeds to the Company were $2,755,500 after deducting $244,500 in offering
costs.

     The Series C Preferred Stock entitles the holder to voting rights equal to
the number of shares of common stock into which the shares of the Series C
Preferred Stock are convertible.  The Series C Preferred Stock specifies a 4%
per annum cumulative, non-compounding dividend based on the stated value of
$1,000 per share.  The Company may redeem the Series C Preferred Stock at any
time at a redemption price per share equal to $1,200 plus any accrued but unpaid
dividends plus a warrant to purchase a number of shares equal to each Series C
Preferred Stock holder's pro-rata allocation of 100,000 shares.  Such warrant
has a term of three years from the date of issuance and a per share exercise
price equal to the applicable Maximum Conversion Price (as defined) for the
Series C Preferred Stock being redeemed.  In addition, the Company may redeem
the Series C Preferred Stock upon the receipt of a notice of conversion with
respect to the Series C Preferred Stock for which the Conversion Price (as
defined) is less than $5.40 per share for a per share price equal to the product
of (i) the number of shares of common stock otherwise issuable upon conversion
of such shares of Series C Preferred Stock on the date of conversion and (ii)
the closing bid price of common stock on the date of conversion.  Each share of
Series C Preferred Stock is convertible, at the option of the holder, at any
time after February 1, 1999, into the number of shares of common stock equal to
$1,000 divided by the lesser of (i) the number of shares of common stock
otherwise issuable upon conversion of such shares of Series C Preferred Stock on
the date of conversion and (ii) the closing bid price of common stock on the
date of conversion.  Each share of Series C Preferred Stock is convertible, at
the option of the holder, at any time after February 1, 1999, into the number of
shares of common stock equal to $1,000 divided by the lesser of (i) 140% of the
closing bid price of the common stock on the date of the issuance of the Series
C Preferred Stock being converted (initially $20.65), or if less and if the
conversion is occurring at least 120 days after the issuance of the Series C
Preferred Stock being converted, 100% of the closing bid price of the Company's
common stock on the trading day closest to the date that is 120 days after the
Series C Preferred Stock that is being converted was issued or (ii) the average
of the five lowest closing bid prices of common stock during the 44 consecutive
trading days immediately preceding the conversion of the Series C Preferred
Stock conversion date.

     In addition, the Company may require the conversion of the Series C
Preferred Stock at any time during the 20 day period immediately following 20
consecutive trading days during which the closing bid price of common stock is
not less than 200% of the Maximum Conversion Price of the Series C Preferred
Stock being converted.  The Series C Preferred Stock must be converted on the
date which is five years after the date on which the Series C Preferred Stock
being converted was issued.


                                       9
<PAGE>
 
     The beneficial conversion feature (a "Guaranteed Return") of the Series C
Preferred Stock is considered to be an additional preferred stock dividend.  The
computed value of the Guaranteed Return of $3,914,063 is initially recorded as a
reduction of the Series C Preferred Stock and an increase to additional paid-in
capital.  The Guaranteed Return reduction to preferred stock will be accreted,
as additional dividends, by recording a charge to income available to common
stockholders from the date of issuance to the earliest date of conversion.  The
Company will also record annual dividends of $40 per share as a reduction of
income available to common stockholders, whether or not declared by the Board of
Directors, which totaled $13,534 for the three months ended March 31, 1999.  The
Company has the option to pay the dividends either in cash or in common stock
upon conversion.  It is the Company's intention to pay the accrued dividends on
the Series C Preferred Stock through the issuance of its common stock at the
time the Series C Preferred Stock is converted.  Consequently, the Company has
recorded the dividends payable within the preferred stock balance in the
accompanying balance sheets, which totaled $4,386 as of March 31, 1999.

     The difference between the stated redemption value of $1,000 per share and
the recorded value on January 11, 1999, totaling $4,158,563 (which includes
$1,158,563 of accretion of preferred stock for the Guaranteed Return in excess
of the redemption value), was accreted as a charge to income available to common
stockholders on the date that the Series C is first convertible, which occurred
in the first quarter of 1999 and is comprised of the following:


     Guaranteed Return                                    $3,914,063
     Series C Preferred Stock offering costs                 244,500
                                                       --------------
     Total accretion recorded                             $4,158,563
                                                       ==============


     In addition, the Company also issued a warrant that expires June 30, 1999,
which entitles the holder to purchase, at a price of $1,000 per share, up to
2,000 shares of the Company's Series C Preferred Stock.  This warrant also
grants the Company the right to require the holder to exercise such warrants on
or before June 30, 1999; provided that there is an effective Registration
Statement with the SEC relating to the common stock issuable upon conversion of
the Series C Preferred Stock.

     During February 1999, the investor converted 2,500 shares of the Series C
Preferred Stock, including accrued dividends payable of $9,149, into 232,564
shares of the Company's common stock at a conversion price per share ranging
from approximately $10.74 to $11.00 as summarized in the following table:

<TABLE>
<CAPTION>
                                            Number of Shares
                             ---------------------------------------------
                                 Series C                                           Common Stock
                                 Preferred                   Common                  Conversion
   Conversion Date                 Stock                     Stock                  Price per Share
----------------------       -------------------       -------------------       --------------------
<S>                            <C>                       <C>                       <C>
February 10, 1999                          1,500                   140,157                     $10.74
February 11,1999                             500                    46,724                      10.74
February 26, 1999                            500                    45,683                      11.00
                             -------------------       -------------------
Total                                      2,500                   232,564
                             ===================       ===================
</TABLE>

NOTE 8 - CONVERSION OF PREFERRED STOCK AND EXERCISE OF COMMON STOCK
         WARRANT

     On January 13, 1999, all 1,400 outstanding shares of the Series A Preferred
Stock, including accrued dividends payable of $12,465, were converted into
247,366 shares of the Company's common stock at a conversion price per share of
$5.71.

     In connection with the issuance of the Series A Preferred Stock, the
Company issued a warrant to the investor to purchase 140,000 shares of the
Company's common stock for a purchase price of $5.71 per share.  During January
1999, the investor exercised the warrant for a total purchase price of $799,400.


                                       10
<PAGE>
 
     During January and February 1999, 160,000 shares of the 10% Preferred
Stock, including accrued dividends payable of $165,093, were converted into
177,106 shares of the Company's common stock at conversion prices ranging from
$9.46 to $10.00 as summarized in the following table:

<TABLE>
<CAPTION>
                                            Number of Shares
                             ---------------------------------------------
                                      10%                                            Common Stock
                                   Preferred                  Common                  Conversion
   Conversion Date                  Stock                     Stock                 Price per Share
----------------------       -------------------       -------------------       ---------------------
<S>                            <C>                       <C>                       <C>
January 5, 1999                           10,000                    11,590                      $ 9.46
January 7, 1999                           10,000                    11,039                        9.98
January 14, 1999                           5,000                     5,422                       10.00
January 15, 1999                          60,000                    66,248                       10.00
January 19, 1999                          10,000                    10,858                       10.00
January 20, 1999                          25,000                    27,636                       10.00
January 28, 1999                          10,000                    11,077                       10.00
February 2, 1999                          20,000                    22,083                       10.00
February 25, 1999                         10,000                    11,153                       10.00
                             -------------------       -------------------
Total                                    160,000                   177,106
                             ===================       ===================
</TABLE>

NOTE 9 - COMMON STOCK

     In February 1999, the Company entered into a six-month agreement with an
individual to provide the Company consulting services in his capacity as the
Company's Chief Operating Officer.  Pursuant to the terms of the agreement, in
addition to a monthly cash fee of $15,000, the consultant earns shares of the
Company's common stock determined by dividing $15,000 by the fair market value
of the common stock on the last trading day of the month.  During the three
months ended March 31, 1999, the Company issued 2,112 shares of common stock
under this agreement valued in the aggregate at $30,000.

NOTE 10 - COMMON STOCK WARRANTS

     In March 1999, the Company granted a warrant to a single customer to
purchase 7,000 shares of the Company's common stock at an exercise price of
$9.75 per share, which vests one year from the date of the executed contract and
is exercisable for two years.  The Company recorded deferred customer
acquisition costs of $64,470 for the value of these warrants, which was expensed
during the three months ended March 31, 1999.  The Company's policy with regard
to customer acquisition costs is to capitalize costs to acquire customers if the
contract contains guarantees of minimum revenue which supports the amount paid.
Because the agreement does not contain minimum guaranteed revenue and due to the
start-up nature of this service and other uncertainties regarding this
arrangement, the Company has expensed the amount during the 1999 period.  The
Company valued these options utilizing the Black-Scholes option pricing model
using the following assumptions:


     Exercise price                                          $ 9.75
     Fair market value of common stock on grant date         $13.00
     Option life                                            3 years
     Volatility rate                                           104%
     Risk free rate of return                                  5.0%
     Dividend rate                                               0%


NOTE 11 - RELATED PARTY TRANSACTIONS

     A director of the Company is also the general partner and chief executive
officer for one of the Company's WEBBbuilder customers.  The Company entered
into a contract during August 1997, as amended, whereby the Company provides its
i2u/WEBBbuilder products and services to the customer for several markets.  The
Company earns revenue from the sale of computer hardware and third party
software, engineering fees, equipment installation fees, and royalties from
subscriber Internet access and content fees.  The Company recognized revenue
from the customer totaling $95,536 and $87,740 for the three months ended March
31, 1999 and 1998, respectively.


