<PAGE>

                                                                      EXHIBIT 13
 
Management's Discussion and Analysis 
  of Financial Condition and Results of Operation
--------------------------------------------------------------------------------

Banyan Systems Incorporated, founded in 1983, is a leading provider of advanced
enterprise solutions that integrate multi-vendor networking environments and
helps people communicate across enterprise networks, intranets and the Internet
by creating highly reliable, easily managed and secure global networks. The
Company's primary software products include StreetTalk for Windows NT,(R)
VINES,(R) Intelligent Messaging,(TM) BeyondMail,(R) Banyan Intranet Connect(R)
and several third-party networking solutions. I addition, the Company provides
co-existence and migration services, secure and remote access for business
applications and tools to deploy and manage intranets, directories and
messaging. The Company's primary service offerings include network consulting,
management and integration services; directory planning, design and integration;
network monitoring and support; and technical support and education. In
addition, the Company's majority-owned subsidiary, Switchboard Incorporated
("Switchboard"), hosts one of the Internet's leading people-to-people and
business directory services aimed at generating advertising revenues from major
domestic corporations and local merchants.

Since 1995, the Company's software revenues have been in a state of decline
primarily due to competitive pressures in the network operating system and
electronic messaging markets. Although the Company made progress in expanding
its network solutions and further establishing its Internet products identity
with the introduction of its intranet suite of products and expansion of its
Switchboard business, the Company's operating results for 1996 and 1997 were
negatively impacted by a number of factors, including the aforementioned
introduction of new competitive product offerings by other vendors, an effort by
the Company to reduce its worldwide channel inventories and delays in delivery
of several products, as well as translated versions of these products. To
address these factors, the Company restructured its operations in the quarter
ended December 31, 1996 and implemented a further reorganization in the quarter
ended June 30, 1997, following the hiring of a new chief executive officer in
February 1997. The 1997 reorganization, which was intended to stabilize and
rejuvenate the business, and ultimately achieve sustainable, long-term
profitable growth, resulted in a 22% reduction of the Company's work force, and
consolidated facilities and product lines in order to balance expenses with
expected revenues. As a result of the reorganization efforts, Banyan finished
1997 by achieving profitability in both the third and fourth quarters, and
continued that trend through 1998. In addition, the Company strengthened its
balance sheet in March 1998 through a $10.0 million equity investment from
HarbourVest Partners to support its efforts to stabilize and rejuvenate its
business.

During 1998, the Company focused its efforts on expanding its network services
business initiatives, ensuring its software product offerings were year 2000-
ready, initiating new vendor relationships to offer new enterprise networking
and intranet solutions, and growing its Switchboard revenues through direct
selling efforts and strategic partnering. As a result of these initiatives, the
Company was able to stabilize its revenue performance in 1998 at $75.2 million
versus revenue of $74.3 million in 1997 by offsetting declines in its
traditional software product revenues with increases in services revenues and
Internet advertising revenues from Switchboard as well as additional software
revenues from its intranet and third-party product offerings. The Company also
reported its first profitable year in 1998 since fiscal 1994. Excluding one-time
charges in 1998 and 1997, net income for the year ended December 31, 1998 was
$2.5 million, or $0.11 per share, as compared to a net loss in 1997 of $8.9
million, or $0.51 per share.



Results of Operations
---------------------
Revenues
--------

Software revenues for 1998 decreased 27% to $43.0 million, compared with $58.5
million in 1997 and $89.0 million in 1996. The decline in software revenues in
1998 was primarily due to lower levels of sales of the Company's VINES and
messaging products, primarily as a result of competitive product offerings,
offset in part by an increase in sales of third-party products. The decline in
software revenues in 1997 was primarily due to lower levels of sales of the
Company's VINES offerings and messaging products as a result of competitive
product offerings as well as delays in the delivery of new versions of
BeyondMail IM. In addition, the decline in software revenues in 1997 was
attributable to a decline in third-party products.

Services revenues for 1998 increased 71% to $25.7 million, compared with $15.1
million in 1997 and $16.3 million in 1996. The increase in services revenues in
1998 was attributable primarily to additional revenues generated from consulting
services and an increase in customer support revenues, offset in part by a
decrease in revenues from education services. The decrease in services revenues
in 1997 was attributable to lower education revenues due to delays in the
delivery of certain new product offerings. The decrease was offset in part by
increases in revenues from consulting services delivered by the Company,
particularly in the second half of 1997.

                                                                              15
<PAGE>
 
Management's Discussion and Analysis 
  of Financial Condition and Results of Operation
--------------------------------------------------------------------------------

Internet advertising revenues for 1998 increased $5.8 million to $6.5 million,
compared with $0.7 million in 1997 and $0.2 million in 1996. The increase in
Internet advertising revenues in both 1998 and 1997 was primarily due to
increased yellow pages advertising revenues related to major sponsorships
generated by Switchboard.


North American revenues for 1998 decreased 2% to $51.8 million, compared with
$53.0 million in 1997 and $79.9 million in 1996. The decrease in 1998 was
primarily due to a decrease in revenues from the Company's VINES and messaging
products, offset in part by an increase in sales, services and third-party
products. The decrease in 1997 was attributable primarily to lower revenues from
the Company's VINES products and messaging products as well as reduced shipments
to third-party distribution partners in an effort to reduce channel inventories.
International revenues for 1998 increased 10% to $23.4 million, compared with
$21.3 million in 1997 and $25.6 million in 1996. The increase in 1998 was
primarily the result of increased revenues from consulting services and customer
support, offset in part by a decrease in revenues from the Company's VINES and
messaging products, and delayed purchasing decisions in Southeast Asia due to
economic uncertainty in the region from financial market instability. The
decrease in 1997 was due to lower revenues in Asia Pacific/Japan primarily due
to channel inventory reduction efforts, particularly in Japan, and delayed
purchasing decisions in Southeast Asia due to economic uncertainty in the region
from financial market instability in the fourth quarter of 1997.


Gross Margins
-------------

Gross margins for software in 1998 were 84.3%, or $36.2 million, compared with
88.1%, or $51.6 million, in 1997 and 87.3%, or $77.6 million, in 1996. The
decrease in gross margin percentage in 1998 was primarily due to an increase in
lower-margin, third-party sales and a decrease in sales of higher-margin VINES
and messaging products. The decreases in gross margin dollars in 1998 and 1997
were primarily due to the decline in software revenues. The increase in gross
margin percentage in 1997 was primarily due to a lower proportion of product
revenues from sales of lower-margin, third-party products as well as cost
reduction efforts. Cost of software revenues consist of product media,
documentation, manufacturing costs and amortization of capitalized software.


Gross margins for services in 1998 were 36.9%, or $9.5 million, compared with
34.5%, or $5.2 million, in 1997 and 17.5%, or $2.8 million in 1996. The
increases in gross margin percentage and dollars in 1998 were primarily due to
increased revenues from consulting services and customer support, offset in part
by an increase in delivery personnel and related costs to expand consulting
services. The increases in gross margin percentages and dollars in 1997 were
primarily due to lower personnel costs as a result of the reduction in force as
part of the Company's reorganizations in the quarters ended December 31, 1996
and June 30, 1997. Cost of services revenues consists primarily of customer
support costs, including Technical Response Centers, third-party field service
costs, costs of training materials and personnel.


Gross margins for Internet advertising were 69.3%, or $4.5 million, compared
with $(0.1) million in 1997 and $0.1 million in 1996. The increase in gross
margin dollars and percentage in 1998 was due to an increase in advertising
revenues generated by Switchboard, offset in part by an increase in variable
costs related to advertising arrangements. The decrease in gross margin
percentage and dollars in 1997 was primarily due to an increase in overhead
costs, offset in part by an increase in advertising revenues. Cost of Internet
advertising revenues consists primarily of data communications, labor, and
depreciation expenses related to the operation of the Switchboard Internet Web
site as well as fees for personal and business names and listings.


Operating Expenses
------------------

Sales and marketing expenses decreased 23% to $30.8 million in 1998, compared
with $40.2 million in 1997 and $60.8 million in 1996. The decrease in 1998 was
due primarily to lower sales staffing and personnel costs as a result of the
reduction in force as part of the Company's reorganization efforts in the
quarter ended June 30, 1997, as well as redeployment of staff into the Company's
expanded consulting services activities. Partially offsetting these decreases
was increased promotional investment in the Internet advertising segment
intended to increase site traffic. The decrease in 1997 was primarily due to
lower sales and marketing staffing and personnel costs as a result of the
reduction in work force as part of the Company's reorganization efforts in the
quarters ended December 31, 1996 and June 30, 1997. In addition, variable sales
costs, including commissions, decreased due to lower revenues in 1997. Sales and
marketing expenses as a percentage of revenues were 41%, 54% and 58% for 1998,
1997 and 1996, respectively.

Product development expenses decreased 32% to $10.9
million in 1998, compared with $15.9 million in 1997 and $21.9 million in 1996.
The decrease in 1998 was primarily due to lower staffing levels as a result of
the reduction in

16
<PAGE>
 
Management's Discussion and Analysis 
  of Financial Condition and Results of Operation
--------------------------------------------------------------------------------



force as part of the Company's reorganization efforts in the quarter ended June
30, 1997. The decrease in 1997 was primarily due to lower staffing and a focus
on the Company's core product set, as a result of the Company's reorganization
efforts in the quarters ended December 31, 1996 and June 30, 1997. The Company
has focused its product development resources on enhancing its existing product
offerings, Internet-related product initiatives, and Switchboard technology and
services. Additionally, the Company has employed resources to address year 2000
compliance. The Company has modified and tested its current product offerings
for year 2000 compliance issues as of December 31, 1998. During 1997 and 1996,
the Company capitalized $0.5 million and $2.3 million of software costs, which
represented 3% and 10% of total product development expenditures respectively.
There were no amounts capitalized in 1998, as amounts qualifying for
capitalization were not material. Product development expenses as a percentage
of revenues were 14%, 21% and 21% for 1998, 1997 and 1996, respectively.

General and administrative expenses decreased 29% to $6.4 million in 1998,
compared with $9.1 million in 1997 and $11.5 million in 1996. The decrease in
1998 was primarily due to lower staffing levels as a result of the reduction in
force as part of the Company's reorganization efforts in the quarter ended June
30, 1997. The decrease in 1997 was primarily due to lower administrative and
personnel costs as a result of the reduction in staffing as part of the
Company's reorganization efforts in the quarters ended December 31, 1996 and
June 30, 1997. General and administrative expenses as a percentage of revenues
were 9%, 12% and 11% for 1998, 1997 and 1996, respectively.


On May 18, 1998, Switchboard acquired the MapsOnUs Web site and Internet mapping
technology from Lucent Technologies Incorporated. The purchase price of $1.6
million was was composed of $0.5 million in cash paid to Lucent upon closing and
a note payable of $1.1 million to be paid over a two year period. A charge was
recorded based on the Comapny's assessment of the value of the asset at the time
of purchase. The Company was required to incur costs in developing and
integrating the technology into its Switchboard Web site in order to generate
future revenue from the technology.


