<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                   FORM 10-KSB

(Mark One)
[X]       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
          EXCHANGE ACT OF 1934 
For the fiscal year ended January 31, 1999

                                       OR

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

                         Commission file number 0-24871

                               FATBRAIN.COM, INC.
                       (FORMERLY COMPUTER LITERACY, INC.)
                 (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

             Delaware                                       77-0389480
  (STATE OR OTHER JURISDICTION OF               (I.R.S. EMPLOYER IDENTIFICATION
   INCORPORATION OR ORGANIZATION)                             NO.)

                               1308 Orleans Drive
                           Sunnyvale, California 94089
           (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE, INCLUDING ZIP CODE)

Issuer's telephone number, including area code:    (408) 541-2020

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None

       Title of each class                 Name of Exchange on which registered
       -------------------                 ------------------------------------
               None                                        None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock
($0.001)

        Indicate by check mark whether the issuer: (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 issuer
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

         Yes     [X]            No     [ ]

         Yes     [X]            No     [ ]

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


                            [Cover page 1 of 2 pages]

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        The Issuer's revenues for its most recent fiscal year are $19.8 million.

        The aggregate market value of voting stock held by non-affiliates of the
issuer, as of March 31, 1999 was approximately $113,987,109 (based on the
closing price for shares of the issuer's Common Stock as reported by the Nasdaq
National Market for the last trading day prior to that date). Shares of Common
Stock held by each executive officer, director, and holder of 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.

        On March 31, 1999 approximately 11,250,066 shares of the issuer's Common
Stock, $0.001 par value, were outstanding.

        Transitional Small Business Disclosure Format (check one):

         Yes     [ ]            No     [X]

                       DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Proxy Statement to be filed by the Company with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year are incorporated by reference in Part III of this Form 10-KSB.



                            [Cover Page 2 of 2 pages]

<PAGE>   3


                               Fatbrain.com, Inc.
                                   Form 10-KSB
                                      INDEX

<TABLE>
<CAPTION>
PART I.                                                                                    PAGE
<S>      <C>                                                                              <C> 
Item 1.  Business ....................................................................     2-18

Item 2.  Properties ..................................................................       18

Item 3.  Legal Proceedings ...........................................................       19

Item 4.  Submission of Matters to a Vote of Security Holders .........................       19

PART II.

Item 5.  Market for Common Equity and Related Shareholder Matters ....................       20

Item 6a. Selected Financial Data .....................................................       21

Item 6.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations ...............................................................    22-26

Item 7.  Financial Statements and Supplementary Data .................................    27-42

Item 8.  Changes in and Disagreements with Accountants on Accounting and
         Financial Disclosure ........................................................       43

PART III.

Item 9.  Directors, Executive Officers, Promoters and Control Persons;
         Compliance with Section 16(a) of the Exchange Act ...........................       43

Item 10. Executive Compensation ......................................................       43

Item 11. Security Ownership of Certain Beneficial Owners and Management ..............       43

Item 12. Certain Relationships and Related Transactions ..............................       43

Item 13. Exhibits and Reports on Form 8-K ............................................       43

SIGNATURES ...........................................................................       44
</TABLE>

<PAGE>   4

        This Annual Report on Form 10-KSB contains forward-looking statements
relating to future events or the future financial performance of the Company,
which involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain important factors, including those set forth under "Item 1.
Business" and elsewhere in this Annual Report on Form 10-KSB. For purposes
herein, the fiscal year ended January 31, 1999 is referred to as fiscal 1999 and
the fiscal year ended January 31, 1998 is referred to as fiscal 1998.

                                     PART I

ITEM 1.    BUSINESS

OVERVIEW

        Fatbrain.com, Inc., (formerly Computer Literacy, Inc.) is the leading
online retailer of information resources singularly focused on business and
technical professionals. With over 300,000 information resource titles from more
than 8,000 publishers, Fatbrain.com offers its customers online access to a
broad and comprehensive selection of technical and professional books,
technology based training solutions, product manuals, research reports and other
information resources. In addition to the Company's extensive product offering,
Fatbrain.com's online store features authoritative and compelling content,
competitive pricing, an easy-to-use navigational interface and a variety of
value-added services. The Company also operates two physical retail stores that
complement its online business by generating increased online traffic and
creating cross-promotional opportunities, thereby providing a profitable means
of customer acquisition. Fatbrain.com has quickly become one of the most widely
recognized online retailers of information resources for professionals. To
enhance brand recognition and increase online traffic, the Company has
established a number of strategic alliances with publishers and other suppliers
of information resources for professionals. For example, the Company has
established an alliance with CBT Group PLC ("CBT") to sell CBT's full library of
technology based training materials, containing over 1,100 titles. In addition,
the Company has established co-branded online stores with a number of technology
companies, including Microsoft, Sun Microsystems, Cisco Systems, Hewlett-Packard
Company, 3Com and Hughes.

        The Company believes that these customized corporate online stores,
combined with its commitment to customer service and readily available product
offerings, create valuable long-term relationships and repeat purchasing
patterns. Since launching its online store in February 1996, the Company has
experienced rapid online revenue growth. On May 31, 1997, the Company completed
the acquisition of all of the outstanding capital stock of Computer Literacy
Bookshops, Inc., a retailer of computer books, with four stores located in
California and Virginia for a purchase price of approximately $5.1 million. For
the two-year period ended January 31, 1999, Fatbrain.com generated total online
revenues of $13.7 million (over $3.5 million of which was generated during the
three months ended January 31, 1999). In addition, the number of online
customers has grown from approximately 1,600 as of January 31, 1997 to
approximately 78,000 as of January 31, 1999, and repeat purchases have accounted
for approximately 52% of the Company's online revenue for the year ended January
31, 1999. See "Risk Factors -- Limited Operating History; Accumulated Deficit;
Anticipated Losses."

STRATEGY

        Fatbrain.com's objective is to maintain and extend its leadership
position as an online retailer of information resources singularly focused on
business and technical professionals. Key elements of the Company's strategy to
achieve this objective include:

        Expand Product Offerings. Fatbrain.com has broadened its areas of
content and expertise in books, training materials and documentation to include
the engineering, science, mathematics and financial services industries,
allowing the Company to serve a number of key professional markets in addition
to information technology, including business and finance, aeronautics,
pharmaceuticals, and manufacturing. In these new markets, Fatbrain.com will seek
to deliver the same subject expertise and special services to which its
customers have become accustomed, such as powerful search tools, expert reviews
and custom recommendations.

        Enhance the Customer Experience. Fatbrain.com seeks to provide its
customers with a superior online shopping experience by offering an extensive
selection, authoritative and compelling content, convenience, value-added
service, a strong commitment to customer service, competitive pricing and an
easy-to-use interface. The Company believes that enhancements to its online
product offering will enable it to capture an increasing share of



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the worldwide market for information resources. The Company expects to continue
investing in its technology and product development to maintain a
state-of-the-art, simple to use and content-rich online store, while broadening
and expanding its product offerings.

        Expand Corporate Relationships. Fatbrain.com believes that there is a
significant opportunity to increase its sales by expanding its corporate sales
force and adding telesales capacity to focus on small and mid-sized businesses,
educational institutions and government agencies. Such corporate relationships
provide a cost-effective means of acquiring a large number of loyal customers
quickly and efficiently. In addition, by building customized co-branded online
stores for many of these corporate customers, the Company is able to secure and
leverage its position with the customer as the preferred provider of information
resources.

        Build Brand Awareness. Fatbrain.com believes it is the first online
retailer to singularly focus on providing information resources to business and
technical professionals. To leverage its first-mover advantage, the Company
seeks to expand awareness of its brand with targeted advertising and marketing
programs, a direct sales force and other marketing initiatives, thereby reducing
customer acquisition costs. The Company's strategy is to promote, advertise and
increase brand equity through excellent customer service, effective marketing
and promotion, and with strategic alliances and partnerships.

        Encourage Customer Loyalty. Fatbrain.com believes that its customized
corporate online stores, its commitment to customer service and readily
available product offerings create valuable long-term relationships and repeat
purchasing behavior. The Company intends to further pursue customized online
retail opportunities and devote significant resources to encourage overall
customer loyalty.

        Capitalize on Expanding Market. Fatbrain.com intends to capitalize on
the growing market for information resources by leveraging its online platform
and brand, and by providing an extensive selection of products and services
previously unavailable through a single or centralized source. In addition, the
Company will consider developing incremental revenue opportunities by promoting
its products through affiliated sites and expanding into related product areas.
Further, the Company's customer demographics and substantial site traffic
creates a meaningful opportunity for potential ancillary revenues such as banner
advertising, links to related sites and cross promotions.

        Establish and Leverage Supplier Relationships. Fatbrain.com intends to
capitalize upon the advantages associated with its online platform to create and
sustain strong relationships with publishers and other suppliers. The Company
also intends to leverage its market leadership position to expand cooperative
marketing campaigns with publishers, pursue direct supply relationships and
improve volume discounts. Fatbrain.com plans to hire additional personnel
primarily dedicated to establishing and maintaining supplier relationships in
order to improve availability, delivery, pricing terms and, in certain
circumstances, exclusivity.

        Maintain Technology Focus and Expertise. Because speed, scalability and
ease-of-use are essential to effectively operating online stores, Fatbrain.com's
internal engineering group will continue to devote substantial resources to
develop, acquire and implement technological enhancements to its Web site and
transaction-processing systems. Among other technology objectives, the Company
intends to provide increasingly value-added services and make the user interface
as intuitive, engaging and effective as possible, while continuously improving
the efficiency of its transaction-processing and fulfillment activities.

FATBRAIN.COM'S ONLINE STORE

        Customers enter the Fatbrain.com online store through the Company's Web
site and, in addition to ordering technical and professional books,
technology-based training solutions, product manuals and research reports,
customers can conduct targeted searches, browse highlighted selections,
bestsellers and other features, read and post reviews, register for value-added
services, check order status and participate in promotions.

        Browsing. The Fatbrain.com online store offers visitors a variety of
highlighted subject areas and special features. Popular features include
"bestsellers," "what's hot" and "our recommendations," which enable individuals
to view the most popular and best selling items. The "what's hot" area directs
customers to information resources for particular subject categories such as
Java or C++, and "partner shelves" provides the user with titles and selections
specific to products from technology leaders such as Cisco, Hewlett-Packard,
Microsoft and Sun Microsystems. In addition, the Fatbrain.com home page presents
a variety of other features of topical or current-event interest, such as



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"what's new" which allows customers to be notified of recent releases of new
versions and "events calendar" which provides the user information on store
events and tradeshows. Further, customers can click on the "suggestions" button,
located at the bottom of each page and make a suggestion to the Company.

        Searching. A primary feature of the Fatbrain.com online store is its
interactive, searchable catalog of more than 300,000 titles. The Company
provides a selection of search tools enabling users to quickly find information
resources based on title, subject, author, publisher or ISBN. Within a
particular search, a customer can choose to sort the selections in various
orders of importance. The Company believes that its focus on professional
materials allows for an efficient search mechanism by delivering search results
of relevant materials. After a selection has been located, Fatbrain.com informs
customers of related products which provides unique up-selling and marketing
opportunities.

        Ordering. To purchase products, customers simply click on an icon to add
books to their online shopping basket and can remove products from their
shopping baskets as they browse. To execute orders, customers click on the
"checkout" icon and are prompted to supply shipping and credit card details,
either online, by e-mail or by telephone. Customer account information is stored
on the Company's secure servers and is automatically recalled for subsequent
purchases. Personal passwords allow repeat customers to automatically access
previously provided information, as well as book notification profiles. The
Company's system automatically confirms each order by e-mail within minutes
after placing the order and advises customers by e-mail shortly after orders are
shipped.

        Reviews and Content. The Fatbrain.com online store offers numerous forms
of content to entertain, engage and inform readers, and enhance the customer's
shopping experience. For many of its selections, customers are able to access
reviews by Fatbrain.com's in-house editorial staff and other industry leaders.
In addition, customers are encouraged to write and post their own reviews which
are also available under "more information available" icons. Within the
"authors' domain" area of the online store, customers can access other
interviews and articles by industry leaders. Due to the customer's need for
credible advice, specific background information about reviewers is posted, such
as the reviewer's profession and level of expertise. In addition, the Company's
practice of displaying the table of contents for many of its selections, and
often sample chapters, enables the purchaser to evaluate the content of the item
being purchased.

        Availability and Fulfillment. Fatbrain.com strives to ship 90% of all
orders received weekdays by 4:00 p.m. Pacific Time on the same day. Below each
product offering is a symbol that indicates whether such item is in stock.
Customers select from a variety of delivery options, including overnight and
various international shipping alternatives. The Company seeks to provide rapid
and reliable fulfillment of customer orders and intends to continue to improve
its record of availability and fulfillment. See "--Warehousing and Fulfillment."

        Customized Online Stores. Fatbrain.com's FindITnow intranet bookstore
program (the "Program") allows businesses to provide customized professional
bookstores within their corporate networks and integrates with existing business
processes to give organizations control over procurement.. The Program provides
the Company with opportunities to be the preferred provider of information
resources to organizations and their employees and constituents. In addition to
its online stores, Fatbrain.com maintains two retail stores located in San Jose
and Sunnyvale, California operating under the name Computer Literacy, Inc. These
stores supplement the Company's operating results and provide a profitable means
of customer acquisition. Additionally, the existence of the stores enables the
Company to engage in unique cross-promotional efforts and offer in-store events
such as guest lectures. The Company periodically evaluates the location and
productivity of its stores, and may close, consolidate or relocate stores as
conditions warrant. See "Risk Factors -- Unpredictability of Future Revenues;
Potential Fluctuations in Quarterly Operating Results; Seasonality."

CUSTOMERS

        The Company's customers consist of both individual professionals, who
primarily purchase for business purposes, and corporate customers. Through its
relationships with corporate customers, the Company sells to purchasing agents,
corporate librarians and training departments as well as to individual employees
within these organizations. Fatbrain.com has also leveraged these corporate
customer relationships into sales to constituents of the corporate customers.
The number of customer accounts has grown from approximately 1,600 as of January
31, 1997 to approximately 78,000 as of January 31, 1999 and repeat purchases
have accounted for approximately 52% of online revenue in the fiscal year ended
January 31, 1999. No single customer accounted for more than 10% of



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total revenues in the fiscal years ended January 31, 1997, 1998 or 1999. Set
forth below are two case studies of representative corporate customer
relationships.

        Microsoft Corporation. Fatbrain.com's relationship with Microsoft began
in January 1997 when the Microsoft Corporate Library ("MS Library") began using
Fatbrain.com as one of its sources to acquire materials for its collection. In
this manner, the library staff acts as central purchasing agents to acquire
resources on behalf of the entire corporate staff, who turn to the MS Library as
an internal one-stop resource for their own information needs. Recognizing the
importance of this strategic account, the Company assigned a member of its sales
team to actively manage the account, deliver personal service and further
develop the relationship. The assigned account manager is in weekly contact to
personally resolve issues, expedite important orders and suggest products and
services. The Company believes that the MS Library chooses to buy from
Fatbrain.com because it delivers higher levels of service by lending personal
attention, accepting orders via its corporate credit card and offering faster
shipping, all at competitive prices. In January 1998, Fatbrain.com extended its
relationship with Microsoft to reach external constituents, specifically with
members of the Microsoft development community, by collaborating with the
Microsoft Site Builder Network ("SBN"). Microsoft chose Fatbrain.com as its
partner to develop a co-branded store for SBN members and visitors. This
selection was based on Fatbrain.com's focus on the technology professional, its
unique ability to provide value-added content and its commitment to partnering
as demonstrated by previous relationships and resource commitments to
partnership projects. Once the selection was made, Fatbrain.com developed the
SBN store site which features books of particular interest to SBN's audience of
Web developers. Together, Microsoft and Fatbrain.com promote the SBN store via
vehicles such as e-mailings to over 500,000 registered SBN members, Web site
links and other mechanisms.

        Sun Microsystems, Inc. Sun Microsystems has a centralized library
resource that serves its entire corporate staff's information needs. Sun
Microsystems was looking for a partner who could provide a secure mechanism to
enable employees to browse and order important technical documents quickly. Sun
Microsystems chose Fatbrain.com because of its unique focus on the technical
professional, immediate inventory of over 30,000 technical titles, departmental
billing, centralized purchasing control and specialized content including
recommended reading lists. The Sun Microsystems Library acts as a central
purchasing agent, and Sun Microsystem's employees are able to browse and order
at the co-branded site developed and hosted by Fatbrain.com. The Sun
Microsystems library and Fatbrain.com work together to help serve the
information needs of the entire employee base, by promoting this new online
channel for information resources that is co-branded with Sun Microsystems
Library and Fatbrain.com logos.