                                       11
<PAGE>
 
NOTE 12 - BUSINESS SEGMENT INFORMATION

     The Company supports products and services that enable individuals to
create and manage their own Internet Web presence, create public or private
online communities and manage their own interactions. The Company's WEBBbuilder
foundation software provides users with the ability to create their own home
pages using simple, on-screen templates, as well as integrated online
communications, e-commerce and publishing tools.

     The Company has three reportable business segments: Community and Web
Services, Financial Services and Enterprise Services.  Each of these is a
business segment, with its respective financial performance detailed herein.

     Community and Web Services consists of customized community and
communication portals or start pages for Internet services providers and others
who provide Internet access and products and services which enable individuals,
businesses, associations, and government institutions to create their own Web
site or a "virtual office" on the Internet.

     Financial Services consists of an online banking solution, marketed
generally to financial institutions having less than $500 million in assets,
using a service bureau approach to e-banking, which enables them to provide many
of the capabilities and services available to the larger financial institutions
without the cost associated with the development of institution specific
systems.

     Enterprise Services consists of products and services that enable
businesses, associations, and government institutions to create commerce-enabled
Internet, Intranet, and Extranet services.  These Enterprise portals provide a
place where people from the business, association or government institution can
meet and communicate in real-time, use online discussions for information
exchange and share files.

     Corporate Activities consists of general corporate expenses, including
capitalized costs that are not allocated to specific business segments.  Assets
of corporate activities include unallocated cash, receivables, prepaid expenses,
note receivable, deferred acquisition costs, deposits and corporate use of
property and equipment.

<TABLE>
<CAPTION>
         Net Sales
         --------------------------------------------------------------------------------
                                                          Three Months Ended
                                                               March 31,
                                            ---------------------------------------------
                                                    1999                      1998
                                            -------------------       -------------------
<S>                                           <C>                       <C>
         Community and Web services             $       173,865            $      670,659
         Financial services                              72,447                    56,580
         Enterprise services                             41,970                         -
                                            -------------------       -------------------
         Total net sales                        $       288,282            $      727,239
                                            ===================       ===================
</TABLE>


<TABLE>
<CAPTION>
         Net Loss
         ---------------------------------------------------------------------------------
                                                           Three Months Ended
                                                                March 31,
                                            ----------------------------------------------
                                                     1999                       1998
                                            -------------------        -------------------
<S>                                           <C>                        <C>
         Community and Web services              $   (1,225,092)            $     (719,926)
         Financial services                            (107,645)                   (54,027)
         Enterprise services                            (10,628)                         -
         Corporate activities                        (1,233,459)                  (714,756)
                                            -------------------        -------------------
         Net loss                                $   (2,576,824)            $   (1,488,709)
                                            ===================        ===================
</TABLE>

                                       12
<PAGE>
 
<TABLE>
<CAPTION>
       Assets
       -----------------------------------------------------------------------------------------
                                                  March 31,               December 31,
                                                    1999                      1998
                                            -------------------       -------------------
      <S>                                   <C>                       <C>
       Community and Web services                $    1,232,659            $      696,219
       Financial services                               498,346                   416,071
       Enterprise services                               26,267                         -
       Corporate activities                           3,283,664                 2,272,986
                                            -------------------       -------------------
       Total                                     $    5,040,936            $    3,385,276
                                            ===================       ===================
</TABLE>


<TABLE>
<CAPTION>
       Property and Equipment
       ----------------------------------------------------------------------------------
                                                  March 31,               December 31,
                                                    1999                      1998
                                            -------------------       -------------------
      <S>                                   <C>                       <C>
       Community and Web services                $    1,037,306             $     516,918
       Financial services                               477,228                   397,721
       Enterprise services                                    -                         -
       Corporate activities                             264,308                   263,989
                                            -------------------       -------------------
       Total                                     $    1,778,842             $   1,178,628
                                            ===================       ===================
</TABLE>


<TABLE>
<CAPTION>
       Depreciation and Amortization
       ----------------------------------------------------------------------------------
                                                          Three Months Ended
                                                               March 31,
                                            ---------------------------------------------
                                                    1999                      1998
                                            -------------------       -------------------
      <S>                                   <C>                       <C>
       Community and Web services                  $     44,073             $      39,032
       Financial services                                35,247                    35,211
       Enterprise services                                    -                         -
       Corporate activities                              28,909                    21,134
                                            -------------------       -------------------
       Total                                       $    108,229             $      95,377
                                            ===================       ===================
</TABLE>


<TABLE>
<CAPTION>
       Property and Equipment Additions
       ----------------------------------------------------------------------------------
                                                          Three Months Ended
                                                               March 31,
                                            ---------------------------------------------
                                                    1999                      1998
                                            -------------------       -------------------
     <S>                                    <C>                       <C>
       Community and Web services                  $    564,462              $     19,537
       Financial services                               114,754                       652
       Enterprise services                                    -                         -
       Corporate activities                              29,184                   146,181
                                            -------------------       -------------------
       Total                                       $    708,400              $    166,370
                                            ===================       ===================
</TABLE>

NOTE 13 - PROPOSED BUSINESS COMBINATION

     On March 19, 1998, the Company entered into an Agreement and Plan of Merger
with Durand Acquisition Corporation (a wholly owned subsidiary of the Company)
and Durand Communications, Inc. ("DCI").  The Merger Agreement contemplates that
the Company will acquire 100% of the outstanding common stock of DCI and in
consideration therefore (i) will issue 955,649 shares of the Company's common
stock to the stockholders of DCI, (ii) reserve approximately 240,000 shares of
common stock for issuance upon exercise of outstanding options and warrants of
the Company that will be issued in connection with the DCI Merger, and will
reserve approximately 40,000 shares of common stock for issuance upon conversion
of convertible securities of DCI that will be assumed 


                                       13
<PAGE>
 
by the Company in connection with the DCI Merger, and (iii) will assume
approximately $2,300,000 of liabilities of DCI. Located in Santa Barbara,
California, DCI is a privately held company that develops and markets Internet
"community" building tools and services, training in the use of these tools and
services and on-line service for hosting these communities. For the twelve
months ended December 31, 1998, DCI reported revenues of $813,522 (unaudited),
of which $540,372 (unaudited) were sales to the Company, and incurred a net loss
of $(1,564,160) (unaudited). For the twelve months ended December 31, 1997, DCI
and an acquired company reported net sales of $740,739 (unaudited) and incurred
net losses of $(2,867,973) (unaudited). At December 31, 1998, DCI had an
accumulated deficit of $(8,397,347) (unaudited).

NOTE 14 - SUBSEQUENT EVENTS

     During April 1999, the Company signed a letter of intent with a leasing
company whereby the Company would receive a master lease credit line of
$1,000,000 for the purchase of computer equipment.  The proposed agreement
stipulates that $500,000 is contingent upon the Company receiving $2,000,000
additional equity funding and $500,000 is contingent upon the Company securing a
minimum of $6,000,000 in additional debt or equity financing no later than June
30, 1999.  The lease terms specify a maximum monthly payment including principle
and interest of $32,110 for a period of 36 months and also require the Company
to pledge certain assets as collateral.  In addition, the Company would be
required to issue a warrant to the leasing company to purchase shares of the
Company's common stock determined by dividing 20% of the credit line by the
average closing per share price for the ten consecutive trading days prior to
execution of the lease.  Based on the current market price of the Company's
common stock, the Company estimates that it would have to record a non-cash
expense of approximately $150,000 on the date the lease is executed.  The
warrant would be exercisable at any time upon execution of the lease and for a
period of five years thereafter.

     During April and May 1999, approximately 340,000 of the Company's Public
Warrants have been exercised, including 305,000 under the cashless exercise
provision, resulting in the issuance of approximately 80,000 shares of the
common stock.  The Company received approximately $150,000 in proceeds from the
exercise of these Warrants.

NOTE 15 - UNAUDITED QUARTERLY INFORMATION

     The Company has revised certain factors used in determining the amounts to
be accreted related to issuances of its 10% Preferred Stock.  These revisions
and their impact on unaudited quarterly amounts previously reported in 1998 are
presented below.