In 1997, the Company recorded net pre-tax restructuring and other charges of
$8.0 million, composed primarily of $1.4 million for severance costs related to
the reduction of approximately 22% of the Company's work force, $1.7 million for
the write-off of idle assets related to the restructuring, and $4.9 million for
costs related to facility and product line consolidation. As of December 31,
1997, the 1997 restructuring resulted in 78 employee separations. The actions
relating to this restructuring were substantially completed in 1997.


In 1996, the Company recorded a pre-tax restructuring charge of $5.5 million,
composed of $1.4 million for closure or consolidation of leased facilities, $3.2
million for severance and related costs and $0.9 million for the write-off of
idle assets related to the restructuring. During 1996, the restructuring
resulted in 70 employee separations. The actions relating to this restructuring
were substantially completed in 1997.


Other Income/(Expense)
----------------------

Other income/(expense) increased to $1.0 million in 1998 compared with $(0.1)
million in 1997 and $1.1 million in 1996. The increase in 1998 was primarily due
to a decrease in foreign exchange losses when compared to 1997, as well as an
increase in available funds invested in marketable securities. The decrease in
1997 was due primarily to foreign exchange losses related to weakened local
currencies in Asia Pacific/Japan subsidiaries.


Income Taxes
------------

No tax provision, other than that required for foreign income and foreign
withholding taxes, was recorded for 1998 and 1997 due to the Company's
previously recorded net operating losses. Management of the Company has
evaluated the positive and negative evidence bearing upon the realizability of
its deferred tax assets. Management has considered the Company's recent results
of operations and concluded that it is more likely than not that the deferred
tax assets will not be fully realizable. Accordingly, deferred tax assets as of
December 31, 1998 and 1997 have been fully reserved. Management re-evaluates the
positive and negative evidence on a quarterly basis. The effective tax provision
for 1998 was 34%. The Company's effective income tax provision was 1.5% in 1997,
compared with 50% in 1996. The effective tax rate for 1996 was principally
affected by the establishment of a valuation allowance for previously recorded
deferred tax assets of $8.0 million based upon management's assessment of future
realizability of these assets per Statement of Accounting Standards ("SFAS") No.
109. Management has considered recent results of operations and concluded that
it is more likely than not that the deferred tax assets will not be fully
realizable. Additionally, losses were not benefited in 1996 and certain foreign
taxes were included in the tax provision.

                                                                              17
<PAGE>
 
Management's Discussion and Analysis 
  of Financial Condition and Results of Operation
--------------------------------------------------------------------------------


Other Matters
-------------

On January 11, 1999, the Company announced a strategic alliance with
Microsoft(R) Corporation ("Microsoft") to deliver integrated messaging,
networking and Internet solutions and the collaboration on the design and
implementation of packaged services, solutions and support offerings based on
Microsoft's enterprise platform. Under the agreement, Microsoft has committed to
contribute $10.0 million over a three-year period. The first of three payments
to be made by Microsoft to the Company was received in January of 1999 in the
amount of $5.9 million. The funding's intended use is for the training of at
least 500 professionals, marketing and product development as well as the
purchase of 1.75 million common stock warrants. The common stock warrants are
subject to a three-year lock-up provision, subject to continuation of the
alliance, and have an exercise price of $10.00 per share. As of December 31,
1998, the shares of common stock issuable upon the exercise of Microsoft's
warrants represent approximately 7.5 percent ownership in the Company.


In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. SFAS No.
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999. The Company does not expect SFAS No. 133 to have a material effect on
its financial position or results of operations.

In December 1998, the AcSEC issued SoP 98-9, "Modification of SoP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions," which will retain
the limitations of SoP 97-2 on what constitutes vendor specific objective
evidence of fair value. SoP 98-9 will be effective for transactions entered into
in fiscal years beginning after March 15, 1999. The Company does not expect SoP
98-9 to have a material effect on its financial position or results of
operations.


Factors Affecting Future Operating Results
------------------------------------------

Certain of the information contained in this Annual Report, including
information with respect to the Company's plans and strategy for its business,
statements relating to the sufficiency of cash and cash equivalent balances,
anticipated expenditures, the intended effects of the Company's restructurings,
sales and marketing, product development efforts and the expected timetable and
costs relating to the Company's Year 2000 readiness (as described below under
the heading "Year 2000 Readiness Disclosure"), consists of forward-looking
statements. Any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "expects," "anticipates," "plans," and
similar expressions are intended to identify forward-looking statements.
Important factors that could cause actual results to differ materially from the
forward-looking statements include the factors listed under "Year 2000 Readiness
Disclosure," as well as the following factors:


The Company is evolving its strategic focus, seeking to decrease its reliance on
its traditional networking software products while devoting additional resources
to its network services business. As part of this strategy, on January 11, 1999
the Company announced a strategic alliance with Microsoft to deliver integrated
messaging, networking and Internet solutions and the collaboration on the design
and implementation of packaged services, solutions and support offerings based
on Microsoft's enterprise platform. The agreement contains various obligations
and milestones that must be met by the Company, including the certification of
500 Microsoft-trained professionals. The failure of the Company to meet such
obligations and milestones could result in a termination of the agreement, which
could have a material adverse effect on the Company. In addition, the Company's
future success will depend in part upon its ability to continue to grow its
network services business, acquire additional network services customers and
adapt to changing technologies and customer requirements. Any failure to do so
could have a material adverse effect on the Company. There can be no assurance
the Company will be successful in its new strategic focus.


In 1998 and 1997, a majority of the Company's network sales were to existing
customers for upgrade, expansion of their networks, or consulting delivery. The
Company's results will depend on its ability both to continue to sell products
for use in networks of existing customers and to attract new customers for the
Company's products and services. There can be no assurance that the Company will
be successful in its sales and marketing efforts. In addition, in 1998 and 1997,
the Company experienced extended selling cycles due to competitive products
introduced by other vendors, an increase in multi-year customer agreements and
longer evaluations of operating systems and hardware platforms by potential
customers. The Company expects that extended selling cycles will continue to
affect the Company's operating results for the foreseeable future.

18
<PAGE>
 
The Company's results are partially dependent on its ability to enhance existing
products and introduce new products on a timely basis, and to achieve market
acceptance for such enhanced and new products. The Company introduced Year 2000-
compliant versions of its VINES and StreetTalk for Windows NT products in April
1998. In April 1998, the Company also introduced the Banyan Intranet Messaging
Suite, a product which when added to a customer's StreetTalk for Windows NT
network, can deploy a variety of standards-based mail clients while maintaining
a unified messaging back-end and enterprise directory service. In June 1998, the
Company introduced LDAP version 3.0 support for StreetTalk, a year 2000-ready
network service that provides access to Banyan's StreetTalk directory services
from LDAP-enabled applications. In August 1998, the Company entered into an
agreement with Netegrity Incorporated to develop and sell Banyan SiteMinder, a
product that enables administrators to control user access to Web applications
from a central location and provides end users with single sign-on to
personalized Web content. Failure of any of these products to achieve market
acceptance could have a material adverse effect on the Company's future results
of operations.

The Company has invested significant resources to develop products and services
to bring the Company's directory and messaging capabilities to Internet users.
In 1996, the Company, through Switchboard, introduced Switchboard, a directory
service for Internet users. The Company has limited experience in developing or
selling products for the Internet, and the success of the Company will depend in
part on its ability to enter into strategic alliances with other Internet
providers.


A substantial percentage of the traffic on the Switchboard Internet Web site in
1998 was attributable to the Company's marketing arrangements with America
Online, Inc. ("AOL"), a minority owner of Switchboard Incorporated. Accordingly,
a substantial percentage of Switchboard Internet advertising revenues in 1998
were generally dependent on the marketing arrangements with AOL. In August 1998,
the Company announced that the White Pages contract between Switchboard and AOL
would not be renewed at the end of November 1998. On December 10, 1998, the
Company announced that the Yellow Pages contract between Switchboard and AOL
would not be renewed at the end of 1998. The Company estimates that AOL's
customers accounted for approximately 45 percent of its overall traffic and 30
percent of its total advertising revenues in 1998. There can be no assurance the
termination of these arrangements with AOL will not have material adverse effect
on the Company.

In May 1998, Switchboard acquired the MapsOnUs Web site and Internet mapping
technology from Lucent Technologies Incorporated. Any delay in integrating the
MapsOnUs technology into Switchboard, or any delay in developing additional or
enhanced products and services for the Internet or failure of its Internet
products and services to achieve increased market acceptance could have a
material adverse effect on the Company's future results of operations.

In 1998, international revenues accounted for 31% of the Company's total
revenues. The Company's results of operations in 1998 were adversely affected by
the global economic uncertainty, and in particular, the financial market
instability in Asia. There can be no assurance such uncertainty will not
continue to adversely affect the Company's operating results. On January 1,
1999, the participating member countries of the European Union adopted the Euro
as the common legal currency and fixed conversion rates between their existing
sovereign currencies and the Euro. The Company believes the Euro conversion will
not have a material impact on its operations.


Because of the foregoing factors, the Company believes that period-to-period
comparisons of its financial results are not necessarily meaningful and it
expects that its results of operations may fluctuate from period-to-period in
the future.

Year 2000 Readiness Disclosure
------------------------------

The following statement shall be considered a Year 2000 readiness disclosure to
the maximum extent allowed under the Year 2000 Information and Readiness
Disclosure Act.

In the past, many information technology products were designed with two digit
year codes that did not recognize century and millenium fields. As a result,
these hardware and software products may not function or may give incorrect
results beginning in the year 2000. In order to address this issue, such
hardware and software products must be upgraded or replaced in order to
correctly process dates beginning in the year 2000.

                                                                              19
<PAGE>
 
Management's Discussion and Analysis 
  of Financial Condition and Results of Operation
--------------------------------------------------------------------------------

The Company has created a company-wide year 2000 team to identify and resolve
year 2000 issues. The Company's year 2000 compliance program has identified
three potential areas of impact for review: (i) the software, information and
non-information systems used in the Company's internal business systems; (ii)
the Company's software offered to customers; and (iii) third-party vendors,
manufacturers and suppliers of products used in the Company's internal systems
or distributed with the Company's products. The Company has identified and is
testing its main internal systems and expects to complete testing by mid-1999.
Currently, the testing is approximately 75% complete. During 1999, the Company
expects to complete implementation of any needed year 2000-related modifications
to its information systems.


The Company is also in the process of communicating with its main suppliers of
technology products and services used in its internal systems regarding the year
2000 status of such products or services. Based upon these communications, the
Company is considering the suppliers' year 2000 preparedness in the Company's
decision to continue to deploy or migrate from these technology products or
services. In addition, the Company is currently assessing its internal non-
information technology systems, and expects to complete testing and any needed
modifications to these systems in mid-1999. The Company has not yet developed a
comprehensive contingency plan to address situations that may result if the
Company is unable to achieve year 2000 readiness of its critical operations. The
Company expects in mid-1999 to finalize its assessment of and contingency
planning for potential operational or performance problems related to year 2000-
related issues with its information systems.