SALES AND MARKETING

        The Company's sales and marketing strategy is focused on both individual
consumers and organizations, which represent distinct yet complementary customer
segments. This approach is designed to cost-effectively strengthen the Company's
brand name, increase customer traffic to the Fatbrain.com online store, build
customer loyalty and develop revenue opportunities through the Company's
distribution channels.

        Corporate Sales. The Company has an increasing number of sales personnel
primarily focused on fulfilling the information resource requirements of
corporate organizations and their employees and constituents. The Company's
direct sales force is headquartered in Sunnyvale, California and each member is
assigned to specific strategic accounts. Each member of the direct sales
organization, including telesales personnel, is compensated with base salary and
commissions. See "Risk Factors -- Need for Additional Personnel," "--Dependence
on Key Personnel" and "--Management of Expanding Business; Limited Senior
Management Resources."

        Marketing and Consumer Sales. Fatbrain.com utilizes a variety of
programs and promotional activities to increase traffic and purchases on its
Website and in retail locations. The Company maintains a proprietary customer
database of e-mail addresses that allows for cost-effective personal
notification and other targeted marketing. Fatbrain.com continues to build
customer loyalty by delivering customized services, promotions and products to
its customers. The Company targets the individual customer through a mix of
promotional activities and strategic advertising. Over 4,000 Web sites have
links to the Company's online store. These links are located primarily on
Websites concerning computers or other technical topics, which are considered
complementary to the Company's online store. The Company also places a limited
number of advertisements on strategic Web sites. The Company advertises in a
number of trade journals, newspapers and magazines targeted to the information
technology professionals and information systems consultants. In addition, the
Company has served as the official bookseller of



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certain trade shows and conventions, such as the Microsoft's TechEd and Software
Development West. See "Risk Factors--Risks Associated with Branding."

        International Sales. For fiscal 1999, approximately 20.8% of online
revenue was derived from international sales. The Company believes that the
Internet offers a unique opportunity for it to rapidly expand its international
presence on a cost-effective basis and it intends to pursue this opportunity
aggressively.

CUSTOMER SERVICE AND SUPPORT

        The Company is committed to providing superior customer service and
support. The Company's customer service and support personnel are trained to
assist customers in purchasing decisions, recommend complementary products and
handle general customer inquiries. The Company answers service and support
questions through e-mail 24 hours a day, seven days a week, and through its
toll-free phone line from 6:00 a.m. to 8:00 p.m., Pacific time on weekdays and
9:00 a.m. to 5:00 p.m., Pacific Time on weekends. The Company has automated
certain portions of its customer service and support operations and intends to
enhance and provide further automation of such service and operations.

WAREHOUSING AND FULFILLMENT

        For fiscal 1999 the Company purchased approximately 37% of its inventory
from Ingram Book Company and 22% of its inventory from Pearson Education
Division ("Pearson"). The Company relies to a large extent on rapid fulfillment
from Ingram, Pearson and other vendors. The Company generally has no commitments
to or arrangements with any of its vendors that guarantee the availability of
merchandise, the continuation of particular payment terms or the extension of
credit limits. There can be no assurance that the Company's current vendors will
continue to sell merchandise to the Company on current terms or that the Company
will be able to establish new or extend current vendor relationships to ensure
acquisition of merchandise in a timely and efficient manner and on acceptable
commercial terms. If the Company were unable to develop and maintain
relationships with vendors that would allow it to obtain sufficient quantities
of merchandise on acceptable commercial terms, its business, financial condition
and results of operations would be materially adversely affected. See "Risk
Factors--Reliance on Certain Suppliers."

        The Company currently maintains a warehouse and distribution center in
Fremont, California. The Company will be moving the warehousing and fulfillment
of orders to Erlanger, Kentucky in May 1999 in order to be in closer proximity
to certain publishers, wholesalers, distributors and delivery services. At the
same time the Company will move from a manual distribution process to a software
supported solution from Manhattan Associates, PKMS Warehouse Management System.
There can be no assurance that relocating such services and moving to an
automated distribution system will result in operating efficiencies or will not
cause a significant disruption in the fulfillment of orders, the distraction of
management and other key personnel and the expenditure of significant financial
and other resources. Any such disruption, distraction or expenditure could
materially adversely affect the Company's business, results of operations and
financial condition. See "Risk Factors--Fulfillment Center Relocation."

TECHNOLOGY AND PRODUCT DEVELOPMENT

        Using a combination of its internally developed proprietary technology
and commercially available licensed technology, the Company has implemented an
integrated system of site management, search engine, customer support, inventory
management, network monitoring, quality assurance, transaction processing and
fulfillment services. The Company's technology architecture is based on a
distributed model that is extremely scalable, flexible and modular. See "Risk
Factors--Trademarks and Proprietary Rights; Unlicensed Arrangements and
Materials."

        The Company's current strategy is to focus its development efforts on
creating and enhancing the proprietary software unique to its business,
especially as it relates to interaction with customers. Fatbrain.com licenses
commercially available technology in areas where the Company cannot create
unique value. See "Risk Factors -- Dependence on Continued Growth of Electronic
Commerce; and "-- Rapid Technological Change." The Company's integrated system
consists of a dynamic Web site and transaction processing components. The
Company's dynamic Web site allows customers to search, browse and view product
information, monitor product status and availability, compare different product
options, and make purchase decisions specific to their particular



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needs. The Company has implemented a transaction processing system that supports
corporate ordering, multiple account profiles for individual and corporate
users, custom integration and co-branding with partner sites, the application of
selective discounting and promotion codes, and referral tracking and reporting.
The system can accommodate large numbers of products, across different product
categories and millions of individual items, offer users multiple shipping and
delivery options and provides secure credit card transactions. The Company has
implemented a customer service system that manages order adjustments, credits,
returns, refunds, cancellations and customer account information. The Company's
back-end system is fully integrated and includes inventory management, accounts
payable, accounts receivable, general ledger, and retail point of sale. The
Company's engineering strategy includes enhancing the functionality of its
existing features, developing new features and integrating off-the-shelf
components into its environment. Fatbrain.com is currently investing significant
resources in its system development and expects to continue to do so in the
future. The Company believes its future success depends on its ability to
continue developing and enhancing this system. The uninterrupted operation of
the Company's online store and related system is essential to its business and
the site operations staff is responsible for ensuring its reliability. The
Company uses three Internet service providers. The Company anticipates upgrading
capacity to allow for faster telecommunication services in the future. See "Risk
Factors--Management of Expanding Business; Limited Senior Management Resources,"
"--Risk of Capacity Constraints; Reliance on Internally Developed Systems;
System Development Risks;" and "--Risk of System Failure; Single Site and Order
Interface."

COMPETITION

        The electronic commerce market is new, rapidly evolving and intensely
competitive. The market for information resources is more mature but also
intensely competitive. The Company expects competition to continue to intensify
in the future. The Company currently or potentially competes with a variety of
companies. These competitors include:

    -   A significant number of retail and online bookstores, including
        Amazon.com, Barnesandnoble.com, Borders Group, Inc. and other vendors of
        books, training products and product manuals;

    -   Various computer super-stores that carry related information resources
        at retail locations, in catalogs and over the Internet;

    -   A number of indirect competitors that specialize in electronic commerce
        or derive a substantial portion of their revenue from electronic
        commerce; and

    -   Other companies with substantial customer bases in the computer and
        other technical fields.

There can be no assurance that the Company can maintain a competitive position
against current or future competitors as they enter the markets in which the
Company competes, particularly those with greater financial, marketing, service,
support, technical and other resources than the Company. The failure by the
Company to maintain a competitive position within the market could have a
material adverse effect on the Company's business, financial condition, results
of operations and cash flows.

        The Company believes that the principal competitive factors on which it
competes in its market are brand recognition, selection, personalized services,
convenience, price, accessibility, customer service, quality of search tools,
quality of editorial and other site content and reliability and speed of
fulfillment. Many of the Company's current and potential competitors have longer
operating histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than the Company.
In addition, online retailers may be acquired by, receive investments from or
enter into other commercial relationships with larger, well-established and
well-financed companies as use of the Internet and other online services
increases. Certain of the Company's competitors may be able to secure
merchandise from vendors on more favorable terms, devote greater resources to
marketing and promotional campaigns, adopt more aggressive pricing or inventory
availability policies and devote substantially more resources to Web site and
systems development than the Company. Increased competition may result in
reduced operating margins, loss of market share and a diminished brand
franchise. As a strategic response to changes in the competitive environment,
the Company may from time to time make certain pricing, service or marketing
decisions or acquisitions that could result in reduced margins or otherwise have
a material adverse effect on its business, financial condition and results of
operations. New technologies and the expansion of existing technologies may
increase the competitive pressures on the Company. For example, applications
that select specific titles from a variety of Web sites may channel customers to
online booksellers that compete with the Company. Companies that control access
to transactions through a network or Web browsers could also promote the
Company's competitors or charge the Company a substantial fee for inclusion. In
addition, vendors of information resources such as technology based training
could provide direct access to training programs



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online. There can be no assurance that the Company will be able to compete
successfully against current and future competitors, and competitive pressures
faced by the Company may have a material adverse effect on the Company's
business, financial condition and results of operations. See "Risk
Factors--Competition."

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

        The Company regards its copyrights, service marks, trademarks, trade
dress, trade secrets and similar intellectual property as critical to its
success, and relies on trademark and copyright law, trade secret protection and
confidentiality and/or license agreements with its employees, customers,
partners and others to protect its proprietary rights. The Company pursues the
registration of its trademarks and service marks in the U.S. and
internationally, and has applied for the registration of certain of its
trademarks and service marks. Effective trademark, service mark, copyright and
trade secret protection may not be available in every country in which the
Company's products and services are made available online. While the Company
attempts to ensure that the quality of its brand is maintained by such
licensees, there can be no assurance that such licensees will not take actions
that might materially adversely affect the value of the Company's proprietary
rights or reputation, which could have a material adverse effect on the
Company's business, financial condition, results of operations and cash flows.
There can be no assurance that the steps taken by the Company to protect its
proprietary rights will be adequate or that third parties will not infringe or
misappropriate the Company's copyrights, trademarks, trade dress and similar
proprietary rights. In addition, there can be no assurance that other parties
will not assert infringement claims against the Company. Such claims, even if
not meritorious, could result in the expenditure of significant financial and
managerial resources. The Company is not currently aware of any legal
proceedings pending or threatened against it.

        In addition, the Company displays reviews and articles on technical
subjects in its online store. Some reviews and articles may be copyrighted and
the Company may not have explicit permission from the author for use of such
intellectual property. There can be no assurance that the authors will not
assert infringement claims against the Company. If a claim is asserted alleging
that the Company has infringed the proprietary rights of a third party, the
Company may be required to seek licenses to continue to use such intellectual
property. The failure to obtain the necessary licenses or other rights at a
reasonable cost could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Risk Factors--Trademarks and
Proprietary Rights; Unlicensed Arrangements and Materials."

EMPLOYEES

        As of January 31, 1999, the Company employed 141 full-time employees. In
addition, the Company employed 30 part-time employees, primarily for its
physical retail stores. The Company also employs independent contractors and
other temporary employees in its editorial, operations and finance and
administration departments. None of the Company's employees are represented by a
labor union, and the Company considers its employee relations to be good.

        Competition for qualified personnel in the Company's industry is
intense, particularly among software development and other technical staff. The
Company believes that its future success will depend in part on its continued
ability to attract, hire and retain a sufficient number of highly skilled
personnel. See "Risk Factors--Dependence on Key Personnel;" and "--Need for
Additional Personnel."


RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

        The Company operates in a rapidly changing environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks. These risks should be read in
conjunction with the "Risk Factors" section included in the Company's
Registration Statement on Form SB-2 as declared effective by the Securities and
Exchange Commission on November 19, 1998 (Reg. No. 333-67397).



                                       8
<PAGE>   11

        Limited Operating History; Accumulated Deficit; Anticipated Losses. We
were incorporated in November 1994 to develop an online retail strategy and we
began selling information resources, initially consisting of technical books,
through our online store on the World Wide Web (the "Web") in February 1996. We
expanded our product offerings to include training materials in January 1998,
product manuals in May 1998 and research reports in June 1998. Accordingly, we
have a very limited operating history from which to evaluate our business and
prospects.

        Our prospects must be considered in light of the risks, expenses and
uncertainties frequently encountered by companies in the early stages of
development, particularly companies in new and rapidly evolving markets such as
electronic commerce. Such risks for us may include:

        -      An evolving and unpredictable business model;

        -      Management of an expanding business;

        -      Fluctuations in sales;

        -      Seasonality;

        -      Entry into new business areas;

        -      Competition;

        -      Need for additional personnel and dependence on key personnel;

        -      Limitations on our ability to establish and expand our brand;

        -      Capacity constraints;

        -      Systems failures;

        -      Announcements by current or potential competitors;

        -      Changes in the needs of technical professionals; and

        -      The other Risk Factors discussed herein.

        To address these risks, we must, among other things:

        -      Implement and successfully execute our business and marketing
               strategy;

        -      Maintain and increase our customer base;

        -      Continue to develop and upgrade our technology and
               transaction-processing systems;

        -      Improve our online store;

        -      Provide superior customer service and order fulfillment;

        -      Respond to competitive developments; and

        -      Attract, retain and motivate qualified personnel.

        We may not be successful in addressing such risks, and the failure to do
so would seriously harm our business, financial condition and results of
operations.

        Since inception, we have incurred significant net operating losses and
expect to incur additional net operating losses for the foreseeable future. We
may not achieve profitability and if achieved, profitability may not be
sustained. As of January 31, 1999, we had an accumulated deficit of $13.8
million. We believe that our success will depend in large part on our ability
to:

        -      Enhance our customers' online shopping experience;

        -      Expand corporate relationships;

        -      Build brand awareness;

        -      Encourage customer loyalty;

        -      Capitalize on the market for information resources;

        -      Establish and utilize supplier relationships; and

        -      Maintain our technology focus and expertise.

        Accordingly, we intend to invest heavily in marketing and promotion, our
direct sales and telesales organizations and systems and infrastructure
development. Such expenditures may not result in increased revenues or customer
growth. Additionally, while in recent periods we have experienced significant
growth in revenues, our customer base and repeat customer revenue, such growth
rates are not sustainable. Such growth rates will decrease in the future and are
not indicative of actual growth rates that we may experience.



                                       9
<PAGE>   12

        Unpredictability Of Future Revenues; Potential Fluctuations In Quarterly
Operating Results; Seasonality. We are unable to accurately forecast our future
revenues because of our limited operating history and the emerging nature of the
markets in which we compete. Revenues and operating results generally depend on
the volume of, timing of and ability to fulfill orders received. These factors
have historically been, and are likely to continue to be, difficult to forecast.
Our current and future expense levels are based largely on our operating plans
and estimates of future revenues and are, to a large extent, fixed. We may be
unable to adjust spending sufficiently quickly to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall in revenues in
relation to our planned expenditures would seriously harm our business,
financial condition and results of operations. Further, we may, from time to
time, make certain pricing, product, service or marketing decisions as a
strategic response to changes in the competitive environment. Such changes could
seriously harm our business, financial condition, results of operations and cash
flows.

        Our future quarterly operating results may vary significantly due to a
variety of factors, many of which are outside our control. Factors that could
affect our quarterly operating results include:

        -      Our ability to establish and expand brand awareness;

        -      Our ability to retain existing customers, attract new customers
               and continuously improve customer satisfaction;

        -      Announcements of, and market anticipation for, new technology
               offerings for which information resources may be sought;

        -      Our ability to manage inventory and fulfillment operations;

        -      Our ability to sustain or improve gross margin levels;

        -      The announcement or introduction of new online stores, services
               and products by us or our competitors;

        -      Price competition or higher wholesale prices in the industry;

        -      The level of usage of and commerce on the Internet and online
               services generally;

        -      Increasing customer acceptance of the Internet for the purchase
               of information resources such as those offered by us;

        -      Our ability to upgrade and develop our systems and infrastructure
               in a timely and effective manner;

        -      The level of traffic on our online store;

        -      The sales mix of our product offerings;

        -      Technical difficulties, system downtime or Internet brownouts;

        -      The amount and timing of operating costs and capital expenditures
               relating to expansion of our business, operations and
               infrastructure;

        -      The introduction of books, technology based training solutions,
               product manuals and research reports;

        -      The level of merchandise returns we experienced;

        -      Governmental regulation; and

        -      General economic conditions and economic conditions specific to
               the Internet, electronic commerce and the technical resource
               industries.