<TABLE>
<CAPTION>
                                                                                                Three Months Ended
                                                                                                  March 31, 1998
                                                                                 ----------------------------------------------
                                                                                      As Reported                 As Revised
                                                                                      (Unaudited)                (Unaudited)
                                                                                 -------------------        -------------------
<S>                                                                             <C>                        <C>                 
Net loss                                                                                 $(1,488,709)               $(1,488,709)
Preferred stock dividends                                                                    (62,399)                   (62,399)
Accretion of preferred stock to redemption value                                            (145,334)                  (418,696) (a)
                                                                                 -------------------        -------------------
 
Net loss available to common stockholders                                                $(1,696,442)               $(1,969,804)
                                                                                 ===================        ===================
 
Loss per share, basic and diluted                                                        $     (0.51)               $     (0.59)
                                                                                 ===================        ===================
Weighted average shares outstanding                                                        3,335,687                  3,335,687
                                                                                 ===================        ===================
</TABLE>

(a)  Increase in accretion of preferred stock to redemption value is due to the
revision of discounts applied to common stock and common stock warrants issued
in connection with the preferred stock private placements.


                                       14
<PAGE>
 
Item 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

General

         OSS develops, markets and supports products and services that enable
individuals and organizations to create and manage their own Internet Web
presence and online communities. We have developed a proprietary suite of Web
site development tools, known as WEBBbuilder and Portal Objects (formerly
marketed under the i2u brand), which enables individuals and organizations to
create their own personal/organizational portals. We have targeted the following
market opportunities:

         .  Community - Customized community and communication portals or start
            pages for broadband operators who provide Internet access.
         .  Consumer - Personal portals for individual Internet users.
         .  Enterprise - Internet and Extranet services for businesses,
            associations and government institutions.
         .  Education - Classroom applications for elementary and secondary
            schools, including parent/teacher communications, virtual campuses
            for colleges and universities and online classrooms for corporate
            training.
         .  Financial Services - Online banking services for banks, credit
            unions and other financial institutions.

         To date, we have generated revenues through the sale of design and
consulting services for Web site development and network engineering services,
resale of software licenses, mark-ups on computer hardware and software sold to
customers, maintenance fees charged to customers to maintain computer hardware
and Web sites, license fees based on a percentage of revenues from our products
and services, training course fees, and monthly fees paid by customers for
Internet access which we have provided.  We commenced sales in February 1995,
and were in the development stage through December 31, 1995.  We have incurred
losses from operations since inception.  At March 31, 1999, we had an
accumulated deficit of $27,555,529.  The reports of our independent public
accountants for the years ended December 31, 1998 and 1997 contained a paragraph
noting substantial doubt regarding our ability to continue as a going concern.

         Prior to the third quarter of 1997, our focus generally was on three
markets: general Web site development, maintenance and hosting; rural or small
market Internet service providers ("ISPs"); and healthcare information services
and continuing medical education.  Each of these activities involved, to varying
degrees, the building of online communities and the development of tools and
services to allow for the building of strategic and customized Web sites.  As an
outgrowth of these activities, since mid 1997, our business has evolved to the
development of online communities and more recently, the development of personal
and organizational portals.

         During 1998, we implemented a new pricing structure whereby we supply
our content and community-building products and services to our Internet service
provider customers and others and provide a channel for the distribution of our
portals and services. This structure results in a lower front-end cost for our
customers, in consideration for which we expect to receive a higher percentage
of advertising and transaction fees they receive in connection with the use of
our products. We will require additional working capital and will realize
substantially lower initial revenues in connection with the sale of our products
and services, as we will, under this structure, be providing our products and
services primarily for a percentage of future revenues rather than license and
service fees. We expect that this pricing strategy will result in higher
revenues in the future as our customers' and our user bases grow. In addition,
we intend to continue to incur significant capital expenditures and operating
expenses in order to continue development and expansion of our products and
services and to market our products and services to an expanding base of
potential customers. As a result, we expect to incur additional substantial
operating and net losses during 1999 and for one or more years thereafter. There
can be no assurance that such expenditures will result in increased revenue
and/or customers. In addition, we expect that our net revenues will decrease
during the first six to nine months of 1999 compared to the similar periods in
1998 as we continue to transition our business and to develop the customer base
required to attract paid advertising and e-commerce opportunities.

         Based on applicable current accounting standards, we recorded a non-
operating expense of $4,158,563 during the first quarter of 1999 in connection
with the private placement of $3,000,000 principal amount of our Series C
preferred stock.  In addition, if we exercise our option to sell an additional
$2,000,000 principal amount of 


                                       15
<PAGE>
 
our Series C preferred stock, we may incur similar non-operating expense in
excess of $2,000,000 at the time of the sale. While these charges do not affect
our operating losses or working capital, they do result in a decrease in our net
income available to common stockholders. Additionally, we recorded a non-cash
charge for preferred stock dividends during the first quarter of 1999 of
approximately $46,013.

Results of Operations

     We have revised certain factors used in determining the amounts to be
accreted related to the issuance of our 10% Preferred Stock.  These revisions
and their impact on unaudited quarterly amounts previously reported in 1998 are
presented below.

<TABLE>
<CAPTION>
                                                                             Three Months Ended
                                                                               March 31, 1998
                                                            -------------------------------------------------
                                                                  As Reported                  As Revised
                                                                  (Unaudited)                 (Unaudited)
                                                            --------------------        ---------------------
<S>                                                           <C>                         <C>                
Net loss                                                             $(1,488,709)                 $(1,488,709)
Preferred stock dividends                                                (62,399)                     (62,399)
Accretion of preferred stock to redemption value                        (145,334)                    (418,696)    (a)
                                                            --------------------        ---------------------
 
Net loss available to common stockholders                            $(1,696,442)                 $(1,969,804)
                                                            ====================        =====================
 
Loss per share, basic and diluted                                    $     (0.51)                 $     (0.59)
                                                            ====================        =====================
Weighted average shares outstanding                                    3,335,687                    3,335,687
                                                            ====================        =====================
</TABLE>

(a)  Increase in accretion of preferred stock to redemption value is due to the
revision of discounts applied to common stock and common stock warrants issued
in connection with the preferred stock private placements.

     The following table sets forth for the periods indicated the percentage of
net sales by items contained in the Statements of Operations. All percentages
are calculated as a percentage of total net sales, with the exception of cost of
sales which are calculated based on the respective net sale amounts.

<TABLE>
<CAPTION>
                                                                    Three Months Ended
                                                                         March 31,
                                                     ----------------------------------------------
                                                              1999                       1998
                                                     -------------------        -------------------
<S>                                                    <C>                        <C>
Net Sales:
 Transaction fee sales                                              36.9%                       3.1%
 Service sales                                                      22.3%                      11.7%
 Hardware and software sales                                        40.8%                      85.2%
                                                     -------------------        -------------------    
   Total net sales                                                 100.0%                     100.0%
                                                     -------------------        -------------------
Cost of sales:
 Cost of transaction fee sales                                      63.8%                      38.3%
 (as percentage of transaction fee sales)
 Cost of services                                                   40.1%                      94.1%
 (as percentage of service sales)
 Cost of hardware and software                                      80.1%                      76.3%
 (as percentage of hardware and software sales)
                                                     -------------------        -------------------
   Total cost of sales                                              65.2%                      77.2%
                                                     -------------------        -------------------
Gross Margin                                                        34.8%                      22.8%
                                                     -------------------        -------------------
Operating expenses:
 Sales and marketing expenses                                      176.9%                      70.7%
</TABLE> 


                                       16
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>                                                  <C>                     <C>  
 Product development expenses                                      207.7%                      30.6%
 General and administrative expenses                               515.0%                     117.1%
 Depreciation and amortization expenses                             37.5%                      13.1%
                                                     -------------------        -------------------
       Total operating expenses                                    937.1%                     231.5%
Loss from operations                                              (902.3)%                   (208.7)%
                                                     -------------------        -------------------
Net Loss                                                          (893.9)%                   (204.7)%
Preferred stock dividends                                          (15.9)%                     (8.6)%
Accretion of preferred stock to redemption value                 (1040.6)%                    (57.6)%
Accretion of preferred stock to redemption value                  (401.9)%                        -
                                                     -------------------        -------------------
Net loss available to common stockholders                        (2352.3)%                   (270.9)%
                                                     ===================        ===================
</TABLE>

Three Months Ended March 31, 1999 and 1998.

     During the fourth quarter of 1998, we implemented a new pricing structure
for our WEBBbuilder products and services whereby we supply any required
equipment and the products and services and the customer is not required to pay
any significant fees upon the delivery of such items.  This structure results in
a lower front-end cost for our customers and lower initial revenues for us, in
consideration for which we expect to receive a higher percentage of advertising
and transaction fees received by our customers in connection with the use of our
products.  We anticipate that our near-term revenues will be less as a result of
the implementation of this pricing strategy, but that our future revenues will
be higher as our customers and our use bases grow.

     Transaction fee sales include revenue from e-banking service bureau fees,
online subscription fees, and Internet access and e-commerce royalties.  Our net
revenue from transaction fees were $106,329 for the three months ended March 31,
1999 compared to $22,825 for the similar 1998 period.  The increase was due to
an increase in the number of subscribers using our financial services product;
the implementation of our Re/Max Main Street product during the second quarter
of 1998 and the steady growth of subscribers through the first quarter of 1999;
and to a lesser extent a more than doubling of our revenues from Internet access
and e-commerce fees.