The Company's total cost relating to these activities has not been and is not
expected to be material to the Company's financial position, results of
operations, or cash flows. The Company's preliminary assessment is that the cost
of completing the Company's year 2000 compliance program will be approximately
$250,000, which does not include amounts related to the diversion of internal
resources including, without limitation, employee salaries, which amount the
Company has yet to fully quantify. The Company has and expects to continue to
fund its year 2000 compliance program from operating cash flows and does not
expect to separately account for these costs. The Company believes that
necessary modifications to its systems and products will be made on a timely
basis. However, there can be no assurance that there will not be a delay in, or
increased costs associated with, the implementation of such modifications, or
that the Company's suppliers will adequately prepare for the year 2000 issue. It
is possible that any such delays, increased costs, or supplier failures could
have a material adverse impact on the Company's operations and financial
results, by, for example, impacting the Company's ability to deliver products or
services to its customers.


The Company's year 2000 effort has included testing products currently or
recently on the Company's price list for year 2000 issues. Products have been
and are expected to continue to be tested internally. Generally, for products
that were identified as needing updates to address year 2000 issues, the Company
has prepared or is preparing updates, or has discontinued or will discontinue
the product. Currently, this testing is approximately 95% complete. Some of the
Company's customers are using product versions that the Company will not support
for year 2000 issues; the Company is attempting to notify customers of these
year 2000 issues and is encouraging these customers to migrate to current
product versions that are year 2000 ready. There can be no assurance the Company
will be successful in migrating these customers to the year 2000-compliant
products of the Company.

For third-party products that the Company distributes with its products, the
Company has sought information from the product manufacturers regarding the
products' year 2000 readiness status. Customers who use the third-party products
are directed to the product manufacturer for detailed year 2000 status
information. On its year 2000 Web site at www.banyan.com, the Company provides
information regarding which of its products are year 2000 ready and other
general information related to the Company's year 2000 efforts. The Company's
total costs relating to these activities has not been and is not expected to be
material to the Company's financial position or results of operations.


The Company believes its current products, with any applicable updates, are
well-prepared for year 2000 data issues, and the Company plans to support
these products for data issues that may arise related to the year 2000.
However, there can be no guarantee that one or more of the Company's products
do not contain year 2000 date issues. The most reasonably likely worst case
scenarios would include (i) corruption of data contained in the Compnay's
information systems, (ii) hardware failure and (iii) the failure of
infrastructure services provided by third parties (e.g. electricity, 
phone service, etc.)

20
<PAGE>
 
Because the Company is in the business of selling software products, the
Company's risk of being subjected to lawsuits relating to year 2000 issues with
its software products is likely to be greater than that of companies in other
industries. Because computer systems may involve different hardware, firmware
and software components from different manufacturers, it may be difficult to
determine which component in a computer system may cause a year 2000 issue. As a
result, the Company may be subjected to year 2000-related lawsuits independent
of whether its products and services are year 2000 ready. The outcome of any
such lawsuit and the impact on the Company cannot be predicted. Any year 2000
problems in the Company's products could also result in delay or loss of
revenue, diversion of development resources, damage to the Company's reputation,
or increased service or warranty costs, any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations.

The foregoing discussion of the Company's Year 2000 readiness contains forward-
looking statements, including estimates of the timeframes and costs for
addressing the known Year 2000 issues confronting the Company, and is based on
management's current estimates, which were derived using numerous assumptions.
There can be no assurance that these estimates will be achieved, and actual
events and results could differ materially from those anticipated. Specific
factors that might cause such material differences include, but are not limited
to, the availability of personnel with required remediation skills, the ability
of the Company to identify and correct all relevant computer code and the
success of third parties with whom the Company does business in addressing their
Year 2000 issues.


Liquidity and Capital Resources
-------------------------------

At December 31, 1998, cash and cash equivalents combined with marketable
securities were $22.3 million, compared with $10.9 million at December 31, 1997.
Cash and cash equivalents increased $8.5 million from December 31, 1997,
resulting in a cash balance of $15.2 million at December 31, 1998. The increase
was due primarily to the net proceeds of $9.5 million from an equity investment
by HarbourVest Partners LLC, depreciation and amortization of $4.7 million,
proceeds from stock plan purchases and stock options of $2.6 million and net
income for the year of $1.1 million, offset in part by an increase in accounts
receivable of $4.4 million, net purchases of marketable securities of $2.9
million and capital expenditures of $1.4 million. Working capital increased to
$10.2 million at December 31, 1998 from a deficit of $2.7 million at December
31, 1997.

In April 1997, the Company announced a reorganization of its operations. As a
result of the reorganization, the Company recorded net pre-tax restructuring and
other charges of $8.0 million in 1997. The restructuring and other charges are
expected to reduce cash flow by approximately $3.1 million, of which $3.0
million had been expended through December 31, 1998. The Company expended $0.3
million in 1998, and expects to expend $0.3 million in 1999 related to the 1997
restructuring. Management believes that remaining accrued balances are adequate
to cover future expenditures associated with the 1997 and 1996 restructuring and
other charges.

On September 4, 1997, the Company entered into a $15.0 million line of credit
agreement (the "Credit Agreement") with Foothill Capital Corporation
("Foothill"). In general, the Company's obligations under the Credit Agreement
bear interest at the variable base rate per annum of Norwest Bank Minnesota,
National Association. The Credit Agreement has a three-year initial term.
Foothill was granted warrants to purchase 75,000 and 50,000 and will be granted
warrants to purchase 25,000 shares of the Company's common stock at the then
current fair market value on September 4, 1997, 1998 and 1999, respectively. On
January 12, 1999, Foothill exercised its warrant to purchase 75,000 shares of
the Company's common stock pursuant to a "cashless" exercise resulting in the
issuance of 58,603 shares to Foothill. There were no amounts outstanding under
the line of credit agreement during the years ended December 31, 1998 and 1997.


On January 11, 1999, the Company announced a strategic alliance with Microsoft.
As part of the agreement, Microsoft has committed to contributing $10.0 million
to the Company over a three-year period to fund the training of at least 500
professionals, marketing and development costs as well as the purchase of 1.75
million common stock warrants. The first of three payments to be made by
Microsoft to the Company was received in January 1999 in the amount of $5.9
million. The remaining two payments totaling $4.1 million are expected to be
received on or before December 31, 1999 and 2000 (see Note Q).


The Company believes that existing cash and marketable securities, combined with
cash expected to be generated from operations and an available line of credit,
will be sufficient to fund the Company's operations through at least the next
twelve months.

                                                                              21
<PAGE>
 
Consolidated
  Balance Sheets
--------------------------------------------------------------------------------
<TABLE>
<CAPTION> 
December 31,                                                                                              1998            1997
--------------------------------------------------------------------------------------------------------------------------------
(in thousands, except share amounts)

<S>                                                                                                 <C>               <C>
Assets
  Current assets:
    Cash and cash equivalents                                                                        $  15,160        $  6,674
    Marketable securities                                                                                4,052           4,202
    Accounts receivable, less allowances of $2,917 and $3,721, respectively                             21,392          16,960
    Inventories                                                                                            890           1,023
    Other current assets                                                                                 3,808           3,113
    ----------------------------------------------------------------------------------------------------------------------------
      Total current assets                                                                              45,302          31,972
  Property and equipment, net                                                                            4,950           5,810
  Marketable securities                                                                                  3,076              --
  Other assets, net of accumulated amortization of $2,669 and $3,770, respectively                       2,882           5,146
--------------------------------------------------------------------------------------------------------------------------------
      Total assets                                                                                   $  56,210        $ 42,928
      --------------------------------------------------------------------------------------------------------------------------

Liabilities
  Current liabilities:
    Accounts payable                                                                                 $   3,861        $  2,039
    Accrued compensation                                                                                 4,137           5,222
    Accrued expenses                                                                                     6,741           6,165
    Accrued costs for restructuring and other charges                                                      710             939
    Other current liabilities                                                                              626             270
    Note payable                                                                                            --           1,139
    Deferred revenue                                                                                    18,430          18,930
    Long-term debt, current portion                                                                        548              --
    ----------------------------------------------------------------------------------------------------------------------------
      Total current liabilities                                                                         35,053          34,704
  Commitments and contingencies
  Software license payable, non-current                                                                    150             590
  Long-term debt                                                                                           600              --
  Minority interests in consolidated subsidiaries                                                        2,008           2,557

Shareholders' Equity
  Convertible preferred stock, $.01 par value; authorized 1,000,000 shares; 
    issued and outstanding 263,158 and none, respectively                                                    3              --
  Common stock, $.01 par value; authorized 35,000,000 shares; issued and 
    outstanding 20,818,982 and 19,346,677 shares, respectively                                             208             193
  Additional paid-in capital                                                                            79,485          66,020
  Unearned compensation                                                                                 (1,326)             --
  Accumulated deficit                                                                                  (31,585)        (32,700)
  Accumulated other comprehensive income                                                                   178             128
  Treasury stock at cost; 1,848,000 shares                                                             (28,564)        (28,564)
  ------------------------------------------------------------------------------------------------------------------------------
      Total shareholders' equity                                                                        18,399           5,077
      --------------------------------------------------------------------------------------------------------------------------
        Total liabilities and shareholders' equity                                                   $  56,210        $ 42,928
        ------------------------------------------------------------------------------------------------------------------------
</TABLE> 

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

22
<PAGE>
 
Consolidated
  Statements of Operations
--------------------------------------------------------------------------------
<TABLE>
<CAPTION> 
Three Ended December 31,                                                             1998            1997            1996
-------------------------------------------------------------------------------------------------------------------------           

(in thousands, except per share amounts)
<S>                                                                        <C>             <C>             <C>
Revenues:
        Software                                                             $     42,966    $     58,546     $    88,968
        Services                                                                   25,743          15,087          16,286
        Internet advertising                                                        6,513             709             170
        -----------------------------------------------------------------------------------------------------------------           

                Total revenues                                                     75,222          74,342         105,424

Cost of Revenues:
        Software                                                                    6,730           6,939          11,332
        Services                                                                   16,245           9,889          13,441
        Internet advertising                                                        1,999             852              29
        -----------------------------------------------------------------------------------------------------------------           

                Total cost of revenues                                             24,974          17,680          24,802
                ---------------------------------------------------------------------------------------------------------           


Gross profit                                                                       50,248          56,662          80,622

Operating Expenses:
        Sales and marketing                                                        30,821          40,236          60,811
        Product development                                                        10,890          15,909          21,875
        General and administrative                                                  6,412           9,069          11,521
        Other charges                                                               1,400           8,000           5,500
        -----------------------------------------------------------------------------------------------------------------           

                Total operating expenses                                           49,523          73,214          99,707
                ---------------------------------------------------------------------------------------------------------           


Income/(loss) from operations                                                         725         (16,552)        (19,085)

Other Income/(Expense):
        Interest income                                                               793             482           1,088
        Minority interest                                                             549             847             571
        Interest expense                                                             (122)            (96)            (80)
        Other, net                                                                   (257)         (1,334)           (511)
        ------------------------------------------------------------------------------------------------------------------          

                Total other income/(expense)                                          963            (101)           1,068
                ----------------------------------------------------------------------------------------------------------          


Income/(loss) before taxes                                                          1,688         (16,653)         (18,017)
Provision for income taxes                                                            573             255            9,013
--------------------------------------------------------------------------------------------------------------------------          

Net income/(loss)                                                            $      1,115     $   (16,908)    $    (27,030)
--------------------------------------------------------------------------------------------------------------------------          


