SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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

                                   FORM 10-KSB

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


                   For the fiscal year ended January 31, 1997

                         Commission file number 0-27776

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

                        GATEWAY DATA SCIENCES CORPORATION
--------------------------------------------------------------------------------
                 (Name of Small Business Issuer in Its Charter)

        ARIZONA                                         86-0527788
------------------------                    ----------------------------------- 
(State of incorporation)                    (I.R.S. Employer Identification No.)

                     3410 East University Drive, Suite 100
                     Phoenix, Arizona 85034 (602) 968-7000
--------------------------------------------------------------------------------
  (Address, including zip code, and telephone number, including area code, of
                          issuer's executive offices)

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

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

                     Common Stock, par value $.01 per share

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days. Yes   No X
                                                             ---  ---
Check if disclosure of delinquent  filers pursuant to item 405 of Regulation S-B
is not contained in this form, and no disclosure will be contained,  to the best
of  registrant's  knowledge,  in  definitive  proxy  or  information  statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
this Form 10-KSB. [X]

Issuer's revenues for its most recent fiscal year:  $27,156,148.

Aggregate  market value of the voting stock held by  non-affiliates  computed by
reference to the price at which the stock was sold, or the average bid and asked
prices of such  stock,  as of a specified  date  within the past 60 days:  As of
October 28, 1997 - $2,248,460.  For purposes of this computation,  all executive
officers, directors and 10% beneficial owners of the registrant are deemed to be
affiliates.  Such  determination  should  not be deemed an  admission  that such
executive officers,  directors or 10% beneficial owners are, in fact, affiliates
of the registrant.

Number of shares  outstanding of each of the issuer's  classes of common equity,
as of the latest  practicable date: As of October 28, 1997 - 2,838,138 shares of
common stock, par value $.01 per share (the "Common Stock").

Documents incorporated by reference:  None.
<PAGE>
                        GATEWAY DATA SCIENCES CORPORATION

                          ANNUAL REPORT ON FORM 10-KSB

                   FOR THE FISCAL YEAR ENDED JANUARY 31, 1997

                                TABLE OF CONTENTS


                                                                            Page
PART I

  ITEM 1.   BUSINESS......................................................     1
  ITEM 2.   PROPERTIES....................................................    16
  ITEM 3.   LEGAL PROCEEDINGS.............................................    16
  ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........    16

PART II

  ITEM 5.   MARKET FOR THE REGISTRANT'S COMMON EQUITY
            AND RELATED STOCKHOLDER MATTERS...............................    17
  ITEM 6.   SELECTED FINANCIAL DATA; MANAGEMENT'S DISCUSSION
            AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
            OF OPERATIONS.................................................    18
  ITEM 7.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................    26
  ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
            ACCOUNTING AND FINANCIAL DISCLOSURE...........................    26

PART III

  ITEM 9.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT;
            COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES
            EXCHANGE ACT OF 1934..........................................    28
  ITEM 10.  EXECUTIVE COMPENSATION........................................    30
  ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
            AND MANAGEMENT................................................    35
  ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................    37

PART IV

  ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K..............................    38

SIGNATURES     ...........................................................    39

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................   F-1
                                        i
<PAGE>
                                     PART I

ITEM 1.  BUSINESS

General

         The  Company  designs,  develops,   markets,  and  implements  software
products and provides related customer support services for retail  applications
and warehouse  automation.  The Company utilizes its knowledge and understanding
of  retail  and  warehouse  operations  as well as its  extensive  expertise  in
specific  software  applications,  systems,  and networking to develop  specific
product  solutions  that  address the needs of its  customers.  The Company also
provides   full-service  product  installation,   customization,   modification,
maintenance, and training in connection with sales of its software products. The
Company's application software products include modular systems developed by the
Company  and,   when   necessary,   product   modifications   that  the  Company
custom-engineers in order to meet the unique requirements of specific customers.
The Company designs each of its software  products and enhancements to integrate
quickly and efficiently with each of its other software products as well as with
software  developed by other vendors.  The Company  approaches  each  customer's
requirements  from  the  customer's  perspective,  strives  to  gain a  thorough
understanding  of the  customer's  needs,  and  applies  specific  technologies,
including  advanced software  development  tools, in order to craft an efficient
and cost-effective solution to the customer's needs.

         Founded in 1985,  the  Company  initially  pursued a  business  plan of
integrating  solutions for customers  utilizing  software and hardware  products
developed by third  parties,  primarily  International  Business  Machines Corp.
("IBM").  See Item 1, "Business -- Resale of Third-Party  Products." The Company
believes that its dependence on the resale of third parties' products  adversely
affected the Company's competitive position, gross profit margins, and operating
results.  As a result,  in 1991 the Company  first began to change its  business
strategy to emphasize  the  development  and sale of its own software  products.
Despite a lack of adequate capital prior to the completion of its initial public
offering in March 1996, the Company has changed its focus from selling  products
developed by others to the  development  and sale of its own software  products.
The Company has  utilized a  substantial  portion of the proceeds of its initial
public  offering to  accelerate  significantly  its  emphasis on the sale of its
recently  developed  software  products  and  the  development  and  sale of new
software products, including two open architecture, client/server-based software
systems introduced in early 1997.

         Approximately  56% of the  Company's  revenue in the fiscal  year ended
January  31,  1997 was  derived  from the resale of IBM  hardware  and  software
products.  The Company's  reseller agreement with IBM expired in accordance with
its terms in July 1997.  As a result,  the  Company  anticipates  that  software
revenue will  represent a  significantly  increased  percentage of total revenue
beginning in fiscal 1998. See Item 6,  "Management's  Discussion and Analysis of
Financial Condition and Results of Operations."

Strategy

Emphasis on Developing Innovative Products with Market-Leading Functionality

         The  Company  continually  strives  to design  and  develop  innovative
software  products  that  deliver  outstanding   functions,   effectively  solve
difficult problems,  and grow with the Company's customers.  The Company intends
to continue its emphasis on market  research and  technological  development  in
order to determine the new products and features that will be in greatest demand
among its  customers  as well as to  develop  and  market on a timely  basis new
products and  features  that  satisfy  customer  demand and that are superior to
comparably priced products offered by its competitors. In addition to developing
pre-packaged  software  solutions,  the Company also  maintains  the capacity to
customize its software  products to achieve full  functionality  and to maximize
system utility in order to meet the  specialized  business  requirements  of its
customers.  The Company often refines these specialized  features to develop new
add-on  modules  that make its base  products  more robust and  appealing to new
customers.
<PAGE>
Combining Business Knowledge with Software Expertise

         The  Company  focuses on  specific  business  segments  and applies its
knowledge of those  segments  with its  extensive  software  expertise to create
specific  commercial  application  software that addresses the complex  business
requirements  of  its  customers.   In  addition  to  their  advanced   software
development  expertise,  the Company's  personnel possess extensive knowledge of
and experience in the retail and warehouse industries.  The Company currently is
concentrating  its  resources on developing  software  products that improve and
integrate  operational  decision-making  processes  and make useful  information
available throughout a business enterprise. The Company also places considerable
emphasis on ensuring that its software products integrate easily and effectively
with other software  applications  used by its customers.  The Company  believes
that, by consistently  applying its knowledge of specific  business  segments to
the development of flexible,  feature-rich  commercial  application software, it
will be able to capitalize  on its expertise in retail and warehouse  management
systems and participate in what it believes is a rapidly growing and potentially
large market.

Develop Software Products in Java(TM)

         The  Company  believes  that  the  Java(TM)  programming  language  and
environment developed by Sun Microsystems,  Inc. represents a fundamental change
in the  software  industry  paradigm.  Java(TM)  offers a number of  benefits to
customers of the Company's  products,  including  platform  independence,  which
means that  software  written in  Java(TM)  allows  the  customer  to chose from
virtually all major hardware platforms and all major computer operating systems;
reduction or elimination of complexities associated with distributing updated or
corrected  versions of software  throughout  an  enterprise;  providing a single
standard  for  connecting  software  objects  (the  building  blocks  from which
software  products are  assembled)  that spans all desktops and all servers that
support  Java(TM);  and support of both traditional PC client desktop  platforms
and the new network computer client desktop platforms.

Focus on Customer Service

         The Company seeks to provide  outstanding  customer  service  levels in
order to differentiate the Company from its competitors in the marketplace.  The
Company provides a range of services to its customers,  including implementation
and consulting services,  software maintenance services, and help desk services.
The  Company  strives to exceed  its  customers'  expectations  in each of these
service  areas.  The Company  supports  this  strategy by setting  service level
objectives  for managers,  by providing  training and  recognition  programs for
employees, and through its ongoing quality and customer satisfaction measurement
systems.

Software Products

         The Company's  primary software product lines currently  consist of the
Transact(TM)   Point-of-Sale   System   ("Transact"),    the   MarketBuilder(TM)
Relationship and Database Marketing System ("MarketBuilder"),  the Gift Registry
System  ("Gift  Registry"),   and  Kinetics(TM)  Warehouse  Automation  Software
("Kinetics").  License fees for Kinetics  accounted for  approximately 8% of the
Company's  total revenue and virtually  all of the  Company's  software  license
revenue during fiscal 1997.

Transact Point-of-Sale System

         In January  1997,  the Company  introduced  the Transact  Point-of-Sale
System for specialty and general  merchandise  retailers.  Transact is the first
point-of-sale   software   product   developed   in   Java(TM),   which   is   a
platform-independent,  object oriented  programming  environment that provides a
wide range of flexibility  and value to end users. As a result of the high level
of marketplace  interest in Transact,  the Company has made Transact its primary
strategic focus and is devoting substantial  resources to further development of
and  refinements  to Transact.  As of October 28, 1997, the Company has achieved
limited  sales of Transact and  anticipates  that Transact will be available for
general  distribution  in the third  quarter of calendar  1997.  There can be no
assurance,  however, that the Company will be able to realize meaningful revenue
from sales of Transact in the future.
                                        2
<PAGE>
         Because it has been developed in Java(TM), Transact's open architecture
design enables the Company's  customers to choose the optimal in-store  hardware
and software  combination for their needs,  including systems developed by major
point-of-sale and computer manufacturers,  and to take advantage of new hardware
and software technologies that may be developed in the future. Transact's object
oriented architecture enables the system to grow and adapt along with the users'
business.  In  addition,  Transact  features  open  database  connectivity  to a
relational  database,  which  enables the user to quickly  and easily  store and
access point-of-sale information and to ensure data integrity.

          Transact  features  a  graphical,   intuitive   transaction  set  that
simplifies  operation  by  cashiers,   sales  personnel,   and  store  managers.
Transact's  standard features  currently include customer  information  capture;
price lookup with date-sensitive pricing; start-of-day and end-of-day procedures
with till count functions;  function level and employee group security; training
mode;  sales,   returns,   and  exchanges;   reporting   functions;   item-  and
transaction-level  discounts  and tax  adjustments;  and item void,  transaction
cancel, and post-sale void.

          Transact integrates with the Company's "Credit Authorization" software
module,   which   provides   base  support  for   integrated   dial-out   credit
authorization.  The module  requires only one  telephone  line and modem for all
credit  transactions  performed at all of the  registers in a store.  The module
creates a data file of credit transactions for electronic  settlement at the end
of the day.  Transact also integrates with the Company's  MarketBuilder  System,
which is described below, and the Company's Sales Reporter, which is a graphical
inquiry and sales  reporting query tool that store personnel can use to retrieve
register and cashier activity and sales information on sales persons.

MarketBuilder Relationship and Database Marketing System

          In January 1997, the Company introduced the MarketBuilder Relationship
and Database Marketing System for use in the retail  marketplace.  MarketBuilder
enables  retailers  to  capture,  compile,  and  process a  database  containing
customer  profile  information  in order to expand store  traffic and profits by
encouraging  customers  to shop at the  retailers'  stores more  frequently,  by
persuading  customers  to spend  more  money on each  visit,  and by  persuading
customers to purchase items with higher profit margins.

          MarketBuilder assists retailers in (i) identifying their customers and
the type of  transactions  or  purchases  that  individual  customers  make on a
regular basis;  (ii) evaluating their customers based upon a variety of factors,
including   geographic,   demographic,   and  purchasing  activity  data;  (iii)
interacting  with  those  customers  by a  variety  of  means  initiated  by the
retailer,  such as direct  mail or  telemarketing;  and (iv)  building  customer
loyalty  through  special  promotional  incentives,  such  as  "frequent  buyer"
programs.  MarketBuilder  also allows  retailers  to compile and analyze data to
determine the promotional methods that most effectively stimulate sales.

          MarketBuilder operates on a client/server configuration in conjunction
with a wide variety of servers and operating systems. In addition, MarketBuilder
interfaces  with the Company's  retail  merchandising  system in order to permit
broader data  integration  and increased  flexibility and  functionality.  As of
October 28, 1997, the Company has achieved limited sales of MarketBuilder. There
can be no  assurance,  however,  that  the  Company  will  be  able  to  realize
meaningful revenue from sales of MarketBuilder in the future.

Gift Registry System

         The Company's  Gift  Registry  System is a  sophisticated  program that
actively tracks gift registrant  information and gift  preferences for weddings,
birthdays,   anniversaries,   and  other  occasions.   Gift  Registry   features
menu-driven  functions that enable the registrant to use either a PC terminal or
a hand-held  portable data terminal to record gift  preferences  by scanning bar
code product labels on store  merchandise and entering  additional  information,
such as  quantities  and color  desired.  The  Company  recently  enhanced  Gift
Registry with Microsoft  Merchant  Server(TM)  technology to enable retailers to
develop a visually  exciting online  "storefront" to enable remote gift shopping
via the Internet. Out-of-town relatives and friends who otherwise would not have
access to a retailer's 
                                       3
<PAGE>
stores can use standard  browser  software to locate and select the registrant's
preferred  gift  items.  Gift  Registry  enables  online  shoppers  to include a
personalized  note to be enclosed with the gift and to complete the  transaction
with an approved credit card payment.

         Gift Registry  provides an application  program  interface that enables
the retailer's  point-of-sale  system to automatically  update information about
purchases and returns of the  registrant's  preference  items in order to reduce
duplicate gift  purchases and to optimize  inventory  quantities.  Gift Registry
supports a unique rebate  program that  accumulates  a predefined  percentage of
total gift purchases and rewards the registrant  with a gift  certificate.  Gift
Registry  also enables  store or corporate  management  to produce  standard and
custom-designed  comprehensive  reports on gift  registry  performance  based on
criteria, such as type of registry,  specific merchandise preferences,  value of
items requested,  and names of in-store  consultants.  Gift Registry operates on
the Microsoft WindowsNT(TM) server platform.

Kinetics Warehouse Automation Software

          The Company's Kinetics Warehouse  Automation Software (formerly called
"Warehouse  Control  System/400")  enables  warehouse  operators to  prioritize,
direct,  verify,  and measure all of the operations  that occur within a retail,
wholesale distribution, or manufacturing warehouse facility. Kinetics utilizes a
dynamic  prioritized  task  management  logic structure that  facilitates  rapid
movement of goods throughout a warehouse,  increases the efficiency of warehouse
employees,  and improves  warehouse  space  utilization.  Kinetics  supports all
functions  within the warehouse and typically  interfaces  with an external host
computer in order to transmit receiving,  shipping,  and inventory  information.
Kinetics  operates on the IBM AS/400 family of computers and utilizes the OS/400
operating system and DB2/400 integrated relational database.

          Kinetics   provides   the   capability   to   reduce   operating   and
administrative  costs by (i)  decreasing  labor  costs  and  improving  employee
productivity;  (ii) improving  merchandise  flow; (iii) reducing clerical costs;
(iv) automating manual operations,  such as cycle counting;  (v) improving space
utilization  in the  warehouse  and in  outbound  vehicles;  and  (vi)  reducing
inventory  losses  and  excess   inventory.   Kinetics  also  enables  warehouse
operations to improve  customer  service by increasing  order accuracy rates and
prioritizing and promptly filling customer orders.

          Kinetics   consists  of  modules  that  regulate  the  daily  flow  of
merchandise into, out of, and within the warehouse; perform inventory functions,
such as cycle counting and physical inventory adjustment procedures; and provide
administrative and management activities,  such as downloading  information from
and uploading  information to the business's  host computer  system,  performing
database administration and file maintenance tasks, and printing system reports.
The  Company  or  the  customer  can  configure  Kinetics  to  support  multiple
distribution  centers by setting enterprise and warehouse  parameters that model
each unique  operating  environment  and to provide  full  support for  wireless
communications networks,  barcode labeling,  scanning, and integration with most
material handling systems. The Company consults with each customer to design and
implement  modifications to the Kinetics base system in order to tailor Kinetics
to the customer's specific needs.

          In July  1997,  the  Company  entered  into an  arrangement  with Info
Systems of North Carolina, Inc. ("ISI") with respect to future sales of Kinetics
and related  products and services  (the  "Covered  Products") to certain of the
Company's customers (the "Designated  Customers").  Under this arrangement,  the
Company has ceased selling the Covered Products to the Designated Customers, and
the Company and ISI have entered into a reseller agreement pursuant to which ISI
will have the right to resell the Covered Products to the Designated  Customers.
The  arrangement  requires  ISI to pay to the  Company  50% of  ISI's  operating
profits (as defined)  from sales of the Covered  Products  during the  four-year
term of the arrangement.  The Company has the right to terminate the arrangement
and resume selling the Covered Products to the Designated Customers in the event
that  ISI's  payments  to the  Company  are  less  than  $50,000  in each of two
consecutive  quarterly periods. In addition,  ISI has the right to terminate the
arrangement upon written notice to the Company, provided that ISI ceases selling
the Covered Products to the Designated Customers for a period of two years after
such termination. As of the date of this
                                        4
<PAGE>
Report,  this  arrangement  has not  provided  the Company  with any  meaningful
revenue,  and there can be no assurance that the Company will derive significant
revenue from this arrangement in the future.