        In the past, we have experienced seasonality in our business and we
expect that we will continue to experience such seasonality in the future.
Internet usage and the amount of purchases from individual and corporate
consumers tend to decline during August, November and December. During these
times many technical professionals are either absent from the workplace, on
vacation or experience a holiday closure at their company. Our results in future
quarters may be negatively affected by seasonal trends.

        Due to the foregoing factors, we cannot predict with any significant
degree of certainty our quarterly revenue and operating results. Further, we
believe that period-to-period comparisons of our operating results are not
necessarily a meaningful indication of future performance. It is likely that in
one or more future quarters our results may fall below the expectations of
securities analysts and investors. In such event, the trading price of the
Common Stock would likely be seriously harmed.

        Risks Associated With Entry Into New Business Areas. For fiscal 1999
approximately 83% of our online revenues were derived from sales of books. We
recently expanded our product offerings to include technology based training
materials, product manuals and research reports and future revenues from these
new product offerings are



                                       10
<PAGE>   13

difficult to forecast. Additionally, we expanded our focus to include resource
materials for professionals in the engineering, science, mathematics and
financial services industries and future revenues from these new areas are
difficult to forecast.

        We may choose to further expand our operations by promoting new or
complementary products and expanding the breadth and depth of products and
services offered. In addition, we may decide to utilize third-party
relationships to extend our brand or establish additional co-branded online
stores. We may pursue the acquisition of new or complementary businesses,
products or technologies. However, we have no present commitments or agreements
for any material acquisitions or investments. We may not be able to expand our
product offerings and related operations in a cost-effective or timely manner.
Such efforts may fail to increase online traffic and purchases from our online
or physical retail stores or to increase our overall market acceptance.
Furthermore, any new business or online store launched by us that is not
favorably received by individuals, corporate customers or their employees or
constituents could damage our reputation or the Fatbrain.com brand. Expansion of
our operations in this manner would also require significant additional expenses
and development, operations and editorial resources. Such efforts may strain our
management, financial and operational resources. The lack of market acceptance
of such efforts (including our recent expansion of product offerings to include
technology based training materials, manuals and research reports and our new
focus on professionals in other fields) or our inability to generate
satisfactory revenues from such expanded services or products to offset related
increased costs could seriously harm our business, financial condition and
results of operations.

        Competition. The electronic commerce market is new, rapidly evolving and
intensely competitive. The market for information resources is more mature but
also intensely competitive. We expect competition to continue to intensify in
the future. We currently or potentially compete with a variety of companies.
These competitors include:

        -      A significant number of traditional retail and online bookstores,
               including Amazon.com, barnesandnobel.com., Borders Group, Inc.
               and other vendors of books, training products and product
               manuals;

        -      Various computer super-stores that carry related information
               resources at retail locations, in catalogs and over the Internet;

        -      A number of indirect competitors that specialize in electronic
               commerce or derive a substantial portion of their revenue from
               electronic commerce; and

        -      Other companies with substantial customer bases in the computer
               and other technical fields.

        We may not be able to maintain a competitive position against current or
future competitors as they enter the markets in which we compete. This is true
particularly with respect to competitors with greater financial, marketing,
service, support, technical and other resources than the Company. Our failure to
maintain a competitive position within the market could seriously harm our
business, financial condition, results of operations and cash flows.

        -      We believe that the principal competitive factors on which we
               compete in our market include:Brand recognition;

        -      Selection;

        -      Personalized services;

        -      Convenience;

        -      Price;

        -      Accessibility;

        -      Customer service;

        -      Quality of search tools;

        -      Quality of editorial and other site content; and

        -      Reliability and speed of fulfillment.

        Many of our current and potential competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources than the Company. In addition,
online retailers may be acquired by, receive investments from or enter into
other commercial relationships with larger, well-established and well-financed
companies as use of the Internet and other online services increases. Certain of
our competitors may be able to secure merchandise from vendors on more favorable
terms, devote greater



                                       11
<PAGE>   14

resources to marketing and promotional campaigns, adopt more aggressive pricing
or inventory availability policies and devote substantially more resources to
Web site and systems development than the Company.

        Increased competition may result in reduced operating margins, loss of
market share and a diminished brand franchise. We may from time to time make
certain pricing, service or marketing decisions or acquisitions as a strategic
response to changes in the competitive environment. Such actions could result in
reduced margins or otherwise seriously harm our business, financial condition,
results of operations and cash flows.

        New technologies and the expansion of existing technologies may increase
the competitive pressures on the Company. For example, applications that select
specific titles from a variety of Web sites may channel customers to online
booksellers that compete with the Company. Companies that control access to
transactions through a network or Web browsers could also promote our
competitors or charge us a substantial fee for inclusion. In addition, vendors
of information resources such as technology based training materials could
provide direct access to training programs online. We may be unable to compete
successfully against current and future competitors, and competitive pressures
faced by us could seriously harm our business, financial condition, results of
operations and cash flows.

        Management Of Expanding Business; Limited Senior Management Resources.
We have rapidly expanded our operations, and we anticipate that further
expansion will be required to address potential growth in our customer base and
market opportunities. Specifically, we expect to significantly increase our
direct corporate and telesales organization and marketing initiatives. This
expansion has placed, and future expansion is expected to place, a significant
strain on our management, operational and financial resources. Our new employees
include a number of key managerial, technical and operations personnel who have
not yet been fully integrated into the Company, and we expect to add additional
key personnel in the near future.

        To manage the expected growth of operations and personnel, we will need
to improve existing and implement new transaction-processing, operational and
financial systems, procedures and controls. In addition, we will need to expand,
train and manage an increasing employee base. We will also need to expand our
finance, administrative and operations staff. Our management will be required to
maintain and expand our relationships with:

        -      Various suppliers;

        -      Freight companies;

        -      Other Web sites;

        -      Other Web service providers;

        -      Internet and other online service providers; and

        -      Other third parties necessary to our business.

        Our current and planned personnel, systems, procedures and controls may
be inadequate to support our future operations. Further, management may be
unable to attract, retain, motivate and manage required personnel or to
successfully identify, manage and exploit existing and potential market
opportunities. If we are unable to manage growth effectively, our business,
financial condition and results of operations could be seriously harmed.

        Risks Associated With New Brand. We believe we must establish, maintain
and enhance our "Fatbrain.com" brand. We have only been operating under the
"Fatbrain.com" name since the end of March 1999. To attract and retain online
users and to promote and maintain our new brand, we may need to substantially
increase our marketing expenditures to create and maintain strong brand loyalty
among our customers. Additionally, customers may react negatively to our new
brand. Our business could be adversely affected if our customers react
negatively, our marketing efforts are unproductive or if we cannot increase our
brand awareness and acceptance. If we fail to promote and maintain our brand, or
if we incur excessive expenses in an attempt to do so, our business, operating
results, financial condition and cash flows would be seriously harmed.


        Risk Of Capacity Constraints; Reliance On Internally Developed Systems;
System Development Risks. A key element of our strategy is to generate a high
volume of traffic on, and use of, our online store. Accordingly, the
satisfactory performance, reliability and availability of the online store,
transaction-processing systems and network infrastructure are critical to our
reputation. These factors are similarly critical to our ability to attract and
retain customers and maintain adequate service and customer support levels. Our
revenues depend on the number of visitors who shop at our online store and the
volume of orders we fulfill. Any system interruptions that cause our



                                       12
<PAGE>   15

online store to be unavailable or impair order fulfillment performance would
reduce the volume of goods sold and the attractiveness of our product and
service offerings. We have experienced periodic system interruptions, which we
believe will continue to occur from time to time. If there is a substantial
increase in the volume of traffic on our online store or the number of orders
placed by customers we will need to expand and further upgrade our technology,
transaction-processing systems and network infrastructure. We may be unable to
accurately project the rate or timing of increases, if any, in the use of our
online store or timely expand and upgrade our systems and infrastructure to
accommodate such increases.

        We use an internally developed system, which is supplemented by
commercially available licensed technology, for:

        -      Our online store;

        -      Search engine; and

        -      Substantially all aspects of transaction processing, including
               order management, cash and credit card processing, purchasing,
               inventory management and shipping.

        We intend to upgrade and expand our transaction-processing systems and
to integrate newly developed and purchased modules with our existing systems in
order to improve our accounting, control and reporting methods and support
increased transaction volume. We may be unable to add additional software and
hardware or to develop and further upgrade our existing technology,
transaction-processing systems or network infrastructure to accommodate
increased traffic through our online store or increased sales volume. Any
inability to do so may result in:

        -      Unanticipated system disruptions;

        -      Slower response times;

        -      Degradation in levels of customer service;

        -      Impaired quality and speed of order fulfillment; and

        -      Delays in reporting accurate financial information.

        We may be unable in a timely manner to effectively upgrade and expand
our transaction-processing system or to smoothly integrate any newly developed
or purchased modules with our existing systems. Any inability to do so could
seriously harm our business, financial condition, results of operations and cash
flows.

        Need For Additional Personnel. Our future success depends on our ability
to attract, retain and motivate highly skilled technical, managerial, editorial,
merchandising, marketing and customer service personnel. Competition for such
personnel is intense, particularly in the San Francisco Bay Area, where our
headquarters are located. As a result, we may be unable to successfully attract,
assimilate or retain qualified personnel. We have encountered difficulties in
attracting a sufficient number of qualified software developers for our online
store and transaction-processing systems. Further, we may be unable to retain
those developers we currently employ or attract additional developers. The
failure to retain and attract the necessary personnel could seriously harm our
business, financial condition, results of operations and cash flows.

        Fulfillment Center Relocation. We currently maintain a temporary
warehouse and distribution center in Fremont, California. We will be moving the
warehousing and fulfillment of orders to Erlanger, Kentucky in May 1999 in order
to be in closer proximity to certain publishers, wholesalers, distributors and
delivery services. At the same time we will move from a manual distribution
process to a software supported solution from Manhattan Associates, PKMS
Warehouse Management System. Relocating such services and moving to an automated
distribution process may not result in operating efficiencies or may cause a
significant disruption in the fulfillment of orders, the distraction of
management and other key personnel and the expenditure of significant financial
and other resources. Any such disruption, distraction or expenditure could
seriously harm our business, results of operations and financial condition.

        Sales And Other Tax Collection. We do not currently collect sales or
other similar taxes in respect of shipments of goods into states other than
California and Virginia. However, one or more states or foreign countries may
seek to impose sales tax collection obligations on out-of-state or foreign
companies, such as the Company, which engage in electronic commerce. In
addition, any new operations established by the Company in states outside
California and Virginia could subject shipments into such states to state sales
taxes. A successful assertion by one or



                                       13
<PAGE>   16

more states or any foreign country that we should collect sales or other similar
taxes on the sale of merchandise could seriously harm our business, financial
condition, results of operations and cash flows.

        Risk Of System Failure; Single Site And Order Interface. Our success, in
particular our ability to successfully receive and fulfill online orders and
provide high-quality customer service, largely depends on the efficient and
uninterrupted operation of its computer and communications hardware systems.
Substantially all of our computer and communications hardware is located at a
single leased facility in Sunnyvale, California. Our systems and operations are
vulnerable to damage or interruption from a number of sources, including:

        -      Fire;

        -      Flood;

        -      Power loss;

        -      Telecommunications failure;

        -      Break-ins; and

        -      Earthquake and similar events.

        We have experienced minor and infrequent system interruptions in the
past. We do not presently have a formal disaster recovery plan and do not carry
sufficient business interruption insurance to compensate us for losses that may
occur. Despite the implementation of network security measures by the Company,
our servers are vulnerable to computer viruses, physical or electronic break-ins
and similar disruptions. Such disruptions could lead to interruptions, delays,
loss of data or the inability to accept and fulfill customer orders. The
occurrence of any of the foregoing risks could seriously harm our business,
financial condition and results of operations.

        Reliance On Certain Suppliers. For fiscal 1999 we purchased
approximately 37% and 22%, of our books from Ingram Book Company ("Ingram") and
Pearson Education Division ("Pearson"). We rely to a large extent on rapid
fulfillment from Ingram, Pearson and other vendors. Barnes and Noble, Inc., one
of our competitors, has agreed to purchase Ingram Book Group, which owns Ingram.
We generally have no commitments to or arrangements with any of our vendors that
guarantee the availability of merchandise, the continuation of particular
payment terms or the extension of credit limits. Our current vendors may not
continue to sell merchandise to us on current terms. In addition, we may be
unable to establish new or extend current vendor relationships to ensure
acquisition of merchandise in a timely and efficient manner and on acceptable
commercial terms. If we were unable to develop and maintain relationships with
vendors that would allow us to obtain sufficient quantities of merchandise on
acceptable commercial terms, our business, financial condition, results of
operations and cash flows would be seriously harmed.

        Dependence On Key Personnel. Our performance is substantially dependent
on the continued services and on the performance of our senior management and
other key personnel. Our performance also depends on our ability to retain and
motivate our senior management and other key employees. The loss of the services
of any of our executive officers or other key employees could seriously harm our
business, financial condition, results of operations and cash flows.

        The Company has entered into employment agreements with several members
of its senior management, including:

        -      Mr. MacAskill, its President and Chief Executive Officer;

        -      Mr. Orumchian, its Vice President of Engineering;

        -      Mr. Alvarez, its Vice President of Finance and Chief Financial
               Officer; and

        -      Mr. Cudd, its Vice President of Marketing.

        Each employment agreement sets forth the officer's base salary and
general employee benefits, including acceleration of a portion of such
employee's Common Stock option vesting. We maintain $2.0 million of key person
life insurance on Chris MacAskill, our President and Chief Executive Officer.

        Dependence On Continued Growth Of Electronic Commerce Our future
revenues and profits, if any, substantially depend upon the acceptance and use
of the Internet and other online services as an effective medium of commerce by
our target customers. Rapid growth in the use of and interest in the Internet,
the Web and online services is a recent phenomenon. As a result, acceptance and
use may not continue to develop at historical rates and



                                       14
<PAGE>   17

a sufficiently broad base of consumers may not adopt, and continue to use, the
Internet and other online services as a medium of commerce. Demand and market
acceptance for recently introduced services and products over the Internet are
subject to a high level of uncertainty and there exist few proven services and
products. Our target customer has historically used traditional means of
commerce to purchase information resources. For us to be successful, these
customers must accept and utilize our online store to satisfy their information
resource needs.

        In addition, the Internet may not be accepted as a viable long-term
commercial marketplace for a number of reasons, including potentially inadequate
development of the necessary network infrastructure or delayed development of
enabling technologies and performance improvements. To the extent that the
Internet continues to experience significant expansion in the number of users,
frequency of use or bandwidth requirements, the infrastructure for the Internet
may be unable to support the demands placed upon it. In addition, the Internet
could lose its viability due to delays in the development or adoption of new
standards and protocols required to handle increased levels of Internet
activity, or due to increased governmental regulation. Changes in or
insufficient availability of telecommunications services to support the Internet
also could result in slower response times and adversely affect usage of the
Internet generally and the Company in particular. Our business, financial
condition, results of operations and cash flows would be seriously harmed if:

        -      Use of the Internet and other online services does not continue
               to increase or increases more slowly than expected;

        -      The infrastructure for the Internet and other online services
               does not effectively support expansion that may occur; or

        -      The Internet and other online services do not become a viable
               commercial marketplace.

Rapid Technological Change

        To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our online operations. The
Internet and the electronic commerce industry are characterized by:

        -      Rapid technological change;

        -      Changes in user and customer requirements and preferences;

        -      Frequent new product and service introductions embodying new
               technologies; and

        -      The emergence of new industry standards and practices.

        The evolving nature of the Internet could render our existing online
store and proprietary technology and systems obsolete. Our success will depend,
in part, on our ability to:

        -      License leading technologies useful in its business;

        -      Enhance its existing services;

        -      Develop new services and technology that address the increasingly
               sophisticated and varied needs of its current and prospective
               customers; and

        -      Respond to technological advances and emerging industry standards
               and practices on a cost-effective and timely basis.

        The development of our Web site and other proprietary technology entails
significant technical and business risks. We may not successfully use new
technologies effectively or adapt our online store, proprietary technology and
transaction-processing systems to customer requirements or emerging industry
standards. If we are unable, for technical, legal, financial or other reasons,
to adapt in a timely manner, in response to changing market conditions or
customer requirements, our business, financial condition and results of
operations could be seriously harmed.