Net Income/(Loss) per Share:
                Basic                                                        $       0.06     $      (0.97)   $      (1.59)
                Diluted                                                      $       0.05     $      (0.97)   $      (1.59)
Weighted average number of common
  and common equivalent shares outstanding:
                Basic                                                              18,085           17,367          16,947 
                Diluted                                                            22,377           17,367          16,947

</TABLE> 

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

                                                                              23
<PAGE>
 
Consolidated
  Statements of Shareholders' Equity
--------------------------------------------------------------------------------

<TABLE> 
<CAPTION> 

Three years ended December 31, 1998 
------------------------------------------------------------------------------------------------------------------------------------

                                                                                 Retained     Accumulated
                            Convertible            Additional                   Earnings/           Other                    Total
                              Preferred   Common     Paid-in       Unearned  (Accumulated   Comprehensive   Treasury  Shareholders'
                                  Stock    Stock     Capital   Compensation      Deficit)          Income      Stock        Equity
------------------------------------------------------------------------------------------------------------------------------------

(in thousands)
<S>                         <C>           <C>      <C>         <C>           <C>            <C>             <C>         <C>  
Balance, December 31, 1995         $ --    $ 186    $ 62,347      $      --     $  11,238         $ (865)   $(28,564)     $  44,342
   Net loss                                                                       (27,030)                                  (27,030)

   Foreign currency 
    translation adjustment                                                                           845                        845
   Change in net 
    unrealized gain/(loss) 
    on investments                                                                                   (73)                       (73)

   Comprehensive income                                                                                                     (26,258)

   373,728 shares of
    common stock issued
    under stock and option
    plans including
    related tax benefits                       4       2,234                                                                  2,238
------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996           --      190      64,581             --       (15,792)           (93)    (28,564)        20,322
   Net loss                                                                       (16,908)                                  (16,908)

   Foreign currency 
    translation adjustment                                                                           159                        159
   Change in net 
    unrealized gain/(loss) 
    on investments                                                                                    62                         62
   Comprehensive income                                                                                                     (16,687)

   349,795 shares of
    common stock issued
    under stock and option
    plans including
    related tax benefits                       3       1,439                                                                  1,442
------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997           --      193      66,020             --       (32,700)           128     (28,564)         5,077
   Net income                                                                       1,115                                     1,115
   Foreign currency 
    translation adjustment                                                                            42                         42
   Change in net 
    unrealized gain/(loss) 
    on investments                                                                                     8                          8
   Comprehensive income                                                                                                       1,165
   1,472,305 shares of 
   common stock issued 
   under stock and option 
   plans including
   related tax benefits                       15       2,542                                                                  2,557
263,158 shares of 
  convertible preferred 
  stock issued                        3                9,497                                                                  9,500
Unearned compensation                                  1,426         (1,426)                                                    --
Amortization of unearned 
  compensation                                                          100                                                    100
------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998         $  3    $ 208    $ 79,485      $  (1,326)    $ (31,585)        $  178    $(28,564)     $  18,399
------------------------------------------------------------------------------------------------------------------------------------
</TABLE> 


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

24
<PAGE>
 
Consolidated
  Statements of Cash Flows
--------------------------------------------------------------------------------
<TABLE>
<CAPTION> 
Three Ended December 31,                                                             1998              1997                   1996
------------------------------------------------------------------------------------------------------------------------------------

(in thousands)
<S>                                                                         <C>             <C>                     <C>
Cash Flows from Operating Activities:
        Net income/(loss)                                                   $       1,115   $       (16,908)        $       (27,030)

        Adjustments to reconcile net income/(loss) to net cash 
                provided by/(used in) operating activities:
                        Depreciation and amortization                               4,662             7,847                   8,928
                        Other charges, noncash portion                              1,400             5,835                   1,852
                        Amortization of unearned compensation                         100                --                      --
                        Changes in operating assets and liabilities, net of
                                affect of acquisition:
                        (Increase)/decrease in accounts receivable                 (4,370)            2,475                   4,521
                        Decrease/(increase) in inventories                            192             1,335                    (292)

                        Decrease in income tax receivable                              --                --                   6,042
                        Increase/(decrease) in other current assets                  (327)            1,214                    (576)

                        (Increase)/decrease in other noncurrent assets               (125)              195                      68
                        Increase/(decrease) in accounts payable 
                                and accrued compensation and expenses                 707            (4,056)                 (2,893)

                        (Decrease) in accrued costs for restructuring
                                and other charges                                    (873)           (3,549)                 (5,149)

                        (Decrease)/increase in other current liabilities              (69)             (186)                  1,085
                        Decrease in deferred taxes                                     --                --                   9,926
                        (Decrease) in deferred revenue                               (483)             (921)                 (2,448)

                        (Decrease) in other liabilities                              (724)             (787)                   (211)

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

        Net cash provided by/(used in) operating activities                         1,205            (7,506)                 (6,177)


Cash Flows from Investing Activities:
        Capital expenditures                                                       (1,420)           (1,328)                 (5,683)

        Purchases of investments in unconsolidated affiliates                          --               --                   (2,001)

        Acquisition of technology                                                    (500)              --                       --
        Acquisition of software licenses                                               --              (150)                 (1,125)

        Capitalization of software costs                                               --              (549)                 (2,314)

        (Purchase of)/proceeds from marketable securities, net                     (2,918)            4,435                  10,217
        ---------------------------------------------------------------------------------------------------------------------------
        Net cash (used in)/provided by investing activities                        (4,838)            2,408                    (906)


Cash Flows from Financing Activities:
        Net proceeds from issuance of convertible preferred stock                   9,500                --                      --
        Minority interest equity investments                                           --                50                   3,095
        Proceeds from stock plan purchases, stock options 
                and warrants and related tax benefits                               2,557               944                   2,238
-----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities                                          12,057               994                   5,333
Effect of exchange rate changes on cash and cash equivalents                           62               165                     (35)

-----------------------------------------------------------------------------------------------------------------------------------
Net increase/(decrease) in cash and cash equivalents                                8,486            (3,939)                 (1,785)

Cash and cash equivalents at beginning of the year                                  6,674            10,613                  12,398
-----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of the year                               $       15,160     $       6,674          $       10,613
-----------------------------------------------------------------------------------------------------------------------------------

Supplememtal Disclosures of Cash Flow Information:
        Cash paid during the year for:
                Interest                                                   $           74     $          36          $           20
                Income taxes                                               $          372     $         522          $          688
</TABLE> 
The accompanying notes are an integral part of the consolidated financial
statements.

                                                                              25
<PAGE>
 
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

A. Nature of Business
----------------------
   Banyan Systems Incorporated has two reportable segments: Network software
   and services, and Internet advertising. The Company's network software and
   services segment designs, develops and markets standards-based networking
   directory and messaging products that help people communicate across
   enterprise networks, intranets and the Internet. In addition, the network
   software and services segment delivers professional services including
   technical support, education and consulting, including network performance,
   integration and Year 2000 compliance services. The Company's Internet
   advertising segment is organized as a majority-owned subsidiary, Switchboard
   Incorporated ("Switchboard"), and generates advertising revenue through its
   Internet people-to-people and business directory services. The Company's
   reportable segments are managed separately because they market and
   distribute distinct products and services.


B. Summary of Significant Accounting Policies
---------------------------------------------
   Basis of Presentation
   ---------------------
   The consolidated financial statements comprise those of the Company and its
   subsidiaries. Intercompany accounts and transactions have been eliminated.
   Certain previously reported amounts have been reclassified to conform to the
   current method of presentation.

   Cash Equivalents and Marketable Securities
   ------------------------------------------
   In accordance with Statement of Accounting Standards ("SFAS") No. 115, the
   Company classifies all of its marketable debt and marketable equity
   securities as available for sale securities. These securities are valued at
   fair value. Unrealized holding gains and losses are reported as a net amount
   in a separate component of stockholders' equity (see Note K).

   The Company considers all highly liquid investments with an original maturity
   of three months or less to be cash equivalents. Those instruments with
   maturities between three and twelve months are considered to be short-term
   marketable securities, and investments with maturities of greater than one
   year are classified as long-term marketable securities. Cash equivalents and
   marketable securities are carried at market, and consist primarily of U.S.
   government securities, corporate and municipal issues, and interest bearing
   deposits with major banks. These investments generally mature within twelve
   months.


   Inventories
   -----------

   Inventories are stated at the lower of cost (first-in, first-out) or market.

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

   Properties and equipment are stated at cost. Depreciation is computed using
   the straight-line method over the following estimated asset lives:

   Computers and peripherals                                            3 years
   Equipment                                                          2-5 years
   Furniture and fixtures                                               5 years

   Maintenance and repairs are charged to expense when incurred, while
   betterments are capitalized. Leasehold improvements are amortized over the
   lesser of the lease term or the life of the asset. When property is retired
   or otherwise disposed of, the related cost and accumulated depreciation are
   removed from the respective amounts and any gain or loss is reflected in
   operations.


   Software Development Costs
   --------------------------
   
   The Company capitalizes costs for internally developed software after
   technological feasibility of the product are charged to research and
   development expense. Costs incurred prior to the establishment of
   technological feasibility are charged to research and development expense.
   Software costs are amortized, on a product by product basis, ratably over the
   estimated economic life of the product (generally three years), or the ratio
   of current gross revenues to total current and expected future gross revenues
   of the product, whichever is greater.

26
<PAGE>
 
   The Company evaluates the net realizable value of capitalized software on an
   ongoing basis, relying on a number of factors including operating results,
   business plans, budgets, and economic projections and undiscounted cash
   flows. In addition, the Company's evaluation considers non-financial data
   such as market trends, project development cycles and changes in management's
   market emphasis.


   Software Licenses
   -----------------
   The Company has purchased various software licenses for technology that is
   incorporated in the Company's products. The cost of these licenses, included
   in other assets, is amortized on a straight-line basis over their estimated
   useful lives, not to exceed three years (see Note E). Certain of these
   licenses require royalty payments based on future sales. Such amounts are
   expensed as incurred.

   The Company has entered into agreements with various third parties to develop
   or license products. Under the terms of these agreements, the Company is
   generally required to pay minimum annual royalties commencing upon first
   customer shipment. Such amounts are expensed as incurred. The committed
   royalties are included in current and noncurrent assets and liabilities.


   Revenue Recognition
   -------------------
   The Company recognizes software revenues in accordance with the provisions of
   Statement of Postion 97-2, "Software Revenue Recognition." Revenue from
   software license fees are recorded upon execution of the contract provided
   that all shipment obligations have been met, fees are fixed or determinable,
   and collection is deemed probable. Revenue from maintenance contracts,
   including amounts bundled in initial software licenses, is deferred and
   recognized ratably over the term of the agreement, generally one year.
   Internet advertising consists of advertising revenue and engineering services
   delivered through Switchboard. Advertising revenues are recognized when the
   services are provided. Engineering and programming fees for site
   implementation and/or customization work performed is recognized based upon
   completion and acceptance. Reserves for sales returns and allowances are
   recorded in the same period as the related revenues.