Resale of Third-Party Products

          In  conjunction  with and in addition to the sale of its own  software
products, the Company resells,  installs, and supports a variety of hardware and
software  products  developed  by third  parties,  including  computer  systems,
wireless terminal  networks,  bar code printers and scanners,  and point-of-sale
and other software.  The Company resells all  third-party  products  pursuant to
agreements with the products'  manufacturers.  These agreements generally permit
the Company to sell the third-parties'  products to any unaffiliated end user of
the  Company's  and other  manufacturers'  software  products  within the United
States. Sales of third-party products accounted for approximately 82% and 75% of
the  Company's  total  revenue for the fiscal  years ended  January 31, 1996 and
1997, respectively. Sales of IBM hardware and software represented approximately
66% and 56% of the  Company's  total  revenue for the fiscal years ended January
31, 1996 and 1997,  respectively.  The  Company's  reseller  agreement  with IBM
expired in  accordance  with its terms in July 1997.  As a result,  the  Company
anticipates that sales of third-party products will decrease  significantly as a
percentage  of  revenue  beginning  in fiscal  1998.  See Item 6,  "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

Customers

          The Company has designed  Transact,  MarketBuilder,  and Gift Registry
for  specialty  retailers.  The  Company  has  designed  Kinetics  for  sale  to
retailers,  distributors,  and manufacturers with warehouse operations involving
at least 250,000 square feet of space and at least 40 employees.  In addition to
Kinetics,  the Company has designed and installed  custom  warehouse  automation
software at several major distribution sites in the United States. The following
sets forth representative customers for Transact,  MarketBuilder,  Kinetics, and
other warehouse automation software.

<TABLE>
<CAPTION>
              Customer                              Description                                 Product
              --------                              -----------                                 -------

<S>                                         <C>                                <C>
The Walking Company..................       Specialty retailer                 Transact
Samsonite............................       Specialty retailer                 Transact
Burlington Coat Factory..............       Specialty retailer                 MarketBuilder
Baskin Robbins.......................       Food manufacturer,                 Kinetics in five warehouses
                                            distributor, and retailer
SuperAmerica.........................       Convenience store chain            Kinetics in two warehouses
Brookstone...........................       Specialty retailer                 Kinetics in one warehouse
TJX Co. (T.J. Maxx stores)...........       Discount fashion retailer          Custom warehouse automation software
                                                                                 in four warehouses
CSK Automotive Corp..................       Auto parts retailer                Custom warehouse automation software
                                                                                 in three warehouses
Consolidated
  Communications Inc.................       Telecommunications                 Warehouse and materials management
                                            company                              software
</TABLE>

          Sales to Consolidated  Communications,  Inc.  ("CCI") and Factory Card
Outlet,  Inc.  accounted for  approximately  31% and 21%,  respectively,  of the
Company's total revenue in the year ended January 31, 1997. Sales to CCI and TJX
Co.  accounted for  approximately  18% and 12%,  respectively,  of the Company's
total revenue in the year ended  January 31, 1996.  Because of the nature of the
Company's  business  operations,  the Company  anticipates  that  customers that
represent  more  than 10% of total  revenue  will  vary  from  period  to period
depending upon the placement of significant  orders by a particular  customer or
customers in any given year.
                                        5
<PAGE>
Customer Services and Support

          The Company has  established  high-quality  systems  installation  and
after-sale customer support as critical customer service priorities. The Company
assigns an account manager to each customer immediately after the execution of a
license agreement. The account manager works closely with the customer to ensure
that the optimal system  solution is designed and properly  integrated  into the
customer's business organization.  The Company provides  implementation services
teams  consisting of business  consultants  and software  developers who conduct
project management,  implementation  consulting,  and training at the customer's
site. Following  installation and implementation,  the account manager continues
to work closely  with the  customer to ensure that the system has been  properly
integrated into the customer's  business,  to offer consulting services designed
to enable the customer to fully utilize the system,  to work in conjunction with
the customer to develop  enhancements  or specialized  features that address the
customer's  needs,  and to suggest system  modifications  or upgrades that would
further  benefit the  customer.  The Company also provides a variety of training
services  designed  to enable  its  customers  to  utilize  fully the  Company's
software  applications.  The Company's  specialists  conduct  training  sessions
ranging from introductory  courses to advanced  techniques  courses in using the
Company's products.

          The  Company  provides  maintenance  and  support  services  under its
license  agreements  without  charge  for 90  days  following  installation  and
renewable,  annual  maintenance  contracts  thereafter.  Annual maintenance fees
generally equal 15% of the then-current list price of the products under license
by the customer.  A staff of qualified  customer  support  specialists  provides
toll-free  telephone  technical  support and advice.  The Company also  provides
error  corrections  and any product  enhancements  that it  releases  during the
maintenance period.

New Product Development

         The Company recognizes that timely development of new software products
as well  as  enhancements  to its  existing  software  applications,  each  with
functions and features that distinguish the Company's products from those of its
competitors,  represents a critical factor in determining the Company's  ongoing
success.  The  Company's  engineering  staff  consists  of  highly  trained  and
experienced  software  professionals  who  focus  on  providing  and  supporting
high-quality,  user-friendly software systems and related products and services.
The availability of in-house software and systems  development  expertise at the
Company's  facility in  Phoenix,  Arizona  provides  the  Company  with  product
control,  permits  faster  turnaround  and  reaction  time  to  changing  market
conditions, and provides a solid base of maintenance and support services to end
users.  Product  development teams work in cooperation with the Company's sales,
marketing,  support,  and customer service personnel to assess market demand, to
establish product development  priorities,  and to evaluate the effectiveness of
new product solutions.  The Company also collaborates with selected customers to
develop new software  solutions that the Company  believes will address specific
demands of the marketplace.  In addition,  the Company has established  channels
for customer feedback and continually  evaluates responses to determine customer
satisfaction  with  existing  products and demand for  enhancements  to existing
products  or  for  new   software   applications.   The  Company   currently  is
concentrating the majority of its product development  resources towards further
development   of  and   refinements   to  Transact  and  to   developing   other
Java(TM)-based software products.

          The Company's  product  development staff consisted of 34 employees as
of October 28, 1997.  The  Company's  product  development  expenses  consist of
internal product development costs, expenses for customer-funded  projects,  and
fees  paid  for  external  product  development.  The  Company's  total  product
development  expenses were  approximately $2.1 million,  $2.9 million,  and $3.7
million  in  the  fiscal  years  ended  January  31,  1995,   1996,   and  1997,
respectively.  The  Company  historically  has  expensed  all  of  its  software
development  costs.  See  Item  6,  "Management's  Discussion  and  Analysis  of
Financial  Condition and Results of Operations." The Company intends to continue
to increase its internal product  development efforts as part of its strategy to
provide comprehensive software solutions to its customers.
                                        6
<PAGE>
Sales and Marketing

          The Company markets  software  products and related  customer  support
services and hardware  primarily to retailers and to warehouse and  distribution
center operators in the continental  United States through a direct sales force.
The Company's  marketing managers work in conjunction with the Company's product
development staff to develop product specifications and requirements, assess the
competitive  strengths of the Company's products,  determine strategic marketing
focus, and provide strategic marketing support. The Company's account executives
develop leads through ongoing customer communications,  trade shows and industry
conventions, requests for proposals ("RFPs"), requests for information ("RFIs"),
and  referrals  from  existing  customers or sales  representatives  of hardware
vendors.  One or more product  specialists  support each account executive.  The
product  specialists  provide presale marketing support consisting of trade show
support,  product  demonstrations,  and support in preparing  sales proposals or
responses to RFPs and RFIs. The Company also employs  marketing  representatives
who conduct  marketing efforts designed to sell add-on  enhancement  products to
existing customers.  The Company has established strategic alliances in the form
of lead  referral and  informal  co-marketing  arrangements  with vendors of the
hardware  that the Company  installs in  conjunction  with sales of its software
applications.  During fiscal 1997, the Company used a portion of the proceeds of
its initial public offering to hire additional sales and marketing personnel, to
develop and  implement  new  advertising  campaigns,  and to develop and produce
collateral   marketing   materials  such  as  sales   brochures.   See  Item  6,
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations."

License Agreements

          In recent  years,  the Company has  changed its  business  strategy to
emphasize the development of its own software  products.  The Company  generally
grants  nonexclusive,  nontransferable  perpetual licenses that limit the use of
its software  products to a designated  user,  site, or central  processing unit
("CPU").  The Company charges license fees that vary depending upon (i) the type
of software  products  subject to the license;  (ii) whether the product will be
installed on a client/server  environment or midrange platform; (iii) the number
of users  (in the case of  client/server  installations)  or the CPU  processing
power (in the case of midrange  installations);  and (iv) the number and type of
modules  purchased.  Each license agreement includes an initial 90-day period of
maintenance and support services  without  additional  charge.  The customer may
purchase from the Company renewable annual contracts for maintenance and support
services for a fee of approximately  15% of the  then-current  list price of the
product under license to the customer. The Company also charges a standard "time
and materials" rate for software  programming  services required to write custom
modifications to Transact, MarketBuilder, Gift Registry, or Kinetics in order to
tailor the systems to a particular customer's business operations.

Competition

          The market for software  products  such as the  Company's is intensely
competitive and is  characterized  by rapid changes in technology and user needs
and the frequent  introduction  of new products  and product  enhancements.  The
Company's competitors and potential market entrants range from small,  privately
held firms to large national and international organizations with more extensive
technical  staffs  and  technological  resources,  larger  marketing  and  sales
organizations,  and greater  financial  resources than the Company.  The Company
also competes with software  applications  developed by the internal  management
information system departments of its potential customers. The Company, however,
believes  that  potential   customers   increasingly   will  purchase   software
applications  from outside  vendors,  including  the Company,  as such  products
become more widely available and the cost savings of such products become better
demonstrated.

          The Company competes  primarily on the basis of the flexibility,  ease
of   use,   application   features,    customization   capabilities,    platform
configurations,   and  prices  of  its  software  products;  its  knowledge  and
experience  in  retail  and  warehouse  management  systems;  the  depth  of its
technical  skills,  its  responsiveness  to customer  needs,  and its ability to
achieve desired results; and the quality of its technical support services.  The
Company believes that it competes  favorably with respect to these factors.  The
Company's ability to compete successfully will depend
                                        7
<PAGE>
upon its  ability to respond  promptly  and  effectively  to  customer  demands,
technological changes, and competitive innovations,  to develop new products and
services,   to  attract  new  customers  and  to  deliver  and  support  product
enhancements  to  existing  customers,  and  to  attract  and  retain  qualified
technical sales personnel.  The Company's  Kinetics software  currently operates
only on the IBM AS/400 midrange platform and competes with products that operate
on client/server environments such as Unix or WindowsNT.

Proprietary Rights and Licenses

          The Company  considers its software to be proprietary  and attempts to
protect it with a combination  of copyright,  trademark,  and trade secret laws,
nondisclosure and other contractual agreements with employees and third parties,
and technical measures designed to protect its proprietary  technology.  Despite
these precautions, there can be no assurance that the steps taken by the Company
will be adequate to prevent  misappropriation  of its proprietary rights or that
third parties will not independently  develop equivalent or superior technology.
However,  the  Company  believes  that,  as  a  result  of  the  rapid  pace  of
technological   change  in  the  software  industry,   trademark  and  copyright
protections  are less  significant to the Company's  success than other factors,
such  as  the  knowledge  and  experience  of  the  Company's  personnel,   name
recognition, and ongoing product development and support.

          The Company generally grants nonexclusive,  nontransferable  perpetual
licenses that limit the use of its software products to a designated user, site,
or computer. In certain  circumstances,  the Company makes source code available
for specific  products  and/or  enters into source code escrow  agreements.  The
providing of source code may  increase the  likelihood  of  misappropriation  or
other misuse of the Company's intellectual property.

          The  software   industry  is  characterized  by  rapid   technological
development and frequent introductions of new products and features. In order to
remain competitive,  the Company and other software developers  continually find
it necessary to develop products and features that provide  functions similar or
superior  to  those  of  other  industry  participants,  often  with  incomplete
knowledge of whether patent or copyright protection may have been applied for or
obtained by other parties.  Although the Company  believes that its products and
technology do not infringe upon the proprietary  rights of others,  there can be
no assurance that third parties will not assert  infringement claims against the
Company in the future.  The defense of such claims,  fees paid in  settlement of
such claims,  or costs  associated with licensing rights to use the intellectual
property  of others or to  develop  alternative  technology  may have a material
adverse effect on the Company's operations.  See Item 1, "Special Considerations
- Dependence Upon Proprietary Technology; Intellectual Property Claims."

Employees

          As of October 28, 1997,  the Company  employed a total of 90 full-time
employees and one part-time  employee at its offices in Phoenix,  Arizona.  This
includes  34 persons in software  engineering  and  product  development,  45 in
sales,  marketing,  and technical support,  and 12 in administration,  including
executive  personnel.  The Company considers its relationship with its employees
to be good,  and none of its employees  currently are  represented by a union in
collective bargaining with the Company.
                                        8
<PAGE>
                             SPECIAL CONSIDERATIONS

          The following  factors,  in addition to those  discussed  elsewhere in
this Report,  should be carefully  considered in evaluating  the Company and its
business.

Disclaimer of Audit Opinion

          The Company's financial statements for the year ended January 31, 1997
were prepared assuming that the Company will continue as a going concern.  Those
financial  statements  report that the Company (i) had  negative  cash flow from
operations  of  $2,612,680  during the year ended  January 31, 1997,  (ii) is in
default of certain  terms of its line of credit  agreement,  (iii) does not have
readily  available  financing,  (iv) is engaged in  material  litigation  with a
significant customer,  (v) recorded a net loss of approximately  $702,000 during
the six months ended July 31, 1997,  and (vi) has not yet  generated  sufficient
revenue from sales of its software products to fund its ongoing  operations.  In
addition,  the Company's reseller agreement with IBM expired in July 1997. These
factors raise  substantial  doubt about the  Company's  ability to continue as a
going  concern.  As a result  of the  factors  described  above,  the  Company's
auditors  have  reported to the Company that they are unable to express,  and do
not express, an opinion on the Company's financial statements for the year ended
January 31, 1997. The Company  currently is taking steps intended to address the
factors described above,  including seeking additional sources of debt or equity
financing. There can be no assurance, however, that additional financing will be
available to the Company on terms that are  acceptable to the Company.  See Item
1, "Special  Considerations - Capital  Requirements"  and Item 6,  "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

Certain Factors Affecting Operating Results

          The  Company's  operating  results are  affected by a wide  variety of
factors that could adversely impact its total revenue and  profitability.  These
factors,  many of which are  beyond  the  control of the  Company,  include  the
Company's  ability to identify  market  segments  that have  significant  growth
potential and to  successfully  market its products and services to those market
segments;  the Company's ability to maintain the software design and development
capabilities  necessary to design and produce  innovative and desirable products
on a timely and  cost-effective  basis;  the  Company's  success in  maintaining
customer satisfaction with its products;  the Company's ability to establish and
maintain strong and long-lasting relationships with the independent hardware and
software  vendors that supply the various  components that support its products;
the level and timing of orders placed by customers that the Company can complete
in a  quarter;  customer  order  patterns  and  seasonality;  the  length of the
Company's  sales  cycle;  delays  and other  risks  associated  with  customers'
budgetary constraints, internal authorization reviews, and program specification
development and acceptance  procedures  generally  associated with large capital
expenditures;  unanticipated postponement or cancellation of significant orders;
changes in product mix, professional services, and the level of expenses related
thereto; the performance and reliability of the software  applications  designed
and  marketed by the Company;  the life cycles of the  Company's  products;  the
ability  of  the  Company  to  deliver,  install,  and  integrate  its  software
applications and product  components in an efficient,  timely,  and high-quality
manner; the availability and cost of computer hardware,  equipment, and supplies
required  to  support  the  Company's  software  applications;   the  timing  of
expenditures in  anticipation of orders;  the cyclical nature of the businesses,
industries,  and  markets  served by the  Company;  technological  changes;  the
introduction  of new products by  competitors;  and  competition and competitive
pressures on prices which, among other things, may decrease gross margins.

          The Company's ability to increase its software development and systems
integration capacity in order to meet customer demand and maintain  satisfactory
installation  and  integration  schedules  will be an  important  factor  in its
long-term  prospects.  The  business  segments  that  certain  of the  Company's
products  serve suffer  periodic  slowdowns as a result of general  economic and
other conditions. A slowdown in demand for the Company's products as a result of
economic  or  other  conditions  in  markets  served  by the  Company  or  other
broad-based factors would adversely affect the operating results of the Company.
The Company will be required  to obtain  additional  capital to fund its planned
growth in the  future,  particularly  to provide  funds  required to finance the
Company's
                                        9
<PAGE>
planned software  development programs and increased sales and marketing efforts
or to finance acquisition  opportunities that may arise in the future,  although
the Company  currently has no  acquisition  targets.  Potential  sources of such
capital may include the proceeds  from the exercise of  outstanding  options and
warrants, bank financing,  strategic alliances,  and additional offerings of the
Company's equity or debt securities. There can be no assurance such capital will
be available on acceptable terms from these or other potential sources,  and the
lack of such capital could have a material adverse effect on the Company.