     Service sales include revenue from professional services for programming,
network engineering fees, equipment installation and Internet connectivity fees.
Our net revenue from service sales were $64,444 for the three months ended March
31, 1999 compared to $84,747 for the similar 1998 period.  The decrease was
primarily due to a decrease in fees charged for professional programming
services related to customization of our e-banking product for an existing
customer and a reduction in revenue from Internet connectivity services. This
decrease was offset in part by network engineering fees we earned in connection
with implementing our i2u/WEBBbuilder product in a new market with an existing
customer.

     Hardware and software sales include revenue from the resale of computer
hardware and third party software to customers generally in connection with
implementing our WEBBbuilder products and services. Our net revenues from
hardware and software sales were $117,509 for the three months ended March 31,
1999 compared to $619,667 for the similar 1998 period. The decrease was due to a
change in our pricing structure during the fourth quarter of 1998 whereby we
supply any required equipment and the products and services and the customer is
not required to pay any significant fees upon the delivery of such items. During
the 1999 three-month period, we sold equipment to customers with whom we have
existing contracts to provide equipment. We anticipate that revenue from
hardware and equipment sales will continue to decrease in future periods.

     We had four customers representing 93% of sales for the 1999 period and
three customers representing 80% of sales for the 1998 period. During the first
quarter of 1999, Intermedia Partners, a related party (See Note 11 of Notes to
Consolidated Financial Statements), announced that it intended to sell several
of its cable systems in its Tennessee market and elsewhere to TCI and Charter
Communications, Inc..  We currently provide services to Intermedia in three
Tennessee markets and have generated revenues from the sale of computer
hardware, network engineering services, and royalties from Internet access sales
to their customers. Intermedia accounted for approximately 33% of our sales for
the three months ended March 31, 1999, primarily due to equipment sales which
similar sales were not anticipated to continue during the balance of 1999, and
approximately 12% and 2% of total

                                       17
<PAGE>
 
revenue for the years ended December 31, 1998 and 1997, respectively. As a
result of these factors and further consolidation of Intermedia's cable
operations and the announcement by Charter Communications that its affiliate
High Speed Access Corp will be the Internet access provider for these Tennessee
markets beginning in mid to late 1999, we expect to receive substantially less
revenue from Intermedia during the remainder of 1999 and in future periods.
Provisions of the contracts may remain in effect whereby we may receive revenue
from Internet content fees; however, to date, revenue from this source has been
insignificant. In addition, in January 1999, we signed a trial letter of intent
with Intermedia to provide WEBBbuilder products and services for its Nashville
market. As a result of these transactions, this contract will be terminated.

     Cost of sales as a percentage of net sales was 65.2% for the 1999 period
and 77.2% for the 1998 period.

     Transaction fee sales - Cost of transaction fee sales (as a percentage of
transaction fee sales) was 63.8% for the 1999 three-month period and 38.3% for
the comparable 1998 period.  Cost of transaction fees increased because we
incurred more costs related to our e-banking revenue and Internet access revenue
primarily as a result of increased revenue.  We also incurred costs related to
our online subscription revenue which are at slightly lower margins than other
transaction fee revenue.

     Service sales - Cost of service sales (as a percentage of service sales)
was 40.1% for the 1999 three-month period and 94.1% for the comparable 1998
period.  Cost of service sales decreased because we had less revenue from
programming services which are generally at lower margins and more revenue from
network engineering fees which are generally at higher margins.  In addition,
during the 1998 period we incurred costs totaling approximately $55,000
associated with Web hosting and maintenance activities we no longer offer to our
customers.

     Hardware and software sales - Cost of hardware and software sales was 80.1%
for the 1999 three-month period and 76.3% for the comparable 1998 period.  Cost
of hardware and software sales increased slightly because we sold equipment to
existing customers at somewhat lower margins.

     Sales and marketing expenses were $509,859 for the three months ended March
31, 1999, compared to $514,315 for the similar 1998 period.  Sales and marketing
expenses as a percentage of net sales increased from 70.7% in 1998 to 176.9% in
1999.  Included in sales and marketing expenses are new market development costs
associated with developing our WEBBbuilder business.  These costs consist of
expenses incurred by us, principally labor, travel and other third-party costs
such as software licenses, in connection with getting our customer's ISP
presence established, including design and branding of the customer's Internet
start page, developing local area content, and assisting our customers in
developing our Internet business presence.  During the 1999 period, we incurred
$170,000 more new market start-up expenses to support five additional customers
and we also hired four new employees to assist with our expanding customer base.
This increase was offset by a decrease in sales and marketing expenses during
the 1999 period primarily as a result of our focus on domestic markets and our
de-emphasis on international markets as well as employing seven fewer sales and
marketing personnel.

     Product development expenses were $598,840 for the three months ended March
31, 1999, compared to $222,368 for the 1998 period. Product development expense
as a percentage of net sales increased from 30.6% in 1998 to 207.7% in 1999. We
capitalized $68,672 of development costs during the 1998 period related to the
development of our WEBBbuilder product offerings. During the 1999 period, we
continued developing our WEBBbuilder products and services. Version 3.0 of our
WEBBbuilder product is expected to be released during the second quarter of
1999. We expect product development expenses to continue to increase during 1999
as we continue to develop our products and services.

     General and administrative expenses were $1,484,545 for the three months
ended March 31, 1999, compared to $851,474 for the 1998 period. General and
administrative expenses as a percentage of net sales increased from 117.1% in
1998 to 515.0% in 1998. During the 1999 period, we recorded non-cash charges of
$155,229 for grants of common stock and options and warrants to purchase common
stock to non-employees in exchange for services and to a customer in connection
with contract costs. We also incurred legal, accounting and registration fees in
connection with capital raising activities; and costs in connection with
establishing our computer operating center, including a facility lease; and
compensation for bonuses earned in the 1999 period.


                                       18
<PAGE>
 
     Depreciation and amortization was $108,229 for the three months ended
March 31, 1999, compared to $95,377 for the 1998 period.  We recorded more
depreciation expense as a result of an increase in fixed assets, including
equipment and software to support our WEBBbuilder development and testing.

     Loss from investment in subsidiary is our share of the net losses from
NetIgnite and consists primarily of product development expenses.

     Interest income was $46,142 during the three-month period ended March
31, 1999, compared to $29,139 for the 1998 period.  We earn interest by
investing surplus cash in highly liquid investment funds or commercial paper of
credit worthy Fortune 500 companies.  During the 1999 period, we recorded
$22,050 of interest income from our note receivable from DCI.

     Net losses allocable to common stockholders were $6,781,400 for the
three-month period ended March 31, 1999 compared to $1,696,442 for the 1998
period.  We recorded non-operating expenses for preferred stock dividends and
accretion of preferred stock to redemption value during the 1999 period of
$46,013 and $4,158,563, respectively, and $62,399 and $418,696, respectively,
during the 1998 period.  Additionally, the increase in losses reflect expenses
in sales and marketing, product development, and general and administrative
areas that have increased at a faster rate than net sales.  This is due to the
time lag associated with product development and market introduction as well as
the long sales cycle for most of our products and services.  We expect to
continue to experience increased operating expenses and capital investments
during 1999, as we continue to develop new product offerings and the
infrastructure required to support our anticipated growth.  We believe that,
initially, these expenses will be greater than increases in net sales.  We
expect to report operating and net losses for 1999 and for one or more years
thereafter.

Liquidity and Capital Resources

     As of March 31, 1999, we had cash and cash equivalents of $1,651,254 and
working capital of $372,430 excluding the note receivable from DCI and deferred
acquisition costs. We financed our operations and capital expenditures and other
investing activities primarily through private sales of preferred stock
resulting in net proceeds of $2,755,500. (See Note 7 of Notes to Consolidated
Financial Statements for information regarding these sales of securities).

     We used $2,203,562 in cash to fund our operations for the three months
ended March 31, 1999, compared to $1,407,186 for the similar 1998 period.  The
increase in net cash used resulted primarily from an increase in our net
operating losses and payment of 1998 accounts payable and accrued liabilities
and accrued compensation in the first quarter of 1999.  These items were offset
by cash we received from customers that represents future revenue and by non-
cash expenses for stock and stock options we issued for services as well as
product development expenses we incurred and paid for through a reduction in the
DCI note receivable.

     We used $603,113 in cash for capital expenditures and other investing
activities for the three months ended March 31, 1999, compared to $360,909 for
the similar 1998 period.  The increase between periods is primarily a result of
property and equipment we purchased in connection with establishing our computer
operating center and our continuing development of the e-banking system for CU
Cooperative as well as our continued funding of DCI's working capital needs (See
Note 13 of Notes to Consolidated Financial Statements).

     We received $3,759,590 in cash from financing activities for the three
months ended March 31, 1999, compared to $242,445 for the similar 1998 period.
During January 1999, we sold 3,000 shares of Series C Preferred Stock with a
stated value of $1,000 per share, which resulted in net proceeds of $2,755,500.
In connection with that transaction, we also have the right (subject to a
related registration statement being declared effective by the Securities and
Exchange Commission) to exercise a warrant to require the investor to purchase
2,000 additional shares of the Series C Preferred Stock, which would result in
additional net proceeds of approximately $2,000,000.  To date, we have not
exercised this warrant.  In addition, during January 1999, an investor exercised
the warrant to purchase common stock we issued in connection with the Series A
Preferred Stock, which resulted in proceeds of $799,400.  We also received
$213,233 in cash during the 1999 three-month period from the issuance of our
common stock as a result of the exercise of options and warrants.