   Foreign Currency Translation
   ----------------------------
   The Company's subsidiaries generally use the U.S. dollar as the functional
   currency, and transaction gains and losses are included in other income and
   expenses in the statement of operations. For those subsidiaries which use the
   local currency as the functional currency, assets and liabilities are
   translated into U.S. dollars at the period ended exchange rate and income and
   expense amounts are translated using the average rate prevailing for the
   period. Adjustments resulting from translation are included in other
   comprehensive income. The Company's foreign subsidiaries, Nihon Banyan
   Systems Kabushiki Kaisha (NBSKK) and Banyan Systems Australia Pty., used the
   local currency as functional currency for the years ended December 31, 1997
   and 1996. In January 1998, the Company made a determination to change the
   functional currency of NBSKK and Banyan Systems Australia Pty. to the U.S.
   dollar. In 1998, the remainder of the Company's subsidiaries used the U.S.
   dollar as their functional currency.

   Minority Interests
   ------------------
   Minority interests in consolidated subsidiaries represent minority
   shareholders' proportionate shares of the equities in the Company's
   subsidiaries, NBSKK and Switchboard. At December 31, 1998, the Company owned
   approximately 70% of the capital stock of NBSKK and approximately 90% of the
   capital stock on a fully diluted basis of Switchboard (see Note P).


   Risks and Uncertainties
   -----------------------
   The Company invests its cash and cash equivalents primarily in deposits and
   money market funds with a single commercial bank. The Company has not
   experienced any losses to date on its invested cash.

   The Company sells its products principally through a direct sales force
   domestically and through distributors outside of the United States to
   customers in a broad range of industries. The Company performs ongoing credit
   evaluations of its customers but does not require collateral or other
   security to support customer receivables. The Company maintains reserves for
   credit losses and, to date, such losses have been within management's
   expectations.

                                                                              27
<PAGE>
 
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------

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

   Income/(Loss) Per Share
   -----------------------
   Basic income/(loss) per share excludes dilution and is computed by dividing
   income/(loss) available to common shareholders by the weighted average number
   of common shares outstanding for the period. Diluted income per share
   includes the dilution from the assumed exercise of stock options, warrants
   (using the treasury stock method) and the assumed conversion of preferred
   shares (using the if converted method). In loss periods, common equivalents
   are excluded from the diluted loss per share calculation as the effect is
   anti-dilutive.

   Comprehensive Income
   --------------------
   In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income."
   This statement establishes rules for the reporting of comprehensive income
   and its components. Comprehensive income consists of net income, foreign
   currency translation adjustments and unrealized gains/(losses) on investments
   and is presented in the Consolidated Statement of Shareholders' Equity. The
   adoption of SFAS No. 130 had no impact on total shareholders' equity. Prior
   year financial statements have been reclassified to conform to the SFAS No.
   130 requirements.


   Derivative Instruments and Hedging 
   ----------------------------------
   In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
   Instruments and Hedging Activities." The new standard establishes accounting
   and reporting standards for derivative instruments, including certain
   derivative instruments embedded in other contracts, and for hedging
   activities. SFAS No. 133 is effective for all fiscal quarters of fiscal years
   beginning after June 15, 1999. The Company does not expect SFAS No. 133 to
   have a material effect on its financial position or results of operations.


   Software Revenue Recognition
   ----------------------------
   In December 1998, the AcSEC issued SoP 98-9, "Modification of SoP 97-2,
   Software Revenue Recognition, With Respect to Certain Transactions," which
   will retain the limitations of SoP 97-2 on what constitutes vendor specific
   objective evidence of fair value. SoP 98-9 will be effective for transactions
   entered into in fiscal years beginning after March 15, 1999. The Company does
   not expect SoP 98-9 to have a material effect on its financial position or
   results of operations.


C. Inventories
--------------
   Inventories consist of the following at:

<TABLE> 
<CAPTION> 

   December 31,                            1998            1997
   ------------------------------------------------------------
   (in thousands)
   <S>                              <C>             <C>  
   Purchased parts                  $       309     $       356
   Work in process                           80             270
   Finished goods                           501             397
   ------------------------------------------------------------
                                    $       890     $     1,023
                                    ---------------------------
</TABLE> 

28
<PAGE>
 
D. Property and Equipment
-------------------------

   Property and equipment consists of the following at:

<TABLE> 
<CAPTION> 


   December 31,                                           1998            1997
   ---------------------------------------------------------------------------
   (in thousands)
   <S>                                             <C>             <C>
   Computer and peripherals                        $    24,859     $    23,848
   Equipment                                            10,455           9,587
   Furniture and fixtures                                2,659           2,725
   Leasehold improvements                                2,586           2,536
   ---------------------------------------------------------------------------
   Total cost                                      $    40,559     $    38,696
   Accumulated depreciation and amortization           (35,609)        (32,886)
   ---------------------------------------------------------------------------
                                                   $     4,950     $     5,810
                                                   ---------------------------
</TABLE> 

    Depreciation expense for 1998, 1997 and 1996 was $3,607,000, $6,340,000 and
    $7,022,000, respectively.


E.  Other Assets
----------------
    Other assets consist of the following at:

<TABLE> 
<CAPTION> 


   December 31,                                           1998            1997
   ---------------------------------------------------------------------------
   (in thousands)
   <S>                                             <C>             <C>
   Capitalized software costs, net                 $       473     $       991
   Investment in unconsolidated affiliate                2,001           2,001
   Software licenses, net                                  150           2,154
   Other                                                   258              --
   ---------------------------------------------------------------------------
                                                   $     2,882     $     5,146
                                                   ---------------------------
</TABLE> 

    During 1997 and 1996, the Company capitalized $549,000 and $2,314,000 of
    software costs, respectively. There were no amounts capitalized during 1998,
    as amounts qualifying for capitalization were not material. Amortization
    expense for other assets was $1,185,000, $1,453,000 and $1,796,000 for 1998,
    1997 and 1996, respectively. In 1998, other assets totaling $1,554,000 were
    written off along with the reversal of associated long-term liabilities and
    a note payable.


F. Other Charges
----------------

   On May 18, 1998, Switchboard acquired the MapsOnUs Web site and Internet
   mapping technology from Lucent Technologies Incorporated. The purchase price
   of $1,600,000 was was composed of $500,000 in cash paid to Lucent upon
   closing and a note payable of $1,100,000 to be paid over a two year period. A
   charge was recorded based on the Company's assessment of the value of the
   asset at the time of purchase. The Company was required to incur costs in
   developing and integrating the technology into its Switchboard Web site in
   order to generate future revenue from the technology.


   On April 21, 1997, the Company announced a reorganization of its operations.
   As a result of the reorganization, the Company recorded net pre-tax
   restructuring and other charges of approximately $9,700,000. The
   restructuring and other charges were composed of $1,700,000 for severance
   costs, $2,100,000 for the write-off of idle assets related to restructuring
   and $5,900,000 for costs related to facility and product line consolidations.
   These restructuring charges provided for the reduction of approximately 22%
   of the Company's work force. In the fourth quarter of 1997, the Company
   reversed $1,700,000 of previously recorded restructuring and other charges
   related to the Company's better-than-expected progress in consolidating
   facilities and product lines, completing its severance programs, and selling
   and redeploying fixed assets.

   At December 31, 1997, the Company's cash expenditures for employee
   separations related to the 1997 restructuring were approximately $1,250,000.
   During 1997, the restructuring action resulted in approximately 78 employee
   separations. The restructuring and other actions were substantially completed
   in 1997. The restructuring and other charges related to the 1997
   restructuring are expected to use cash of $3,100,000, of which $3,000,000 had
   been expended through December 31, 1998, while providing an annual cash flow
   benefit beginning in 1998.

                                                                              29
<PAGE>
 
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------


   On November 7, 1996, the Company announced a reorganization of its
   operations. As a result of the reorganization, the Company recorded a pre-tax
   restructuring charge of approximately $5,500,000 in the fourth quarter ended
   December 31, 1996. This reorganization charge was composed of $1,400,000 for
   the closure or consolidation of leased facilities, $3,200,000 for severance
   and costs related to the reduction of approximately 15% of the Company's work
   force and $900,000 for the write-off of idle assets related to the
   restructuring. The November 1996 restructuring resulted in 70 employee
   separations. The restructuring and other charges relating to the November
   1996 restructuring are expected to use cash of $3,800,000, of which
   $3,500,000 had been expended through December 31, 1998.

   For the year ended December 31, 1997, the Company's cash expenditures for
   employee separations related to the 1996 restructuring were approximately
   $1,800,000. The restructuring and other charges reduced cash flow by
   approximately $2,600,000 in 1997 while providing an annual cash flow benefit
   beginning in 1998.


   Restructuring costs are accrued and charged to expense in accordance with an
   approved management plan, supported by an appropriate level of specificity
   for the planned actions. Actual restructuring costs are recognized as a
   reduction in the accrued liability in the period incurred. The Company
   believes the remaining reserve balance of approximately $710,000 is adequate
   to cover the remaining restructuring and other actions.


G. Line of Credit
------------------
   In September 1997, the Company entered into a $15,000,000 line of credit
   agreement with a commercial lender that replaced the Company's prior
   $10,000,000 credit facility that expired in May 1997. There were no
   borrowings under the agreement or the prior line of credit facility in 1998.
   This agreement has a three-year initial term and is renewable thereafter for
   successive one-year periods. The lender was granted warrants to purchase
   75,000 and 50,000 and will be granted warrants to purchase 25,000 shares of
   the Company's common stock on September 4, 1997, 1998 and 1999, respectively.
   The exercise price of the warrants shall equal the then current fair market
   value of the Company's common stock on the date of grant. On January 12,
   1999, the lender exercised its warrant to purchase 75,000 shares of the
   Company's common stock pursuant to a "cashless" exercise resulting in the
   issuance of 58,603 shares to Foothill.

   Outstanding borrowings drawn under this line are restricted to (a) 85% of the
   Company's eligible accounts receivable plus (i) the lower of $2,000,000 or
   75% of eligible foreign accounts plus (ii) the lowest of $3,000,000 or 80% of
   the aggregate depreciated equipment value or 50% of the amount of credit
   availability by the sum of clauses (i) and (ii), or (b) $15,000,000.

H. Commitments and Contingencies
-------------------------------
   The Company leases its facilities and certain equipment under non-cancelable
   lease agreements which expire at various dates through March 2014. Rental
   expense under these leases totaled $2,241,000, $2,857,000 and $4,872,000 in
   1998, 1997 and 1996, respectively. Under these agreements, the Company is
   obligated to pay for utilities, taxes, insurance and maintenance.

   At December 31, 1998, future minimum lease payments under operating leases
   with initial terms exceeding one year are as follows:


<TABLE> 
<CAPTION> 
   -----------------------------------------------------------------------
   (in thousands)
   <S>                                                             <C> 
   1999                                                            $ 3,877
   2000                                                              3,359
   2001                                                              2,787
   2002                                                              2,390
   2003                                                              1,207
   Thereafter                                                        3,375
   -----------------------------------------------------------------------
   Total future minimum lease payments                             $16,995
   -----------------------------------------------------------------------

</TABLE> 

The total of future minimum rentals to be received under non-cancelable
subleases related to the above leases is $1,103,000 and $668,000 for the years
ending 1999 and 2000, respectively.