Change in Product Mix

         Historically,  the  Company has  derived a  substantial  portion of its
revenue from the sale of hardware and software  developed by others. The Company
has changed  its  business  strategy to  emphasize  the  development  of its own
software products in an effort to increase the relative percentage of revenue it
derives from sales of such  products.  The Company has  successfully  introduced
Kinetics, a proprietary  warehouse management software product, and has achieved
a  meaningful  level of revenue  with this  product.  In  addition,  the Company
recently has introduced  Transact,  a Java(TM)-based  point-of-sale  system, and
MarketBuilder,  a relationship  and database  marketing  system.  Sales of these
products  have not  been  significant  to date,  however,  and  there  can be no
assurance that either product will achieve market acceptance in the future.  The
Company also intends to continue to develop and market new software products and
services to address  customer  needs and  changes in  computing  technology  and
methodology.  There can be no assurance,  however, that the Company will be able
to  successfully  complete  the  transition  of its  business  focus,  that  the
Company's   internally   developed   products  will  achieve   increased  market
acceptance,  that the Company  will be able to develop new products and services
in a timely and cost-effective  manner, or that such products that are developed
will be accepted in the  marketplace.  See Item 1,  "Special  Considerations  --
Dependence  on New Products and  Technologies"  and "Special  Considerations  --
Dependence  on  Midrange  Computer  Technology."  The  failure of the Company to
successfully  complete the change in its business  focus,  to develop and market
its own software products,  and to overcome the loss of revenue from the sale of
hardware and software products developed by others could have a material adverse
effect on the Company.

Dependence on New Products and Technologies

          The  Company   operates  in  an  industry  that  is  characterized  by
fast-changing  technology.  As a result,  the Company will be required to expend
substantial  funds  for and  commit  significant  resources  to the  conduct  of
continuing product  development,  including research and development  activities
and the engagement of additional engineering and other technical personnel.  Any
failure by the Company to  anticipate  or respond  adequately  to  technological
developments, customer requirements, or new design and production techniques, or
any  significant  delays in product  development or  introduction,  could have a
material adverse effect on the operating results of the Company.

         The  Company's  future  operating  results will depend to a significant
extent  on  its  ability  to  identify,  develop,  and  market  enhancements  or
improvements  to existing  software  applications  as well as to  introduce  new
product lines that compare favorably on the basis of time to introduction, cost,
and performance  with the product lines offered by  competitors.  The success of
new product lines depends on various  factors,  including  proper market segment
selection, utilization of advances in technology,  innovative development of new
product concepts,  timely completion and delivery,  efficient and cost-effective
features, and market acceptance.  The success of the Company's new product lines
also  will  depend to a  significant  extent on  marketplace  acceptance  of the
Java(TM)  programming  language  and  software  environment,  which  is not  yet
assured.  Because of the complexity of the design and  implementation  processes
required by the Company's products,  the Company may experience delays from time
to time in completing the design and  implementation of improvements to existing
product lines or the  introduction of new product lines. In addition,  there can
be no assurance that any new product lines will receive or maintain  customer or
market  acceptance.  The Company's future  operating  results would be adversely
affected in the event that it is unable to design and implement  enhancements to
existing product lines or introduce new products on a timely and  cost-effective
basis. See Item 1, "Business -- Software Products."
                                       10
<PAGE>
          Complex software programs,  such as those developed by the Company and
incorporated  into  its  products,   often  encounter   development  delays  and
occasionally  contain errors that are discovered only after the product has been
installed  and  used  by many  different  customers  in a  variety  of  business
operations. Significant development delays in the future may result in increased
product  development  costs,  delays in market  acceptance,  loss of sales,  and
reduction of market  share,  which could have a material  adverse  effect on the
Company's operating results.  Although the Company conducts extensive testing of
the software programs  included in its products,  there can be no assurance that
the Company will successfully detect and eliminate all programming errors in its
products  prior  to  shipment.   Significant   programming  errors  in  software
applications  could require  substantial  design  modifications  that may create
delays in product  introduction and shipment and that could result in an adverse
impact on the Company's goodwill as well as on its operating results.

Management of Change in Business

          The Company  currently is experiencing a period of significant  growth
in the development and sale of its software  products.  The Company's ability to
manage  effectively  this change in its business  operations  will require it to
enhance  its  operational,  financial,  and  management  systems;  to expand its
facilities  and  equipment;  and  to  successfully  hire,  train,  and  motivate
additional employees, including the technical personnel necessary to develop the
Company's  software  applications  and to integrate  new  software  systems with
evolving hardware technologies. The failure of the Company to manage effectively
the change in its  business  focus could have a material  adverse  effect on the
Company.

Dependence on IBM Midrange Computer Technology

          The Company's  Kinetics software product currently  operates solely on
IBM AS/400 midrange computers  utilizing IBM's OS/400 operating system. To date,
the Company has derived  substantially  all of its  software  revenue  from this
AS/400 application.  In recent years, however, business organizations have begun
utilizing alternative computing platforms, such as client/server networks, local
area  networks,  work  stations,  and PCs,  to operate  large  portions of their
computer processing functions. Future revenue from sales of the Kinetics product
and related  services will depend upon continued  widespread use of IBM midrange
computers and related  operating  system software and upon continued  support of
such  computers by IBM. In  addition,  the Company will be required to adapt its
existing  Kinetics  product to any changes  made by IBM to the OS/400  operating
system in the  interim.  A  significant  shift away from IBM  midrange  computer
systems by the Company's customers or the failure by IBM to continue its support
of such computer  systems could have a material  adverse  effect on the Company.
See  Item  1,  "Special   Considerations  --  Dependence  on  New  Products  and
Technologies."

Fluctuations in Operating Results

          The software  industry has experienced  economic  downturns at various
times,  characterized by diminished product demand and increased availability of
alternative software solutions. The Company has sought to reduce its exposure to
industry downturns by targeting its product lines towards specific niches within
the retail  merchandising and logistics  industries,  which the Company believes
will sustain  continued growth in the near and long term,  resulting in steadily
increasing  demand  for newly  developed  and  enhanced  software  applications.
However,  these  industries  are subject to intense  competitive  pressures  and
suffer periodic  slowdowns as a result of general economic  conditions and other
broadbased factors. The retail industry in particular has suffered disappointing
overall results and increased  consolidation  in recent years. In addition,  the
Company's  customers may postpone or abandon planned  purchases of the Company's
software  products  during  periods  of  economic  downturns  as a result of the
significant  capital  expenditures for new computer hardware frequently required
to operate the  Company's  software.  As a result,  the  Company may  experience
substantial period-to-period fluctuations in future operating results because of
general  industry  conditions  or events  occurring in the general  economy.  In
addition, although the Company has experienced some quarterly sales fluctuations
in the past, the size and timing of sales of its new software  applications  may
be expected to vary from quarter to quarter to a greater  extent.  The expanding
importance of these new products could result in  significant  variations in the
Company's overall operating results on a quarterly basis.
                                       11
<PAGE>
          Quarterly revenue and operating results depend primarily on the volume
and  timing of orders  received  during  the  quarter,  which are  difficult  to
forecast.  The Company often recognizes a substantial  portion of its revenue in
the last month of each quarter.  The Company  believes that these sales patterns
are attributable to the budgeting and purchasing practices of its customers, the
length of time that  customers  devote to evaluation of the Company's  products,
and the customers' timing of computer and operational systems  installations and
upgrades.  The Company  establishes  personnel  levels and other fixed  expenses
based upon anticipated  revenue.  Because a substantial portion of the Company's
revenue may not materialize to the extent or in the time frame anticipated,  the
Company may not be able to reduce  expenses in response to sales  shortfalls  or
delays.  These factors may cause significant  variations in quarterly  operating
results in the future.

Capital Requirements

          To remain  competitive,  the Company must continue to make significant
investments in product development,  equipment, and facilities as well as in its
ongoing  sales and  marketing  programs.  The  Company  also may be  required to
increase  staffing  and  other  expenses  in order to meet  the  demand  for its
products  and  services.  Customers,  however,  generally  do not commit to firm
purchase  orders  for more  than a short  time in  advance.  As a result  of the
increase in fixed costs and operating  expenses  related to these  expenditures,
the Company's  operating  results may be adversely  affected if its revenue does
not increase  sufficiently to offset the increased costs. The development of new
products or product  enhancements or unexpected customer orders also may require
rapid  increases  in  design  and  production   services  that  place  excessive
short-term burdens on the Company's resources. The Company from time to time may
seek  additional  equity  or debt  financing  to  provide  for the  expenditures
required to maintain or expand the Company's  product  development,  facilities,
and equipment or its sales and marketing  efforts.  The timing and amount of any
such capital requirements cannot be predicted at this time.

         Subsequent  to January 31,  1997,  the  Company  obtained a new line of
credit from Norwest Business Credit, Inc. ("Norwest"). See Item 6, "Management's
Discussion  and  Analysis of  Financial  Condition  and Results of  Operations -
Liquidity  and Capital  Resources."  As of October 28, 1997,  the Company was in
default under certain covenants in this line of credit. As a result, Norwest has
the right to demand payment of all amounts outstanding under the line of credit.
In  addition,  in October 1997  Norwest  exercised  its right to not provide any
further  advances  under the line of credit.  The Company  currently  is seeking
additional  sources  of  financing,  which  may  include  one  or  more  private
placements  of debt or equity  securities.  There can be no  assurance  that any
additional  financing will be available to the Company or as to the terms of any
such financing that is available.  The inability to obtain such financing  could
result in the inability of the Company to continue as a going  concern.  If such
financing is not available in sufficient  amounts or on satisfactory  terms, the
Company  also may be unable to expand its  business or develop new  customers at
the rate desired and its operating results may be adversely affected.

Weaknesses in Internal Controls

         The  Company's  independent  public  accountants  have  reported to the
Company that, in the course of their audit of the Company's financial statements
for the fiscal year ended  January 31,  1997 and their  review of the  unaudited
financial  statements  for the six months ended July 31, 1997,  they  discovered
various  conditions  that they believe  constitute  material  weaknesses  in the
Company's  internal  controls.  These  conditions  consist of (i)  weaknesses in
forecasting  internal  cash  requirements;   (ii)  weaknesses  in  policies  and
procedures  to ensure the  accurate  timing,  classification,  and  recording of
significant   transactions;   and  (iii)   weaknesses  in   maintaining   formal
documentation regarding acquisitions and dispositions of assets. The Company has
been  taking  various  steps  intended  to  strengthen  its  internal  controls,
including engaging more experienced  personnel in both operational and financial
positions and working more closely with its  independent  public  accountants to
identify weaknesses and take corrective measures. The Company also has requested
its independent public accountants to perform quarterly reviews of its financial
statements.
                                       12
<PAGE>
Competition

          The markets for the  Company's  software  applications  are  intensely
competitive and have been characterized by rapid technological change,  evolving
industry  standards,  constant  changes  in  customer  needs,  and the  frequent
introduction of new products.  The Company  competes with small,  privately held
companies as well as with major domestic and  international  companies,  many of
which have greater  market  recognition  and  substantially  greater  financial,
technical,  marketing,  distribution,  and  other  resources  than  the  Company
possesses.  The  ability of the  Company to  compete  successfully  depends on a
number of factors  both within and outside its control,  including  the quality,
performance,  reliability,  features, ease of use, pricing, and diversity of its
product lines; the quality of its customer services;  its ability to address the
needs of its customers;  its success in designing and  implementing new software
applications,  including those incorporating new technologies;  the availability
of  adequate  sources  of  computer  hardware,  finished  components,  and other
supplies necessary to support the Company's software  applications at acceptable
prices; the rate at which end users install,  upgrade, or expand new or existing
computerized  retail and logistics  systems;  new product  introductions  by the
Company's  competitors;  the number, nature, and success of its competitors in a
given  market;  the emergence of new  competitors  or alliances  among  existing
competitors;  and general market and economic conditions.  The Company currently
competes principally on the basis of the technical innovation and performance of
its  software  applications,  including  their ease of use,  reliability,  cost,
timely  introduction,  delivery schedules,  and after-sale service and technical
support.  There is no  assurance  that the Company  will  continue to be able to
compete successfully in the future. See Item 1, "Business -- Competition."

Dependence on Management and Other Key Personnel

          The Company's  development  and  operations to date have been, and its
proposed  operations  will be,  substantially  dependent  upon the  efforts  and
abilities  of its  senior  management  and  technical  personnel.  The  software
industry is  characterized  by a high level of employee  mobility and aggressive
recruiting of skilled technical personnel.  The Company does not have employment
agreements with any of its executive officers. The Company,  however,  maintains
agreements  with each of its officers and  employees  that prohibit such persons
from  disclosing  confidential  information  obtained  while  employed  with the
Company. The loss of existing key personnel or the failure to recruit and retain
necessary  additional  personnel would adversely  affect the Company's  business
prospects. There can be no assurance that the Company will be able to retain its
current personnel or to attract and retain necessary additional  personnel.  The
Company's  internal  growth and the  expansion of its product lines will require
additional  expertise  in  such  areas  as  software  development,   operational
management,  and marketing.  Such growth and expansion  activities will increase
further the demand on the  Company's  resources  and require the addition of new
personnel and the development of additional expertise by existing personnel. The
failure of the  Company  to attract  and  retain  personnel  with the  requisite
expertise or to develop  internally such expertise  could  adversely  affect the
prospects  for  the  Company's  success.  The  Company  maintains  "key  person"
insurance covering Michael M. Gordon, its Chairman of the Board and President.

Dependence Upon Proprietary Technology; Intellectual Property Claims

         The Company's  success  depends in part upon its ability to protect its
proprietary  technology.  The  Company  relies on a  combination  of  copyright,
trademark, and trade secret laws, nondisclosure and other contractual agreements
with  employees  and third  parties,  and  technical  measures  to  protect  its
proprietary  technology.  There can be no assurance  that the steps taken by the
Company  to  protect  its  proprietary   rights  will  be  adequate  to  protect
misappropriation  of such rights or that third  parties  will not  independently
develop  equivalent  or superior  technology.  The  Company has no patents,  and
existing  trade secret and  copyrights  laws  provide  only limited  protection.
Certain  provisions  of the license  agreements  generally  used by the Company,
including provisions protecting against unauthorized use, copying, transfer, and
disclosure,  may be unenforceable under the laws of certain  jurisdictions.  The
Company may be subject to or may initiate interference proceedings in the United
States Patent and Trademark Office,  which can demand significant  financial and
management  resources.  Although  the Company  believes  that its  products  and
technology do not infringe upon the proprietary rights of others, there
                                       13
<PAGE>
can be no  assurance  that third  parties  will not assert  infringement  claims
against  the  Company in the future.  Based on  industry  practice,  the Company
believes  that in most cases it could  obtain any  necessary  licenses  or other
rights on commercially  reasonable  terms.  There can be no assurance,  however,
that licenses would be available on acceptable  terms, that litigation would not
ensue,  or that  damages  for any  past  infringements  would  not be  assessed.
Litigation, which could result in substantial cost to and diversion of effort by
the Company,  may be necessary to enforce  intellectual  property  rights of the
Company or to defend the Company against  claimed  infringement of the rights of
others.  The failure to obtain necessary  licenses or other rights or litigation
arising out of infringement  claims could have a material  adverse effect on the
Company. See Item 1, "Business -- Proprietary Rights and Licenses."

Warranty Claims

          The  Company's   agreements  with  its  customers   generally  include
warranties  that  provide  that,  for a period of 90 days  after  shipment,  the
Company's  software  products  will  conform to and operate in  accordance  with
documentation  provided  to the  customer  by the  Company.  The  terms  of such
warranties require the Company to correct any defects identified by the customer
during the warranty  period and to refund the purchase  price for any  defective
software  that the Company is unable to correct  within a  reasonable  period of
time. The Company generally assigns to its customers any warranties  provided by
third-party  manufacturers  of hardware and software  products  that the Company
resells and warrants that the computer hardware that it resells will operate and
perform  as  warranted  by the  manufacturer  for the  period  specified  in the
manufacturer's  warranty.  The Company's  agreements with its customers  include
provisions   intended  to  limit  the  Company's  liability  under  its  product
warranties.  Such  provisions  may be held to be  invalid or  ineffective  under
applicable  laws in the event that a customer  makes a claim against the Company
pursuant to a warranty on any of its software products. Although the Company has
not experienced any material  warranty claims on its software  products to date,
there can be no assurance  that the Company will not be subjected to significant
warranty  claims  on one or more  of its  software  products  in the  future.  A
successful warranty claim or series of claims, if sufficiently large, could have
a material adverse effect on the Company.

Control by Current Shareholders

          The Company's  directors and officers and affiliates of certain of the
Company's  directors currently own approximately 36.6% of the outstanding shares
of Common Stock.  Consequently,  such shareholders voting together will continue
to have the power to elect all of the  Company's  directors  and to  effectively
control the Company.

Possible Volatility of Stock Price

          The  trading  price  of the  Company's  Common  Stock  in  the  public
securities market could be subject to wide fluctuations in response to quarterly
variations  in operating  results of the Company or its  competitors,  actual or
anticipated   announcements   of   technological   innovations  or  new  product
developments by the Company or its competitors,  changes in analysts'  estimates
of the Company's  financial  performance,  developments  or disputes  concerning
proprietary  rights,  regulatory  developments,   general  industry  conditions,
worldwide  economic  and  financial  conditions,  and other  events and factors.
During certain  periods,  the stock markets have  experienced  extreme price and
volume  fluctuations.  In particular,  prices for many  technology  stocks often
fluctuate widely,  frequently for reasons unrelated to the operating performance
of such  companies.  These  broad  market  fluctuations  and other  factors  may
adversely affect the market price of the Company's Common Stock.

Rights to Acquire Shares

          A total of  1,306,665  shares of Common  Stock has been  reserved  for
issuance  upon  exercise  of options  granted or which may be granted  under the
Company's 1990 Stock Option Plan (the "1990 Plan"),  1995 Stock Option Plan (the
"1995 Plan"), and Employee Stock Purchase Plan (the "Purchase Plan"). Options to
acquire 871,525 shares of Common Stock at a weighted  average  exercise price of
$6.10 per share were outstanding under
                                       14
<PAGE>
the 1990 Plan and 1995 Plan as of October 28,  1997.  In  addition,  warrants to
purchase  516,044 shares of Common Stock at a weighted average exercise price of
$6.29 per share were  outstanding  as of October 28,  1997.  During the terms of
such options,  warrants,  and purchase rights pursuant to the Purchase Plan, the
holders  thereof  will have the  opportunity  to profit  from an increase in the
market price of the Common Stock. The existence of such stock options, warrants,
and  purchase  rights may  adversely  affect the terms on which the  Company can
obtain  additional  financing,  and the holders of such options,  warrants,  and
purchase rights can be expected to exercise such options,  warrants and purchase
rights at a time when the Company,  in all  likelihood,  would be able to obtain
additional  capital  by  offering  shares  of its  Common  Stock on  terms  more
favorable  to the Company than those  provided by the exercise of such  options,
warrants, and purchase rights.