                                       19
<PAGE>
 
     We believe that our cash and cash equivalents and working capital at March
31, 1999, plus the anticipated proceeds from the sale of 2,000 shares of our
Series C Preferred Stock described above will be adequate to sustain our
operations through at least July 1999.  In order to continue to finance our
operations, we are pursing several funding possibilities.  These funding
activities are intended to raise the approximately $12 million of net proceeds
we estimate will be required to sustain operations for the next twelve months
and the additional approximately $13 million we estimate will be required to
implement our business plan.  First, we are pursuing various potential strategic
relationships which, if consummated, could result in one or more significant
investments by strategic partners.  Second, in connection with our initial
public offering during May 1996, warrants representing the right to acquire
632,500 shares of our common stock at $9.00 per share were issued to investors.
These warrants expire on May 23, 1999, if not exercised prior thereto.  In the
event that all of the warrants were exercised for cash, we would receive in
excess of $5.6 million in net proceeds.  In lieu of exercising the warrants for
cash, holders may utilize a "cashless exercise" option whereby they may apply
the value of a portion of their warrants (i.e., the difference between the
market value for our common stock and $9.00, the exercise price of the warrants)
to pay the exercise price for the balance of the warrants to be exercised.
Therefore, we are unable to predict the amount of net proceeds, if any, which we
may receive upon exercise of the warrants.  We have also initiated discussions
with various potential private investors which could result in additional debt
or equity investments and have begun discussions regarding a possible offering
of our securities during the fall of 1999.  There can be no assurance that we
will be successful in obtaining any additional equity or debt capital or that if
such capital is available, that it will be available on acceptable terms.  If we
are unable to obtain the capital required to sustain our operations, we will be
required to reduce or terminate certain of our operations which could have a
material adverse affect on our operating results and financial condition.  In
its reports accompanying the audited financial statements for the years ended
December 31, 1998 and 1997, our auditors, Arthur Andersen LLP, expressed
substantial doubt about our ability to continue as a going concern.

Year 2000

     The Year 2000 issue involves the potential for system and processing
failures of date-related data resulting from computer-controlled systems using
two digits rather than four to define the applicable year.  For example,
computer programs that contain time-sensitive software may recognize a date
using two digits of "00" as the year 1900 rather than the year 2000.  This could
result in system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar ordinary business activities.

     We have reviewed our internal software and hardware systems and believe
they will function properly with respect to dates in the year 2000 and
thereafter.  We expect to incur no significant costs in the future for Year 2000
problems.  Nonetheless, there can be no assurance in this regard until such
systems are operational in the Year 2000.  We are in the process of contacting
all of our significant suppliers to determine the extent to which our systems
are vulnerable to those third parties' failure to make their own systems Year
2000 compliant.  As of the date of this report, we have completed a significant
portion of this review and expect to have completed it by the end of the second
quarter of 1999.  Based on the review to date, we believe our significant
suppliers and vendors are Year 2000 compliant and that should any of them prove
not to be Year 2000 compliant, we could find a replacement vendor or supplier
which is Year 2000 compliant without significant delay or expense.  However, the
failure to correct material Year 2000 problems by our suppliers and vendors
could result in an interruption in, or a failure of, certain of our normal
business activities or operations.  While our review has not identified any Year
2000 problems that will have a material effect on our business, due to the
general uncertainty inherent in the Year 2000 problem, resulting from the
uncertainty of the Year 2000 readiness of third-party suppliers and vendors and
of our customers, we are unable to determine at this time that the consequences
of Year 2000 failures will not have a material impact on our results of
operations, liquidity or financial condition.

     Of our product offerings, the one that may be most impacted by Year 2000
problems or peoples' concern about potential Year 2000 problems, is our
Financial Services product offering.  We have recently entered into an agreement
with CU Cooperative Systems, Inc., a national cooperative association
representing over 500 credit unions.  The services to be provided to the members
of the Cooperative are scheduled for introduction during the second half of
1999.  Our Financial Services products are Year 2000 compliant, however,
concerns about Year 2000 problems may cause individual cooperatives or their
members to be reluctant to offer or to engage in e-banking transactions prior to
the end of 1999.  While we have not anticipated any significant income from the
use of this 

                                       20

<PAGE>
 
system prior to 2000, a delay in the implementation of the system by the
Cooperative's members could result in a decrease in anticipated revenues for the
product offering in 2000, particularly during the first six months of the year.

Factors That May Affect Future Results

     Factors that may affect our future results include, but are not limited to,
the following items as well as the information in "Item 1 - Financial Statements
- Note 1 to the Consolidated Financial Statements" and "Item 2 - Management's
Discussion and Analysis of Financial Condition and Results of Operations."

     Our limited operating history could affect our business. We were founded in
March 1994, commenced sales in February 1995, and were in the development stage
through December 31, 1995. DCI was founded in 1993. Accordingly, we have a
limited operating history upon which you may evaluate us. Our business is
subject to the risks, expenses and difficulties frequently encountered by
companies with a limited operating history including:

     .  Limited ability to respond to competitive developments,
     .  Exaggerated effect of unfavorable changes in general economic and market
        conditions,
     .  Ability to attract qualified personnel, and
     .  Ability to develop and introduce new product and service offerings.

There is no assurance we will be successful in addressing these risks.  If we
are unable to successfully address these risks our business could be
significantly affected.

     We have accumulated losses since inception and we anticipate that we will
continue to accumulate losses for the foreseeable future. We have incurred net
losses since inception totaling $27,555,529 through March 31, 1999. DCI has
incurred net losses since its formation totaling $8,397,347 through December 31,
1998. In addition, we expect to incur additional substantial operating and net
losses in 1999 and for one or more years thereafter. We expect to incur these
additional losses because:

     .  We currently intend to increase our capital expenditures and operating
        expenses to expand the functionality and performance of our WEBBbuilder
        products and services, support additional subscribers of our ISP
        customers in future markets, and market and provide our products and
        services.
     .  We will be required to recognize as a loss in the fiscal period in which
        the DCI acquisition is consummated that portion of the purchase price
        for DCI which we allocate to in-process research and development.
     .  We will be required to record goodwill and other intangible assets in
        connection with the DCI acquisition which we will amortize over their
        estimated useful lives of approximately three years. We currently expect
        to allocate approximately $12.5 million to goodwill and other intangible
        assets, however, this amount could change significantly once the actual
        amount is determined after the consummation of the DCI acquisition.

     We expect to complete the DCI acquisition in the second quarter of 1999. If
we do not complete the DCI acquisition, it is likely that we would have to
record as a loss all or a portion of the note receivable from DCI of
approximately $996,141, including accrued interest, at March 31, 1999. DCI would
not have the ability to repay our advances without obtaining significant
additional working capital through the sale of its securities. There is no
assurance that DCI would be able to raise working capital in the amounts
required.

     If we are unable to raise additional working capital funds, we may not be
able to sustain our operations. We believe that our present cash and cash
equivalents, working capital and commitments for additional equity investments
will be adequate to sustain our current level of operations only through July
1999. If we cannot raise additional funds when needed, we may be required to
curtail or scale back our operations. These actions could have a material
adverse effect on our business, financial condition, or results of operations.
We estimate that we will need to raise through equity, debt or other external
financing at least $11 million to sustain operations for the next 12 months and
$1 million to pay DCI indebtedness which would be assumed as part of the DCI
acquisition. There is no assurance that we will be able to raise additional
funds in amounts required or upon acceptable terms. In addition, we may discover
that we have underestimated our working capital needs, and we may need to obtain
additional funds to sustain our operations. In its report accompanying the
audited financial statements for the years


                                       21
<PAGE>
 
ended December 31, 1998 and 1997, our auditor, Arthur Andersen LLP, expressed
substantial doubt about our ability to continue as a going concern. See 
"Item 2 - Management's Discussion of Financial Condition and Results of
Operations -Liquidity and Capital Resources."

     We may never become or remain profitable. Our ability to become profitable
depends on the ability of our WEBBbuilder products and services to generate
revenues. The revenue model for certain of our i2u/WEBBbuilder products and
services assumes that our broadband customers and other distribution partners
will share with us a percentage of their revenues generated by advertising and
e-commerce conducted through our WEBBbuilder products. The success of our
revenue model will depend upon many factors including:

     .  The success of broadband operators and other distribution partners in
        marketing Internet services to subscribers in their local areas, and
     .  The extent to which consumers and businesses use our WEBBbuilder
        products and conduct e-commerce transactions and advertising utilizing
        our products.

     Because of the new and evolving nature of the Internet, we cannot predict
whether our revenue model will prove to be viable, whether demand for our
products and services will materialize at the prices we expect to be charged, or
whether current or future pricing levels will be sustainable.