30
<PAGE>
 
I. Income Taxes
--------------
   The components of the (benefit)/provision for income taxes are as follows:

<TABLE> 
<CAPTION> 


    Years ended December 31,           1998            1997              1996
    ---------------------------------------------------------------------------
    <S>                           <C>             <C>             <C> 
    Currently Payable
        U.S. Federal              $      --       $      --       $    (1,598)
        State                            --              --                --
        Foreign                         573             255               974
    ---------------------------------------------------------------------------
                                        573             255              (624)
    Deferred:
        U.S. Federal                     --              --             9,637
        State                            --              --                --
    ---------------------------------------------------------------------------
                                         --              --             9,637
                                  ---------------------------------------------
                                  $     573       $     255       $     9,013
                                  ---------------------------------------------

</TABLE> 

    Management of the Company has evaluated the positive and negative evidence
    bearing upon the realizability of its deferred tax assets. Management has
    considered the Company's recent results of operations and concluded that it
    is more likely than not that the deferred tax assets will not be realizable.
    Accordingly, deferred tax assets as of December 31, 1998 and 1997 have been
    fully reserved. Management re-evaluates the positive and negative evidence
    on a quarterly basis. Temporary differences which give rise to deferred tax
    assets and liabilities for the years ended December 31, 1998 and 1997 are as
    follows:


<TABLE> 
<CAPTION> 

                                             1998            1997
    ---------------------------------------------------------------------------
    <S>                            <C>             <C>                 
    Deferred tax assets:
        Net operating loss and
          other carryforward       $       15,805  $       16,126
        Purchased research and
          development                       7,104           7,014
        Depreciation and 
          amortization                      1,419           1,801
        Benefit plans                         612             986
        Bad debt allowance                    509             663
        Other                                 724             922
        -----------------------------------------------------------------------
    Gross deferred tax asset               26,173          27,512
    Deferred tax liabilities:
        Capitalized software                 (195)         (1,012)
        -----------------------------------------------------------------------
    Gross deferred tax liability             (195)         (1,012)
    Less: valuation allowance             (25,978)        (26,500)
    ---------------------------------------------------------------------------
    Net deferred tax asset         $           --  $           --
    ---------------------------------------------------------------------------
</TABLE> 

    At December 31, 1998, the Company had federal net operating losses and
    federal tax credit carryforwards of $39 million and $2.3 million,
    respectively. The net operating losses will begin to expire between the
    years 2010 and 2018 and the credits will begin to expire between the years
    2007 and 2011.

    A reconciliation of the statutory U.S. Federal income tax rate and the
    effective tax rate is as follows:

<TABLE> 
<CAPTION> 


    Years ended December 31,           1998            1997              1996
    ---------------------------------------------------------------------------
    <S>                           <C>             <C>             <C> 
    Tax at statutory rate              35.0%          (35.0)%           (35.0)%
    State income taxes, net of
      U.S. federal benefit              3.7%           (1.3)%            (3.9)%
    Effect of foreign tax rates         3.0%            1.6%              5.4%
    Minority interest                 (11.4)%          (1.8)%            (1.1)%
    Foreign losses not benefited       35.4%            2.7%              3.0%
    Other                              (0.8)%          (0.2)%             2.0%
    Valuation                         (30.9)%          35.5%             79.6%
    ---------------------------------------------------------------------------
    Effective tax rate                 34.0%            1.5%             50.0%
    ---------------------------------------------------------------------------
</TABLE> 

                                                                              31
<PAGE>
 
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------


J. Preferred Stock
------------------
   In July 1992, the shareholders of the Company approved the creation of a new
   class of undesignated preferred stock and authorized 1,000,000 shares of
   $0.01 par value, in one or more series, with voting rights and preferences to
   be determined by the Board of Directors. In March 1998, 263,158 shares were
   designated as Series A Convertible Preferred Banyan Stock and were issued to
   HarbourVest Partners along with warrants to acquire 65,790 shares of Series B
   convertible preferred stock and 65,790 shares of Series C convertible
   preferred stock at an exercise price of $45.00 and $50.00 per share,
   respectively, in exchange for cash of $9,500,000, net of issuance costs of
   $500,000. Each share of preferred stock is initially convertible, at the
   option of the holder, into ten shares of common stock, subject to adjustment
   for certain dilutive issuances. The preferred stock is generally entitled to
   vote together with the common stock on all matters submitted to shareholders.
   Upon any liquidation, dissolution or winding up of affairs of the Company, no
   distribution shall be made to the holders of the common stock unless, prior
   to the first such distribution, the holders of the Series A, Series B and
   Series C preferred shall have received an amount equal to $38.00, $45.00 and
   $50.00 per share of Series A , Series B and Series C preferred respectively.


K. Marketable Securities
------------------------
   Marketable securities consisted of the following at December 31, 1998
   and 1997:

<TABLE> 
<CAPTION> 

                                                           1998                            1997
                                                 --------------------------------------------------------
                                                  Aggregate     Amortized       Aggregate       Amortized
    Security Type                                Fair Value          Cost      Fair Value            Cost
    -----------------------------------------------------------------------------------------------------     
    (in thousands)
    <S>                                          <C>            <C>            <C>              <C> 
    Maturing within one year:
        U.S. Treasury Notes                      $      130     $     130      $    4,202       $   4,210
        Commercial paper/agencies                     3,922         3,919             --              --
    -----------------------------------------------------------------------------------------------------     
                                                 $    4,052     $   4,049      $    4,202       $   4,210

    Maturing after one year through five years:
        U.S. Treasury Notes                      $      --      $      --      $       --       $      --
        Commercial paper/agencies                    3,076          3,079              --              --
    -----------------------------------------------------------------------------------------------------     
                                                 $   3,076      $   3,079      $       --       $      --
                                                 --------------------------------------------------------     
                Totals                           $   7,128      $   7,128      $    4,202       $   4,210
                -----------------------------------------------------------------------------------------  
</TABLE> 

    Realized and unrealized gains/(losses) were immaterial for the years ended
    December 31, 1998 and 1997.


L.  Stock Option Plans
----------------------
    Under the Company's 1984 stock option plans, the Company granted incentive
    and non-qualified stock options to purchase up to an aggregate of 5,113,841
    shares of common stock, of which 59,304 options were outstanding at December
    31, 1998. In June 1992, the Board of Directors voted that no further options
    be granted under the 1984 stock option plans. Generally, options outstanding
    vest ratably over a four-year period and expire ten years from the date of
    grant.


    Under the Company's 1992 Stock Incentive Plan, (the "1992 Stock Incentive
    Plan"), as amended, the Company may grant incentive stock options and non-
    statutory options for the purchase of an aggregate of 3,500,000 shares of
    common stock to employees, officers, directors, consultants and advisors. At
    December 31, 1998, 1,742,040 options were outstanding under this plan. The
    1992 Stock Incentive Plan provides that incentive stock options may not be
    granted at less than the fair market value of the Company's common stock at
    the grant date, and options generally vest ratably over a three or four-year
    period and expire ten years from the date of grant.


    The 1992 plan permits awards of restricted stock at a price determined by
    the Compensation Committee of the Board of Directors subject to the
    Company's right to repurchase such stock in specified circumstances prior to
    the expiration of a restricted period. On October 16, 1998, the Company
    issued 396,000 shares of restricted common stock to executive officers and
    certain members of senior management at par value. These shares are subject
    to the Company's repurchase right and certain other restrictions for a
    period of up to three years. An amount for unearned compensation of
    $1,426,000 was recorded within shareholders' equity equal to the fair market
    value of the stock on the date it was issued, less the purchase price. In
    1998, amortization of $100,000 was recorded as compensation expense related
    to the transaction. The remainder of the unearned compensation will be
    amortized over a period up to three years from the date of issuance.

32
<PAGE>
 
    Under the Company's 1992 Director Stock Option Plan (the "1992 Director
    Plan"), as amended , the Company may grant non-statutory stock options for
    the purchase of up to an aggregate of 200,000 shares of common stock to
    directors of the Company who are not officers or employees of the Company or
    any subsidiary of the Company. Under the terms of the 1992 Director Plan,
    initial options shall be granted to each eligible director upon his or her
    initial election as a director that cover 15,000 shares of common stock and
    annual options shall be granted on the date of each Annual Meeting of
    Shareholders of the Company that cover 3,000 shares of common stock. The
    1992 Director Plan provides that options shall be granted at the fair market
    value of the Company's common stock at the grant date. Annual options
    generally vest twelve months after the grant date and initial options vest
    ratably over a four-year period. At December 31, 1998, 105,000 options had
    been outstanding under the 1992 Director Plan.

    Under the Company's 1995 Employee Stock Purchase Plan (the "1995 Employee
    Stock Purchase Plan"), 1,050,000 shares of common stock are available to all
    full-time employees through semi-annual offerings. At December 31, 1998,
    785,720 shares of common stock have been purchased under this plan.

    During 1997, in addition to the options described above, options to purchase
    an aggregate of 1,300,000 shares were issued to four executive officers of
    the Company. The underlying shares were registered with the SEC and
    generally vest over a four-year period. At December 31, 1998, 1,170,000 of
    such options were outstanding.

    The Company applies ABP Opinion 25 and related interpretations in accounting
    for its plans. In fiscal year 1996, the Company adopted the disclosure
    provisions only of SFAS No. 123, "Accounting for Stock-Based Compensation."
    Accordingly, no compensation cost has been recognized for its stock-based
    compensation plans. Had compensation cost for the Company's stock-based
    compensation plans been recorded based on the fair value of awards at the
    grant dates as calculated in accordance with SFAS No. 123, the Company's net
    income/(loss) and earnings/(loss) per share for the years ended December 31,
    1998, 1997 and 1996 would have been reduced to the pro forma amounts
    indicated below:

<TABLE> 
<CAPTION> 
                                          1998                               1997                              1996
                              ---------------------------------------------------------------------------------------------------
                              As Reported       Pro Forma       As Reported       Pro Forma       As Reported         Pro Forma
    -----------------------------------------------------------------------------------------------------------------------------
    <S>                       <C>              <C>             <C>              <C>              <C>               <C>  
    Net income/(loss)          $    1,115      $    1,194      $    (16,908)    $   (21,270)     $    (27,030)     $    (30,562)
    Basic income/(loss)
         per share             $     0.06      $     0.07      $      (0.97)    $     (1.22)     $      (1.59)     $      (1.80)
    Diluted income/(loss)
         per share             $     0.05      $     0.05      $      (0.97)    $     (1.22)     $      (1.59)     $      (1.80)
</TABLE> 

    The fair value of each option grant is estimated on the date of grant using
    the Black-Scholes option-pricing model with the following weighted-average
    assumptions used for grants in 1998, 1997 and 1996, respectively; dividend
    yield of 0%, 0% and 0%; expected volatility of 90%, 70% and 62%; risk-free
    interest rates of 5.5%, 6.4% and 6.4%; and expected lives of 5.0, 5.5 and
    5.5 years. The effects of applying SFAS No. 123 in this pro forma disclosure
    are not likely to be representative of the effects on reported net income
    for future years. Additional awards in future years are anticipated. SFAS
    No. 123 does not apply to awards granted prior to 1995. The 1998 pro forma
    amounts include $3,542,000 of pro forma income related to stock option
    forfeiture experience.

    A summary of the status of the Company's stock plans as of December 31,
    1998, 1997 and 1996, and changes during the years ending on those dates, is
    presented below.