Shares Eligible for Future Sale

          Sales of  substantial  amounts of Common  Stock in the  public  market
could adversely  affect  prevailing  market prices.  Of the 2,838,138  shares of
Common Stock currently outstanding,  approximately 1,785,000 shares are eligible
for resale in the public  market  without  restriction  or further  registration
unless held by an "affiliate" of the Company,  as that term is defined under the
Securities Act of 1933, as amended (the  "Securities  Act").  The  approximately
1,053,000  remaining  outstanding  shares of Common Stock currently are eligible
for sale in the public market,  subject to compliance  with the  requirements of
Rule 144 under the  Securities  Act.  The  Company  has  registered  for sale an
aggregate  of  1,306,665  shares of Common  Stock that are reserved for issuance
pursuant to the 1990 Plan, the 1995 Plan,  and the Purchase Plan.  Shares issued
upon the exercise of stock options issued under the Company's stock option plans
or pursuant to the  Purchase  Plan  generally  will be eligible  for sale in the
public market.  The Company also has the authority to issue additional shares of
Common  Stock and shares of preferred  stock.  The issuance of such shares could
result in the dilution of the voting power of outstanding shares of Common Stock
and could have a dilutive effect on earnings per share.

Change in Control Provisions

          The  Company's  Amended and Restated  Articles of  Incorporation  (the
"Restated  Articles") and Amended and Restated Bylaws (the "Bylaws") and certain
provisions of the Arizona  Revised  Statutes (the  "Arizona  Corporate  Takeover
Act") contain  provisions  that may have the effect of making more  difficult or
delaying  attempts by others to obtain  control of the Company,  even when these
attempts may be in the best  interests of  shareholders.  The Restated  Articles
authorize the Board of Directors,  without shareholder approval, to issue one or
more  series of  preferred  stock that could have voting and  conversion  rights
adversely affecting the voting power of the holders of Common Stock. The Arizona
Corporate  Takeover  Act (i) places  restrictions  on the  Company's  ability to
purchase  shares of its capital stock from persons that hold more than 5% of the
voting power of the Company; (ii) limits the voting power of certain shares held
by persons engaged in a "control share  acquisition" (as such term is defined in
the Arizona  Corporate  Takeover Act);  and (iii) imposes  conditions on certain
business combination transactions with "interested  shareholders" (as defined in
the Arizona Corporate Takeover Act).

Lack of Dividends

          The Company has never paid any cash  dividends on its Common Stock and
does  not  anticipate  that it will pay  dividends  in the  foreseeable  future.
Instead,  the  Company  intends  to apply  any  earnings  to the  expansion  and
development of its business.  Furthermore,  the terms of the Company's  existing
revolving  line of credit  facility  prohibit the Company from paying  dividends
without the consent of the lender.  Such restrictions  could limit the Company's
ability to pay dividends in the future.

Cautionary Statement Regarding Forward-Looking Statements

          Certain   statements  and   information   contained  in  this  Report,
particularly  under  the  headings  "Business,"  "Special  Considerations,"  and
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations,"  concerning  future,  proposed,  and anticipated  activities of the
Company,  certain  trends  with  respect  to 
                                       15
<PAGE>
the Company's revenue,  operating results,  capital resources,  and liquidity or
with  respect to the  markets in which the  Company  competes  or the  software,
retail, or warehouse  industries in general,  and other statements  contained in
this Report regarding matters that are not historical facts are  forward-looking
statements,  as such term is  defined  in the  Securities  Act.  Forward-looking
statements, by their very nature, include risks and uncertainties, many of which
are beyond the  Company's  control.  Accordingly,  actual  results  may  differ,
perhaps materially,  from those expressed in or implied by such  forward-looking
statements. Factors that could cause actual results to differ materially include
those discussed elsewhere under Item 1, "Business - Special Considerations."

ITEM 2.   PROPERTIES

          The Company leases,  for a term expiring in April 1998,  approximately
20,730  square feet of space in Phoenix,  Arizona,  where it  maintains  product
engineering and design laboratories,  software development  facilities,  testing
laboratories, customer service support facilities, employee training facilities,
sales and marketing offices, and administrative and executive offices.

ITEM 3.   LEGAL PROCEEDINGS

          On May 30, 1997,  Hagemeyer  Foods North America,  Inc.  ("Hagemeyer")
filed suit  against  the  Company in the United  States  District  Court for the
Eastern District of Wisconsin (Case No.  97-C-0635).  The complaint alleges that
the Company  breached its contract with  Hagemeyer by (i) failing to deliver and
install  certain  software  products,  (ii)  failing to use its best  efforts to
achieve productive use of the Company's software products,  and (iii) failing to
provide  its  professional  consulting  services  in a  reasonable,  workmanlike
manner.  Hagemeyer is seeking an unspecified amount of damages and a declaratory
judgment with respect to the parties'  respective rights and legal  obligations.
The  complaint  also  alleges that the Company  acted in a fraudulent  manner by
making false  representations  to Hagemeyer in connection  with the  contractual
agreements  between the Company and  Hagemeyer.  On October 15, 1997,  the court
dismissed  Hagemeyer's fraud claim against the Company.  The Company has filed a
counterclaim  for the amounts that the Company  claims  Hagemeyer owes under the
contract and has filed an answer  denying  Hagemeyer's  claims in the complaint.
The Company  intends to  vigorously  pursue its  counterclaim  and to vigorously
defend the  lawsuit  by  Hagemeyer.  In the event that the  Company is unable to
obtain a successful  decision on its  counterclaim or a decision  adverse to the
Company is rendered with respect to the claims by Hagemeyer,  the  resolution of
this matter could have a material adverse effect on the Company.

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

          Not applicable.
                                       16
<PAGE>
                                     PART II

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

          The  Company's  Common  Stock has been  quoted on the Nasdaq  National
Market under the symbol "GDSC" since March 19, 1996.  The  following  table sets
forth the  quarterly  high and low closing sale prices of the  Company's  Common
Stock for the calendar periods indicated on the Nasdaq National Market.

                                                                  Common Stock
                                                                  ------------
                                                                 High       Low
                                                                 ----       ---
1996:
   First Quarter (beginning March 19, 1996)............       $  6.50    $  5.00
   Second Quarter......................................          7.38       4.50
   Third Quarter.......................................          6.13       4.00
   Fourth Quarter......................................         16.50       4.63

1997:
   First Quarter.......................................        $15.48     $10.00
   Second Quarter......................................         11.00       3.75
   Third Quarter.......................................          5.50       3.25
   Fourth Quarter (through October 28, 1997)...........          4.13       1.25

         As of October 28, 1997,  there were  approximately 90 holders of record
and  approximately  800  beneficial  owners of the Company's  Common  Stock.  On
October 28, 1997,  the closing sales price of the Company's  Common Stock on the
Nasdaq National  Market was $1.25 per share. On October 8, 1997,  Nasdaq advised
the Company that the Common  Stock may be delisted as a result of the  Company's
failure to timely file reports,  including this Report on Form 10-KSB,  with the
Securities and Exchange Commission and Nasdaq.
                                       17
<PAGE>
ITEM 6.  SELECTED  CONSOLIDATED  FINANCIAL  DATA;  MANAGEMENT'S  DISCUSSION  AND
         ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

                      SELECTED CONSOLIDATED FINANCIAL DATA

         The following selected consolidated financial data for the fiscal years
ended  January 31, 1995,  1996,  and 1997 have been  derived from the  Company's
audited consolidated  financial statements.  The selected consolidated financial
data should be read in conjunction  with, and are qualified by reference to, the
Company's  Consolidated  Financial  Statements and Notes thereto and "Management
Discussion  and  Analysis of  Financial  Condition  and  Results of  Operations"
included elsewhere in this Report.

<TABLE>
<CAPTION>
                                                                 Year Ended January 31,
                                                       --------------------------------------
                                                           1995           1996           1997
                                                           ----           ----           ----
                                                       (in thousands, except per share amounts)
<S>                                                    <C>            <C>            <C>     
Statement of Operations Data:
Revenue:
      Product ...................................      $ 18,956       $ 19,544       $ 20,324
      Software license ..........................         1,009          2,947          4,082
      Professional services .....................           741          1,449          2,750
                                                       --------       --------       --------
           Total revenue ........................        20,706         23,940         27,156
Expenses:
      Cost of products sold .....................        13,870         14,240         14,487
      Software development ......................         2,141          2,877          3,693
      Professional services .....................         1,093          1,795          2,523
      Sales and marketing .......................         1,453          1,627          1,927
      General and administrative ................         1,059          1,546          1,947
                                                       --------       --------       --------
Income from operations ..........................         1,090          1,855          2,579
                                                       --------       --------       --------
Other income (expense):
      Interest expense, net .....................          (554)          (777)          (266)
      Other, net ................................           (30)             6             98
                                                       --------       --------       --------
           Total and other income (expense) .....          (524)          (771)          (168)
                                                       --------       --------       --------
Income before income taxes ......................           566          1,083          2,411
Provisions for income taxes .....................          --             --               98
                                                       --------       --------       --------
Net income ......................................      $    566       $  1,083       $  2,313
                                                       ========       ========       ========
Net income per common and common share equivalent      $   0.39       $   0.71       $   0.81
                                                       ========       ========       ========
Common and common share equivalents outstanding .         1,662          1,601          2,843
                                                       ========       ========       ========

                                                                     As of January 31,
                                                       --------------------------------------
                                                           1995           1996           1997
                                                           ----           ----           ----
                                                                    (in thousands)
Balance Sheet Data:
Cash and cash equivalents........................       $   312         $   93         $  936
Working capital (deficit)........................        (2,706)        (1,194)         5,490
Total assets.....................................         5,847          7,138         15,598
Long-term debt, less current portion.............         1,134          1,252            281
Deferred revenue (long-term).....................         1,168          1,769          1,785
Total shareholders' equity (deficit).............        (3,773)        (1,461)         7,493
</TABLE>
                                       18
<PAGE>
          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
                            AND RESULTS OF OPERATIONS

Statement Regarding Forward-Looking Statements

         The  statements  contained  in this  Report on Form 10-KSB that are not
purely historical are  forward-looking  statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of  1934,   including   statements   regarding  the  Company's   "expectations,"
"anticipation,"  "intentions,"  "beliefs," or "strategies" regarding the future.
Forward-looking   statements  include  statements  regarding  revenue,  margins,
expenses, and earnings analysis for fiscal 1998 and thereafter;  future products
or  product  development;  future  research  and  development  spending  and the
Company's product development strategy; and liquidity and anticipated cash needs
and availability.  All  forward-looking  statements  included in this Report are
based on  information  available to the Company on the date of this Report,  and
the Company assumes no obligation to update any such forward-looking  statement.
It is  important  to  note  that  the  Company's  actual  results  could  differ
materially from those in such forward-looking statements. Among the factors that
could cause actual  results to differ  materially  are the factors  discussed in
Item 1, "Special Considerations."

Operations

         The  Company  designs,  develops,   markets,  and  implements  software
products and provides related customer support services for retail  applications
and  warehouse  automation.  The Company also  provides  professional  services,
including installation, training, maintenance,  customization, and modifications
in  conjunction  with sales of its software  products.  The Company  markets its
products and services entirely through an internal sales force.

         Founded in 1985,  the  Company  historically  has  derived  its revenue
primarily  from sales of  hardware  and  software  products  developed  by third
parties,   primarily  IBM.  Sales  of  IBM  products  (hardware,   software  and
maintenance)  accounted for  approximately  66% and 56% of the  Company's  total
revenue  for the  years  ended  January  31,  1996 and 1997,  respectively.  The
Company's dependence on the resale of third parties' products adversely affected
the Company's competitive position, gross profit margins, and operating results.
As a result,  in 1991 the Company changed its business strategy to emphasize the
development  and  sale of its own  software  products.  The  Company  has used a
substantial  portion of the proceeds from its March 1996 initial public offering
to significantly  accelerate the transition of its business focus to proprietary
software  products.  The  Company's  reseller  agreement  with  IBM  expired  in
accordance  with its terms in July 1997.  As a result,  the Company  anticipates
that revenue from  third-party  hardware and software  products will continue to
decrease  from  historical  levels and that revenue from  software  licenses and
professional services will increase in dollar amounts as well as a percentage of
total revenue during the next several years. The Company believes that, although
the change in revenue mix may result in lower total revenue, it will result in a
more  favorable  gross  profit  margin for the Company as sales of software  and
services become a higher percentage of total revenue.

         The Company has  marketed the Kinetics  warehouse  management  software
product for several years and will continue its current sales efforts  dedicated
to this product and related services.  Kinetics  currently  operates only on the
IBM AS/400  family of  midrange  computers.  To date,  the  Company  has derived
substantially  all of its  software  revenue from  Kinetics and other  IBM-based
software  products.  Future revenue from sales of Kinetics and related  services
will depend upon continued widespread use of IBM midrange computers and upon the
continued  support of such  computers by IBM. In  addition,  the Company will be
required to adapt Kinetics to any changes made by IBM to the AS/400's  operating
system software.  A significant shift away from IBM midrange computer systems by
the  Company's  customers or the failure by IBM to continue its support of these
systems could have a material adverse effect on the Company.

         During  the  year  ended  January  31,  1997,  the  Company  introduced
Transact,  a point-of-sale  software  product  developed in Java(TM) that can be
utilized on a wide variety of point-of-sale  hardware  platforms.  Subsequent to
January 31, 1997, the Company introduced MarketBuilder, a relationship marketing
system for retailers, and 
                                       19
<PAGE>
         Crossfire,  an Internet-based store communication system, both of which
are also  developed in Java(TM).  The Company  intends to increase the resources
dedicated  to  software  development  and  marketing  in  support  of its  newly
introduced  retail  point-of-sale  software  products.  In conjunction  with its
increased focus on software  development and marketing and its reduced  emphasis
on reselling the products of others,  the Company has  streamlined its workforce
such that  approximately 40 positions that were not directly related to software
development and marketing were  eliminated in August 1997.  Although the Company
has not yet generated  significant sales of its new Java(TM)-based  products, it
expects  that  the  functionality  of  its  new  products,  the  flexibility  of
Java(TM)-based  software, and the personnel changes that have been made to focus
on software  development and marketing  efforts will result in sufficient future
revenue to fund its ongoing operations.

         Product  revenue   includes   hardware,   third-party   software,   and
third-party  maintenance  sold  to the  Company's  customers.  Software  license
revenue  includes  revenue  from  the  licensing  of the  Company's  proprietary
software offerings as well as revenue from the customization and modification of
the Company's software for its customers. Professional services revenue includes
services to install the Company's software products and third-party hardware and
software  products  as well as  services  to train  customers  in the use of the
Company's software products and third-party hardware and software products.

         Cost of products  sold  includes  costs of those  software and hardware
products not manufactured by the Company and maintenance  resold by the Company.
The Company does not capitalize any software  development  costs associated with
the  development  of its  proprietary  software  products  and has  expensed all
payroll  and  related  costs for  software  development  as  incurred.  Software
development  cost also  includes  all other  general  and  administrative  costs
associated with software development  personnel.  Professional  services expense
consists of  salaries,  benefits,  and other  general and  administrative  costs
attributable to professional  services  personnel.  Sales and marketing expenses
consist  primarily  of salaries,  commissions,  benefits,  marketing  materials,
travel expenses,  and other general and administrative  costs associated with or
allocated  to  the  Company's  sales  and  marketing   personnel.   General  and
administrative  expenses  include  the cost of  finance  and  accounting,  human
resources,  corporate information systems, and other administrative functions of
the Company.

Results of Operations

         The  following  table  sets  forth,  for  the  periods  indicated,  the
percentage of total revenue represented by certain expense and revenue items:

                                                      Year Ended January 31,
                                                   ----------------------------
                                                   1995        1996        1997
                                                   ----        ----        ----
Revenue:
      Product ...............................        91%         82%         75%
      Software license ......................         5%         12%         15%
      Professional services .................         4%          6%         10%
                                                   ----        ----        ----
           Total revenue ....................       100%        100%        100%
Expenses:
      Cost of products sold .................        67%         59%         53%
      Software development ..................        10%         12%         14%
      Professional services .................         5%          7%          9%
      Sales and marketing ...................         7%          7%          8%
      General and administrative ............         5%          6%          7%
                                                   ----        ----        ----
Income from operations ......................         5%          8%          9%
                                                   ----        ----        ----
Other income (expense):
      Interest expense, net .................        (2)%        (3)%         1%
      Other, net ............................         0%          0%          0%
                                                   ----        ----        ----
           Total other income (expense) .....        (2)%        (3)%         1%
                                                   ----        ----        ----
Income before income taxes ..................         3%          5%          9%
Provision for income taxes ..................         0%          0%          0%
                                                   ----        ----        ----
Net income ..................................         3%          5%          9%
                                                   ====        ====        ====
                                       20
<PAGE>
Results of  Operations  of the Company for the Years Ended  January 31, 1996 and
1997

         Revenue.  Total  revenue  increased  by 13%  from  approximately  $23.9
million in the year ended January 31, 1996 to approximately $27.2 million in the
year ended January 31, 1997.  Product revenue increased by 4% from approximately
$19.5  million to  approximately  $20.3 million  during the same  periods.  As a
percentage of total revenue,  product revenue decreased from 82% during the year
ended January 31, 1996 to 75% during the year ended  January 31, 1997.  Software
license  revenue  increased by 38% from  approximately  $2.9 million in the year
ended January 31, 1996 to  approximately  $4.1 million in the year ended January
31, 1997. As a percentage of total revenue,  software license revenue  increased
from 12% to 15% during the same periods. Professional services revenue increased
90% from  approximately  $1.4 million to  approximately  $2.8 million during the
years ended  January 31, 1996 and 1997,  respectively.  As a percentage of total
revenue, professional services revenue increased from 6% to 10% during the years
ended January 31, 1996 and 1997, respectively.