        Electronic Commerce Security Risks. A significant barrier to electronic
commerce and communications is the secure transmission of confidential
information over public networks. We rely on encryption and authentication
technology licensed from third parties to provide the security and
authentication necessary for secure transmission of confidential information,
such as customer credit card numbers. Advances in computer capabilities, new
discoveries in the field of cryptography, or other events or developments may
result in a compromise or breach of the algorithms used by us to protect
customer transaction data. If any such compromise of our security were to occur,
it could seriously harm our reputation, business, financial condition and
results of operations. A party who is able to



                                       15
<PAGE>   18

circumvent our security measures could misappropriate proprietary information or
cause interruptions in our operations.

        We may be required to expend significant capital and other resources to
protect against such security breaches or to alleviate problems caused by such
breaches. Concerns over the security of the Internet and other online
transactions and the privacy of users may also inhibit the growth of the
Internet and other online services generally, and the Web in particular,
especially as a means of conducting commercial transactions. To the extent that
activities of the Company or third-party contractors involve the storage and
transmission of proprietary information, such as credit card numbers, security
breaches could damage our reputation and expose us to a risk of loss or
litigation and possible liability. Our security measures may not prevent
security breaches and failure to prevent such security breaches may seriously
harm our business, financial condition and results of operations.

        Risks Associated With International Sales For fiscal 1999 international
sales accounted for approximately 20.8% of our online revenue. We expect that
our percentage of online revenue from international markets will continue to
represent a significant portion of our total revenue. Our international business
activities are subject to a variety of potential risks, including the adoption
of laws, political and economic conditions and actions by third parties that
would restrict or eliminate our ability to do business in certain jurisdictions.
Although we currently transact business in U.S. dollars, to the extent that we
determine to transact business in foreign currencies, we will become subject to
the risks attendant to transacting in foreign currencies, including potential
adverse effects of exchange rate fluctuations.

        Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field and cannot distinguish dates in the 1900's from dates in the 2000's. These
date code fields will need to distinguish the 1900's from the 2000's. This could
result in system failures or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. Although we believe that our
products and internal systems are Year 2000 compliant, we utilize third-party
equipment and software that may not be Year 2000 compliant. Failure of such
third-party equipment or software to operate properly with regard to the Year
2000 and thereafter could require us to incur unanticipated expenses to remedy
any problems, which could seriously harm our business, operating results,
financial condition and cash flows.

        Any failure by the Company to make its products Year 2000 compliant
could result in:

        -      A decrease in sales of our products;

        -      An increase in the allocation of resources to address Year 2000
               problems of our customers without additional revenue commensurate
               with such dedication of resources; and

        -      An increase in litigation costs relating to losses suffered by
               our customers due to such Year 2000 problems.

        Furthermore, the purchasing patterns of customers or potential customers
may be affected by Year 2000 issues as companies expend significant resources to
correct their current systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase products and services such as
those offered by us, which could seriously harm our business, operating results
and financial condition. We have conducted a preliminary review of our internal
computer systems to identify the systems that could be affected by the Year 2000
issue and to develop a plan to resolve the issue. Based on this preliminary
review, we currently have no reason to believe that our internal software
systems are not Year 2000 compliant. However, we will continue to evaluate our
systems and in the event we conclude that our systems are not Year 2000
compliant, we will develop a contingency plan to address these issues. There can
be no assurance that Year 2000 compliance issues will not have a material
adverse effect on the Company.

        Trademarks And Proprietary Rights; Unlicensed Arrangements And
Materials. We regard our copyrights, service marks, trademarks, trade dress,
trade secrets and similar intellectual property as critical to our success.
Further, we rely on trademark and copyright law, trade secret protection and
confidentiality and license agreements with our employees, customers, partners
and others to protect our proprietary rights. We pursue the registration of our
trademarks and service marks in the U.S. and internationally, and have applied
for the registration of certain of our trademarks and service marks. Effective
trademark, service mark, copyright and trade secret protection may not



                                       16
<PAGE>   19

be available in every country in which our products and services are made
available online. While we attempt to ensure that the quality of our brand is
maintained by such licensees, such licensees may take actions that could
seriously harm the value of our proprietary rights or reputation and in turn our
business, financial condition and results of operations. The steps taken by the
Company to protect our proprietary rights may not be adequate and third parties
may infringe or misappropriate our copyrights, trademarks, trade dress and
similar proprietary rights.

        In addition, other parties may assert infringement claims against us.
Such claims, even if not meritorious, could result in the expenditure of
significant financial and managerial resources. We are not currently aware of
any legal proceedings pending or threatened against it. In addition, we display
reviews and articles on technical subjects in our online store. Some reviews and
articles may be copyrighted and we may not have explicit permission from the
author for use of such intellectual property. The authors may assert
infringement claims against the Company. If a claim is asserted alleging that we
have infringed the proprietary rights of a third party, we may be required to
seek licenses to continue to use such intellectual property. The failure to
obtain the necessary licenses or other rights at a reasonable cost could
seriously harm our business, financial condition, results of operations and cash
flows.

        Governmental Regulation And Legal Uncertainties. We are not currently
subject to direct regulation by any domestic or foreign governmental agency,
other than regulations applicable to businesses generally, and laws or
regulations directly applicable to access to electronic commerce. However, due
to the increasing popularity and use of the Internet, it is possible that a
number of laws and regulations may be adopted with respect to the Internet,
relating to:

        -      User privacy;

        -      Pricing;

        -      Content;

        -      Copyrights;

        -      Distribution; and

        -      Characteristics and quality of products and services.

        Furthermore, the growth and development of the market for electronic
commerce may prompt calls for more stringent consumer protection laws that may
impose additional burdens on those companies conducting business online. The
adoption of any additional laws or regulations may decrease the expansion of the
Internet. A decline in the growth of the Internet could decrease demand for our
products and services and increase our cost of doing business, or otherwise
seriously harm our business, financial condition, results of operations and cash
flows. Moreover, the applicability to the Internet of existing laws in various
jurisdictions governing issues such as property ownership, sales tax, libel and
personal privacy is uncertain and may take years to resolve. Our business,
financial condition and results of operations could be seriously harmed by:

        -      Any such new legislation or regulation;

        -      The application of laws and regulations from jurisdictions whose
               laws do not currently apply to our business; or

        -      The application of existing laws and regulations to the Internet
               and other online services.

        As our service is offered over the Internet in multiple states and
foreign countries, such jurisdictions may claim that we are required to qualify
to do business as a foreign corporation in each such state and foreign country.
The failure by the Company to qualify as a foreign corporation in a jurisdiction
where it is required to do so could subject us to taxes and penalties for the
failure to qualify. It is possible that the governments of other states and
foreign countries also might attempt to regulate the content of our online store
or prosecute us for violations of their laws. Violations of local laws may be
alleged or charged by state or foreign governments. Further, we might
unintentionally violate such laws and such laws may be modified and new laws may
be enacted in the future.

        In addition, several telecommunications carriers are seeking to have
telecommunications over the Internet regulated by the Federal Communications
Commission (the "FCC") in the same manner as other telecommunications services.
The growing popularity and use of the Internet has burdened the existing
telecommunications infrastructure and many areas with high Internet use have
begun to experience interruptions in phone service. As a result, local exchange
carriers have petitioned the FCC to regulate Internet Service Providers ("ISPs")
in a manner similar to long distance telephone carriers and to impose access
fees on the ISPs. If any effort to increase regulation of ISPs is successful,
the expense of communicating on the Internet could increase



                                       17
<PAGE>   20

substantially, potentially slowing the growth in the use of the Internet. Any
such new legislation or regulation or application or interpretation of existing
laws could seriously harm our business, financial condition, results of
operations and cash flows.

    Possible Volatility Of Stock Price. The trading price of the Common Stock is
likely to be highly volatile and could be subject to wide fluctuations in price
in response to such factors as:

        -      Actual or anticipated variations in quarterly operating results;

        -      Announcements of technological innovations;

        -      New sales formats or new products or services by us or our
               competitors;

        -      Changes in financial estimates by securities analysts;

        -      Conditions or trends in the Internet and electronic commerce
               industries;

        -      Changes in the market valuations of other Internet, online
               service or retail companies;

        -      Announcements by us of significant acquisitions, strategic
               partnerships, joint ventures or capital commitments;

        -      Additions or departures of key personnel;

        -      Sales of Common Stock; and

        -      Other events or factors, many of which are beyond the Company's
               control.

        In addition, the stock market in general, and the Nasdaq National Market
and the market for Internet-related and technology companies in particular, has
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of such companies. The trading
prices of many technology companies' stocks are at or near historical highs and
reflect price earnings ratios substantially above historical levels. These
trading prices and price earnings ratios may not be sustained. These broad
market and industry factors may seriously harm the market price of the Common
Stock, regardless of our operating performance. In the past, following periods
of volatility in the market price of a company's securities, securities
class-action litigation has often been instituted against such company. Such
litigation, if instituted, could result in substantial costs and a diversion of
management's attention and resources, which would seriously harm our business,
financial condition, results of operations and cash flows.

        Anti-Takeover Effect Of Certain Charter Provisions And Delaware Law. The
Company's Board of Directors has the authority to issue up to 5,000,000 shares
of Preferred Stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of Common Stock
will be subject to, and may be seriously harmed by, the rights of the holders of
any Preferred Stock that may be issued in the future. The issuance of Preferred
Stock may have the effect of delaying, deferring or preventing a change in
control of the Company without further action by the stockholders and may
seriously harm the voting and other rights of the holders of Common Stock. We
have no present plans to issue shares of Preferred Stock. Further, certain
provisions of our Second Amended and Restated Certificate of Incorporation and
Delaware law could delay or make more difficult a merger, tender offer or proxy
contest involving the Company.

ITEM 2.    PROPERTIES

        The Company's principal administrative, engineering, marketing, customer
service and merchandising facility totals approximately 13,635 square feet and
is located in Sunnyvale, California under a master lease that expires on July
31, 1999. In addition, the Company leases a temporary warehousing facility in
Fremont, California. The Company also leases two physical stores located in San
Jose and Sunnyvale, California. In February 1999 the Company entered into a
seven (7) year lease agreement for its new Company headquarters. The new
building is 64,750 square feet, and is located in Santa Clara, California. The
Company expects to initially occupy approximately 50,000 square feet, with the
remainder under sublease for one to three years. The lease term will commence on
May 1st, 1999, or upon substantial completion of the building. In April 1999 the
Company entered into a three (3) year sub-lease for a 40,000 square foot
distribution facility in Erlanger, Kentucky. The Company will occupy
approximately 20,000 square feet of the facility and plans to sub-lease the
remaining 20,000 square feet for one to two years. The Company does not own any
real property. The Company expects that its current facilities, in addition to
the new headquarters and distribution center leases, will be sufficient for the
foreseeable future. The Company periodically evaluates the location and
productivity of its stores, and may close, consolidate or relocate stores as
conditions warrant.



                                       18
<PAGE>   21

ITEM 3.    LEGAL PROCEEDINGS

        We are not currently aware of any legal proceedings pending or
threatened against us.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY

        No matters were submitted to a vote of the stockholders during the
fourth quarter of fiscal 1999.



                                       19
<PAGE>   22

                                     PART II

ITEM 5.    MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

        The Company's Common Stock is listed on the Nasdaq National Market
("Nasdaq") under the symbol "FATB." The Company's stock has been traded on that
market since November 20, 1998. Prior to that date, when the Company completed
its initial public offering, there was no public market for the Company's Common
Stock. As of January 31, 1999, there were approximately 86 holders of record of
the Company's Common Stock. The following table sets forth, for the periods
indicated, the high and low closing sales prices, as to Nasdaq prices of shares
of the Company's Common Stock:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED JANUARY 31, 1999                  HIGH              LOW
                                               ---------------   --------------
<S>                                            <C>               <C>
Fourth Quarter                                    $20 1/16          $11 1/2
Third Quarter                                       N/A               N/A
Second Quarter                                      N/A               N/A
First Quarter                                       N/A               N/A
</TABLE>

DIVIDEND POLICY

        The Company has not paid any cash dividends on its Common Stock since
inception and does not anticipate paying cash dividends in the foreseeable
future. The Company's line of credit arrangement prohibits the payment of
dividends by the Company without the lender's prior consent. The Company
currently anticipates that it will retain its earnings, if any, for use in the
operation of its business and does not expect to pay cash dividends on its
capital stock in the foreseeable future.

CHANGES IN SECURITIES AND USE OF PROCEEDS

        The effective date of the registration statement for the Company's
initial public offering, filed on Form SB-2 under the Securities Act of 1933
(File No. 333-67397), was November 19, 1998 (the "IPO Registration Statement").
The class of securities registered was Common Stock. The managing underwriters
for the offering were NationsBanc Montgomery Securities LLC, Piper Jaffray Inc,
and Needham & Company, Inc.

        Pursuant to the IPO Registration Statement, the Company sold 3,450,000
shares of its Common Stock, including 450,000 shares pursuant to the
Underwriters' over-allotment, for an aggregate offering price of $34,500,000.

        The Company incurred expenses of approximately $3.7 million of which
approximately $2.4 million represented underwriting discounts and commissions
and approximately $1.3 million represented other expenses related to the
offering. The net offering proceeds to the Company after total expenses was
$30.8 million. The Company expects to use approximately $6.1 million of the net
proceeds for capital expenditures, with the remaining approximately $24.7
million to be used for working capital and general corporate purposes, including
expanding its direct sales, telesales and marketing operations and systems and
infrastructure development activities.

        The foregoing amounts represent estimates and the amounts actually
expended by the Company for such purposes may vary significantly and will depend
on a number of factors, including the amount of the Company's future revenues
and cash generated by operations and the other factors described under "Risk
Factors." Accordingly, the Company's management will retain broad discretion in
the allocation of the net businesses. The Company has no current agreements or
commitments with respect to any such acquisition or investment, and the Company
is not currently engaged in any negotiations with respect to any such
transaction. Pending such uses, the net proceeds of this offering will be
invested in short-term, interest bearing, investment grade securities.



                                       20
<PAGE>   23

ITEM 6A.   SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)

        The following selected financial data should be read in conjunction with
the Financial Statements and related Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included herein..

<TABLE>
<CAPTION>
                                                               Year ended January 31,
                                                   -----------------------------------------------
                                                     1996         1997         1998         1999
                                                   --------     --------     --------     --------
<S>                                                <C>          <C>          <C>          <C>     
STATEMENT OF OPERATIONS DATA:
Revenues:
     Online                                        $     --     $    180     $  3,021     $ 10,662
     Retail and other                                    --           --        7,927        9,118
                                                   --------     --------     --------     --------
            Total revenues                               --          180       10,948       19,780

Cost of revenues:
     Online                                              --          150        2,189        8,433
     Retail and other                                    --           --        5,216        5,967
                                                   --------     --------     --------     --------
            Total cost of revenues                       --          150        7,405       14,400
                                                   --------     --------     --------     --------
Gross profit                                             --           30        3,543        5,380
Operating expenses:
     Sales and marketing                                  3          130        4,192        9,918
     Development and engineering                         65          110          860        2,858
     General and administrative                          26          412        1,674        2,909
                                                   --------     --------     --------     --------
            Total operating expenses                     94          652        6,726       15,685
                                                   --------     --------     --------     --------
Loss from operations                                    (94)        (622)      (3,183)     (10,305)
Interest, net                                            --           55           (7)         413
                                                   --------     --------     --------     --------
Net loss                                           $    (94)    $   (567)    $ (3,190)    $ (9,892)
                                                   ========     ========     ========     ========
Basic and diluted net loss per share (1)           $  (0.10)    $  (0.38)    $  (2.11)    $  (2.87)
                                                   ========     ========     ========     ========
Shares used in computing net loss per share (1)         960        1,504        1,509        3,441
</TABLE>


<TABLE>
<CAPTION>
                                                                 As of January 31,
                                                   -----------------------------------------------
                                                     1996         1997         1998         1999
                                                   --------     --------     --------     --------
<S>                                                <C>          <C>          <C>          <C>     
BALANCE SHEET DATA:
Cash and equivalents                               $     29     $  3,228     $  4,974     $  9,341
Working capital                                          29        3,242        5,630       17,142
Total assets                                            101        3,583       13,598       39,614
Total liabilities                                        49          182        3,673        3,118
Total stockholders' equity                               52        3,401        9,925       36,496
</TABLE>


(1)  See Note 1 of Notes to Financial Statements for an explanation of shares
     used in computing basic and diluted net loss per share.