     Our revenue model may not generate significant revenues, if any, until some
time in the future. We expect a significant portion of our revenues to come from
advertising revenues and in connection with e-commerce transactions conducted
using our products. However, we do not expect to realize these revenues, if at
all, until a significant time after we have licensed our WEBBbuilder products
and services. This expectation is based on the fact that we believe that it may
take broadband operators and other distribution partners several months or more
to:

     .  Market and sell Internet access to their subscribers, and
     .  Establish a significant enough user base to attract advertisers and for
        users to conduct significant e-commerce transactions.

     Our business depends on the growth of the Internet. Our business plan
assumes that the Internet will develop into a significant source of
communication and communication interactivity. However, the Internet market is
new and rapidly evolving and there is no assurance that the Internet will
develop in this manner. If the Internet does not develop in this manner, our
business, operating results and financial condition would be materially
adversely effected. Numerous factors could prevent or inhibit the development of
the Internet in this manner, including:

     .  The failure of the Internet's infrastructure to support Internet usage
        or electronic commerce,
     .  The failure of businesses developing and promoting Internet commerce to
        adequately secure the confidential information, such as credit card
        numbers, needed to carry out Internet commerce, and
     .  Regulation of Internet activity

     Use of certain of our products and services may be dependent on broadband
operators. Because we have elected to partner with broadband operators for the
distribution of many of our products and services, many users of our WEBBbuilder
products and services are expected to subscribe through a broadband operator. As
a result, the broadband operator, and not us, will substantially control the
customer relationship with these users. If the business of broadband operators
with whom we partner is adversely affected in any manner, business, operating
results and financial condition could be materially adversely effected. Many
factors may affect the business of broadband operators, including:

     .  General economic and market conditions,
     .  Competition among broadband operators,
     .  Costs associated with the renewal of operator licenses, and
     .  Costs associated with the operation and maintenance of an Internet
        service provider business segment.


                                       22
<PAGE>
 
     We may be unable to develop desirable products. Our products are subject to
rapid obsolescence and our future success will depend upon our ability to
develop new products and services that meet changing customer and marketplace
requirements. There is no assurance that we will be able to successfully:

     .  Identify new product and service opportunities, or
     .  Develop and introduce new products and services to market in a timely
        manner.

     If we are unable to accomplish these items, our business, including the
business of DCI if the DCI acquisition is completed, operating results and
financial condition could be materially adversely affected.

     Our products and services may not be successful. Even if we are able to
successfully identify, develop, and introduce new products and services there is
no assurance that a market for these products and services will materialize to
the size and extent that we anticipate. If a market does not materialize as we
anticipate, our business, including the business of DCI if the DCI acquisition
is completed, operating results, and financial condition could be materially
adversely affected. The following factors could affect the success of our
products and services:

     .  The failure of our business plan to accurately predict the rate at which
        the market for Internet products and services will grow,
     .  The failure of our business plan to accurately predict the types of
        products and services the future Internet marketplace will demand,
     .  Our limited experience in marketing our products and services,
     .  The failure of our business plan to accurately predict our future
        participation in the Internet marketplace,
     .  The failure of our business plan to accurately predict the estimated
        sales cycle, price, and acceptance of our products and services,
     .  The development by others of products and services that renders our and
        DCI's, products and services noncompetitive or obsolete, or
     .  Our failure to keep pace with the rapidly changing technology, evolving
        industry standards, and frequent new product and service introductions
        that characterize the Internet marketplace.

     The intense competition that is prevalent in the Internet market could have
a material adverse effect on our business. DCI's and our current and prospective
competitors include many companies whose financial, technical, marketing and
other resources are substantially greater than ours. There is no assurance that
we will have the financial resources, technical expertise, or marketing, sales
and support capabilities to compete successfully. The presence of these
competitors in the Internet marketplace could have a material adverse effect on
our business, operating results, or financial condition by causing us to:

     .  Reduce the average selling price of our products and services, or
     .  Increase our spending on marketing, sales, and product development.

     There is no assurance that we would be able to offset the effects of any
such price reductions or increases in spending through an increase in the number
of our customers, higher sales from premium services, cost reductions or
otherwise. Further, our financial condition may put us at a competitive
disadvantage relative to our competitors. If we fail to, or cannot, meet
competitive challenges, our business, operating results and financial condition
could be materially adversely affected.

     A limited number of our customers generate a significant portion of our
revenues. For the three months ended March 31, 1999, four of our customers
produced approximately 93% of our revenues, including one customer, Intermedia
Partners, who produced approximately 33% of our revenues. There is no assurance
that we will be able to attract or retain major customers. The loss of, or
reduction in demand for products or related services from, any of these major
customers could have a material adverse effect on our business, operating
results, cashflows, and financial condition. See "Item 2 - Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Results of Operations."


                                       23
<PAGE>
 
     The sales cycle for our products and services is lengthy and unpredictable.
While our sales cycle varies from customer to customer, it typically has ranged
from one to six months for WEBBbuilder projects.  Our pursuit of sales leads
typically involves an analysis of our prospective customer's needs, preparation
of a written proposal, one or more presentations and contract negotiations.  We
often provide significant education to prospective customers regarding the use
and benefits of Internet technologies and products.  Our sales cycle may also be
affected by a prospective customer's budgetary constraints and internal
acceptance reviews, over which we have little or no control.

     We may be unable to adjust our spending to account for potential
fluctuations in our quarterly results. As a result of our limited operating
history and the recent increased focus on our WEBBbuilder products and services,
we do not have historical financial data for a sufficient number of periods on
which to base planned operating expenses. Therefore, our expense levels are
based in part on our expectations as to future sales and to a large extent are
fixed. We typically operate with little backlog and the sales cycles for our
products and services may vary significantly. As a result, our quarterly sales
and operating results generally depend on the volume and timing of and the
ability to close customer contracts within the quarter, which are difficult to
forecast. We may be unable to adjust spending in a timely manner to compensate
for any unexpected sales shortfalls. If we were unable to so adjust, any
significant shortfall of demand for our products and services in relation to our
expectations would have an immediate adverse effect on our business, operating
results and financial condition. Further, we currently intend to increase our
capital expenditures and operating expenses to fund product development and
increase sales and marketing efforts. To the extent that such expenses precede
or are not subsequently followed by increased sales, our business, operating
results and financial condition will be materially adversely affected.

     We may be unable to retain our key executives and research and development
personnel. We are highly dependent on the technical and management skills of our
key employees, including in particular R. Steven Adams, our founder, President
and Chief Executive Officer. The loss of Mr. Adams' services could have a
material adverse effect on our business and operating results. We have not
entered into employment agreements with Mr. Adams, or any of our other officers
or employees. We do not maintain key person insurance for Mr. Adams or any other
member of management. In addition, the success of the DCI acquisition is highly
dependent on the technical and management skills of Andre Durand, the founder,
President and Chief Executive Officer of DCI. The loss of Mr. Durand's services
could have a material adverse affect on the value of the DCI acquisition.

     Our future success also depends in part on our ability to identify, hire
and retain additional personnel, including key product development, sales,
marketing, financial and executive personnel. Competition for such personnel is
intense and there is no assurance that we can identify or hire additional
qualified personnel.

     Executives and research and development personnel who leave us may compete
against us in the future. We generally enter into written nondisclosure and
nonsolicitation agreements with our officers and employees which restrict the
use and disclosure of proprietary information and the solicitation of customers
for the purpose of selling competing products or services. Other than Andre
Durand, who, as a condition to the acquisition of DCI, will be required to
execute a three-year non-compete agreement with us, we generally do not require
our employees to enter into non-competition agreements. Thus, if any of these
officers or key employees left, they could compete with us, so long as they did
not solicit our customers. Any such competition could have a material adverse
effect on our business.

     We may be unable to manage our expected growth. If we are able to implement
our growth strategy, we will experience significant growth in the number of our
employees, the scope of our operating and financial systems, and the geographic
area of our operations. There is no assurance that we will be able to implement
in whole or in part our growth strategy or that our management or other
resources will be able to successfully manage any future growth in our business.
Any failure to do so could have a material adverse effect on our operating
results and financial condition.

     We may be unable to protect our intellectual property rights. Intellectual
property rights are important to our success and our competitive position. There
is no assurance that the steps we take to protect our intellectual property
rights will be adequate to prevent the imitation or unauthorized use of our
intellectual property rights. Policing unauthorized use of proprietary systems
and products is difficult and, while we are unable to determine the extent to
which piracy of our software exists, we expect software piracy to be a
persistent problem. In addition, the


                                       24
<PAGE>
 
laws of some foreign countries do not protect software to the same extent as do
the laws of the United States. Even if the steps we take to protect our
proprietary rights prove to be adequate, our competitors may develop products or
technologies that are both non-infringing and substantially equivalent or
superior to our products or technologies.