         The overall  increase in total  revenue is  attributed  to increases in
software  and  professional  services.  The  increase  in  software  license and
professional  services  revenue  resulted from the Company's  continued focus on
sales of its proprietary software products,  as well as the Company's continuing
efforts to provide  professional  services to implement  its software  products.
Although revenue from third-party  products  increased  slightly during the year
ended  January 31,  1997,  the Company  continues  to believe  that revenue from
third-party products will decrease as a percentage of total revenue and that the
total dollar  amounts of revenue from  third-party  products may decrease in the
future,  particularly after the expiration of the reseller agreement with IBM in
July 1997.

         Cost  of  Products  Sold.  Cost  of  products  sold  increased  2% from
approximately   $14.2  million  during  the  year  ended  January  31,  1996  to
approximately  $14.4  million  during  the year ended  January  31,  1997.  This
increase is attributed  to the  corresponding  increase in sales of  third-party
products  during the same period.  As a percentage of product  revenue,  cost of
products sold was  approximately  73% and 71% during the years ended January 31,
1996 and 1997, respectively.

         Software  Development  Expense.  Software development expense increased
from  approximately  $2.9 million to approximately $3.7 million during the years
ended January 31, 1996 and 1997, respectively. The 28% increase is attributed to
increased  research and development  efforts  associated with the development of
the Company's  proprietary software products.  As a percentage of total revenue,
software development costs increased from 12% in the year ended January 31, 1996
to 14% in the year ended January 31, 1997.

         Professional Services Expense.  Professional services expense increased
by 41% from  approximately $1.8 million to approximately $2.5 million during the
years ended January 31, 1996 and 1997, respectively. Salaries and other expenses
for  additional  personnel  contributed  to this  increase.  As a percentage  of
professional services revenue, professional services expense decreased from 123%
in the year ended  January 31, 1996 to 92% in the year ended  January 31,  1997.
This  decrease  as  a  percentage  is  attributed  to  better   utilization   of
professional services personnel.

         Sales and Marketing Expense.  Sales and marketing expense increased 18%
from approximately $1.6 million to approximately $1.9 million in the years ended
January 31, 1996 and 1997, respectively. The increase can be attributed to costs
incurred for marketing literature, additional sales and marketing personnel, and
an increased marketing presence at industry trade shows.

         General and Administrative Expense.  General and administrative expense
increased from  approximately $1.5 million in the year ended January 31, 1996 to
approximately $1.9 million in the year ended January 31, 1997. This 26% increase
is attributed to additional personnel and associated costs, additional insurance
costs, and increased building rent costs.
                                       21
<PAGE>
         Other Income  (Expense).  Interest expense was  approximately  $777,000
during the year ended January 31, 1996, as compared with approximately  $266,000
during the year ended January 31, 1997. In September 1995, the Company converted
approximately $1.2 million of debt into shares of Common Stock. Interest expense
related to that debt, together with interest expense attributable to vendor late
payments  that were incurred  during the year ended  January 31, 1996,  were not
incurred during the year ended January 31, 1997.

         Net Income.  Net income increased 122% from approximately $1.1 million,
or $.71 per share,  in the year ended  January  31, 1996 to  approximately  $2.3
million,  or $.81 per share,  in the year ended  January 31,  1997.  The Company
attributes  this  increase to the 66%  decrease in interest  expense  during the
comparable periods, together with the 39% increase in income from operations.

Quarterly Results of Operations

         The following table sets forth certain  unaudited  quarterly results of
operations for each of the eight quarters in the period ending January 31, 1997.
All quarterly  information was obtained from unaudited financial  statements not
otherwise contained herein. The Company believes that all necessary  adjustments
have  been  made to  present  fairly  the  quarterly  information  when  read in
conjunction  with  the  Consolidated  Financial  Statements  and  Notes  thereto
included elsewhere in this Report. The operating results for any quarter are not
necessarily indicative of the results of the full year or any future quarter.

<TABLE>
<CAPTION>
                                                                            Quarter Ended
                                        ------------------------------------------------------------------------------------
                                         Apr 30    July 31     Oct 31     Jan 31     Apr 30    July 31     Oct 31     Jan 31
                                          1995       1995       1995       1996       1996       1996       1996       1997
                                          ----       ----       ----       ----       ----       ----       ----       ----
                                                              (in thousands, except per share amounts)
<S>                                     <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>    
Revenue:
   Product revenue ..................   $ 6,882    $ 3,968    $ 5,982    $ 2,711    $   969    $ 6,251    $ 7,163    $ 5,941
   Software license revenue .........       484      1,074        446        943      1,296      1,086        726        973
   Consulting services revenue ......       228        465        447        309        530        624        775        822
                                        -------    -------    -------    -------    -------    -------    -------    -------
      Total revenue .................     7,594      5,507      6,875      3,963      2,795      7,961      8,664      7,736
Expenses:
   Cost of products sold ............     5,357      2,870      4,484      1,529        557      4,598      4,910      4,422
   Software development expense .....       681        764        687        744        755      1,054      1,017        868
   Consulting services expense ......       425        431        450        488        489        708        794        531
   Sales and marketing expense ......       382        465        425        354        342        529        493        562
   General and administrative expense       302        462        432        351        345        473        625        504
                                        -------    -------    -------    -------    -------    -------    -------    -------
Income from operations ..............       447        515        397        497        307        599        825        849
                                        -------    -------    -------    -------    -------    -------    -------    -------
Other income (expense):
   Interest expense, net ............      (236)      (217)      (115)      (210)       (51)       (36)      (102)       (77)
   Other, net .......................      --            3       --            3          0          2          0         95
                                        -------    -------    -------    -------    -------    -------    -------    -------
      Total other income (expense) ..      (236)      (214)      (115)      (207)       (51)       (34)      (102)        18
                                        -------    -------    -------    -------    -------    -------    -------    -------
Income before income taxes ..........       211        301        282        290        256        565        723        867
Provision for income taxes ..........      --         --         --         --         --         --         --           98
                                        -------    -------    -------    -------    -------    -------    -------    -------
Net income ..........................   $   211    $   301    $   282    $   290    $   256    $   565    $   723    $   769
                                        =======    =======    =======    =======    =======    =======    =======    =======
Net income per common and common
  equivalent shares outstanding .....   $  0.14    $  0.20    $  0.19    $  0.18    $  0.12    $  0.19    $  0.26    $  0.24
Common and common equivalent shares
  outstanding .......................     1,557      1,567      1,544      1,381      2,215      2,921      2,820      3,256
</TABLE>

         The Company's  revenue and  operating  results are subject to quarterly
and other  fluctuations  as a result  of a variety  of  factors,  including  the
budgeting and purchasing practices of its customers,  the length of the customer
evaluation  process  for  Company  products,   the  timing  of  customer  system
conversions, and, to a lesser extent, the
                                       22
<PAGE>
Company's  sales  commission  practices,  which  are based  partly on  quarterly
incentives and annual  quotas,  and other  factors.  The Company's  professional
services  revenue tends to fluctuate due to the  completion or  commencement  of
significant projects,  which may continue over multiple quarters,  the number of
working days in a quarter,  and the utilization  rate of  professional  services
personnel. The Company often has recognized a substantial portion of its license
revenue  in the last  month  of the  quarter,  sometimes  in the  last  week.  A
significant  portion of the Company's  operating  expenses is relatively  fixed,
since personnel  levels and other expenses are based upon  anticipated  revenue.
Because a substantial portion of this revenue may not be generated until the end
of each quarter,  the Company may not be able to reduce  spending in response to
sales  shortfalls  or delays.  These  important  factors  can cause  significant
variations in operating  results from quarter to quarter.  The Company  believes
that quarter-to-quarter comparisons of its financial results are not necessarily
meaningful and should not be relied upon as an indication of future performance.

Liquidity and Capital Resources

         The Company's  working  capital  position  increased  from a deficit of
approximately  ($880,000) at January 31, 1996 to  approximately  $5.5 million at
January  31,  1997.  In March  1996,  the Company  completed  an initial  public
offering  of  1,250,000  shares  of Common  Stock and  raised  net  proceeds  of
approximately $6.9 million. The Company used a portion of the proceeds from this
offering to retire  $810,000 of bridge notes and related  accrued  interest,  to
purchase  approximately  $528,000 of capital equipment,  to retire approximately
$536,000 of debt to officers and employees,  to fund additional  development for
new software products, and to develop new marketing collateral material.

         The Company used net cash of approximately  $2.6 million for operations
during the year ended January 31, 1997, primarily as a result of the increase in
accounts receivable and inventories,  partially offset by an increase in accrued
liabilities  and  deferred  revenue.  An  increase  in  accounts  receivable  of
approximately  $1.3 million is attributed to one customer.  (See Note 2 of Notes
to Consolidated Financial Statements.)

         Capital  expenditures  for the year  ended  January  31,  1997  totaled
approximately  $1.9  million,  of which  approximately  $1.4 million was for the
purchase of computer  hardware and software  products  needed for the  continued
efficient  development  of the  Company's  proprietary  software  products.  The
balance of $500,000  was used for the  expansion  of physical  office  space and
related purchases of furniture and fixtures.

         Financing activities provided net cash of approximately $4.8 million in
the year ended  January 31,  1997.  The  Company  completed  its initial  public
offering in March 1996,  which provided  approximately  $6.9 million,  partially
offset  by  retirement  of  approximately  $810,000  in  bridge  notes  payable,
retirement of  approximately  $311,000 of amounts  borrowed  under the Company's
line of  credit,  and  payments  to  officers  and  employees  of  approximately
$536,000.

         During the year ended  January 31,  1997,  the Company had an agreement
with Concord  Growth  Corporation  providing  for a line of credit in the amount
that was the lower of $2.0 million or 75% of eligible accounts  receivable.  The
line of credit bore  interest  at the prime rate of interest  quoted in the Wall
Street  Journal on the first day of each month plus 8.0% and  required a monthly
minimum payment of $5,000.  The average  outstanding  balance was  approximately
$841,400 and  approximately  $550,000  for the years ended  January 31, 1996 and
1997, respectively.  The weighted average interest rate was 16.0% and 16.25% for
the years ended January 31, 1996 and 1997,  respectively.  Subsequent to January
31,  1997,  the  Company  canceled  that line of credit and  secured a borrowing
facility with Norwest Business Credit,  Inc. That line of credit,  which expires
on February 21, 2000,  provides borrowing capacity in the amount of the lower of
$3.0 million or 80% of accounts receivable, plus the lower of $250,000 or 50% of
eligible  inventory,  as defined in the agreement.  Borrowings under the line of
credit are secured by substantially all of the Company's tangible and intangible
assets.  The  agreement,  as  subsequently  amended,  requires a $5,000  minimum
monthly fee that  includes  interest  calculated at the base lending rate (prime
rate) plus 2.0%, plus an unused facility fee of .25%. Had the new line of credit
been in place at
                                       23
<PAGE>
January  31,  1997,  the  Company  would  have had  approximately  $1.0  million
available for advance under the line,  based on eligible  inventory and accounts
receivable balances.

         The Company's financial statements for the year ended January 31, 1997,
have been prepared  assuming that the Company will continue as a going  concern.
The Company had negative cash flow from  operations  of $2,612,680  for the year
ended  January 31,  1997,  is in default of certain  terms in its line of credit
agreement, recorded a net loss of approximately $702,000 (unaudited) for the six
months ended July 31, 1997,  and has not yet generated  sufficient  revenue from
its  software  products to fund its ongoing  operations.  Additionally,  its IBM
reseller  agreement  expired in July 1997. These factors raise substantial doubt
about the Company's ability to continue as a going concern.  The Company's plans
with  regard to these  matters  are  described  in  "Business  Outlook  and Risk
Factors," below. The Company's  consolidated  financial  statements for the year
ended  January  31,  1997,  do  not  include  any  adjustments  relating  to the
recoverability  and  classification  of asset carrying amounts or the amount and
classification  of liabilities that might result should the Company be unable to
continue as a going concern.  As a result of the factors  described  above,  the
Company's auditors have reported to the Company that they are unable to express,
and do not express,  an opinion on the Company's  financial  statements  for the
year ended January 31, 1997.

         As of October  28,  1997,  the  Company  was in default  under  certain
covenants in the line of credit with Norwest. As a result, Norwest has the right
to demand  payment  of all  amounts  outstanding  under the line of  credit.  In
addition, in October 1997 Norwest exercised its right to not provide any further
advances  under  the line of  credit.  In July  1997,  Michael  M.  Gordon,  the
Company's Chairman of the Board, President,  and Chief Executive Officer and Mr.
Gordon's spouse personally guaranteed the Company's indebtedness under this line
of credit.  The Company  currently is seeking  additional  sources of financing,
which may include one or more private  placements of debt or equity  securities.
There can be no assurance that any additional financing will be available to the
Company  or as to the  terms  of any  such  financing  that  is  available.  The
inability to obtain such financing  could result in the inability of the Company
to continue as a going concern. If such financing is not available in sufficient
amounts or on satisfactory  terms,  the Company also may be unable to expand its
business  or to develop new  customers  at the rate  desired  and its  operating
results may be adversely affected.

Business Outlook and Risk Factors

         The trends  indicated by the Company's  operating  results for the year
ended January 31, 1997, coupled with the expiration of the IBM contract, reflect
the  Company's  belief that  although  total  revenue  may  decrease in the near
future,  software and services  revenue  should  contribute to a larger share of
overall revenue,  which should result in an increase in gross profit margins and
net margins. The Company continues to invest heavily in research and development
of new and enhanced  software products in order to reach a larger segment of its
targeted market.  The Company recently  announced new software products that are
platform  independent  and  contain  added  and  improved   functionality.   The
transition to hardware  platform  independence  is designed to lead to a broader
market for the Company's  products.  The Company's total revenue and product mix
could be materially  and adversely  affected by many factors,  some of which are
beyond the control of the Company.  Those factors include the Company's  ability
to maintain the software design and development capabilities necessary to design
and produce  innovative  and desirable  products on a timely and  cost-effective
basis; the Company's ability to penetrate new markets and attract new customers;
the budgeting and purchasing  practices or  constraints  of its  customers;  the
length of the Company's sales cycles;  the  complicated  nature of the Company's
product  installations;   and  unanticipated  postponement  or  cancellation  of
significant  orders.  There also can be no assurance that the Company's recently
introduced  software products will achieve market acceptance or that the Company
will be able to develop new products and services in a timely and cost-effective
manner.  The failure of the Company to  successfully  develop and market its own
software  products and to overcome the loss of revenue from the sale of hardware
and software  products  developed by others could have a material adverse effect
on the Company.

         As a  result  of  the  factors  described  in  "Liquidity  and  Capital
Resources," above, the Company is in default under certain covenants in its line
of credit  agreement  and the lender has  exercised its right to not provide any
                                       24
<PAGE>
further advances under the line of credit. In addition,  the Company has not yet
generated  sufficient  revenue  from its  software  products to fund its ongoing
operations.  The Company currently is seeking  additional  sources of financing,
which may include one or more private  placements of debt or equity  securities.
There can be no assurance that such financing will be available.

         During July 1997, the Company's reseller agreement with IBM expired and
the  Company  entered  into an  agreement  with  Information  Systems  of  North
Carolina,  Inc. with respect to future sales of specified IBM AS/400 and related
products  and  services  to  certain  of the  Company's  customers.  Under  this
agreement,  the  Company  has ceased  selling,  and ISI has begun  selling,  the
specified  AS/400-related  products and services to the designated customers (as
defined).  The  agreement  provides  that ISI will pay to the Company 50% of its
operating  profits  (as  defined)  from sales of the  specified  products to the
designated customers during the four-year term of the agreement. The Company has
the right to terminate  the  agreement  and resume direct sales of the specified
AS/400-related  products and services to the  designated  customers in the event
that  ISI's  payments  to the  Company  are  less  than  $50,000  in each of two
consecutive  quarterly periods. In addition,  ISI has the right to terminate the
agreement upon written  notice to the Company,  provided that ISI ceases selling
the specified  AS/400-related  products and services to the designated customers
for a period of two years after such termination. As of the date of this Report,
this arrangement has not provided the Company with any revenue, and there can be
no  assurance  that the  Company  will  derive  significant  revenue  from  this
arrangement in the future.

         The  Company  continues  to invest in sales and  marketing  in order to
enhance its image and brand awareness. The Company added new marketing and sales
personnel during the last 12 months,  updated its industry  trade-show  presence
and image, invested heavily in collateral marketing materials, and redefined the
Company's image through a new corporate logo. Although the Company believes that
its increased sales and marketing efforts will contribute to an increased number
of  customers  and  increased  revenue  associated  with the  sales of  software
products,  certain risk factors exist that could have a material  adverse effect
on the Company's operating results. Those risk factors include lack of assurance
that its products will achieve or maintain market acceptance;  the complexity of
the Company's software programs,  which may cause delays in product  development
and could result in loss of market  acceptance,  loss of sales, and reduction of
market share;  and the fact that the Company's  software  products  compete with
those of many major  domestic and  international  companies,  many of which have
greater market recognition and substantially greater financial,  technical,  and
marketing resources than the Company possesses.