                                       21
<PAGE>   24

ITEM 6.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
           RESULTS OF OPERATIONS

        The discussion in this Report contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in "Risk
Factors That May Affect Future Results" as well as those discussed in this
section and elsewhere in this Report, and the risks discussed in the "Risk
Factors" section included in the Company's Registration Statement on Form SB-2
as declared effective by the Securities and Exchange Commission on November 19,
1998 (Reg. No. 333-67397).

Overview

        Fatbrain.com is the leading online retailer of information resources
singularly focused on professionals. With over 300,000 information resource
titles from more than 8,000 publishers, Fatbrain.com offers its customers online
access to a broad and comprehensive selection of technical books, technology
based training solutions, product manuals, research reports and other
information resources. In addition to the Company's extensive product offering,
Fatbrain.com's online store features authoritative and compelling content,
competitive pricing, an easy-to-use navigational interface and a variety of
value-added services. The Company also operates two physical retail stores that
complement its online business by generating increased online traffic, building
the Company's brand and creating cross-promotional opportunities, thereby
providing a profitable means of customer acquisition.

        Incorporated in November 1994, the Company (formerly CBooks Express,
Inc. and Computer Literacy, Inc.) began selling technical books through its
online store in February 1996, technology based training solutions in January
1998, product manuals in May 1998 and research reports in June 1998. In March
1999, the Company announced that it would be expanding its focus to include
resource materials for professionals in the engineering, science, mathematics
and financial services industries. From inception through January 1996, the
Company's operating activities consisted primarily of developing the
infrastructure necessary to conduct online sales of information resources,
establishing vendor relationships, recruiting personnel, and purchasing and
leasing operating assets, including warehousing, fulfillment and customer
service capabilities. The Company acquired four physical retail stores in May
1997 in connection with its $5.1 million acquisition of Computer Literacy
Bookshops, Inc. ("CLBI"), which was accounted for as a purchase. Accordingly,
the Company's results of operations include those of CLBI for all periods
subsequent to the acquisition date.

        Fatbrain.com generates revenues from sales of books, technology based
training materials, product manuals and research reports through its online
store, certain co-branded corporate online stores and in its two remaining
retail locations (see Note 11 to the Financial Statements). The Company
recognizes revenue from its online store upon shipment and, from its physical
retail stores, at the time of sale.

        Cost of revenues includes costs of products and inbound and outbound
freight. These costs may vary as a percentage of total revenues in any given
period due to a number of factors, including increased price competition, varied
levels of cooperative advertising dollars received from certain publishers of
books and changes in the size and timing of discounts and other promotional
activities. In addition, as sales of higher gross margin products, such as
technology based training materials, manuals and research reports increase as a
percentage of total revenues, gross margins may increase accordingly. For fiscal
1998 and 1999, the Company purchased approximately 30% and 37%, respectively, of
its books from Ingram, an indirect reseller. Although the primary advantage
associated with purchasing from Ingram is just in time inventory management, the
Company believes it will make a larger number of its purchases directly from
publishers as its sales volume increases, thereby enabling the Company to take
advantage of favorable volume discounts. For fiscal 1999, the Company purchased
approximately 22% of its books from Pearson Education Division.

        Since inception, the Company has incurred significant net operating
losses and expects to incur additional net operating losses for the foreseeable
future. There can be no assurance that the Company will achieve profitability or
that, if profitability is achieved, it will be sustained. As of January 31,
1999, the Company had an accumulated deficit of $13.8 million. The Company
believes that its success will depend in large part on its ability to enhance
its customers' online shopping experience, expand corporate relationships, build
brand awareness, encourage customer loyalty, capitalize on the market for
information resources, establish and leverage supplier relationships and
maintain its technology focus and expertise. Accordingly, the Company intends to
invest heavily in marketing and promotion, its direct sales and telesales
organizations, and infrastructure development. There can be no assurance



                                       22
<PAGE>   25

that such expenditures will result in increased revenues or customer growth.
Additionally, while in recent periods the Company has experienced significant
growth in revenues, its customer base and repeat customer revenue, such growth
rates are not sustainable, will decrease in the future and are not indicative of
actual growth rates that the Company may experience. In view of the rapidly
evolving nature of the Company's business and its limited operating history, the
Company believes that period-to-period comparisons of its operating results,
including the Company's operating expenses as a percentage of total revenues,
are not necessarily meaningful and should not be relied upon as an indication of
future performance. See "Risk Factors -- Limited Operating History; Accumulated
Deficit; Anticipated Losses."

Results Of Operations

        The following table presents the Company's results of operations as a
percentage of total revenues for the periods indicated.

<TABLE>
<CAPTION>
                                            Year ended January 31,
                                       ----------------------------------
                                        1997          1998          1999
                                       ------        ------        ------
<S>                                    <C>           <C>           <C>  
Revenues:
      Online                            100.0%         27.6%         53.9%
      Retail and other                     --          72.4          46.1
                                       ------        ------        ------
         Total revenues                 100.0         100.0         100.0
Cost of revenues (1):
      Online                             83.3          72.5          79.1
      Retail and other                     --          65.8          65.4
                                       ------        ------        ------
         Total cost of revenues          83.3          67.6          72.8
                                       ------        ------        ------
Gross profit                             16.7          32.4          27.2
Operating expenses:
      Sales and marketing                72.2          38.3          50.1
      Development and engineering        61.1           7.8          14.5
      General and administrative        228.9          15.3          14.7
                                       ------        ------        ------
         Total operating expenses       362.2          61.4          79.3
                                       ------        ------        ------
    Loss from operations               (345.6)        (29.1)        (52.1)
    Interest, net                        30.6          (0.1)          2.1
                                       ------        ------        ------
    Net loss                           (315.0%)       (29.1%)       (50.0%)
                                       ======        ======        ======
</TABLE>


(1)     Cost of online revenue and cost of retail and other revenue are shown as
        a percentage of related online revenue and retail and other revenue,
        respectively.

Fiscal 1998 Compared To Fiscal 1999.

        Online Revenue. Online revenue is comprised of revenue from online sales
of information resources and associated outbound shipping charges, net of
returns. Online revenue increased from $3.0 million, or 27.6% of total revenues,
to $10.7 million, or 53.9% of total revenues, respectively, as a result of
significant increases in the customer base (from 19,979 to 77,956) and repeat
purchases from the Company's existing customers.

        International sales represented approximately 21.4% and 20.8% of online
revenue for fiscal 1998 and fiscal 1999, respectively. The Company believes that
the international market for its products is large and expanding, and that the
Internet offers a unique opportunity for it to expand its international presence
quickly and cost-effectively. The Company expects international sales to
increase as the Company begins to direct corporate sales, telesales and
marketing resources towards international markets.

        Retail and Other Revenue. Retail and other revenue is comprised
primarily of revenue generated by the Company's physical retail stores and, to a
lesser extent, by trade shows and book fairs. Retail and other revenue increased
from $7.9 million, or 72.4% of total revenues, to $9.1 million, or 46.1% of
total revenues, for fiscal 1998 and fiscal 1999, respectively, primarily due to
only nine months of retail revenues being recorded in fiscal 1998, and



                                       23
<PAGE>   26

a full year in fiscal 1999. The Company closed its retail stores in Cupertino,
California and Vienna, Virginia in September and December, 1998, respectively.
The Company does not expect that the closing of these stores will have a
material impact on future operations. The Company periodically evaluates the
location and productivity of its retail stores and may close, consolidate or
relocate stores as conditions warrant. Any closure, consolidation or relocation
of a retail store is likely to decrease retail and other revenue.

        Cost of Online Revenue. Cost of online revenue is comprised primarily of
the cost of merchandise sold through the Company's online store and associated
inbound and outbound shipping costs. Cost of online revenue increased from $2.2
million, or 72.5% of online revenue, to $8.4 million, or 79.1% of online
revenue, for fiscal 1998 and fiscal 1999, respectively. The increase in absolute
dollars was attributable to increased online sales volume.

        Cost of Retail and Other Revenue. Cost of retail and other revenue is
comprised of the cost of merchandise sold through the Company's retail stores
and at trade shows and book fairs and includes associated inbound and outbound
shipping costs. Cost of retail and other revenue increased from $5.2 million, or
65.8% of retail and other revenue, to $6.0 million, or 65.4% of retail and other
revenue, in fiscal 1998 and fiscal 1999, respectively, primarily as a result of
the increase in retail and other revenue.

        Gross Profit. Gross profit as a percentage of total revenues decreased
from 32.4% to 27.2% for fiscal 1998 and fiscal 1999, respectively. The
percentage decrease was primarily a result of the increase in online sales as a
percent of total revenues, as well as the implementation by the Company of an
online competitive pricing policy. The Company has offered, and expects to
continue to offer in the foreseeable future, discounts on various product
offerings to encourage new customers and online traffic. The expense associated
with certain marketing programs, such as discounted international shipping
promotions, decrease revenues, and thus decrease gross profit, instead of
increasing marketing programs expense. Such pricing pressure is likely to reduce
gross profit in the future but may be partially offset by the change in mix of
products sold towards higher margin technology based training materials, product
manuals and research reports.

        Sales and Marketing Expenses. Sales and marketing expenses consist of
direct expenses associated with the Company's retail stores, as well as
advertising, promotional and public relations expenditures, payroll and related
expenses for personnel engaged in corporate sales, marketing and fulfillment.
Sales and marketing expenses increased from $4.2 million, or 38.3% of total
revenues, to $9.9 million, or 50.1% of total revenues, for fiscal 1998 and
fiscal 1999, respectively. The increase in absolute dollars was primarily
attributable to the expansion of the Company's online store and its direct sales
force, the increase in advertising, public relations and other promotional
expenditures, and the increased personnel and related expenses required to
implement the Company's marketing strategy and fulfill customer demand. The
Company intends to pursue aggressive branding, marketing and telesales campaigns
to generate increased online traffic and acquire customers. Accordingly, the
Company expects sales and marketing expenses to increase in absolute dollars for
the foreseeable future, but decrease as a percentage of total revenues as total
revenues increase.

        Development and Engineering Expenses. Development and engineering
expenses primarily consist of costs associated with systems and
telecommunications infrastructure, editorial operations and content acquisition.
Development and engineering expenses increased from $860,000 or 7.8% of total
revenues, to $2.9 million, or 14.5% of total revenues, for fiscal 1998 and
fiscal 1999, respectively. The increase in absolute dollars was primarily
attributable to increased staffing and associated costs related to enhancing the
features, content and functionality of the Company's online store and
transaction-processing systems, as well as increased investments in systems and
telecommunications infrastructure. To date, all development and engineering
costs have been expensed as incurred. The Company believes that continued
investment in systems and infrastructure development is critical to attaining
its strategic objectives and, as a result, expects development and engineering
expenses to increase significantly in absolute dollars for the foreseeable
future, but decrease as a percentage of total revenues as total revenues
increase.

        General and Administrative Expenses. General and administrative expenses
consist of payroll and related costs associated with executive, accounting and
administrative personnel, recruiting, professional service fees and other
general corporate expenses. General and administrative expenses increased from
$1.7 million, or 15.3% of total revenues, to $2.9 million or 14.7% of total
revenues, for fiscal 1998 and fiscal 1999, respectively. This increase in
absolute dollars was primarily due to increased salaries and related expenses
associated with the hiring of additional personnel and increases in professional
fees. The Company expects general and administrative expenses to increase in
absolute dollars as the Company expands its staff and incurs additional costs
related to the expansion



                                       24
<PAGE>   27

of its business and the costs resulting from being a public company, but
decrease as a percentage of total revenues as total revenues increase.

        Interest, Net. Net interest expense was $7,000 for fiscal 1998, as
compared with net interest income of $413,000 for fiscal 1999. Net interest
expense during fiscal 1998 was primarily attributable to borrowings on the
Company's bank line of credit. Net interest income in fiscal 1999 resulted from
the investment of cash proceeds from private and public financing.

        Recent Developments. In September 1998, the Company closed its retail
store in Cupertino, California. Total revenues for the Cupertino store for each
of the fiscal years ended January 31, 1998 and 1999 were $947,000 and $849,000,
respectively. In December 1998, the Company closed its retail store in Vienna,
Virginia. Total revenues for the Vienna store for each of the fiscal years ended
January 31, 1998 and 1999 were $1.2 million and $1.5 million, respectively. The
Company does not expect that the closing of these stores will have a material
impact on future operations. The Company incurred less than $10,000 in costs
associated with the closing of these stores and does not expect to experience
any further significant gain or loss.

        In February 1999 the Company entered into a seven (7) year lease
agreement for its Company headquarters. The new building is 64,750 square feet,
and is located in Santa Clara, California. The Company expects to occupy
approximately 50,000 square feet, with the remainder under sublease. The lease
term will commence on May 1st, 1999, or upon substantial completion of the
building. Future minimum lease commitments under the new lease are as follows:
fiscal 2000: $816,000; fiscal 2001: $1.1 million; fiscal 2002: $1.1 million;
fiscal 2003: $1.2 million; fiscal 2004: $1.2 million; and thereafter: $2.9
million

        In March 1999, the Company changed its name to Fatbrain.com, Inc. The
Company changed its name to reflect the Company's expanded scope and to
communicate its role in helping professionals and organizations to locate the
resources that help them address serious information needs and pursue
professional growth.

        In April 1999 the Company entered into a three (3) year sub-lease for a
40,000 square foot distribution facility in Erlanger, Kentucky. The Company will
occupy approximately 20,000 square feet of the facility and plans to sub-lease
the remaining 20,000 square feet for one to two years. Future minimum lease
commitments under the new lease are as follows: fiscal 2000: $142,500; fiscal
2001: $171,000; fiscal 2002: $171,000; and fiscal 2003; $28,500. The Company
will be moving the warehousing and fulfillment of orders to Kentucky in May 1999
in order to be in closer proximity to certain publishers, wholesalers,
distributors and delivery services. At the same time the Company will move from
a manual distribution process to a software supported solution from Manhattan
Associates, PKMS Warehouse Management System.

        Liquidity And Capital Resources. Since inception, the Company has
financed its operations primarily through private sales of Preferred Stock which
totaled approximately $19.3 million (net of issuance costs), and public sale of
Common Stock in November 1998 which totaled approximately $30.8 million net of
issuance costs as of January 31, 1999.

        Net cash used in operating activities was $2.7 million in fiscal 1998
and $11.1 million in fiscal 1999. Cash used in operating activities in fiscal
1998 was primarily attributable to a net loss of $3.2 million and an increase of
$1.1 million in inventories, partially offset by an increase of $1.7 million in
accounts payable, as well as depreciation and amortization of $297,000. For
fiscal 1999, cash used in operating activities primarily resulted from a net
loss of $9.9 million plus increases of $1.1 million in accounts receivable and
$826,000 in prepaid expenses and other assets, as well as a decrease in accounts
payable of $622,000 offset by a reduction in inventory of $479,000 as well as
depreciation and amortization of $648,000.

        Net cash used in investing activities was $5.3 million and $21.0 million
in fiscal 1998 and fiscal 1999, respectively. Investing activities in fiscal
1998 are related to the acquisition of CLBI in May 1997 for $4.3 million (net of
cash acquired) and purchases of property and equipment of $941,000. Investing
activities in fiscal 1999 are primarily attributable to $19.6 million in
purchases of investment securities, as well as purchases of property and
equipment of $1.4 million.

        Cash provided by financing activities was $9.7 million and $36.5 million
in fiscal 1998 and fiscal 1999, respectively. Cash provided by financing
activities in fiscal 1998 consisted primarily of $9.7 million in proceeds from
the issuance of preferred stock. Cash provided by financing activities in fiscal
1999 consisted primarily of



                                       25
<PAGE>   28

proceeds from the issuance of common stock in an initial public offering of
$30.8 million (net of issuance costs), as well as proceeds from the issuance of
preferred stock of $5.5 million. The Company has a $4 million line of credit
which expires on December 31, 1999. As of January 31, 1999, the Company has no
borrowings outstanding under its line of credit.

        As of January 31, 1999, the Company had $9.3 million of cash and
equivalents. As of that date, the Company's principal commitments consisted of
obligations outstanding under an agreement with CBT Systems, Ltd. and operating
and capital leases. Although the Company has no material long-term commitments
for capital expenditures, it anticipates a substantial increase in its capital
expenditures and lease commitments consistent with anticipated growth in
operations, infrastructure and personnel.

Year 2000 Compliance.

        Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field and cannot
distinguish dates in the 1900's from dates in the 2000's. These date code fields
will need to distinguish the 1900's from the 2000's. This could result in system
failures or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices or
engage in similar normal business activities. As a result, many companies'
software and computer systems may need to be upgraded or replaced in order to
comply with such "Year 2000" requirements. Although the Company believes that
its products and internal systems are Year 2000 compliant, the Company utilizes
third-party equipment and software that may not be Year 2000 compliant. Failure
of such third-party equipment or software to operate properly with regard to the
Year 2000 and thereafter could require the Company to incur unanticipated
expenses to remedy any problems, which could seriously harm its business,
operating results, financial condition and cash flows. Furthermore, the
purchasing patterns of customers or potential customers may be affected by Year
2000 issues as companies expend significant resources to correct their current
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase products and services such as those offered by the
Company, which could seriously harm its business, operating results and
financial condition. The Company has conducted a preliminary review of its
internal computer systems to identify the systems that could be affected by the
Year 2000 issue and to develop a plan to resolve the issue. Based on this
preliminary review, the Company currently has no reason to believe that its
internal software systems are not Year 2000 compliant. However, the Company will
continue to evaluate our systems and in the event it concludes that systems are
not Year 2000 compliant, the Company will develop a contingency plan to address
these issues. There can be no assurance that Year 2000 compliance issues will
not have a material adverse effect on the Company.



                                       26
<PAGE>   29

ITEM 7.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

SELECTED QUARTERLY RESULTS OF OPERATIONS

        The following table sets forth certain unaudited selected quarterly
results of operations data for the eight quarters ended January 31, 1999 as well
as such data expressed as a percentage of total revenue. In the opinion of
management, this information has been prepared substantially on the same basis
as the audited Financial Statements appearing elsewhere in this Form 10-KSB. The
operating results for any quarter are not necessarily indicative of results for
any future period.




<TABLE>
<CAPTION>
                                                                        Three Months Ended
                                   --------------------------------------------------------------------------------------------
                                   April 30,   July 31,    Oct. 31,    Jan. 31,    April 30,   July 31,    Oct. 31,    Jan. 31,
                                     1997        1997        1997        1998        1998        1998        1998        1999
                                   --------    --------    --------    --------    --------    --------    --------    --------
<S>                                <C>         <C>         <C>         <C>         <C>         <C>         <C>         <C>     
Revenues:
    Online                         $    176    $    444    $  1,089    $  1,312    $  1,761    $  2,464    $  2,934    $  3,503
    Retail and other                     71       2,192       3,124       2,540       2,633       2,351       2,296       1,838
                                   --------    --------    --------    --------    --------    --------    --------    --------
        Total revenues                  247       2,636       4,213       3,852       4,394       4,815       5,230       5,341
Cost of revenues:
    Online                              115         303         802         969       1,326       1,965       2,347       2,795
    Retail and other                     53       1,372       2,041       1,750       1,688       1,538       1,501       1,240
                                   --------    --------    --------    --------    --------    --------    --------    --------
        Total cost of revenues          168       1,675       2,843       2,719       3,014       3,503       3,848       4,035
                                   --------    --------    --------    --------    --------    --------    --------    --------
Gross profit                             79         961       1,370       1,133       1,380       1,312       1,382       1,306
Operating expenses:
    Sales and marketing                 272         968       1,126       1,826       1,986       2,070       2,759       3,103
    Development and engineering          76         137         311         336         554         594         763         947
    General and administrative          123         473         552         526         543         681         799         886
                                   --------    --------    --------    --------    --------    --------    --------    --------
        Total operating expenses        471       1,578       1,989       2,688       3,083       3,345       4,321       4,936
                                   --------    --------    --------    --------    --------    --------    --------    --------
Loss from operations                   (392)       (617)       (619)     (1,555)     (1,703)     (2,033)     (2,939)     (3,630)
Interest, net                            31          (8)        (27)         (3)         32          67          45         269
                                   --------    --------    --------    --------    --------    --------    --------    --------
Net loss                           $   (361)   $   (625)   $   (646)   $ (1,558)   $ (1,671)   $ (1,966)   $ (2,894)   $ (3,361)
                                   ========    ========    ========    ========    ========    ========    ========    ========
</TABLE>

<TABLE>
<CAPTION>
                                                                       Three Months Ended
                                   --------------------------------------------------------------------------------------------
                                   April 30,   July 31,    Oct. 31,    Jan. 31,    April 30,   July 31,    Oct. 31,    Jan. 31,
                                     1997        1997        1997        1998        1998        1998        1998        1999
                                   --------    --------    --------    --------    --------    --------    --------    --------
<S>                                <C>         <C>         <C>         <C>         <C>         <C>         <C>         <C>     
As a Percentage of Total Revenues
Revenues:
    Online                             71.3%       16.8%       25.8%       34.1%       40.1%       51.2%       56.1%       65.6%
    Retail and other                   28.7        83.2        74.2        65.9        59.9        48.8        43.9        34.4
                                   --------    --------    --------    --------    --------    --------    --------    --------
        Total revenues                100.0       100.0       100.0       100.0       100.0       100.0       100.0       100.0
Cost of revenues (1):
    Online                             65.3        68.2        73.6        73.9        75.3        79.7        80.0        79.8
    Retail and other                   74.6        62.6        65.3        68.9        64.1        65.4        65.4        67.5
                                   --------    --------    --------    --------    --------    --------    --------    --------
        Total cost of revenues         68.0        63.5        67.5        70.6        68.6        72.8        73.6        75.5
                                   --------    --------    --------    --------    --------    --------    --------    --------
Gross profit                           32.0        36.5        32.5        29.4        31.4        27.2        26.4        24.5
Operating expenses:
    Sales and marketing               110.1        36.7        26.7        47.4        45.2        43.0        52.7        58.1
    Development and engineering        30.8         5.2         7.4         8.7        12.6        12.3        14.6        17.7
    General and administrative         49.8        17.9        13.1        13.7        12.4        14.1        15.3        16.6
                                   --------    --------    --------    --------    --------    --------    --------    --------
        Total operating expenses      190.7        59.9        47.2        69.8        70.2        69.4        82.6        92.4
                                   --------    --------    --------    --------    --------    --------    --------    --------
Loss from operations                 (158.7)      (23.4)      (14.7)      (40.4)      (38.8)      (42.2)      (56.2)      (67.9)
Interest, net                          12.6        (0.3)       (0.6)       (0.1)        0.7         1.4         0.9         5.0
                                   --------    --------    --------    --------    --------    --------    --------    --------
Net loss                             (146.2%)     (23.7%)     (15.3%)     (40.4%)     (38.0%)     (40.8%)     (55.3%)     (62.9%)
                                   ========    ========    ========    ========    ========    ========    ========    ========
</TABLE>


(1) Cost of online revenues and cost of retail and other revenues are shown as a
    percentage of related online revenue and retail and other revenue,
    respectively.



                                       27
<PAGE>   30

                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
Fatbrain.com, Inc.
Sunnyvale, California

     We have audited the accompanying balance sheets of Fatbrain.com (formerly
Computer Literacy, Inc.) (the "Company") as of January 31, 1998 and 1999, and
the related statements of operations and comprehensive loss, stockholders'
equity, and cash flows for each of the three years in the period ended January
31, 1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

     In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at January 31, 1998 and 1999,
and the results of its operations and its cash flows for each of the three years
in the period ended January 31, 1999 in conformity with generally accepted
accounting principles.

                                             DELOITTE & TOUCHE LLP

San Jose, California
March 10, 1999



                                       28
<PAGE>   31
                               FATBRAIN.COM, INC.
                       (FORMERLY COMPUTER LITERACY, INC.)
                                 BALANCE SHEETS
                      (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                   January 31,    January 31,
                                                                      1998           1999
                                                                   -----------    -----------
<S>                                                                <C>            <C>     
ASSETS
Current assets:
    Cash and equivalents                                            $  4,974       $  9,341
    Short-term investments                                                --          5,344
    Accounts receivable, net of allowance of $67 and $161                153          1,268
    Inventories                                                        3,683          3,204
    Prepaid expenses and other current assets                            440          1,068
                                                                    --------       --------
       Total current assets                                            9,250         20,225

Property and equipment, net                                            1,182          2,097
Investments                                                               --         14,181
Goodwill, net                                                          2,962          2,751
Other assets                                                             204            360
                                                                    --------       --------
       Total assets                                                 $ 13,598       $ 39,614
                                                                    ========       ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                                $  2,518       $  1,896
    Accrued expenses                                                   1,084          1,169
    Current portion of capital lease obligations                          18             18
                                                                    --------       --------
       Total current liabilities                                       3,620          3,083
Capital lease obligations                                                 53             35
                                                                    --------       --------
       Total liabilities                                               3,673          3,118
Stockholders' equity:
    Preferred stock, $0.001 par value, 5,500 and 5,000
      authorized, 5,222 and 0 shares issued and outstanding at
      January 31, 1998 and January 31, 1999, respectively;
      (aggregate liquidation preference of $13,843 and $0 at
      January 31, 1998 and January 31, 1999, respectively)                 5             --
    Common stock, $0.001 par value, 8,750 and 50,000
      shares authorized, 1,527 and 11,172 shares issued and
      outstanding at January 31, 1998 and January 31, 1999,
      respectively                                                         2             11
    Additional paid-in capital                                        13,764         50,270
    Warrants                                                              12             12
    Unrealized loss on investments                                        --            (47)
    Accumulated deficit                                               (3,858)       (13,750)
                                                                    --------       --------
       Total stockholders' equity                                      9,925         36,496
                                                                    --------       --------
       Total liabilities and stockholders' equity                   $ 13,598       $ 39,614
                                                                    ========       ========
</TABLE>



                                       29
<PAGE>   32

                               FATBRAIN.COM, INC.
                       (FORMERLY COMPUTER LITERACY, INC.)
                 STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
                      (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                      Years ended January 31,
                                                               --------------------------------------
                                                                 1997           1998           1999
                                                               --------       --------       --------
<S>                                                            <C>            <C>            <C>     
Revenues:
      Online                                                   $    180       $  3,021       $ 10,662
      Retail and other                                               --          7,927          9,118
                                                               --------       --------       --------
         Total revenues                                             180         10,948         19,780
Cost of revenues:
      Online                                                        150          2,189          8,433
      Retail and other                                               --          5,216          5,967
                                                               --------       --------       --------
         Total cost of revenues                                     150          7,405         14,400
                                                               --------       --------       --------
Gross profit                                                         30          3,543          5,380
Operating expenses:
      Sales and marketing                                           130          4,192          9,918
      Development and engineering                                   110            860          2,858
      General and administrative                                    412          1,674          2,909
                                                               --------       --------       --------
         Total operating expenses                                   652          6,726         15,685
                                                               --------       --------       --------
Loss from operations                                               (622)        (3,183)       (10,305)
Interest, net                                                        55             (7)           413
                                                               --------       --------       --------
Net loss                                                           (567)        (3,190)        (9,892)
                                                               --------       --------       --------

Other comprehensive loss - unrealized loss on investments            --             --            (47)
                                                               --------       --------       --------
    Comprehensive loss                                         $   (567)      $ (3,190)      $ (9,939)
                                                               ========       ========       ========

Basic and diluted net loss per share                           $  (0.38)      $  (2.11)      $  (2.87)
                                                               ========       ========       ========
Shares used in calculating basic and diluted
    net loss per share                                            1,504          1,509          3,441
                                                               ========       ========       ========
</TABLE>



                                       30
<PAGE>   33

                               FATBRAIN.COM, INC.
                       (FORMERLY COMPUTER LITERACY, INC.)
                        STATEMENT OF STOCKHOLDERS' EQUITY
                                 (in thousands)

<TABLE>
<CAPTION>
                                   -------------------------------------------------------------------------------------------------

                                          COMMON                PREFERRED                 PREFERRED                  PREFERRED      
                                          STOCK                  SERIES A                  SERIES B                   SERIES C      
                                    SHARES      AMOUNT      SHARES       AMOUNT       SHARES       AMOUNT       SHARES       AMOUNT 
                                   -------------------------------------------------------------------------------------------------
<S>                                <C>         <C>          <C>         <C>           <C>          <C>          <C>         <C>     
Balances, February 1, 1996            1,504    $      2         117     $     --                                                    
Repayment of stockholder note
  receivable                                                                                                                        
Issuance of Preferred Series B
  (net of issuance costs of $9)                                                         2,280     $      2                          
Conversion of Preferred Series
  A into Preferred Series B                                    (117)         (--)         155           --                          
Net loss                                                                                                                            
                                   -------------------------------------------------------------------------------------------------
Balances, January 31, 1997            1,504           2          --           --        2,435            2                          
                                   -------------------------------------------------------------------------------------------------
Issuance of Preferred Series B                                                             19           --                          
Issuance of Preferred Series C
  (net of issuance costs of $5)                                                                                   1,042    $      1 
Issuance of Preferred Series D
  (net of issuance costs of $56)                                                                                                    
Issuance of stockholder note
  receivable                                                                                                                        
Exercise of stock options                23          --                                                                             
Options granted to consultants                       --                                                                             
Warrants granted to creditor                                                                                                        
Net loss                                                                                                                            
                                   -------------------------------------------------------------------------------------------------
Balances, January 31, 1998            1,527           2          --           --        2,454            2        1,042           1 
                                   -------------------------------------------------------------------------------------------------
Repayment of stockholder note
  receivable                                                                                                                        
Options granted to consultants                                                                                                      
Exercise of stock options               116          --                                                                             
Issuance of Preferred Series E
  (net of issuance costs of $24)                                                                                                    
Issuance of common stock in
  Initial Public Offering (net
  of issuance costs of $1,247)        3,450           3                                                                             
Conversion of preferred stock to
  common in connection with
  Initial Public Offering             6,079           6                                (2,454)          (2)      (1,042)         (1)
Unrealized loss on investments                                                                                                      
Net Loss                                                                                                                            
                                   -------------------------------------------------------------------------------------------------
Balance, January 31, 1999            11,172    $     11          --     $     --           --     $     --           --    $     -- 
                                   =================================================================================================
</TABLE>

<TABLE>
<CAPTION>
                                 ---------------------------------------------------------------------------------------------------
                                                                                                                            TOTAL
                                      PREFERRED           PREFERRED        ADDITIONAL             UNREALIZED                STOCK-
                                       SERIES D            SERIES E          PAID-IN               LOSS ON   ACCUMULATED    HOLDERS'
                                 SHARES      AMOUNT    SHARES     AMOUNT     CAPITAL   WARRANTS  INVESTMENTS   DEFICIT      EQUITY
                                 ---------------------------------------------------------------------------------------------------
<S>                              <C>         <C>       <C>        <C>      <C>         <C>       <C>         <C>           <C>
Balances, February 1, 1996                                                   $    151                          $   (101)   $     52
Repayment of stockholder note
  receivable                                                                      125                                           125
Issuance of Preferred Series B
  (net of issuance costs of $9)                                                 3,789                                         3,791
Conversion of Preferred Series
  A into Preferred Series B                                                        --                                            -- 
Net loss                                                                                                           (567)       (567)
                                 --------------------------------------------------------------------------------------------------
Balances, January 31, 1997                                                      4,065                              (668)      3,401
                                 --------------------------------------------------------------------------------------------------
Issuance of Preferred Series B                                                     31                                            31
Issuance of Preferred Series C
  (net of issuance costs of $5)                                                 2,494                                         2,495
Issuance of Preferred Series D
  (net of issuance costs of $56)   1,726    $      2                            7,192                                         7,194
Issuance of stockholder note
  receivable                                                                      (25)                                          (25)
Exercise of stock options                                                           4                                             4
Options granted to consultants                                                      3                                             3
Warrants granted to creditor                                                           $     12                                  12
Net loss                                                                                                         (3,190)     (3,190)
                                 --------------------------------------------------------------------------------------------------
Balances, January 31, 1998         1,726           2                           13,764        12                  (3,858)      9,925
                                 --------------------------------------------------------------------------------------------------
Repayment of stockholder note
  receivable                                                                       25                                            25
Options granted to consultants                                                     19                                            19
Exercise of stock options                                                         129                                           129
Issuance of Preferred Series E
  (net of issuance costs of $24)                           857   $      1       5,498                                         5,499
Issuance of common stock in
  Initial Public Offering (net
  of issuance costs of $1,247)                                                 30,835                                        30,838
Conversion of preferred stock to
  common in connection with
  Initial Public Offering         (1,726)         (2)     (857)        (1)                                                       --
Unrealized loss on investments                                                                    $    (47)                     (47)
Net Loss                                                                                                         (9,892)     (9,892)
                                 --------------------------------------------------------------------------------------------------
Balance, January 31, 1999             --    $     --  $     --   $     --    $ 50,270  $     12   $    (47)    $(13,750)   $ 36,496
                                 ==================================================================================================
</TABLE>