     Computer viruses and similar disruptive problems could have a material
adverse effect on our business. Our software and equipment may be vulnerable to
computer viruses or similar disruptive problems caused by our customers or other
Internet users. Our business, financial condition or operating results could be
materially adversely effected by:

     .  Losses caused by the presence of a computer virus that causes us or
        third parties with whom we do business to interrupt, delay or cease
        service to our customers,
     .  Losses caused by the misappropriation of secured or confidential
        information by a third party who, in spite of our security measures,
        obtains illegal access to this information,
     .  Costs associated with efforts to protect against and remedy security
        breaches, or
     .  Lost potential revenue caused by the refusal of consumers to use our
        products and services due to concerns about the security of transactions
        and commerce that they conduct on the Internet.

     Future government regulation could materially adversely effect our
business. There are currently few laws or regulations directly applicable to
access to, communications on, or commerce on the Internet. Therefore, we are not
currently subject to direct regulation of our business operations by any
government agency, other than regulations applicable to businesses generally.
Due to the increasing popularity and use of the Internet, however, federal,
state, local, and foreign governmental organizations are currently considering a
number of legislative and regulatory proposals related to the Internet. The
adoption of any of these laws or regulations may decrease the growth in the use
of the Internet, which could, in turn:

     .  Decrease the demand for our products and services,
     .  Increase our cost of doing business, or
     .  Otherwise have a material adverse effect on our business, results of
        operations and financial condition.

     Moreover, the applicability to the Internet of existing laws governing
issues such as property ownership, copyright, trademark, trade secret,
obscenity, libel and personal privacy is uncertain and developing. Our business,
results of operations and financial condition could be materially adversely
effected by the application or interpretation of these existing laws to the
Internet.

     Our systems may not be year 2000 compliant. We have reviewed our internal
software and hardware systems. Based on this review, we believe that our
internal software and hardware systems will function properly with respect to
dates in the year 2000 and thereafter. We expect to incur no significant costs
in the future for Year 2000 problems. Nonetheless, there is no assurance in this
regard until our internal software and hardware systems are operational in the
year 2000.

     We are in the process of contacting all of our significant suppliers to
determine the extent to which our systems are vulnerable to those third parties'
failure to make their own systems Year 2000 compliant.  The failure to correct
material Year 2000 problems by our suppliers and vendors could result in an
interruption in, or a failure of, certain of our normal business activities or
operations.  Due to the general uncertainty inherent in the Year 2000 problem,
resulting from the uncertainty of the Year 2000 readiness of third-party
suppliers and vendors and of our customers, we are unable to determine at this
time that the consequences of Year 2000 failures will not have a material impact
on our results of operations, liquidity or financial condition.  See "Item 2 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Compliance Disclosure."

     Our articles of incorporation and bylaws may discourage lawsuits and other
claims against our directors.  Our articles of incorporation provide, as
permitted by Colorado law, that our directors shall have no personal liability
for certain breaches of their fiduciary duties to us.  In addition, our bylaws
provide for mandatory indemnification of directors and officers to the fullest
extent permitted by Colorado law.  These provisions may reduce the likelihood of
derivative litigation against directors and may discourage shareholders from
bringing a lawsuit against directors for a breach of their duty.


                                       25
<PAGE>
 
     The completion of the DCI acquisition will have an immediate dilutive
effect on our current shareholders.  If the DCI acquisition is consummated, we
will issue 955,649 shares of our common stock as consideration for DCI.  The
issuance of these shares will have an immediate dilutive effect on our current
shareholders and will increase our outstanding common stock by approximately
15%.  There is no assurance that our results of operations will improve enough,
if at all, as a result of the DCI acquisition, to offset this dilution.

     On a pro forma basis, we estimate that the issuance of these shares would
have resulted in an increase to our net book value per share as of December 31,
1998 from $0.43 (actual) to $2.20 (pro forma) and $2.48 (pro forma adjusted to
reflect the subsequent conversions of 10% Preferred Stock and Series A Preferred
Stock, the subsequent exercise of the warrants to purchase 140,000 shares of
common stock issued in connection with the issuance of the Series A Preferred
Stock, and the subsequent issuance and conversions of Series C Preferred Stock).
  
     In addition to issuing these shares of common stock, in connection with the
DCI acquisition we will reserve for issuance shares that, when issued, may have
a dilutive effect on our shareholders.  There is no assurance that our results
of operations will improve enough, if at all, as a result of the DCI
acquisition, to offset this possible future dilution.  These shares consist of
approximately:

     .  240,000 shares of our common stock for issuance upon exercise of
        outstanding options and warrants that will be issued in connection with
        the DCI acquisition, and
     .  40,000 shares of our common stock for issuance upon conversion of
        convertible securities of DCI that we will assume in connection with the
        DCI acquisition.

     The price of our common stock has been highly volatile due to factors that
will continue to effect the price of our stock.  Our common stock traded as high
as $19.38 per share and as low as $11.50 per share during the three months ended
March 31, 1999.  Historically, the over-the-counter markets for securities such
as our common stock have experienced extreme price and volume fluctuations.
Some of the factors leading to this volatility include:

     .  Price and volume fluctuations in the stock market at large that do not
        relate to our operating performance,
     .  Fluctuations in our quarterly operating results,
     .  Announcements of product releases by us or our competitors, and
     .  Announcements of acquisitions and/or partnerships by us or our
        competitors,
     .  Increases in outstanding shares of common stock upon exercise or
        conversion of derivative securities. (See "We have issued numerous
        options, warrants and convertible securities to acquire our common stock
        that could have a dilutive effect on our shareholders.")

     The trading volume of our common stock may diminish significantly if our
common stock is prohibited from being traded on the Nasdaq SmallCap Market.
Although our shares are currently traded on The Nasdaq SmallCap Market, there is
no assurance that we will remain eligible to be included on Nasdaq.  If our
common stock was no longer eligible for quotation on Nasdaq, it could become
subject to rules adopted by the Securities and Exchange Commission regulating
broker-dealer practices in connection with transactions in "penny stocks."  If
our common stock became subject to the penny stock rules, many brokers may be
unwilling to engage in transactions in our common stock because of the added
regulation, thereby making it more difficult for purchasers of our common stock
to dispose of their shares.

     We have issued numerous options, warrants, and convertible securities to
acquire our common stock that could have a dilutive effect on our shareholders.
We have issued numerous options, warrants, and convertible securities to acquire
our common stock.  During the terms of these outstanding options, warrants, and
convertible securities, the holders of these securities will have the
opportunity to profit from an increase in the market price of our common stock
with resulting dilution to the holders of shares who purchased shares for a
price higher than the respective exercise or conversion price.  The existence of
such stock options, warrants and convertible securities may adversely affect the
terms on which we can obtain additional financing, and you should expect the
holders of such options or warrants to exercise or convert those securities at a
time when we, in all likelihood, would be able to obtain additional capital by
offering securities on terms more favorable to us than those provided by the
exercise or conversion of such options or warrants.


                                       26
<PAGE>
 
     As of May 3, 1999, we have issued the following warrants and options to
acquire shares of our common stock:

     .  Options and warrants to purchase 1,755,015 shares of common stock upon
        exercise of such options and warrants, exercisable at prices ranging
        from $0.50 to $18.25 per share, with a weighted average exercise price
        of approximately $7.22 per share.
     .  Warrants issued in connection with our initial public offering on May
        23, 1996 (the "IPO Warrants") to purchase 602,450 shares upon exercise
        of the IPO Warrants at an exercise price of $9.00 per share.
     .  Options issued to EBI Securities Corporation, the representative of the
        underwriters involved in such initial public offering (the
        "Representative's Option"), to purchase 106,700 shares upon exercise of
        the Representative's Option at a purchase price of $8.10 per share.
     .  The Representative's Option to purchase 106,700 IPO Warrants issuable
        upon exercise of the Representative's Option at a purchase price of
        $.001 per IPO Warrant. These IPO Warrants entitle the holder to purchase
        up to 53,350 shares upon exercise of such IPO Warrants at an exercise
        price of $9.00 per share.
     .  Warrants issued in connection with the issuance of the 10% Preferred
        Stock to purchase 53,500 shares of common stock upon exercise of such
        warrants, exercisable at $15.00 per share.
     .  Warrants issued in connection with the issuance of the 5% Preferred
        Stock to purchase 100,000 shares of common stock upon exercise of such
        warrants, exercisable at $16.33 per share.
     .  Warrants issued in connection with the issuance of the Series A
        Preferred Stock to purchase 20,000 shares of common stock upon exercise
        of such warrants, exercisable at $5.71 per share.

     In addition to these warrants and options, we:

     .  Will issue 955,649 shares of our common stock upon the completion of the
        DCI acquisition,
     .  Will reserve approximately 240,000 shares of common stock for issuance
        upon exercise of options and warrants to be issued in connection with
        the DCI acquisition,
     .  Will reserve approximately 40,000 shares of our common stock for
        issuance upon conversion of convertible securities of DCI that will be
        assumed by OSS in connection with the DCI acquisition, and
     .  Have reserved an indeterminate number of shares of common stock for
        issuance upon conversion of outstanding shares of our 10% and Series C
        Preferred Stock.