         The  Company  has  hired a new Vice  President  -  Marketing  and Chief
Operating  Officer  who has  considerable  experience  in the  sale of  software
products to retail  enterprises  and in the  management of software  development
companies.  The  Company  believes  that  this  individual's  expertise  in  the
development  of  retail  software  applications,  his  contacts  in  the  retail
industry,  and his expertise in the management of software development companies
will enhance the Company's  ability to  successfully  transition from a hardware
reseller to a licenser of its proprietary software products.

         The  Company   operates  in  an  industry  that  is   characterized  by
fast-changing  technology.  As a result,  the Company will be required to expend
substantial  funds  for  continuing  product  development,   including  expenses
associated with research and development  activities and additional  engineering
and other technical personnel. There can be no assurance that such funds will be
available to the Company  given its current  financial  condition and results of
operations.  Any failure by the Company to anticipate  or respond  adequately to
technological developments,  customer requirements, or new design and production
techniques,  or any significant  delays in product  development or introduction,
could have a material adverse effect on the operating results of the Company.

         The  Company  plans  to  continue  to  increase  the   utilization   of
professional  services  personnel.  An increase in utilization  of  professional
services  personnel can have a direct impact on revenue  without any  additional
associated  costs.  Risk  factors  that could,  however,  materially  affect the
ability of the Company to increase  utilization rates and professional  services
revenue include factors such as fluctuating demand for professional services and
lack of  assurance  that there will  continue  to be a demand for the  Company's
services.  The  Company  may not be able to 
                                       25
<PAGE>
react to a  significant  decrease  in demand for its  services  during any given
quarter,  which could result in continued  expenses for  professional  personnel
without offsetting revenue.

         Although the Company has focused on controlling  administrative  costs,
it  recognizes  the added costs  associated  with  attracting  and retaining key
personnel.  Because it operates in an industry that is  characterized  by a high
cost of  recruiting  and a current  lack of  qualified  personnel,  the  Company
constantly evaluates employee benefits and the work environment that it provides
for its employees. The high cost associated with industry hiring practices could
have a material adverse effect on the Company's quarterly operating results. The
Company intends to continue to moderate general and administrative costs so that
revenue  growth will  continue  to exceed  operating  expenses.  There can be no
assurance,  however,  that the  Company  will be able to predict or respond to a
shortfall in sales during any given quarter in order to reduce its fixed general
and administrative expenses on a timely basis.

         The Company believes that the industry in which it markets its products
and services has a strong outlook,  with expanding  markets  characterized  by a
highly  fragmented  group of competitors.  As competition for consumer  products
rises,  retailers that represent a significant  portion of the Company's current
and  potential  customers  increasingly  are  aware  of the  need  for  business
information  systems that allow them to focus on efficiently  managing inventory
and of finding  new ways to bring  customers  into  their  stores.  The  Company
strives  to provide  market-leading  solutions  that  address  those  real-world
problems.  Due to the  risk  factors  discussed  above  and in Item 1,  "Special
Considerations,"  as well as other factors that generally affect high technology
companies,  there  can  be no  assurance  that  the  Company  will  be  able  to
successfully penetrate these markets in the future.

ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         Reference is made to the  financial  statements,  the notes thereto and
reports  thereon,  commencing  at  page  F-1 of  this  Report,  which  financial
statements, report, notes and data are incorporated herein by reference.


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

         Effective  December  11,  1995,  the Company  and its former  auditors,
Deloitte & Touche LLP ("Deloitte & Touche"), mutually agreed to the cessation of
the  client-auditor  relationship and on December 28, 1995, the Company retained
Arthur Andersen LLP ("Arthur  Andersen") as its independent public  accountants.
The  change in  independent  public  accountants  was  approved  by the Board of
Directors of the Company. Deloitte & Touche's report on the financial statements
of the Company for the years ended  January 31, 1994 and 1995,  which  financial
statements  have since been recalled by the Company,  did not contain an adverse
opinion or a  disclaimer  of opinion  and was not  qualified  or  modified as to
uncertainty,  audit scope, or accounting  principles.  Prior to retaining Arthur
Andersen,  the Company had not  consulted  with Arthur  Andersen  regarding  the
application  of  accounting  principles  or the type of  opinion  that  might be
rendered on the  Company's  financial  statements.  The  Company has  authorized
Deloitte & Touche to respond fully to inquiries from Arthur Andersen.

         During  the term of  Deloitte  &  Touche's  engagement,  there  were no
disagreements  on any matter of accounting  principles  or practices,  financial
statement disclosure, or auditing scope or procedure, which disagreement, if not
resolved to the satisfaction of Deloitte & Touche,  would have caused it to make
reference  to the subject  matter of the  disagreement  in  connection  with its
report. However,  Deloitte & touche advised the Company that they believed that,
during  the  term  of its  engagement  by the  Company,  the  internal  controls
necessary  for the  Company to develop  reliable  financial  statements  did not
exist.  Furthermore,  prior to the  cessation the  client-auditor  relationship,
Deloitte & Touche  informed  the  Company  that  certain  information  regarding
revenue  recognition  had come to its attention  that, if further  investigated,
might affect the Company's previously issued financial  statements.  At the time
of the cessation of the client-auditor  relationship,  Deloitte & Touche had not
yet investigated such information.
                                       26
<PAGE>
         The Company made Arthur  Andersen aware of the issues noted above prior
to their  acceptance  of the  engagement  as the  Company's  independent  public
accountants.  The Company has subsequently recalled its financial statements for
the years ended January 31, 1994 and 1995, that were  previously  reported on by
Deloitte & Touche.
                                       27
<PAGE>
                                    PART III

ITEM 9.  DIRECTORS AND EXECUTIVE  OFFICERS OF THE  REGISTRANT;  COMPLIANCE  WITH
         SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934

Directors and Executive Officers

         The  following  table  sets forth  certain  information  regarding  the
directors and executive officers of the Company:

<TABLE>
<CAPTION>
         Name                   Age                     Position Held
         ----                   ---                     -------------
                                              
<S>                             <C>           <C>
Michael M. Gordon               41            Chairman of the Board and President
Matthew J. Gordon               39            Vice President and Secretary
Steven A. Beck                  57            Vice President - Marketing and Chief Operating Officer
Vickie B. Jarvis                35            Vice President-- Finance, Chief Financial Officer,
                                                and Treasurer
Gregory S. Anderson             40            Director
Larry J. Wells                  54            Director
Steven A. Rothstein             46            Director
Robert D. Bressler              49            Director
</TABLE>                                 

         Michael  M.  Gordon  founded  the  Company  in 1985 and has  served  as
President and a director of the Company  since that time.  Mr. Gordon has served
as  Chairman  of  the  Board  since  July  1989.  Mr.  Gordon  was  a  marketing
representative  with International  Business Machines Corp. in Phoenix,  Arizona
from 1980 until he founded the Company in 1985. From 1979 until 1980, Mr. Gordon
was Commercial Lending Manager at National City Bank in Cleveland, Ohio.

         Matthew J.  Gordon has served as Vice  President - Store  System  Sales
since November 1986 and as Secretary of the Company since March 1993.  From 1980
until October 1986, Mr. Gordon was an account executive with AT&T Corporation in
Phoenix, Arizona. Matthew J. Gordon is the brother of Michael M. Gordon.

         Steven A. Beck has served as the Company's  Vice  President - Marketing
since March 1997 and as Chief Operating Officer since July 1997. Mr. Beck worked
as an independent  consultant to the retial software industry from 1993 to March
1997.  From 1986 to 1992,  Mr.  Beck  served as a  founder  and Chief  Executive
Officer of Comshare  Retail,  which  developed  and marketed  ARTHUR,  a leading
retail  merchandise  planning software  product.  Mr. Beck has worked in various
capacities in the retail and retail  software and  consulting  industries  since
1964, including six years as a senior executive at The Limited, Inc.

         Vickie B.  Jarvis has  served as Vice  President  -- Finance  and Chief
Financial Officer of the Company since July 1995. From September 1991 until July
1995, Ms. Jarvis was Manager,  Strategic Programs of the Company. Ms. Jarvis was
an industry  specialist at the Company from September 1989 until September 1991.
From 1986 until 1989,  Ms.  Jarvis was  Controller  at Cal-Pac  Construction,  a
subsidiary of David H. Murdock Companies in Los Angeles, California.

         Gregory S.  Anderson has served as a director of the Company since June
1989. Since October 1993, Mr. Anderson has served as President of Anderson Wells
Company,  which manages  Sundance Venture  Partners,  L.P.,  ("SVP"),  a venture
capital  firm.  Mr.  Anderson  also has served as a  director,  Vice  President,
Secretary, and Treasurer of Sundance Capital Corporation ("SCC") since May 1989.
Mr. Anderson also served as Managing  Director of El Dorado  Investment  Company
("El  Dorado"),  a venture  capital firm,  from 1993 to 1996, and served as Vice
President of El Dorado from May 1986 to October  1993 and as General  Manager of
El Dorado from
                                       28
<PAGE>
February 1985 to October  1993.  Mr.  Anderson was employed by First  Interstate
Bank of Arizona,  N.A., from July 1979 to January 1985. Mr.  Anderson  currently
serves on the boards of directors of Megafoods  Stores,  Inc. and Regency Health
Services,  Inc., which are publicly held companies.  Megafoods Stores,  Inc. has
filed for protection under the United States  Bankruptcy Code. Mr. Anderson also
currently  serves on the boards of directors of  Spectrascan  Imaging  Services,
Inc., Border Alliance Trading Company, Nuclear Assurance Corporation, SA Oil and
Gas Company,  SunVen  Entertainment  Group,  Quality Care  Solutions,  Inc., and
Valley Commerce Bank, which are privately held.

         Larry J. Wells has served as a director of the Company since June 1989.
Mr.  Wells is the Chairman of Anderson  Wells  Company,  which  manages SVP. Mr.
Wells  also  has  served  as  a  director  and  President  of  Sundance  Capital
Corporation  since  May  1989.  From  1983 to 1987,  Mr.  Wells  served  as Vice
President of Citicorp  Venture  Capital and then became Senior Vice President of
Inco Venture Capital.  From May 1969 to June 1983, Mr. Wells was the founder and
President of Creative  Strategies  International,  a market research  consulting
firm specializing in emerging  markets.  Mr. Wells currently serves on the board
of  directors  of Cellegy  Pharmaceutical,  Inc.,  Identix,  Inc.,  and  Telegen
Corporation,  which are publicly  held  companies  as well as VoiceCom  Systems,
Inc., which is privately held.

         Steven A. Rothstein has served as a director of the Company since March
1996.  Mr.  Rothstein  has been  Chairman  of the Board of  National  Securities
Corporation,  a  securities  broker-dealer  and one of the  underwriters  of the
Company's initial public offering,  since 1995. See "Certain  Transactions." Mr.
Rothstein  also serves as Chairman and  President of Olympic  Cascade  Financial
Corporation,  which  is  the  parent  holding  company  of  National  Securities
Corporation.  From 1994 to 1995, Mr. Rothstein served as a Managing  Director of
H.J. Meyers & Co., a securities broker-dealer.  From 1992 to 1994, Mr. Rothstein
served as a Managing Director of Rodman and Renshaw, a securities broker-dealer.
From 1989 to 1992, Mr. Rothstein served as a Managing  Director of Oppenheimer &
Co., a securities broker-dealer.  From 1979 to 1989, Mr. Rothstein was a limited
partner  of Bear  Stearns  & Co.,  a  securities  broker-dealer.  Mr.  Rothstein
currently  is a director of SigmaTron  International,  Inc.,  New World  Coffee,
Inc.,  Vita Food  Products,  Inc.,  and  American  Craft  Brewing  International
Limited, all of which are publicly held companies.

         Robert D.  Bressler  has  served as a  director  of the  Company  since
January 1997.  Mr.  Bressler has served as Chief  Scientist - Networking for Sun
Microsystems,  Inc., a $7 billion company that provides hardware,  software, and
services for network  computing and the Internet,  since April 1994.  From March
1990 to March 1994,  Mr.  Bressler  held various  senior  technology  positions,
including  Senior Vice President of Corporate  Development and Chief  Technology
Officer, with Network Equipment  Technologies,  Inc. Mr. Bressler served as Vice
President Corporate  Development and Chief Technical Officer of 3Com Corporation
("3Com") from March 1988 to March 1990 and as Vice President and General Manager
of Software  Products of 3Com from 1986 to 1988. Mr.  Bressler  served as Senior
Vice President - Development  and Engineering  for BBN  Communications  Corp., a
subsidiary of Bolt Beranek and Newman Inc., from 1980 to 1986.

Key Employees

         The Company has  identified J. Michael  McPheeters,  Stephen M. Derbis,
and Mark J. Jarvis as key employees.  Each of these individuals is a director of
one of the Company's key divisions.

         J. Michael  McPheeters  cofounded the Company in 1985 and has served as
Vice President -- Client  Services since that time. Mr.  McPheeters  served as a
director of the Company  from 1985 until  February  1994 and as  Secretary  from
October 1985 until July 1989.

         Stephen M.  Derbis has served as  Director,  Software  Products  of the
Company since February  1995.  From May 1989 until February 1995, Mr. Derbis was
Manager,  Server Software at FileNet Corporation in Costa Mesa, California.  Mr.
Derbis is the brother-in-law of Michael M. Gordon.
                                       29
<PAGE>
         Mark J. Jarvis has served as Director of Client Services of the Company
since July 1993.  From March  1990  until July 1993,  Mr.  Jarvis was  Director,
Marketing  Support at Applied  Retail  Solutions,  a  Phoenix,  Arizona  company
engaged in retail automation software  development.  From April 1987 until March
1990, Mr. Jarvis was Systems Engineering  Manager of the Company.  Mr. Jarvis is
the husband of Vickie B. Jarvis.

Section 16 Beneficial Ownership Reporting Compliance

         Section  16(a) of the Exchange Act  requires the  Company's  directors,
officers,  and persons who own more than 10 percent of a registered class of the
Company's  equity  securities  to file  reports  of  ownership  and  changes  in
ownership  with  the SEC.  Directors,  officers,  and  greater  than 10  percent
shareholders  are  required by the SEC  regulations  to furnish the Company with
copies of all Section  16(a) forms they file.  Based  solely upon the  Company's
review of the copies of such forms  received  by it during the fiscal year ended
January  31,  1997  and  written  representations  that no  other  reports  were
required,  the  Company  believes  that each  person who at any time during such
fiscal year was a director, officer, or beneficial owner of more than 10 percent
of  the  Company's   Common  Stock   complied  with  all  Section  16(a)  filing
requirements during such fiscal year.

ITEM 10. EXECUTIVE COMPENSATION

Summary of Cash and Other Compensation

         The  following  table sets forth  certain  information  concerning  the
compensation  for the fiscal years ended January 31, 1995, 1996, and 1997 earned
by the Company's  Chief  Executive  Officer and by the Company's other executive
officer whose cash salary and bonus  exceeded  $100,000  during fiscal 1997 (the
"Named  Officers").  No other officer of the Company  received  compensation  of
$100,000 or more during fiscal 1997.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                               Long Term                     
                                                                              Compensation                   
                                                                              ------------                   
                                                                                 Awards                      
                                                                              ------------                   
                                                   Annual Compensation         Securities         All Other  
                                                -------------------------      Underlying        Compensation
Name and Principal Position          Year       Salary($)(1)     Bonus($)     Options(#)(2)         ($)(3)
---------------------------          ----       ------------     --------     -------------      ------------
<S>                                  <C>            <C>          <C>              <C>               <C>   
Michael M. Gordon                    1997           $199,869     $     --         62,500            $3,487
  Chairman of the Board and          1996            149,038      113,981             --                --
  President                          1995            132,495           --             --                --

Matthew J. Gordon                    1997           $131,733     $     --         15,000            $2,435
  Vice President and Secretary       1996            108,671       49,048             --                --
                                     1995             95,106           --             --                --
</TABLE>
------------------

(1)      Messrs. Gordon and Gordon also received certain perquisites,  the value
         of which did not exceed 10% of their  salary  and bonus  during  fiscal
         1997. The Company offers its employees, including officers, medical and
         life insurance benefits.
(2)      The exercise price of all stock options  granted were equal to the fair
         market value of the Company's Common Stock on the date of grant.
(3)      Amounts shown for fiscal 1997 represent matching  contributions made by
         the Company to the Company's 401(k) plan.
                                       30
<PAGE>
Option Grants

         The following  table provides  information on stock options  granted to
the Company's Named Officers during the fiscal year ended January 31, 1997.

                        OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
                                                  Individual Grants
-------------------------------------------------------------------------------------------------------------
                                                 Number of       % of Total
                                                Securities         Options
                                                Underlying       Granted to      Exercise
                                                  Options       Employees in       Price
Name                                          Granted (#)(1)     Fiscal Year      ($/Sh)      Expiration Date
-----------------                             --------------     -----------      ------      ---------------

<S>                                               <C>                <C>           <C>             <C>
Michael M. Gordon........................         62,500             13.8%         $4.63           4/11/06
Matthew J. Gordon........................         15,000              3.3%         $4.63           4/11/06
</TABLE>

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

(1)      The options were granted at the fair value of the shares on the date of
         grant and have a ten-year  term.  Forty percent of the options vest and
         become  exercisable on the second anniversary of the date of grant, and
         the  remaining  options vest and become  exercisable  at the rate of 20
         percent on each of the third,  fourth,  and fifth  anniversaries of the
         date of grant.

Fiscal Year-end Option Values

         The following table provides  information on the value of the Company's
Named Officers unexercised options at January 31, 1997.