                                       31
<PAGE>   34

                               FATBRAIN.COM, INC.
                       (FORMERLY COMPUTER LITERACY, INC.)
                            STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                                Years ended January 31,
                                                                         ------------------------------------
                                                                           1997          1998          1999
                                                                         --------      --------      --------
<S>                                                                      <C>           <C>           <C>      
Cash from operating activities:
   Net loss                                                              $   (567)     $ (3,190)     $ (9,892)
   Adjustments to reconcile net loss to net cash used in operations:
      Depreciation and amortization                                            13           297           648
      Write-off of fixed assets in connection with closing of stores           --            --            61
      Options and warrants granted to consultants and creditor                 --            15            19
      Amortization of premium on investments                                   --            --            44
   Changes in current assets and liabilities:
      Accounts receivable                                                      --           (35)       (1,115)
      Inventories                                                             (96)       (1,145)          479
      Prepaid expenses and other assets                                       (18)         (173)         (826)
      Accounts payable                                                         89         1,680          (622)
      Accrued expenses                                                          5          (117)           85
                                                                         --------      --------      --------
      Net cash used in operations                                            (574)       (2,668)      (11,119)

Cash from investing activities:
      Purchase of property and equipment                                     (140)         (941)       (1,371)
      Purchase of investment securities                                        --            --       (19,616)
      Acquisition of CLBI, net of cash acquired                                --        (4,334)           --
                                                                         --------      --------      --------
      Net cash used in investing activities                                  (140)       (5,275)      (20,987)

Cash from financing activities:
      Repayment of capital lease obligation                                    (2)          (10)          (18)
      Issuance of preferred stock, net                                      3,916         9,695         5,524
      Exercise of stock options                                                --             4           129
      Net proceeds from initial public offering                                --            --        30,838
                                                                         --------      --------      --------
      Net cash provided by financing activities                             3,914         9,689        36,473
                                                                         --------      --------      --------

Net increase in cash and equivalents:                                       3,200         1,746         4,367
      Cash and equivalents at beginning of period                              28         3,228         4,974
                                                                         --------      --------      --------
      Cash and equivalents at end of period                              $  3,228      $  4,974      $  9,341
                                                                         ========      ========      ========

Non-cash investing and financing activities:
      Conversion of preferred stock into common stock                    $     --      $     --      $ 19,268
      Equipment acquired through capital lease transactions              $     42      $     42      $     --
      Sale of preferred stock for note receivable                        $     --      $     25      $     --
      Unrealized loss on investments                                     $     --      $     --      $    (47)
      Cash paid to acquire CLBI, net of cash acquired:
         Assets acquired                                                               $  2,926              
         Liabilities assumed                                                             (1,897)             
         Excess of purchase price over net assets acquired                                3,095              
         Covenant not to compete                                                            210              
                                                                                       --------
         Cash paid to acquire CLBI, net of cash acquired                               $  4,334              
                                                                                       ========              
Supplemental disclosure of cash flow information
       Cash paid for interest                                            $      1      $     74      $      6
       Cash paid for income taxes                                        $      1      $      1      $      1
</TABLE>



                                       32
<PAGE>   35

                               Fatbrain.com, Inc.
                       (formerly Computer Literacy, Inc.)
                          Notes to Financial Statements


1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Description of Business and Basis of Presentation

     Fatbrain.com, Inc., formerly Computer Literacy, Inc., (the "Company") was
incorporated in California in November 1994 and reincorporated in Delaware in
May 1998. The Company is an online retailer of professional books, technology
based training solutions, product manuals, research reports and other
information resources, all of which are targeted to information technology
professionals. Business is transacted through the Company's online store, or
through one of its two physical retail locations. In March, 1999 the Company
changed its name to Fatbrain.com, Inc.

     On May 31, 1997, the Company acquired Computer Literacy Bookshops, Inc.
("CLBI") (see Note 2). The acquisition was accounted for as a purchase. The
accompanying financial statements include the operations of CLBI from the date
of acquisition.

     In November 1998, the Company sold 3,450,000 common shares in its initial
public offering for $30,838,000, net of issuance costs of $1,247,000.

     The Company's fiscal year ends on January 31st. The accompanying financial
statements include the years ended January 31, 1997 (fiscal 1997), January 31,
1998 (fiscal 1998) and January 31, 1999 (fiscal 1999).

Reverse Stock Split

     In August 1998, the Board of Directors authorized a four-for-one reverse
stock split. All share and per share amounts have been restated to reflect such
split.

Cash equivalents

     Cash equivalents are highly liquid debt instruments acquired with an
original maturity of three months or less. The recorded carrying amounts of the
Company's cash equivalents approximate the fair market value.

Concentration of Credit Risk

     Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash equivalents,
receivables and investments. Risks associated with cash equivalents are
mitigated by banking with credit worthy institutions. Risks associated with
receivables are mitigated as the Company performs on-going credit evaluations of
its customers and requires deposits for sales on credit when deemed necessary.
The Company maintains reserves for estimated credit losses. The carrying value
of accounts receivable approximates fair value due to their short-term maturity.
One customer accounted for 27% of the gross accounts receivable balance at
January 31, 1999. No one customer accounted for more than 10% of accounts
receivable at January 31, 1998.


     The objective of the Company's investment policy is conservation of capital
and maintenance of liquidity until funds are needed for use in business
operations. Funds are diversified to minimize risk and the inappropriate
concentrations of investments. Under policy guidelines, the following are
considered eligible investments: obligations of the U.S. Treasury, U.S.
government agencies, certain financial institutions and corporations, as well as
investment in money market funds. All investments are limited to those highly
rated by outside organizations and derivative instruments are ineligible as
investments.

Inventories

     Inventories are valued at the lower of average cost (first in, first out
method) or market. The Company's two largest vendors accounted for approximately
59% of the Company's book purchases in fiscal 1999. In fiscal 1998, one such
vendor accounted for approximately 30% of the Company's book purchases.



                                       33
<PAGE>   36

Property and Equipment

     Property and equipment is recorded at cost less accumulated depreciation
and amortization. Furniture and equipment are depreciated using the
straight-line method over the estimated useful lives of three to five years.
Leasehold improvements are amortized on a straight-line basis over the lesser of
the lease term or the estimated useful life.

Investments

     Investments represent debt securities which are stated at fair value. All
investments are classified as available-for-sale securities. Any temporary
difference between an investment's amortized cost and its market value is
recorded as a separate component of stockholders' equity until such gains or
losses are realized. Gains or losses on the sales of securities are determined
on a specific identification basis.

Long-lived Assets

     Goodwill arising from the acquisition of Computer Literacy Bookshops, Inc.
is amortized over its estimated life of 15 years. Accumulated amortization was
approximately $133,000 and $344,000 at January 31, 1998 and 1999, respectively.
The Company evaluates the recoverability of its long-lived assets in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." SFAS No. 121 requires recognition of impairment of long-lived assets in the
event the net book value of such assets exceeds the future undiscounted cash
flows attributable to such assets. No such impairments have been identified to
date. The Company assesses the impairment of long-lived assets when events or
changes in circumstances indicate that the carrying value of an asset may not be
recoverable.

Revenue Recognition

     The Company recognizes revenue from product sales, net of any discounts,
when the products are shipped to customers. Outbound shipping charges are
included in net sales.

Fair Value of Financial Instruments

     The recorded carrying amounts of the Company's financial instruments,
namely cash and equivalents and investments, approximate their value and are
based on quoted market prices.

Advertising Costs

     The cost of advertising is expensed as incurred. For the years ended
January 31, 1997, 1998 and 1999, the Company incurred advertising expense of
approximately $45,000, $920,000 and $3.0 million, respectively.

Product Development

     Product development expenses primarily consist of costs associated with the
systems and telecommunications infrastructure, editorial operations and content
acquisition. All product development costs have been expensed as incurred.

Income Taxes

     Income taxes are accounted for in accordance with SFAS No. 109, "Accounting
for Income Taxes," an approach which requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been recognized in the Company's financial and tax reporting. In estimating
future tax consequences, management generally considers all expected future
events other than enactments of changes in the tax laws or rates. Under the
provisions of SFAS No. 109, a valuation allowance is provided when it is more
likely than not that some portion or all of the deferred tax assets recorded
will not be recognized.

Stock-Based Compensation



                                       34
<PAGE>   37

     Stock-based compensation is recognized under Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations, using the intrinsic value method. Therefore, the Company
measures compensation cost for stock options as the difference, if any, between
the quoted market price of the Company's stock, at the date of grant, and the
price the employee must pay to acquire the stock under its stock option plans.
SFAS No. 123 "Accounting for Stock-Based Compensation," establishes financial
accounting and reporting standards for stock-based compensation plans. The
accounting standards prescribed are optional, although certain pro-forma
disclosures are required, and allows for a company to account for stock-based
compensation cost under existing accounting rules. The Company accounts for its
compensation costs under APB No. 25. The Company has adopted the disclosure
requirements of SFAS No. 123.

Net Loss Per Share

      Basic earnings per share ("EPS") for all periods presented is computed by
dividing net loss by the weighted average number of common shares outstanding
(excluding shares subject to repurchase - see Note 7). Diluted EPS for all
periods presented is the same as basic EPS since all potential dilutive
securities are excluded as they are anti-dilutive because of the Company's net
losses.

Comprehensive Loss

     In fiscal 1999, the Company adopted SFAS No. 130 "Reporting Comprehensive
Income," which requires an enterprise to report by major components and as a
single total, the change in its net assets during the period from
non-shareholder sources. Statements of comprehensive loss for the years ended
January 31, 1997, 1998 and 1999 have been included with the Statements of
Operations.

Recently Issued Accounting Standards

     In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
defines derivatives, requires that all derivatives be carried at fair value, and
provides for hedge accounting when certain conditions are met. This statement is
effective for all quarters of fiscal years beginning after June 15, 1999.
Although the Company has not fully assessed the implications of this new
statement, the Company does not believe adoption of this statement will have a
material impact on the Company's financial position or results of operations.

Use of Estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Such estimates include the level of inventory reserves for
excess or slow moving inventory, evaluation of goodwill for impairment, accrued
expenses and a valuation allowance against net deferred tax assets. Actual
results could differ from those estimates.

 2.  ACQUISITION

     On May 31, 1997, the Company completed the acquisition of all of the
outstanding capital stock of Computer Literacy Bookshops, Inc., a retailer of
computer books, with four stores located in California and Virginia. The
purchase price was approximately $5.1 million. The acquisition was accounted for
using the purchase method of accounting and accordingly, the assets acquired and
liabilities assumed were recorded at their estimated fair values as of the date
of acquisition. The principal assets acquired and liabilities assumed were cash
($759,000), inventory ($2.4 million), prepaid expenses and other current assets
($272,000), covenant not to compete ($210,000), property and equipment
($142,000), accounts receivable ($119,000), and accounts payable and accrued
expenses ($1.9 million). The excess of the purchase price over the net
identifiable assets acquired of $3.1 million is being amortized over a 15 year
period on a straight-line basis.



                                       35
<PAGE>   38

 3. PROPERTY AND EQUIPMENT

     Property and equipment, at cost, consists of the following:

<TABLE>
<CAPTION>
                                                 January 31,   January 31,
                                                    1998         1999
                                                 -----------   -----------
                                                       (in thousands)
<S>                                              <C>           <C>    
Computer and office equipment                      $   901      $ 1,595
Software                                               574          952
Leasehold improvements                                 252          232
Furniture and fixtures                                 158          121
                                                   -------      -------
                                                     1,885        2,900
Less accumulated depreciation and amortization        (703)        (803)
                                                   -------      -------
Property and equipment, net                        $ 1,182      $ 2,097
                                                   =======      =======
</TABLE>


4.  INVESTMENTS

     The fair value and the amortized cost of investments at January 31, 1999
are presented below. Fair values are based on quoted market prices obtained from
the Company's broker. All of the Company's investments are classified as
available-for-sale, since the Company intends to sell them as needed for
operations. The following table presents the unrealized holding gains and losses
related to each category of investment security. The Company did not hold any
investments at January 31, 1998.

<TABLE>
<CAPTION>
                                                                  UNREALIZED     UNREALIZED
                                                   AMORTIZED       GAIN ON        LOSS ON           MARKET
                                                      COST       INVESTMENTS     INVESTMENTS        VALUE
                                                  -----------   -------------   -------------      --------
                                                                        (in thousands)
<S>                                               <C>           <C>             <C>                <C>     
Corporate debt securities                           $ 18,049       $      7        $    (46)       $ 18,010
Debt securities of states and of the U.S. and
political subdivisions of the states                   1,523                             (8)          1,515
                                                    --------       --------        --------        --------
                                                    $ 19,572       $      7        $    (54)       $ 19,525
                                                    ========       ========        ========        ========
</TABLE>


     There were no sales or maturities of available for sale investments during
the year ended January 31, 1999.

     The short-term investments mature in less than one year and the long-term
investments have maturities of one to five years. The final maturity periods of
investments at January 31, 1999 are as follows:

<TABLE>
<CAPTION>
                                                               Market value
                                                 --------------------------------------
                                                              Greater than 1
                                                  Within one   year and less
                                                     year       than 5 years     Total
                                                 ------------ ---------------   -------
                                                              (in thousands)
<S>                                              <C>          <C>               <C>    
Corporate debt securities                           $ 3,829       $14,181       $18,010
Debt securities of states and of the U.S. and
political subdivisions of the states                  1,515            --         1,515
                                                    -------       -------       -------
                                                    $ 5,344       $14,181       $19,525
                                                    =======       =======       =======
</TABLE>

5.  ACCRUED LIABILITIES

    Accrued expenses consist of the following:



                                       36
<PAGE>   39

<TABLE>
<CAPTION>
                                              January 31,  January 31,
                                                 1998         1999
                                              -----------  -----------
                                                   (in thousands)
<S>                                           <C>          <C>   
Accrued compensation and related benefits       $  420       $  659
Store and mail order credits                       158          184
Accrued sales tax payable                          306           79
Other accrued expenses                             200          247
                                                ------       ------
                                                $1,084       $1,169
                                                ======       ======
</TABLE>


6.  LINE OF CREDIT

    In December 1998, the Company's line of credit was increased to $4 million.
The line of credit expires in December 1999. Borrowings under the line of credit
bear interest at the bank's prime rate (7.75% at January 31, 1999) and are
collateralized by substantially all of the Company's assets including certain
intellectual property. The line of credit also contains restrictive covenants,
including restriction on payment of dividends, a maximum debt to tangible
effective net worth ratio, minimum liquidity and minimum quick ratio. The
Company was in compliance with these covenants at January 31, 1999. There were
no borrowings under this agreement at January 31, 1998 or 1999.

    During fiscal 1998, in connection with the Company's bank line of credit
agreement, the Company issued warrants to the bank to purchase up to 20,832
shares of the Company's Series C Preferred Stock at a price of $2.40 per share.
These warrants converted to warrants to purchase the Company's common shares at
the time of the Company's initial public offering (15,624 shares were
exercisable at January 31, 1998 and 1999). The Company recorded expense of
approximately $12,000 related to the warrants in fiscal 1998. These warrants
expire in May 2002.

7.  STOCKHOLDERS' EQUITY

Common Stock

     At January 31, 1999, the Company had 50,000,000 shares of common stock
authorized of which 11,172,259 were issued and outstanding. At January 31, 1999,
the Company had reserved shares of common stock for issuance as follows:

<TABLE>
<CAPTION>
                                                          (in thousands)
<S>                                                       <C>  
Issuance under stock option plans                                 3,031
Issuance under employee stock purchase plan                         300
Conversion of warrants                                               21
                                                                  -----
   Total shares reserved                                          3,352
                                                                  =====
</TABLE>


1998 Employee Stock Purchase Plan

     In 1998, the Company adopted an Employee Stock Purchase Plan ("the ESPP").
A total of 300,000 shares of common stock are reserved for issuance under the
ESPP. Under the ESPP, eligible employees may purchase common stock over certain
offering periods through payroll deductions, which may not exceed 15% of the
employee's compensation, nor more than 500 shares on any purchase date. Unless
the Board of Directors shall determine otherwise, each offering period will run
for 24 months commencing on each June 1 and December 1, except that the first
offering period commenced on November 19, 1998 and will end on November 30,
2000. The price at which common stock may be purchased under the ESPP is equal
to 85% of the fair market value of common stock on the first or last day of the
applicable offering period, whichever is lower. No shares have been purchased
under the ESPP as of January 31, 1999.