<TABLE> 
<CAPTION> 
                                                    1998                   1997                    1996    
                                            --------------------   ---------------------   ---------------------
                                                        Weighted                Weighted                Weighted
                                                         Average                 Average                 Average
                                                        Exercise                Exercise                Exercise
                                            Shares         Price   Shares          Price   Shares          Price   
    ------------------------------------------------------------   ---------------------   ---------------------
    <S>                                    <C>      <C>            <C>      <C>            <C>      <C>      
    Outstanding at beginning of year        3,293   $       2.77    2,631   $       7.02    2,537   $       8.34
    Granted                                 1,225           3.93    2,289           2.37    1,080           6.32
    Exercised                              (1,108)          1.89      (31)          2.18     (111)          4.16
    Canceled                                 (334)           2.6   (1,596)          4.84     (875)          9.30
    ------------------------------------------------------------------------------------------------------------
    Outstanding at end of year              3,076   $       3.55    3,293   $       2.77    2,631   $       7.02
    ------------------------------------------------------------------------------------------------------------
    Options exercisable at year-end         1,339   $       3.16      705   $       4.31    1,154   $       7.06
    ------------------------------------------------------------------------------------------------------------
    Weighted-average fair value of
        options granted during the year             $       4.24            $       1.69            $       3.93
        --------------------------------------------------------------------------------------------------------
</TABLE> 

                                                                              33
<PAGE>
 
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------


    The following table summarizes information about the stock options at
    December 31, 1998.

<TABLE> 
<CAPTION> 
                                                       Options Outstanding                        Options Exercisable
                                    --------------------------------------------------------------------------------------
                                                                    Weighted     Weighted                        Weighted
                                               Number                Average      Average              Number     Average
                                       Outstanding at              Remaining     Exercise      Exercisable at    Exercise
    Range of Exercise Prices        December 31, 1998       Contractual Life        Price   December 31, 1998       Price
    ---------------------------------------------------------------------------------------------------------------------
    <S>                             <C>                     <C>                  <C>        <C>                   <C>  
    $   1.15   --    $   2.25                   1,822              7.9 years     $   2.20                 940    $   2.21
    $   2.26   --    $   3.99                     350              8.9 years     $   3.46                  69    $   3.21
    $   4.00   --    $   7.00                     796              8.3 years     $   5.62                 270    $   4.17
    $   7.01   --    $   16.25                    108              7.3 years     $  11.55                  60    $  13.48
    ---------------------------------------------------------------------------------------------------------------------
                                                3,076                                                   1,339   
                                    -------------------------------------------------------------------------------------
</TABLE> 


M. Basic and Diluted Earnings/(Loss) Per Share
----------------------------------------------
   Basic earnings/(loss) per share is based upon the weighted average number of
   common shares outstanding during the period. Diluted earnings per share
   includes the dilution of weighted average common equivalent shares
   outstanding during the period. Common equivalent shares have been excluded
   from the computation of diluted loss per share, as their effect would have
   been anti-dilutive in 1997 and 1996. Common equivalent shares result from the
   assumed conversion of preferred stock plus the assumed exercise of
   outstanding stock options and warrants, the proceeds of which are then
   assumed to have been used to repurchase outstanding common stock using the
   treasury stock method. Common equivalents also include the unvested portion
   of restricted stock.


<TABLE> 
<CAPTION> 

    For the years ended December 31,                1998            1997            1996
    -------------------------------------------------------------------------------------
    <S>                                       <C>             <C>               <C> 
    Basic earnings/(loss) per share
    Numerator:
        Net income/(loss)                     $    1,115      $  (16,908)       $ (27,030)
    Denominator:
        Weighted average common shares
           outstanding                            18,085          17,367           16,947
        ---------------------------------------------------------------------------------
    Basic earnings/(loss) per share           $     0.06      $    (0.97)       $   (1.59)
    -------------------------------------------------------------------------------------
    Diluted earnings/(loss) per share
        Net income/(loss)                     $    1,115      $  (16,908)       $ (27,030)
    Denominator:
        Weighted average common shares 
           outstanding                            18,085          17,367          16,947
        Weighted average common equivalent
           shares                                  4,292             --               --
        ---------------------------------------------------------------------------------
                Total shares                      22,377          17,367          16,947
                -------------------------------------------------------------------------
    Diluted earnings/(loss) per share         $     0.05      $    (0.97)       $  (1.59)
    -------------------------------------------------------------------------------------
</TABLE> 

    Options to purchase 1,836,000 shares of common stock outstanding during the
    year ended December 31, 1998 were excluded from the calculation of diluted
    net income, as their exercise price was greater than the average share price
    or they were not vested as of December 31, 1998. Options to purchase
    3,293,000 and 2,631,000 shares of common stock outstanding during the years
    ended December 31, 1997 and 1996, respectively, were excluded from the year-
    to-date calculation of diluted net loss per share as the effect of their
    inclusion would have been anti-dilutive.


N. Employee Benefit Plan
------------------------   
   In 1989, the Company established a savings and profit sharing plan covering
   substantially all U.S. employees. The plan is qualified under Section 401(a)
   of the Internal Revenue Code of 1986, as amended. Effective January 1, 1994,
   the Company elected to match an employee's elective deferrals to the plan
   based upon a prescribed formula. The maximum matching contribution was 2% of
   an employee's annual compensation. Vesting is over a four-year period and
   begins on the date of hire. The Company contributed $297,000, $377,000 and
   $549,000 in 1998, 1997 and 1996, respectively.

34
<PAGE>
 
O. Segment Information
----------------------

    In March 1998, the Company adopted SFAS No. 131, "Disclosures about Segments
    of an Enterprise and Related Information," which supercedes SFAS No. 14,
    "Financial Reporting for Segments of a Business Enterprise." This statement
    changes the way that public business enterprises report segment information,
    including financial and descriptive information about their selected segment
    information. Under SFAS No. 131, operating segments are defined as revenue-
    producing components of an enterprise which are generally used internally
    for evaluating segment performance. SFAS No. 131 is effective for the
    Company's fiscal year ended December 31, 1998, and will not affect the
    Company's financial position or results of operations.


    As described in Note A, "Nature of Business," the Company has two reportable
    segments: Network software and services, and Internet advertising.
    Significant financial information relative to the Company's reportable
    segments is as follows:

<TABLE> 
<CAPTION> 

                                               Network Software        Internet        Total
    Year Ended December 31, 1998                   and Services     Advertising      Company
    ----------------------------------------------------------------------------------------
    (in thousands)
    <S>                                        <C>                  <C>           <C>  
    Revenues
        Network software                              $  42,966       $      --   $   42,966
        Network services                                 25,743              --       25,743
        Internet advertising                                 --           6,513        6,513
    ----------------------------------------------------------------------------------------
                Total revenue                            68,709           6,513       75,222
    Cost of revenues                                     22,975           1,999       24,974
    ----------------------------------------------------------------------------------------
    Gross margin                                         45,734           4,514       50,248
    ----------------------------------------------------------------------------------------
    Operating expenses                                   39,927           9,596       49,523
    ----------------------------------------------------------------------------------------
    Operating income/(loss)                           $   5,807       $  (5,082)  $      725
    ----------------------------------------------------------------------------------------
    Total assets                                      $  53,064       $   3,146   $   56,210
    ----------------------------------------------------------------------------------------
</TABLE> 

    On April 18, 1996, the Company incorporated Switchboard. In 1996 and 1997,
    Switchboard did not generate revenues material to the consolidated Company's
    operating results.

    The Company distributes its network software and services worldwide and
    delivers its Internet advertising within North America. Revenue can be
    grouped into geographic areas as follows:

<TABLE> 
<CAPTION> 

    Years Ended December 31,                              1998            1997            1996
    ------------------------------------------------------------------------------------------
    <S>                                         <C>             <C>             <C>  
    (in thousands)
    Revenues from unaffiliated customers:
        North America
                United States                   $       44,040  $       47,409  $       69,746
                Canada                                   7,734           5,616          10,116
                ------------------------------------------------------------------------------
                                                        51,774          53,025          79,862
        International   
                Europe                                  19,597          17,244          17,757
                Other                                    3,851           4,073           7,805
                ------------------------------------------------------------------------------
                                                        23,448          21,317          25,562
                                                ----------------------------------------------
                Total network product   
                        and services revenues   $       75,222  $       74,342  $       105,424
                        ----------------------------------------------------------------------
</TABLE> 


No one customer accounted for more than ten percent of consolidated revenues in
1998. One customer accounted for 11% of consolidated revenues in both 1997 and
1996. The customers included in this percentage vary from year to year. The
Company does business throughout Europe with the majority of the revenue
concentrated in Germany, The Netherlands, United Kingdom and France for the
years presented. The majority of the revenue in the other category is
concentrated in Australia, Malaysia and Japan for all years presented.

                                                                              35
<PAGE>
 
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------


P. Minority Interests 
---------------------

    In 1996, the Company entered into an agreement with America Online Inc.
    (AOL) and Digital City Inc. (DCI) to sell minority interests in the
    Company's subsidiary, Switchboard, to AOL and DCI. Pursuant to this
    agreement, AOL and DCI invested a total of $3,000,000 in Switchboard and
    currently hold a combined equity interest of 10.0% on a fully diluted basis.
    AOL and DCI's collective minority interest in the net loss of Switchboard is
    deducted from net income on a pro rata basis. For the year ended December
    31, 1998, revenue and expenses were approximately $6,513,000 and
    $11,595,000, respectively. Expenses for the year ended December 31, 1998
    included a one-time charge for the acquisition of in process research and
    development totaling $1,400,000 related to the MapsOnUs Web site purchased
    from Lucent Technologies Incorporated. For the year ended December 31, 1997,
    revenue and expenses were approximately $709,000 and $5,112,000,
    respectively. For the year ended December 31, 1996, revenue and expenses
    were approximately $170,000 and $1,479,000, respectively. AOL and DCI's
    collective minority interest in Switchboard's assets and liabilities is
    shown net in the consolidated balance sheet. At December 31, 1998, assets
    and liabilities for Switchboard were approximately $3,146,000 and
    $10,901,000, respectively. At December 31, 1997, assets and liabilities were
    approximately $1,510,000 and $3,790,000, respectively.


    In 1995, the Company entered into an agreement with Marubeni Corporation to
    sell a minority interest in the Company's Japanese subsidiary, Nihon Banyan
    Systems Kabushiki Kaisha (NBSKK). Subsequently, in 1995, the Company and
    Marubeni Corporation entered into an agreement with NTT Technology
    Corporation to sell a minority interest in NBSKK. In 1998, the Company
    contributed $437,000 of additional capital to NBSKK. Pursuant to these
    events, the Japanese companies hold a 30 percent equity interest in NBSKK.
    All assets, liabilities, revenues and expenses of NBSKK are included in the
    consolidated financial statements for the years ended December 31, 1998,
    1997 and 1996. The minority interest in the net loss of NBSKK is deducted
    from net income for the years ended December 31, 1997 and 1996,
    respectively. For the year ended December 31, 1998, revenue and expenses
    were approximately $619,000 and $1,759,000, respectively. For the year ended
    December 31, 1997, revenue and expenses for NBSKK were approximately
    $1,020,000 and $1,621,000, respectively. For the year ended December 31,
    1996, revenue and expenses for NBSKK were approximately $1,321,000 and
    $3,328,000, respectively. The Japanese companies' minority interest in
    NBSKK's assets and liabilities is shown net in the consolidated balanced
    sheet. At December 31, 1998, assets and liabilities for NBSKK were
    approximately $863,000 and $2,873,000, respectively. At December 31, 1997,
    assets and liabilities for NBSKK were approximately $1,540,000 and
    $2,876,000, respectively.