                      OPTION VALUES AS OF JANUARY 31, 1997

<TABLE>
<CAPTION>
                                             Number of Securities            Value of Unexercised
                                            Underlying Unexercised           In-the Money Options
                                         Options at Fiscal Year-End(#)     at Fiscal Year-End ($)(1)
                                         -----------------------------   -----------------------------
Name                                     Exercisable     Unexercisable   Exercisable     Unexercisable
-----------------                        -----------     -------------   -----------     -------------

<S>                                         <C>             <C>            <C>              <C>     
Michael M. Gordon.....................          0           62,500         $     0          $507,813
Matthew J. Gordon.....................      9,200           21,333         $57,316          $161,330
</TABLE>
------------------

(1)      Calculated  based  upon the  closing  price as  reported  on the Nasdaq
         National Market on January 31, 1997 of $12.75 per share.

Recent Grants of Stock Options

         Subsequent to January 31, 1997, the Company  granted options to acquire
an aggregate of 428,100 shares of Common Stock. These options include options to
acquire 30,000, 40,000, 75,000, and 30,000 shares of Common Stock at an exercise
price of $12.25 per share issued to Michael M. Gordon, Matthew J. Gordon, Steven
A. Beck,  and Vickie B.  Jarvis,  respectively,  on March 13,  1997;  options to
acquire  75,000  shares of Common Stock at an exercise  price of $4.13 per share
issued to Steven A. Beck on July 17, 1997;  and options to acquire 20,000 shares
of Common  Stock at an  exercise  price of $5.50 per share  issued to Matthew J.
Gordon on August 8, 1997.
                                       31
<PAGE>
Director Compensation and Other Information

         Employees  of the  Company do not receive  compensation  for serving as
members of the Company's Board of Directors. During 1996, non-employee directors
received an annual  retainer of $5,000,  which was  increase to $10,000 per year
effective January 1, 1997.  Non-employee  directors also receive $1,000 for each
meeting attended in person, $500 for each meeting held or attended by telephone,
and $500 for each  committee  meeting  held on a date  other than on a date of a
meeting  of the Board of  Directors.  All  directors  are  reimbursed  for their
expenses in  attending  meetings of the Board of  Directors.  Directors  who are
employees  of the  Company  are  eligible  to receive  stock  options  under the
Company's  1995 Stock  Option  Plan.  Directors  who are not  employees  receive
automatic grants of stock options and restricted shares of Common Stock pursuant
to the Company's 1995 Stock Option Plan. See Item 10, "Executive  Compensation -
Stock Option Plans."

401(k) Profit Sharing Plan

         In May 1992,  the Company  adopted a profit  sharing  plan  pursuant to
Section  401(k) (the  "401(k)  Plan") of the Internal  Revenue Code of 1986,  as
amended (the "Internal Revenue Code"). Pursuant to the 401(k) Plan, all eligible
employees  may  make  elective  contributions  through  payroll  deductions.  In
addition,  the 401(k)  Plan  provides  that the Company  may make  matching  and
discretionary contributions in such amounts as may be determined by the Board of
Directors.  During the fiscal year ended January 31, 1997, the Company  expensed
matching  discretionary  contributions  pursuant  to  the  401(k)  Plan  to  all
executive officers as a group in the amount of approximately $7,869.

Stock Option Plans

1995 Stock Option Plan

         The  Company's  1995 Stock Option Plan (the "1995 Plan") was adopted by
the Company's Board of Directors and approved by the shareholders of the Company
in  October  1995.  The 1995 Plan was  amended by the Board of  Directors,  with
shareholder approval, in February 1996. In December 1996, the Board of Directors
amended  the 1995 Plan to conform to  changes to Rule 16b-3  under the  Exchange
Act. Those amendments did not require shareholder approval. The Plan is intended
to comply with Rule 16b-3 as promulgated  under the Exchange Act with respect to
persons subject to Section 16 of the Exchange Act. The Company believes that the
1995 Plan is important in  attracting  and  retaining  executives  and other key
employees and that it constitutes a significant part of the compensation program
for key  personnel,  providing them with an opportunity to acquire a proprietary
interest in the Company and giving  them an  additional  incentive  to use their
best  efforts  for the  long-term  success  of the  Company.  Options to acquire
537,150  shares  of  Common  Stock  were  outstanding  under the 1995 Plan as of
October 28, 1997. The 1995 Plan will remain in force until October 23, 2005.

         The 1995 Plan  provides for the  granting of options to acquire  Common
Stock of the Company  ("Options"),  the direct  granting of Common Stock ("Stock
Awards"),  the granting of stock appreciation rights ("SARs"),  and the granting
of other cash awards ("Cash  Awards")  (Stock Awards,  SARs, and Cash Awards are
collectively referred to herein as "Awards").  Options and Awards under the 1995
Plan may be issued to key personnel and others  providing  valuable  services to
the Company.  The Options issued may be incentive  stock options or nonqualified
stock options.

         A maximum  of  800,000  shares of Common  Stock of the  Company  may be
issued  under the 1995 Plan.  On  September  30, 1997,  the  Company's  Board of
Directors  approved an amendment to increase the number of shares issuable under
the 1995 Plan to  1,200,000  shares,  subject  to  shareholder  approval  of the
amendment on or before  September 30, 1998.  If any Option or SAR  terminates or
expires  without  having been  exercised  in full,  stock not issued  under such
Option or SAR will again be available  for the purposes of the 1995 Plan. If any
change is made in the stock subject to the 1995 Plan or subject to any Option or
Award   granted   under   the  1995   Plan   (through   merger,   consolidation,
reorganization,  recapitalization,  stock  dividend,  split-up,  combination  of
shares,  exchange of shares, change in corporate structure,  or otherwise),  the
1995 Plan provides that appropriate
                                       32
<PAGE>
adjustments  will be made as to the maximum number of shares subject to the 1995
Plan and the number of shares and exercise  price pet share of stock  subject to
outstanding Options or Awards.

         Options and Awards may be granted only to persons ("Eligible  Persons")
who at the time of grant are either (i) key  personnel,  including  officers and
directors,  of  the  Company  or  its  subsidiaries,  or  (ii)  consultants  and
independent  contractors who provide valuable  services to the Company or to its
subsidiaries.  Options that are  incentive  stock options may only be granted to
key personnel of the Company or its  subsidiaries  who are also employees of the
Company or its subsidiaries.

         The  expiration  date,  maximum number of shares  purchasable,  and the
other  provisions  of the  Options  will be  established  at the time of  grant.
Options  may be granted for terms of up to ten years and become  exercisable  in
whole or in one or more installments at such time as may be determined by a plan
administrator upon grant of the Options. To exercise an Option, the optionholder
will be required to deliver to the Company full  payment of the  exercise  price
for the shares as to which the option is being exercised. Generally, options can
be  exercised  by  delivery  of cash,  check,  or shares of Common  Stock of the
Company.

         Awards  granted in the form of SARs entitle the  recipient to receive a
payment equal to the  appreciation  in market value of a stated number of shares
of Common Stock from the price stated in the award agreement to the market value
of the Common Stock on the date first exercised or  surrendered.  Awards granted
in the form of Stock Awards  entitle the  recipient to directly  receive  Common
Stock.  Cash Awards  entitle the  recipient to receive  direct  payments of cash
depending on the market value or the  appreciation  of the Common Stock or other
securities of the Company. The plan administrators may, consistent with the 1995
Plan, determine such other terms, conditions,  restrictions, and limitations, if
any, on any Awards.

         The 1995 Plan  includes an  automatic  program  that  provides  for the
automatic grant of restricted stock and stock options to non-employee directors.
Each of Gregory S.  Anderson  and Larry J.  Wells,  the  non-employee  directors
serving on the Board of  Directors on the date the 1995 Plan was approved by the
Company's  shareholders,  received an automatic grant of 1,532 restricted shares
of Common Stock and options to acquire 4,600 shares of Common Stock (an "Initial
Grant") on that date,  and each of Steven A.  Rothstein  and Robert D.  Bressler
automatically  received an Initial Grant on the date they became  members of the
Board of Directors.  Each subsequent  newly elected  non-employee  member of the
Board will  automatically  receive  an  Initial  Grant on the date of his or her
first appointment or election to the Board of Directors. In addition, options to
acquire 4,600 additional shares of Common Stock will be automatically granted to
each  non-employee  director on the date of each annual meeting of  shareholders
(the "Annual Grant"). A non-employee director may not sell or otherwise transfer
the 1,532  shares of Common Stock  granted in the Initial  Grant for a period of
one year after the date of the Initial Grant. If a non-employee  director ceases
serving as a member of the Board of Directors  during the one-year  period after
the date of the Initial  Grant or does not attend at least 75% of the  scheduled
meetings of the Board of Directors  (including  meetings of  committees of which
such person is a member) during that one-year period, the 1,532 shares of Common
Stock granted in the Initial Grant will be forfeited and must be returned to the
Company.  Any person who has previously  received an Initial Grant is ineligible
to receive any subsequent Initial Grants. A non-employee  member of the Board of
Directors  is not eligible to receive the Annual Grant if that option grant date
is within 90 days of such  non-employee  member  receiving  the  Initial  Grant.
Options  granted  pursuant  to the  automatic  program  of the 1995 Plan  become
exercisable on the first  anniversary  of the date of grant.  The exercise price
per share of Common Stock subject to Options  granted  pursuant to the automatic
program of the 1995 Plan will be equal to 100% of the fair  market  value of the
Company's  Common  Stock (as defined in the 1995 Plan) on the date such  Options
are granted.

1990 Stock Option Plan

         The 1990  Stock  Option  Plan (the  "1990  Plan")  was  adopted  by the
Company's Board of Directors and approved by the  shareholders of the Company in
September  1990.  The 1990 Plan  provides for the  granting of  incentive  stock
options  or  nonqualified  options  to acquire  Common  Stock of the  Company to
certain selected key
                                       33
<PAGE>
employees, including executive officers and members of the Board of Directors of
the Company.  No options may be granted under the 1990 Plan after  September 11,
2000.

         A maximum of 306,665 shares of the Company's Common Stock may be issued
under the 1990 Plan.  If any option  terminates or expires  without  having been
exercised  in full,  stock not issued  under such option will again be available
for the purposes of the 1990 Plan. If any change is made in the stock subject to
the 1990 Plan,  or subject to any option  granted  under the 1990 Plan  (through
merger,  consolidation,  stock  dividend,  split-up,  combination or exchange of
shares, or recapitalization or change in capitalization), the 1990 Plan provides
that the total number of shares  available  for options will be  proportionately
and  appropriately  adjusted,  and the number of shares and  exercise  price per
share of stock  subject  to  outstanding  options  will be  proportionately  and
appropriately adjusted without any change in the aggregate exercise price. As of
October 28, 1997,  there were  outstanding  options to acquire 334,375 shares of
the Company's Common Stock under the 1990 Plan.

         To exercise an option,  the optionholder will be required to deliver to
the Company full  payment of the  exercise  price for the shares as to which the
option is being  exercised.  Generally,  options can be exercised by delivery of
cash, check, bank draft, or money order.

Employee Stock Purchase Plan

         The Company's  employee stock  purchase plan (the "Purchase  Plan") was
adopted by the Company's Board of Directors and approved by the  shareholders of
the Company in February 1996. A total of 200,000 shares of the Company's  Common
Stock have been reserved for issuance under the Purchase Plan. The Purchase Plan
permits  eligible  employees to purchase  shares of the  Company's  Common Stock
during  concurrent  24-month  offering  periods  (an  "Offering  Period").  Each
Offering Period will be divided into four consecutive six-month purchase periods
(a "Purchase Period"). Employees may purchase shares of Common Stock pursuant to
the Purchase Plan at a purchase  price equal to 85% of the lower of (i) the fair
market  value of the Common Stock on the first day of the  Offering  Period,  or
(ii) the fair market value of the Common Stock on the last day of the applicable
Purchase Period.

Limitation  of Directors'  Liability;  Indemnification  of Directors,  Officers,
Employees, and Agents

         The  Company's  Amended and  Restated  Articles of  Incorporation  (the
"Restated  Articles")  eliminate  the personal  liability of any director of the
Company to the  Company or its  shareholders  for money  damages  for any action
taken or failure to take any action as a director of the Company, to the fullest
extent  allowed  by  the  Arizona   Business   Corporation  Act  (the  "Business
Corporation Act"). Under the Business  Corporation Act, directors of the Company
will be liable to the Company or its  shareholders  only for (a) the amount of a
financial  benefit  received  by the  director  to  which  the  director  is not
entitled;  (b)  an  intentional  infliction  of  harm  on  the  Company  or  its
shareholders;  (c) certain unlawful  distributions  to shareholders;  and (d) an
intentional  violation of criminal  law. The effect of these  provisions  in the
Restated Articles is to eliminate the rights of the Company and its shareholders
(through  shareholders'  derivative  suits on behalf of the  Company) to recover
money  damages  from a  director  for all  actions  or  omissions  as a director
(including  breaches  resulting  from negligent or grossly  negligent  behavior)
except in the  situations  described  in clauses (a)  through  (d) above.  These
provisions  do  not  limit  or  eliminate  the  rights  of  the  Company  or any
shareholder to seek  non-monetary  relief such as an injunction or rescission in
the event of a breach of a director's duty of care.

         The Company's  Restated  Articles  require the Company to indemnify and
advance expenses to any person who incurs liability or expense by reason of such
person acting as a director of the Company, to the fullest extent allowed by the
Business  Corporation  Act. This  indemnification  is mandatory  with respect to
directors  in all  circumstances  in which  indemnification  is permitted by the
Business   Corporation   Act,  subject  to  the  requirements  of  the  Business
Corporation Act. In addition, the Company may, in its sole discretion, indemnify
and advance expenses,  to the fullest extent allowed by the Business Corporation
Act,  to any  person who incurs  liability  or expense by reason of such  person
acting  as  an  officer,   employee  or  agent  of  the  Company,  except  where
indemnification is mandatory pursuant to the Business  Corporation Act, in which
case the Company is required to indemnify to the fullest extent  required by the
Business  Corporation Act. The Company currently has indemnification  agreements
with each of its directors and executive officers.
                                       34
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth certain information regarding the shares
of the Company's  outstanding  Common Stock  beneficially owned as of October 1,
1997 by (i) each of the Company's  directors and  executive  officers,  (ii) all
directors and executive  officers as a group, and (iii) each other person who is
known by the  Company to own  beneficially  or  exercise  voting or  dispositive
control over more than 5% of the Company's Common Stock.

<TABLE>
<CAPTION>
                                                 Number of Shares              Approximate
                                                   and Nature of              Percentage of
Name and Address of Beneficial Owner(1)       Beneficial Ownership(2)     Outstanding Shares(2)
---------------------------------------       -----------------------     ---------------------

<S>                                               <C>                             <C>  
Directors and Executive Officers:
Michael M. Gordon                                   535,615(3)                    18.4%
Matthew J. Gordon                                   112,286(4)                     3.9%
Steven A. Beck                                            0                         *
Vickie B. Jarvis                                     60,590(5)                     2.1%
Gregory S. Anderson                                 700,361(6)                    23.1%
Larry J. Wells                                      700,361(7)                    23.1%
Steven A. Rothstein                                  64,182(8)                     2.2%
Robert D. Bressler                                   11,532                         *
All directors and officers                          
  as a group (eight persons)                      1,494,836                       45.4%
                                                    
Other 5% Shareholders:                              
Anderson Wells Company                              690,091(9)                    22.8%
Sundance Venture Partners, L.P.                     444,619(10)                   14.7%
J. Michael McPheeters                               280,065(11)                    9.9%
Kennedy Capital Management, Inc.(12)                248,000                        8.7%
Sundance Capital Corporation                        245,472(13)                    8.6%
Hathaway Partners Investment                        
  Limited Partnership(14)                           167,500                        5.9%
</TABLE>
--------------------
* Less than 1% of outstanding shares of Common Stock