     Based on the market value for the common stock as of May 3, 1999, the then
outstanding 10% Preferred Stock and Series C Preferred Stock were convertible
into approximately 96,318 shares and 43,436 shares, respectfully, of common
stock.  The number of shares of common stock issuable upon conversion of the 10%
Preferred Stock and the Series C Preferred Stock could increase significantly if
the market value for our common stock decreases in the future.  Further, there
could be issuances of additional similar securities in connection with our need
to raise additional working capital.

     Future sales of our common stock in the public market could adversely
affect the price of our common stock.  Sales of substantial amounts of common
stock in the public market that is not currently freely tradable, or even the
potential for such sales, could have an adverse affect on the market price for
shares of our common stock and could impair the ability of purchasers of our
common stock to recoup their investment or make a profit.  As of May 3, 1999,
these shares consist of:

     .  Approximately 1,300,000 shares issued without registration under the
        securities laws ("Restricted Shares"),
     .  Approximately 60,000 shares owned by our officers, directors and holders
        of 10% of our outstanding common stock ("Affiliate Shares"), and
     .  955,649 shares to be issued upon consummation of the DCI acquisition.

     Unless the Restricted Shares and the Affiliate Shares are further
registered under the securities laws, they may not be resold except in
compliance with Rule 144 promulgated by the SEC, or some other exemption from
registration.  Rule 144 does not prohibit the sale of these shares but does
place conditions on their resale which must be complied with before they can be
resold.  Before September 30, 1999, the shares of the common stock to be


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<PAGE>
 
issued to the shareholders of DCI in connection with the DCI acquisition will be
subject to contractual limitations on their transfer, however, such shares or a
portion of them could be sold before September 30, 1999.

     Future sales of our common stock in the public market could limit our
ability to raise capital.  Sales of substantial amounts of common stock in the
public market pursuant to Rule 144, upon exercise or conversion of derivative
securities or otherwise, or even the potential for such sales, could affect our
ability to raise capital through the sale of equity securities.  (See "We have
issued numerous options, warrants, and convertible securities to acquire our
common stock that could have a dilutive effect on our shareholders" and "Future
sales of our common stock in the public market could adversely affect the price
of our common stock.")

     Provisions in our articles of incorporation allow us to issue shares of
stock that could make a third party acquisition of us difficult.  Our Articles
of Incorporation authorize our Board of Directors to issue up to 20,000,000
shares of common stock and 5,000,000 shares of preferred stock in one or more
series, the terms of which may be determined at the time of issuance by the
Board of Directors, without further action by our shareholders.  Preferred stock
authorized by the Board of Directors may include voting rights, preferences as
to dividends and liquidation, conversion and redemptive rights and sinking fund
provisions.  If the Board of Directors authorizes the issuance of preferred
stock in the future, this authorization could affect the rights of the holders
of common stock, thereby reducing the value of the common stock, and could make
it more difficult for a third party to acquire us, even if a majority of the
holders of our common stock approved of an acquisition.  Other than the 2,000
shares of Series C Preferred Stock that will be issued if the warrant to
purchase such shares is exercised, our Board of Directors has no present plans
to issue any shares of preferred stock.

     Our issuance of our Series C Preferred Stock will require us to record a
non-operating expense which will, in turn, increase our net loss available to
shareholders. Based on current accounting standards, we recorded a non-operating
expense of $4,158,563 for the quarter ending March 31, 1999 as a result of the
issuance of the Series C Preferred Stock. In addition, to the extent that we
exercise our right to issue or the investor exercises its right to acquire up to
$2,000,000 additional principal amount of the Series C Preferred Stock, we may
incur similar non-operating expenses in excess $2,000,000 at the time that any
such additional shares of Series C Preferred Stock are issued.

     We do not anticipate paying dividends on our common stock for the
foreseeable future.  We have never paid dividends on our common stock and do not
intend to pay any dividends on our common stock in the foreseeable future.  Any
decision by us to pay dividends on our common stock will depend upon our
profitability at the time, cash available therefor, and other factors.  We
anticipate that we will devote profits, if any, to our future operations.


                                    PART II
                               OTHER INFORMATION

                                        
Items 1 and 3-5.  Not Applicable

Item 2.  Changes in Securities and Use of Proceeds

     On January 11, 1999, we sold 3,000 shares of our Series C Cumulative
Convertible Preferred Stock, $1,000 stated value, to one investor for $3
million.  EBI Securities, Inc. (formerly Cohig & Associates, Inc.) served as the
placement agent for the offering and received a commission equal to 7% of the
gross proceeds of the offering.  See Note 7 of the Notes to Consolidated
Financial Statements for a description of the terms of the Preferred Stock.  The
securities were not registered under the Securities Act of 1933, as amended,
based upon the exemption provided in Section 4(2) of such act and Regulation D
promulgated thereunder.  The securities were "restricted" securities as defined
in Rule 144 promulgated by the Securities and Exchange Commission and were
acquired for investment purposes.  The certificates representing such securities
contained restrictive legends.  The securities are subject to demand
registration rights.


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<PAGE>
 
Item 6.  Exhibits and Reports on Form 8-K

         (a)  Listing of Exhibits:

         2.1  Agreement and Plan of Merger dated March 19, 1998 among OSS,
              Durand Acquisition Corporation and Durand Communications, Inc. (3)
         3.1  Articles of Incorporation, as amended, of OSS (5)
         3.2  Bylaws of OSS (1)
         4.1  Specimen form of OSS' Common Stock certificate (2)
         4.2  Form of Warrant Agreement dated May 23, 1996 between Corporate
              Stock Transfer and OSS, including form of Warrant (2)
         4.3  Stock Option Plan of 1995 (1)
         4.4  Form of Incentive Stock Option Agreement for Stock Option Plan of
              1995 (1)
         4.5  Form of Nonstatutory Stock Option Agreement for Stock Option Plan
              of 1995 (1)
         4.6  Form of Warrant issued in connection with Sale-Leaseback of
              Equipment (1)
         4.7  Form of Warrant issued in 1996 to private investors (1)
         4.8  Specimen of Warrant Certificate--See Exhibit A filed with Exhibit
              4.2
         4.9  Form of Warrant Agreement issued in 1997 and 1998 to private
              investors (3)
        4.10  Form of Warrant Agreement issued in connection with issuance of
              Series A Preferred Stock (4)
        4.11  Form of Warrant Agreement issued in connection with issuance of
              Series C Preferred Stock--See Exhibit B filed with Exhibit 10.8
        10.1  Equipment Lease Agreement dated December 15, 1995 between OSS and
              OSS Equipment Leasing General Partnership (1)
        10.2  Form of Nondisclosure and Nonsolicitation Agreement between OSS
              and its employees (2)
        10.3  Office Lease for OSS' principal offices (2)
        10.4  Long-Term Equipment Sale and Software License Agreement dated
              October 7, 1997 between OSS and FiberTel TCI2 S.A. (3)
        10.5  Agreement dated October 7, 1997 between OSS and Medical Education
              Collaborative, Inc. (3)
        10.6  Form of Change of Control Agreement between OSS and certain
              employees (7)
        10.7  Securities Purchase Agreement and Exhibits thereto dated January
              11, 1999 between OSS and Archer Investors, LLC (6)
        10.8  Operating and Member Control Agreement dated March 10, 1999, among
              NetIgnite2, LLC, OSS and NetIgnite, Inc., Buy-Sell Agreement dated
              March 10, 1999, among NetIgnite2, LLC, OSS and NetIgnite, Inc. and
              Employment Agreement dated March 10, 1999, among OSS, NetIgnite2,
              LLC and Perry Evans (7)
        10.9  Electronic Banking Service Contract dated May 28, 1997 between OSS
              and Rockwell Federal Credit Union (7)
       10.10  Online Banking Service Agreement dated February 10, 1999 between
              OSS and CU Cooperative Systems, Inc. (7)
       10.11  Internet/Business Site Development & Host Agreement dated November
              12, 1997 between OSS and ReMax International, Inc. (7)
       10.12  Long-Term Equipment Sale and Software License Agreement dated
              February 16, 1998 between OSS and Boulder Ridge Cable TV Inc. dba
              Starstream Communications (7)
       10.13  Agreement for the Provision of Internet Services, Equipment, and
              Software Licenses dated November 26, 1997 between OSS and American
              Telecasting, Inc. (7)
       10.14  Equipment Sale and Software License Agreement dated August 4,
              1997, as amended May 26, 1998, between OSS and Intermedia Partners
              Southeast (7)
       27     Financial Data Schedule*
-----------------------------
*         Filed herewith.


          (b)  Reports on Form 8-K
               Filed with the Form 8-K Current Report dated January 11, 1999, as
          amended, Commission File No. 0-28462.


                                       29
<PAGE>
 
                                  Signatures


In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.



                             ONLINE SYSTEM SERVICES, INC.



Date: May 17, 1999           By  /s/ William R. Cullen
                                 -------------------------
                                 Chief Financial Officer


                                 /s/ Stuart Lucko
                                 -------------------------
                                 Controller



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