Q. Subsequent Event
-------------------
   On January 11, 1999, the Company announced a strategic alliance with
   Microsoft(R) Corporation to deliver integrated messaging, networking and
   Internet solutions and the collaboration on the design and implementation of
   packaged services, solutions and support offerings based on Microsoft's
   enterprise platform. Under the agreement, Microsoft has committed to
   contribute $10,000,000 over a three-year period for the training of at least
   500 professionals, certain marketing and product development efforts and the
   purchase of 1,750,000 common stock warrants. The first of these three
   payments was received in January 1999 in the amount of $5,900,000. The
   remaining two payments of $2,500,000 and $1,600,000 are to be received on or
   before December 31, 1999 and 2000, respectively. The common stock warrants
   are subject to a three-year lock-up provision, based on continuation of the
   alliance, and have an exercise price of $10.00 per share. If exercised,
   Microsoft's warrants represent approximately 7.5 percent ownership in the
   Company.

36
<PAGE>
 
Report of Independent Accountants
--------------------------------------------------------------------------------

To the Board of Directors and Shareholders
   of Banyan Systems Incorporated:

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Banyan
Systems Incorporated ("Banyan") at December 31, 1998 and 1997 and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of Banyan's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.



                                                PricewaterhouseCoopers LLP
Boston, Massachusetts
January 26, 1999

                                                                              37
<PAGE>
 
Supplementary Data
--------------------------------------------------------------------------------


Financial Data
--------------------------------------------------------------------------------
<TABLE> 
<CAPTION> 



Years Ended December 31,                                1998          1997            1996            1995            1994
--------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
<S>                                              <C>             <C>             <C>             <C>          <C> 
Statement of operations data:
    Revenues
            Software                             $    42,966     $  57,849       $  87,281       $ 105,160     $   118,899
            Services                                  25,743        15,087          16,286          21,059          20,444
            Internet advertising                       6,513           709             170              --              --
            Hardware                                     --            697           1,687           3,464          10,770
            --------------------------------------------------------------------------------------------------------------
                    Total revenues                   75,222         74,342         105,424         129,683         150,113
    Income/(loss) from operations                       725        (16,552)        (19,085)        (34,201)          5,541
    Net income/(loss)                                 1,115        (16,908)        (27,030)        (21,360)          4,987
    Net income/(loss) per share: 
            Basic                                $     0.06      $   (0.97)      $   (1.59)      $   (1.27)     $     0.29
            Diluted                              $     0.05      $   (0.97)      $   (1.59)      $   (1.27)     $     0.27
    Balance sheet data:
            Working capital                      $  10,249       $  (2,732)      $  (1,513)       $  9,534      $   30,602
            Total assets                            56,210          42,928          69,532         106,309         124,960
            Long-term obligations, less current
                    maturities                         --              --               --              --              61
            Total shareholders' equity              18,399          5,077           20,322          44,342          73,879
</TABLE> 


Quarterly Financial Information (unaudited)
--------------------------------------------------------------------------------
<TABLE> 
<CAPTION> 

1998 Quarter Ended                            Dec. 31        Sept. 30         June 30        March 31        
-----------------------------------------------------------------------------------------------------
<S>                                      <C>             <C>             <C>             <C> 
Revenues:
    Software                             $     10,263    $     10,193    $     10,792    $     11,718
    Services                                    8,462           6,688           5,638           4,955
    Internet advertising                        1,757           1,970           1,706           1,080
    -------------------------------------------------------------------------------------------------
           Total revenues                      20,482          18,851          18,136          17,753
Income/(loss) from operations/1/                  668             650            (930)            337
Net income/(loss)1                                830             681            (773)            377
Net income/(loss) per share 
           Basic                         $       0.05    $       0.04    $      (0.04)   $       0.02
           Diluted                       $       0.04    $       0.03    $      (0.04)   $       0.02
       Stock prices:/2/
           High                          $       9.19    $       9.69    $      12.00    $       6.44
           Low                           $       2.94    $       2.38    $       5.50    $       2.88

</TABLE> 

<TABLE> 
<CAPTION> 

1997 Quarter Ended                            Dec. 31        Sept. 30         June 30        March 31        
-----------------------------------------------------------------------------------------------------
<S>                                      <C>             <C>             <C>             <C> 
Revenues:
        Software                         $     13,465    $     14,846    $      13,857   $     16,378
        Services                                4,582           3,702            3,160          3,643
        Internet advertising                      349             294               56             10
        ---------------------------------------------------------------------------------------------
                Total revenues                 18,396          18,842           17,073         20,031
Income/(loss) from operations/3,4/              2,641             888          (13,693)        (6,388)
Net income/(loss)/3,4/                          2,380             769          (13,665)        (6,392)
Net income/(loss) per share
                Basic                    $       0.14    $       0.04    $       (0.79)  $      (0.37)
                Diluted                  $       0.13    $       0.04    $       (0.79)  $      (0.37)
        Stock prices:/2/
                High                     $       3.94    $       2.75    $       2.38    $       5.56

                Low                      $       2.44    $       1.97    $       1.22    $       2.06

</TABLE> 

1.      In the second quarter of 1998, the Company recorded a one-time charge of
        $1,400 related to the acquisition of the MapsOnUs Web site and
        technology from Lucent Technologies Incorporated.

2.      The Company's common stock is traded on the over-the-counter market and
        is quoted on the Nasdaq National Market under the symbol "BNYN". The
        common stock prices are based on the Nasdaq National Market daily
        closing stock price.

3.      In the second quarter of 1997, the Company recorded a charge of $9,700
        related to restructuring the Company.

4.      In the fourth quarter of 1997, the Company recorded a benefit, reversing
        $1,700 of unneeded restructuring reserves from prior charges.

The Company has not paid cash dividends on its common stock and has historically
retained earnings for use in its business. The Company's current line of credit
prohibits the payment of cash dividends without the consent of the lender. The
Company has no present intention to pay dividends. The Company intends to review
its policy with respect to the payment of dividends from time to time; however,
there can be no assurance that any dividends will be paid in the future. On
December 31, 1998, the Company had 12,869 shareholders.

38
<PAGE>
 
Directors and Officers
--------------------------------------------------------------------------------

Directors
---------

William P. Ferry
        Chairman, Chief Executive Officer 
        and President
        Banyan Systems Incorporated

G. Leonard Baker, Jr.
        General Partner 
        Sutter Hill Ventures

John F. Burton
        Managing Director
        Updata Capital, Inc.

David C. Mahoney
        President and Chief Executive Officer
        Dataware Technologies, Inc.

Fontaine K. Richardson
        General Partner
        Eastech Management Company, Inc.

David N. Strohm
        General Partner
        Greylock Ventures Limited Partnership

Robert M. Wadsworth
        Managing Director
        HarbourVest Partners, LLC


Corporate Officers
------------------

William P. Ferry
        Chairman, Chief Executive Officer 
        and President

Richard M. Spaulding
        Vice President and Chief Financial Officer,
        Treasurer and Secretary

Anthony J. Bellantuoni
        Vice President, Human Resources

Robert D. Burke
        Senior Vice President, 
        Worldwide Sales and Services

Alexander D. Crosett, III
        Vice President, Development 
        Chief Technology Officer

Scott Silk
        Senior Vice President,
        Marketing and Business Development


Senior Management
-----------------

James C. Biggs
        Vice President, Channels, Asia Pacific/Japan

Peter Westra
        Vice President, Europe/Middle East/Africa Sales

Thomas Gleason
        Vice President, Sales and Services - Americas

Dean Polnerow
        President, Switchboard Incorporated

                                                                              39
<PAGE>
 
Shareholder Information
--------------------------------------------------------------------------------

Corporate Headquarters
----------------------
Banyan Systems Incorporated
120 Flanders Road
Westboro, Massachusetts 01581-5013


United States Offices
---------------------
San Francisco, California 
Atlanta, Georgia 
Chicago, Illinois 
Overland Park, Kansas
Westboro, Massachusetts
Okemos, Michigan 
Woodbridge, New Jersey
New York, New York
Jenkintown, Pennsylvania 
Westchester, Pennsylvania 
Dallas, Texas 
Houston, Texas
Annandale, Virginia 

International Offices 
---------------------
Melbourne, Australia 
North Sydney, Australia 
Haacht, Belgium 
Ottawa, Ontario, Canada 
Montreal, Quebec, Canada
Crawley, West Sussex, England 
Paris, France 
Munich, Germany 
Tokyo, Japan 
Kuala Lumpur, Malaysia 
Maarssen, The Netherlands 
Singapore, Singapore

Annual Meeting
--------------
The 1999 Annual Meeting will be held on May 13, 1999 at 2:00 P.M. at the
Westboro Marriott Hotel, 5400 Computer Drive, Westboro, Massachusetts 01581.


Form 10-K
---------
Copies of the Banyan Systems Annual Report on Form 10-K are available upon
written request to Investor Relations, Banyan Systems Incorporated, 120 Flanders
Road, Westboro, Massachusetts 01581.


Common Stock
-------------
Banyan Systems common stock is traded over-the-counter on the Nasdaq National
Market ("BNYN").


Independent Accountants
-----------------------
PricewaterhouseCoopers LLP 
Boston, Massachusetts

Legal Counsel
-------------
Hale and Dorr LLP, Boston, Massachusetts


Transfer Agent and Registrar
----------------------------
EquiServe
150 Royall Street
Canton, MA 02021
781-575-4177




Banyan, VINES, StreetTalk, BeyondMail, SideClick, MapsOnUs and SiteMinder are
registered trademarks and Intelligent Messaging, EBR and Switchboard are
trademarks of Banyan Systems Incorporated. Predefined Access Rights for
Undefined Attributes In a Naming Service patent pending. StreetTalk is
a product of Banyan Systems Incorporated and not a product of McCarthy, Crisanti
& Maffei, Inc. Microsoft, Windows and Exchange are registered trademarks and NT
is a trademark of Microsoft Corporation. BigYellow is a registered trademark of
Bell Atlantic Electronic Commerce Services, Inc. AltaVista is a trademark of
Compaq Computer Corporation. Geocities is a trademark of Geocities. Godiva is a
registered trademark of Godiva Chocolatier. Ford is a trademark of Ford Motor
Company. Comcast is a registered trademark and InYourTown is a trademark of
Comcast Corporation. Oblix is a trademark of Oblix, Inc. CommVault Systems is a
registered trademark of CommVault Systems Inc. Other product, company or
organization names cited in this annual report may be trademarks or registered
trademarks of their respective companies or organizations.
Beyond is a wholly owned subsidiary of Banyan Systems Incorporated.


(C) Copyright 1999 
    Banyan Systems Incorporated. 
    All Rights Reserved. Printed in USA.
    Design: Ellis Pratt Design, Boston

40