Stock Option Plan



                                       37
<PAGE>   40

     Under the 1996 Stock Option Plan (the "Plan" or the "1996 Stock Plan"), the
Company may grant options to purchase up to 1,215,686 shares of common stock to
employees, directors and consultants at prices not less than the fair market
value at the date of grant for incentive stock options and not less than 85% of
fair value for nonstatutory stock options. These options generally vest 25% one
year from the vest start date and ratably over the next 36 months and expire 10
years from the date of grant. Shares issued upon exercise of options that are
unvested are subject to repurchase by the Company upon termination of employment
or services. There were 2,188 shares issued under the 1996 Stock Plan and
outstanding at January 31, 1999 that were subject to repurchase. Upon adoption
of the 1998 Omnibus Equity Incentive Plan (the "1998 Plan"), the Company
transferred all shares available for grant under the Plan to the 1998 Plan.

     The 1998 Omnibus Equity Incentive Plan was adopted by the Board of
Directors on July 13, 1998 and became effective on November 19, 1998. The
Company has reserved 3,000,000 shares, plus the aggregate number of shares
remaining available for issuance under the 1996 Stock Plan, for issuance under
the 1998 Plan. As of January 31, 1999, no options had been granted under the
1998 Plan and 3,030,752 shares are available for option grant.

Option activity under the 1996 Stock Option Plan and 1998 Omnibus Equity
Incentive Plan is as follows (shares in thousands):


<TABLE>
<CAPTION>
                                                                                      Number of    Weighted Average
                                                                                    Shares (000's)  Exercise Price
                                                                                    -------------- ----------------
<S>                                                                                 <C>            <C>
Outstanding, February 1, 1996                                                               --              --
  Options granted (weighted average fair value of $0.03 per share)                         277        $   0.18
                                                                                      --------        --------
Outstanding, January 31, 1997 (8 vested at a weighted average price of $0.18)              277            0.18
  Options granted (weighted average fair value of $0.09 per share)                         795            0.57
  Options exercised                                                                        (23)          (0.18)
  Options canceled                                                                        (183)          (0.26)
                                                                                      --------        --------
Outstanding, January 31, 1998 (118 vested at a weighted average price of $0.28)            866            0.52
  Options granted (weighted average fair value of $0.88 per share)                         431            5.24
  Options exercised                                                                       (116)          (1.12)
  Options canceled                                                                        (135)          (1.05)
                                                                                      --------        --------
Outstanding, January 31, 1999 (284 vested at a weighted average price of $0.61)          1,046        $   2.33
                                                                                      ========        ========
</TABLE>

At January 31, 1997 and 1998, approximately 33,000 and 118,000 options were
vested, respectively.

     Additional information regarding options outstanding as of January 31, 1999
is as follows:


<TABLE>
<CAPTION>
                                    Options Outstanding                             Options Vested
                      ----------------------------------------------        ----------------------------
                                         Weighted
                                          Average           Weighted                            Weighted
                                         Remaining          Average                             Average
   Range of             Number of       Contractual         Exercise          Number of         Exercise
Exercise Price        Shares (000's)     Life (Yrs)          Price          Shares (000's)       Price
--------------------------------------------------------------------        ----------------------------
<S>                   <C>               <C>                 <C>             <C>                 <C>
        $0.18                284               8.0          $   0.18               138          $   0.18
        $0.24                245               8.5          $   0.24               100          $   0.24
  $0.72-$3.40                292               9.0          $   2.19                40          $   1.96
  $6.00-$8.00                225               9.5          $   7.47                 6          $   8.00
--------------------------------------------------------------------          --------------------------
  $0.18-$8.00              1,046               8.7          $   2.33               284          $   0.61
====================================================================          ==========================
</TABLE>


Additional Stock Plan Information



                                       38
<PAGE>   41
     As discussed in Note 1, the Company continues to account for its
stock-based awards using the intrinsic value method in accordance with APB
Opinion No. 25, " Accounting for Stock Issued to Employees," and its related
Interpretations. Accordingly, no compensation expense has been recognized in the
financial statements for employee stock arrangements granted at fair value.

     SFAS No. 123, "Accounting for Stock-Based Compensation", requires the
disclosure of pro forma net loss and net loss per share had the Company adopted
the fair value method as of the beginning of fiscal 1997. Under SFAS 123, the
fair value of stock-based awards to employees is calculated through the use of
option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and the expected time to exercise, which greatly affect the
calculated values. The Company's calculations were made using the minimum value
option pricing model (no options were granted subsequent to the Company's
initial public offering) with the following weighted average assumptions:
expected life, 48 months following the grant; risk-free interest rate of 5.5%
for fiscal 1997, 1998 and 1999; and no dividends during the expected term. The
Company's calculations are based on a multiple option valuation approach and
forfeitures are recognized as they occur. If the computed fair values of the
1997, 1998 and 1999 awards had been amortized to expense over the vesting period
of the awards, pro-forma net loss would have been approximately $575,000 ($0.38
per share), $3,300,000 ($2.19 per share) and $9,950,000 ($2.89 per share) in
fiscal 1997, 1998 and 1999, respectively.

     During fiscal 1998 and 1999 the Company granted 29,301 and 16,151 options
to consultants and directors at exercise prices ranging from $0.18 to $8.00 per
share, and recorded expense of approximately $3,000 and $19,000, respectively.

8.  INCOME TAXES

    The Company's deferred tax balances at January 31, 1998 and 1999 consist of
the following:

<TABLE>
<CAPTION>
                                            Year ended January 31,
                                           -------------------------
                                            1998               1999
                                           -------           -------
                                                (in thousands)
<S>                                        <C>               <C>    
Net operating loss carryforwards           $ 1,043           $ 4,873
Expenses not currently deductible              246               537
Other                                          129                26
                                           -------           -------
                                             1,418             5,436
Valuation allowance                         (1,418)           (5,436)
                                           -------           -------
Net deferred tax asset                     $    --           $    --
                                           =======           =======
</TABLE>

     A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax asset will not be realized. The Company has
established a valuation allowance of $1,418,000 and $5,436,000 as of January 31,
1998 and 1999, respectively, due to the uncertainty of realizing future tax
benefits from its net operating loss carryforwards and other deferred tax
assets.

     At January 31, 1999 the Company had federal and state net operating loss
carryforwards of approximately $12,028,000 and $7,495,000 which expire beginning
in 2011 and in 2004, respectively.

     The extent to which the loss carryforwards can be used to offset future
taxable income may be limited depending on the extent of ownership changes
within any three-year period as provided in the Tax Reform Act of 1986 and the
California Conformity Act of 1987.

9.  COMMITMENTS AND CONTINGENCY

  Lease Commitments



                                       39
<PAGE>   42

     At January 31, 1998 and 1999, the Company leased equipment with a cost of
$84,000 under capital leases. Accumulated amortization was approximately $14,000
and $37,000 for the fiscal years 1998 and 1999, respectively.

     The Company currently leases office and warehouse space, retail store space
and equipment under noncancelable operating leases which expire on various dates
through 2003. Rental expense under operating lease agreements, net of sublease
income, for the years ended January 31, 1997, 1998 and 1999 was approximately
$18,000, $390,000, and $612,000, respectively.

     Future minimum lease commitments under noncancelable capital and operating
leases and service agreements as of January 31, 1999 are as follows (in
thousands):

<TABLE>
<CAPTION>
   Years ending                                       Operating         Capital
    January 31,                                         Leases          Leases
------------------                                    ----------       ---------
<S>                                                   <C>              <C>   
2000                                                    $  438          $   25
2001                                                       351              25
2002                                                       272              11
2003                                                        75              --
2004                                                        21              --
                                                        ------          ------
     Total minimum lease payments                       $1,157              61
                                                        ======
Less: amount representing interest                                          (8)
                                                                        ------
Present value of future minimum lease payments                              53
Current portion                                                            (18)
                                                                        ------
Long-term lease obligations                                             $   35
                                                                        ======
</TABLE>

     In February 1999 the Company entered into a seven (7) year lease agreement
for its Company headquarters. The new building is 64,750 square feet, and is
located in Santa Clara, California. The Company expects to occupy approximately
50,000 square feet, with the remainder under sublease. The lease term will
commence on May 1st, 1999, or upon substantial completion of the building.
Assuming the building is completed May 1st, 1999, future minimum lease
commitments under the new lease are as follows: fiscal 2000: $816,000; fiscal
2001: $1.1 million; fiscal 2002: $1.1 million; fiscal 2003: $1.2 million; fiscal
2004: $1.2 million; and thereafter: $2.9 million.

Purchase commitments

     In March 1999, the Company entered into a revised agreement with CBT
Systems, Ltd. ("CBT"). The agreement requires that the Company make a $2,250,000
minimum purchase commitment of CBT training products, as follows: fiscal 2000:
$415,000; fiscal 2001: $430,000; fiscal 2002: $470,000; and fiscal 2003:
$635,000. In fiscal 1999, the Company made payments of $300,000 towards this
commitment.

10. EMPLOYEE BENEFIT PLANS

     As a result of the acquisition of Computer Literacy Bookshops, Inc., the
Company had a money purchase pension plan, under which the Company contributed
to the plan an amount equal to 10% of the employees' annual compensation through
June 30, 1997. The Company terminated the money purchase pension plan effective
June 28, 1998. The effect of the termination did not have a material adverse
effect on the Company's financial position or results of operations.

     Effective November 1997, the Company adopted the Computer Literacy, Inc.
401(k) Plan (the "401(k) Plan") that qualifies as a deferred salary arrangement
under Section 401 of the Internal Revenue Code. All full-time equivalent
employees, over 21 years of age, are eligible and may participate in the 401(k)
Plan one year subsequent to their hire date. Under the 401(k) Plan,
participating employees may defer a portion of their pretax earnings not to
exceed 15% of their total compensation. Effective January 1, 1999, the Company
revised the plan such that all full-time equivalent employees, over 21 years of
age, are eligible and may participate in the 401(k) Plan six months subsequent
to their hire date. The Company matches 50% for the first 4% contributed by the
employee. The total Company contribution was $7,000 for fiscal 1998 and $31,000
fiscal 1999.

11.  CLOSURE OF RETAIL STORES



                                       40
<PAGE>   43

      In September 1998, the Company closed its retail store in Cupertino,
California. Total revenues for the Cupertino store for fiscal years ended
January 31, 1998 and 1999 were $947,000 and $849,000, respectively. In December
1998, the Company closed its retail store in Vienna, Virginia. Total revenues
for the Vienna store for the fiscal years ended January 31, 1998 and 1999 were
$1.2 million and $1.5 million, respectively. The Company does not expect that
the closing of these stores will have a material impact on future operations,
and the Company does not expect to incur any significant loss from the closure
of these stores.

12. SEGMENT INFORMATION

     On January 31, 1999, the Company adopted SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information," which established standards
for reporting information about operating segments in annual financial
statements, along with related disclosures about products and services,
geographic areas, and major customers. The information for fiscal 1997 and 1998
has been reclassified from the prior year's presentation to conform to the
fiscal 1999 presentation.

     Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
Company's chief operating decision maker. By this definition, Fatbrain.com has
two operating segments, internet commerce and retail stores, which are
differentiated based on the methods used to distribute product. For the internet
commerce segment, products are ordered via the Company's web site and mailed
directly to the customer through the Company's distribution system. The retail
stores maintain inventory within the store in a traditional retail environment.
Unallocated revenues are generated primarily from trade shows. Both segments had
similar product offerings in fiscal 1999.

     The Company evaluates segment performance based on gross profit. The
Company does not analyze the segments individually below the gross profit line.
Direct operating expenses are those directly related to the operating segment
(e.g. direct salaries, rent, etc.) and exclude all corporate office expenses.
Segment assets are not presented as all assets of the Company are commingled and
are not available by segment. The accounting policies of the segments are the
same as those described in the summary of significant accounting policies.



                                       41
<PAGE>   44

SEGMENT CONTRIBUTION

<TABLE>
<CAPTION>
                                                          Years ended January 31,
                                                 ----------------------------------------
                                                   1997            1998            1999
                                                 --------        --------        --------
                                                             (in thousands)
<S>                                              <C>             <C>             <C>     
Revenues (1):
  Internet commerce                              $    180        $  3,021        $ 10,662
  Retail stores                                        --           7,143           9,008
  Unallocated                                          --             784             110
                                                 --------        --------        --------
     Consolidated net revenues                        180          10,948          19,780

Gross profit (1):
  Internet commerce                                    30             832           2,229
  Retail stores                                        --           2,464           3,128
  Unallocated                                          --             247              23
                                                 --------        --------        --------
      Consolidated margin                              30           3,543           5,380

Contribution (2):
  Internet commerce                                    25             332            (283)
  Retail stores                                        --           1,078             744
  Unallocated                                          --              38              (4)
                                                 --------        --------        --------
      Consolidated contribution                  $     25        $  1,448        $    457
                                                 ========        ========        ========
</TABLE>

(1)  The presentation of revenues and gross profit is consistent with the
     Company's internal presentation of financial information to management.

(2)  Contribution is defined as gross profit, less direct operating expenses.

RECONCILIATION OF CONTRIBUTION TO NET LOSS

<TABLE>
<S>                                              <C>             <C>             <C>     
Consolidated Contribution                        $     25        $  1,448        $    457

Interest income, net                                   55              (7)            413

Indirect expenses                                    (647)         (4,631)        (10,762)
                                                 --------        --------        --------
Net loss                                         $   (567)       $ (3,190)       $ (9,892)
                                                 ========        ========        ========
</TABLE>


GEOGRAPHIC INFORMATION

     International sales, measured as shipments to addresses outside the United
States were $60,000 for the year ended January 31, 1997, or 33% of total
revenues. For the year ended January 31, 1998, international sales were less
than 10% of total revenues. For the year ended January 31, 1999, international
sales were 11% of total revenue. No foreign country or geographical area
accounted for more than 10% of revenue in any of the periods presented.

MAJOR CUSTOMERS

     No individual customer accounted for 10% or more of the Company's
consolidated revenues for fiscal years 1997, 1998 or 1999.



                                       42
<PAGE>   45

ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
          FINANCIAL DISCLOSURE

          Not applicable.

                                    PART III

Certain information required by Part III is omitted from this Report in that the
registrant will file a definitive proxy statement pursuant to Regulation 14A
(the "Proxy Statement") not later than 120 days after the end of the fiscal year
covered by this Report, and certain information included therein is incorporated
herein by reference.

ITEM 9.   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
          COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

          The information required by this item is incorporated by reference to
          the registrant's Proxy Statement.

ITEM 10.  EXECUTIVE COMPENSATION

          The information required by this item is incorporated by reference to
          the registrant's Proxy Statement.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

          The information required by this item is incorporated by reference to
          the registrant's Proxy Statement.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

          The information required by this item is incorporated by reference to
          the registrant's Proxy Statement.

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

          The information required by this Item is incorporated by reference to
          the registrant's Proxy Statement except that the following exhibits
          are filed as part of this Report:

               23.1 - Independent Auditors' Consent

               27.01 - Financial Data Schedule



                                       43
<PAGE>   46

                                   SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on April 16, 1999.

                                        FATBRAIN.COM, INC.



                                        By /s/ CHRIS MACASKILL
                                           -------------------------------------
                                               Chris MacAskill
                                               Chief Executive Officer



                                POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Chris MacAskill, as his true and lawful
attorneys-in-fact and agent, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities, to sign any
and all amendments (including post-effective amendments) to this Report on Form
10-KSB, and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
SIGNATURE                           TITLE                               DATE
<S>                                 <C>                                 <C> 
/s/ CHRIS MACASKILL                 Chief Executive Officer
------------------------------      Chairman of the Board             4/16/99
Chris MacAskill

/s/ PETER G. BODINE                 Director
------------------------------                                        4/16/99
Peter G. Bodine

/s/ ALAN S. FISHER                  Director
------------------------------                                        4/16/99
Alan S. Fisher

/s/ TOD H. FRANCIS                  Director
------------------------------                                        4/16/99
Tod H. Francis

/s/ DAVID C. SCHWAB                 Director
------------------------------                                        4/16/99
David C. Schwab

/s/ PETER C. WENDELL                Director
------------------------------                                        4/16/99
Peter C. Wendell

/s/ DONALD P. ALVAREZ               Vice President of Finance and
------------------------------      Chief Financial Officer           4/16/99
Donald P. Alvarez                   
</TABLE>



                                       44
<PAGE>   47

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
Exhibit
Number                             Description    
------                             -----------
<S>                 <C>
23.1      -         Independent Auditors' Consent

27.01     -         Financial Data Schedule
</TABLE>