(1)  Each person  named in the table has sole voting and  investment  power with
     respect to all Common Stock  beneficially  owned by him or her,  subject to
     applicable community property law, except as otherwise indicated. Except as
     otherwise  indicated,  each of such  persons  may be  reached  through  the
     Company at 3410 E. University Drive, Suite 100, Phoenix, Arizona 85034.
(2)  The percentages  shown are calculated based upon 2,838,138 shares of Common
     Stock  outstanding  on October 1, 1997. The numbers and  percentages  shown
     include the shares of Common Stock actually owned as of October 1, 1997 and
     the  shares of Common  Stock  that the  identified  person or group had the
     right to acquire within 60 days of such date. In calculating the percentage
     of  ownership,  all shares of Common  Stock that the  identified  person or
     group had the right to  acquire  within 60 days of October 1, 1997 upon the
     exercise  of  options  are  deemed to be  outstanding  for the  purpose  of
     computing the percentage of the shares of Common Stock owned by such person
     or group, but are not deemed to be outstanding for the purpose of computing
     the percentage of the shares of Common Stock owned by any other person.
(3)  Represents  456,957 shares of Common Stock and 78,658 shares  issuable upon
     exercise of warrants held by Mr. Gordon.
(4)  Represents  66,390  shares of Common  Stock,  27,266  shares  issuable upon
     exercise of vested employee stock options,  and 18,630 shares issuable upon
     exercise of warrants held by Mr. Gordon.
                                       35
<PAGE>
(5)  Represents  30,257 shares of Common Stock  issuable upon exercise of vested
     employee stock options held by Ms. Jarvis and 30,353 shares of Common Stock
     issuable upon exercise of vested employee stock options held by Ms. Jarvis'
     husband.
(6)  Represents  1,532  shares of Common Stock and 4,600  shares  issuable  upon
     exercise of director  stock options held by Mr.  Anderson;  254,423  shares
     held by Sundance Venture  Partners,  L.P.;  245,472 shares held by Sundance
     Capital Corporation;  and 190,196 shares issuable upon exercise of warrants
     held by SVP. Mr.  Anderson is President of Anderson  Wells  Company,  which
     manages SVP. Mr.  Anderson also is a General  Partner of SVP and a director
     and officer of SCC.  See  footnotes 9, 10, and 13. Mr.  Anderson  disclaims
     beneficial  ownership  of all shares  held by each of SVP and SCC except to
     the extent that his  individual  interest  in such  shares  arises from his
     interest in each such entity.
(7)  Represents  1,532  shares of Common Stock and 4,600  shares  issuable  upon
     exercise of director  stock options held by Mr. Wells;  254,423 shares held
     by Sundance Venture Partners,  L.P; 245,472 shares held by Sundance Capital
     Corporation;  and 190,196 shares issuable upon exercise of warrants held by
     SVP. Mr. Wells is Chairman of Anderson  Wells  Company,  which manages SVP.
     Mr.  Wells also is a director of SVP and a director and officer of SCC. See
     footnotes 9, 10, and 13. Mr. Wells  disclaims  beneficial  ownership of all
     shares  held  by each  of SVP  and  SCC,  except  to the  extent  that  his
     individual  interest in such shares  arises from his  interest in each such
     entity.
(8)  Represents  1,532  shares of Common  Stock,  58,050  shares  issuable  upon
     exercise of warrants,  and 4,600 shares  issuable upon exercise of director
     stock options held by Mr. Rothstein.
(9)  Represents 254,423 shares held by Sundance Venture Partners,  L.P.; 245,472
     shares held by Sundance  Capital  Corporation;  and 190,196 shares issuable
     upon exercise of warrants  held by SVP. See  footnotes 10 and 13.  Anderson
     Wells Company is a General Partner of SVP and is the sole owner of SCC. The
     address of Anderson  Wells Company is 400 E. Van Buren  Street,  Suite 750,
     Phoenix, Arizona 85004.
(10) Represents  254,423  shares of Common Stock held by SVP and 190,196  shares
     issuable upon exercise of warrants held by SVP. The address of SVP is 10600
     N. DeAnza Boulevard, Suite 215, Cupertino, California 95014.
(11) Represents   278,465  shares  held  by  Mr.  McPheeters  and  1,600  shares
     beneficially  owned by Mr.  McPheeters  as  custodian  for  certain  of his
     children.  Mr.  McPheeters  is Vice  President  -  Client  Services  of the
     Company.
(12) The address of Kennedy Capital  Management,  Inc. is 10829 Olive Boulevard,
     St. Louis, Missouri 63141.
(13) The address of SCC is c/o Anderson Wells Company,  400 E. Van Buren Street,
     Suite 750, Phoenix, Arizona 85004.
(14) The address of Hathaway  Partners  Investment  Limited  Partnership  is 119
     Rowayton Avenue, Rowayton, Connecticut 06853.
                                       36
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         On  October  13,  1995,  the  Company  issued  notes in the  amounts of
$190,000,  $45,000, $10,000, $10,000, $400,000, and $5,000 to each of Michael M.
Gordon, Matthew J. Gordon, Gregory S. Anderson, Larry J. Wells, Sundance Venture
Partners,  L.P,  and Brian N. Burns (an  officer  of  Anderson  Wells  Company),
respectively,  in connection with a bridge financing. In March 1996, the Company
used a portion of the  proceeds  of its  initial  public  offering  to repay the
notes.

         In March 1996,  the Company  completed its initial  public  offering by
selling an aggregate of  1,437,500  shares of Common Stock at an initial  public
offering price of $6.75 per share.  National Securities  Corporation ("NSC"), of
which  Steven  A.  Rothstein  is  Chairman  of the  Board,  served as one of the
representatives  of the  underwriters of the offering.  Pursuant to the terms of
the  underwriting  agreement  between  the Company and NSC,  NSC  appointed  Mr.
Rothstein as its designee to be a director of the Company upon completion of the
offering.

         In August  1996,  the Company,  Michael M.  Gordon,  Matthew J. Gordon,
Vickie B. Jarvis,  and certain  other  employees of the Company  formed  Cyclone
Software  Corporation  ("Cyclone")  in order to  develop  software  applications
related to electronic commerce on the Internet. The Company,  Michael M. Gordon,
Matthew J. Gordon, and Vickie B. Jarvis own 19.0%,  36.0%, 6.0%, and 6.0% of the
outstanding  stock of Cyclone,  respectively.  During fiscal 1997, the Company's
executive  officers and certain other employees who are  shareholders of Cyclone
provided services to Cyclone valued at approximately $182,000.

         In January 1997, the Company  entered into an equipment lease agreement
with Anderson & Wells Investment Companies,  an affiliate of Gregory S. Anderson
and Larry J. Wells,  who are  directors of the Company.  The lease  provides for
payments  totalling  approximately  $675,000  to  Anderson  &  Wells  Investment
Companies during the period from January 1997 through November 1999.
                                       37
<PAGE>
                                     PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a)   Exhibits

Exhibit
Number                               Exhibit
------                               -------

   1     Form of Underwriting Agreement(1)
 3.1     Second  Amended  and  Restated   Articles  of   Incorporation   of  the
           Registrant(1)
 3.2     Second Amended and Restated Bylaws of the Registrant(1)
 4.1     Form of Certificate representing shares of Common Stock, par value $.01
           per share(1)
 4.2     Form of Representatives' Warrant Agreement(1)
 4.3     Form of Warrant to Purchase  Securities of the Registrant dated October
           13, 1995(1)
 4.4     Form of Common Stock Purchase Warrant dated September 13, 1993(1)
10.1     1990 Stock Option Plan, as amended(1)
10.2     Second Amended and Restated 1995 Stock Option Plan, as amended  through
           December 6, 1996
10.3     Loan  Agreement  dated  August 22,  1995,  between the  Registrant  and
           Concord Growth Corporation, with Amendment(1)
10.4     Security  Agreement  dated August 22, 1995,  between the Registrant and
           Concord Growth Corporation(1)
10.5     General Continuing Guaranty to Concord Growth Corporation by Michael M.
           Gordon(1)
10.6     Form of Unit Subscription Agreement dated October 13, 1995(1)
10.7     Form of Promissory Note dated October 13, 1995(1)
10.8     Form of Security Agreement dated October 13, 1995(1)
10.9     IBM Business Partner Agreement between the Registrant and International
           Business Machines Corporation(1)
10.10    Amendment to IBM Business Partner  Agreement between the Registrant and
           International Business Machines Corp.(1)
10.11    Form of Master Customer Agreement(1)
10.12    Amendment,  Termination  and Waiver  Agreement dated as of September 1,
           1995 among the Registrant,  Sundance Venture Partners, L.P., Sundance
           Capital Corporation, El Dorado Investment Company, Michael M. Gordon,
           J. Michael McPheeters, and Matthew J. Gordon (1)
10.12.1  Amendment No. 1 to Amendment, Termination, and Waiver Agreement(1)
10.13    Employee Stock Purchase Plan, as amended through December 6, 1996
10.14    Form of Indemnity Agreement(1)
11       Computation Re: Earnings Per Share
16       Letter Re: Change in Accountant(1)
21       List of Subsidiaries(1)
23.1     Consent of Arthur Andersen LLP
27       Financial Data Schedule
-------------------
(1)      Incorporated by reference to the Registrant's Registration Statement on
         Form  SB-2  and  amendments  thereto  (No.   33-98512-LA)  as  declared
         effective by the Securities and Exchange Commission on March 15, 1996.

(b)      Reports on Form 8-K.

         None
                                       38
<PAGE>
                                   SIGNATURES


         In accordance  with Section 13 or 15(d) of the Securities  Exchange Act
of 1934,  the  registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.

                                     GATEWAY DATA SCIENCES CORPORATION



Date:  October 29, 1997              /s/ Michael M. Gordon
                                     ---------------------
                                     Michael M. Gordon, Chairman of the Board,
                                     President, and Chief Executive Officer

          In accordance  with the Securities  Exchange Act of 1934,  this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities and on the date indicated.

<TABLE>
<CAPTION>
Signature                                              Capacity                                        Date
---------                                              --------                                        ----


<S>                                     <C>                                                     <C> 
/s/ Michael M. Gordon                   Chairman of the Board, President, and Chief             October 29, 1997
-----------------------------------     Executive Officer (Principal Executive Officer)
Michael M. Gordon


/s/ Vickie B. Jarvis                    Vice President - Finance, Chief Financial               October 29, 1997
-----------------------------------     Officer, and Treasurer (Principal Financial
Vickie B. Jarvis                        and Accounting Officer)



/s/ Gregory S. Anderson                 Director                                                October 29, 1997
-----------------------------------
Gregory S. Anderson


/s/ Larry J. Wells                      Director                                                October 29, 1997
-----------------------------------
Larry J. Wells


/s/ Steven A. Rothstein                 Director                                                October 29, 1997
-----------------------------------
Steven A. Rothstein


/s/ Robert D. Bressler                  Director                                                October 29, 1997
-----------------------------------
Robert D. Bressler
</TABLE>
                                       39
<PAGE>
                GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
                   Index to Consolidated Financial Statements

                                                                            Page
                                                                            ----

Report of Independent Public Accountants................................     F-2

Consolidated Balance Sheet as of January 31, 1997.......................     F-3

Consolidated Statements of Operations for the Years
     Ended January 31, 1996 and 1997....................................     F-4

Consolidated Statements of Shareholders' Equity for the Years
     Ended January 31, 1996 and 1997....................................     F-5

Consolidated Statements of Cash Flows for the Years
     Ended January 31, 1996 and 1997....................................     F-6

Notes to Consolidated Financial Statements..............................     F-7
                                       F-1
<PAGE>
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Gateway Data Sciences Corporation:

We have  audited the  accompanying  consolidated  balance  sheet of Gateway Data
Sciences  Corporation (the "Company") and subsidiary as of January 31, 1997, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the two years in the period  ended  January  31,  1997.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility is to report on these financial statements based on our audits.

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

The  accompanying  financial  statements  have been  prepared  assuming that the
Company will  continue as a going  concern.  As discussed in Note 1, the Company
had negative cash flow from  operations of $2,612,680 for the year ended January
31, 1997, is in default of the terms of its line of credit  agreement,  does not
have any readily available  financing,  is engaged in material litigation with a
significant customer,  recorded a net loss of approximately $700,000 (unaudited)
for the six months ended July 31,  1997,  and has not yet  generated  sufficient
revenue from its software products to fund its ongoing operations. Additionally,
its IBM reseller agreement expired in July 1997. These factors raise substantial
doubt about the Company's  ability to continue as a going concern.  Management's
plans with regards to these  matters are  described in Note 1. The  consolidated
financial   statements   do  not  include  any   adjustments   relating  to  the
recoverability  and  classification  of asset carrying amounts or the amount and
classification  of liabilities that might result should the Company be unable to
continue as a going concern.

Because  of the  possible  material  effect  of  the  matters  discussed  in the
preceding paragraph, we are unable to express, and do not express, an opinion on
the financial statements referred to above.

                                        Arthur Andersen LLP

Phoenix, Arizona
October 27, 1997.
<PAGE>
                GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEET

                                JANUARY 31, 1997
<TABLE>
<CAPTION>
<S>                                                                     <C>          
ASSETS
CURRENT ASSETS:
   Cash and cash equivalents                                            $     936,232
   Trade receivables  --  less allowance of $112,300 (Note 5)               4,813,456
   Inventories (Notes 1 and 5)                                              2,420,393
   Prepaid expenses and other assets                                          432,140
                                                                        -------------

                  Total current assets                                      8,602,221

PROPERTY AND EQUIPMENT  --  Net (Notes 3 and 5)                             1,794,894
NET INVESTMENT IN LEASE RESIDUALS (Note 4)                                  1,663,870
ACCOUNTS RECEIVABLE - LONG TERM (Note 8)                                    2,870,630
OTHER ASSETS (Notes 10 and 12)                                                666,883
                                                                        -------------

                                                                        $  15,598,498
                                                                        =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
   Accounts payable                                                     $   1,452,776
   Accrued liabilities (Note 1)                                             2,889,574
   Accrued payroll and benefits                                               346,319
   Current portion of notes payable (Note 6)                                  161,438
   Current portion of capital lease obligations (Note 7)                       74,375
   Deferred revenue                                                         1,058,759
                                                                        -------------

                  Total current liabilities                                 5,983,241

DEFERRED REVENUE, recognized after one year                                 1,785,266
NOTES PAYABLE, less current portion (Note 6)                                  280,600
CAPITAL LEASE OBLIGATIONS, less current portion (Note 7)                       56,445
                                                                        -------------

                  Total liabilities                                         8,105,552
                                                                        -------------

COMMITMENTS AND CONTINGENCIES (Notes 2, 5, 6, 7, 8 and 11)

SHAREHOLDERS' EQUITY (Note 8):
   Preferred stock, $.01 par value, 5,000,000 shares authorized,
     no shares issued and outstanding                                            --
   Common stock, $.01 par value, 20,000,000 shares authorized,
     2,813,312 shares issued and outstanding                                   28,133
   Additional paid-in capital                                               9,203,940
   Accumulated deficit                                                     (1,739,127)
                                                                        -------------

                  Total shareholders' equity                                7,492,946
                                                                        -------------

                                                                        $  15,598,498
                                                                        =============
</TABLE>

                 See notes to consolidated financial statements.
                                      F-3
<PAGE>
                GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                  FOR THE YEARS ENDED JANUARY 31, 1996 AND 1997





                                                     1996               1997
                                                     ----               ----
REVENUE (Note 1):
   Product                                      $ 19,543,549       $ 20,324,310
   Software license                                2,947,205          4,081,808
   Professional services                           1,448,820          2,750,030
                                                ------------       ------------

                  Total revenue                   23,939,574         27,156,148
                                                ------------       ------------
OPERATING EXPENSES:
   Products sold                                  14,240,309         14,487,317
   Software development                            2,876,895          3,693,255
   Professional services                           1,794,591          2,523,424
   Sales and marketing                             1,626,538          1,926,925
   General and administrative                      1,546,021          1,946,415
                                                ------------       ------------
                  Total expenses                  22,084,354         24,577,336
                                                ------------       ------------

INCOME FROM OPERATIONS                             1,855,220          2,578,812
                                                ------------       ------------
OTHER (INCOME) EXPENSE:
   Interest expense                                  777,422            265,936
   Other, net                                         (5,683)           (97,787)
                                                ------------       ------------
                  Total other expense, net           771,739            168,149
                                                ------------       ------------

INCOME BEFORE INCOME TAXES                         1,083,481          2,410,663

PROVISION FOR INCOME TAXES (Note 9)                     --               97,500
                                                ------------       ------------

NET INCOME                                      $  1,083,481       $  2,313,163
                                                ============       ============
NET INCOME PER COMMON AND COMMON
   EQUIVALENT SHARE (Note 2)                    $        .71       $        .81
                                                ============       ============
COMMON AND COMMON EQUIVALENT SHARES
   OUTSTANDING (Note 2)                            1,601,180          2,842,760
                                                ============       ============

                 See notes to consolidated financial statements.
                                      F-4
<PAGE>
                GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                  FOR THE YEARS ENDED JANUARY 31, 1996 AND 1997

<TABLE>
<CAPTION>
                                           Common Stock          Additional
                                    -------------------------     Paid-in       Deferred     Accumulated
                                       Amount         Shares      Capital     Compensation     Deficit         Total
                                       ------         ------      -------     ------------     -------         -----

<S>                                 <C>             <C>         <C>           <C>            <C>            <C>         
BALANCE, JANUARY 31, 1995           $    10,459     1,045,920   $ 1,352,565   $      --      $(5,135,771)   $(3,772,747)
  Conversion of debentures
    payable, notes payable and
    related accrued interest into
    common stock .................        4,942       494,218     1,219,713          --             --        1,224,655
  Issuance of common stock to
    non-employee directors .......           30         3,061        15,570       (15,600)          --             --
  Amortization of deferred
    compensation .................         --            --            --           3,900           --            3,900
  Net income .....................         --            --            --            --        1,083,481      1,083,481
                                    -----------   -----------   -----------   -----------    -----------    -----------

BALANCE, JANUARY 31, 1996                15,431     1,543,199     2,587,848       (11,700)    (4,052,290)    (1,460,711)
  Net proceeds, initial public
    offering .....................       12,500     1,250,000     6,519,309          --             --        6,531,809
  Issuance of common stock to
    non-employee directors .......           15         1,532          --            --             --               15
  Amortization of deferred
    compensation .................         --            --            --          11,700           --           11,700
  Issuance of common stock
    under Incentive Stock Option
    Plan .........................           86         8,536        42,390          --             --           42,476
  Issuance of common stock
    under Employee Stock
    Purchase Plan ................          101        10,045        54,393          --             --           54,494
  Net income .....................         --            --            --            --        2,313,163      2,313,163
                                    -----------   -----------   -----------   -----------    -----------    -----------

BALANCE, JANUARY 31, 1997 ........  $    28,133     2,813,312   $ 9,203,940   $      --      $(1,739,127)   $ 7,492,946
                                    ===========   ===========   ===========   ===========    ===========    ===========
</TABLE>
                 See notes to consolidated financial statements
                                      F-5
<PAGE>
                GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                  FOR THE YEARS ENDED JANUARY 31, 1996 AND 1997

<TABLE>
<CAPTION>
                                                                                1996           1997
                                                                                ----           ----
<S>                                                                         <C>            <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income ...........................................................   $ 1,083,481    $ 2,313,163
   Adjustments to reconcile net income to net cash provided
     by (used in) operating activities:
       Depreciation and amortization ....................................       344,775        585,976
       Provision for doubtful accounts ..................................        53,100         22,200
       Net loss on property dispositions and other ......................          --            3,184
       Recognition of non-employee director compensation ................         3,900         11,700
   Effect of changes in assets and liabilities:
       Trade receivables ................................................    (1,435,824)    (4,792,132)
       Inventories ......................................................     2,302,435     (2,032,352)
       Prepaid expenses and other assets ................................      (928,846)       (54,521)
       Accounts payable .................................................      (410,566)       172,828
       Accrued liabilities ..............................................        74,302        767,704
       Accrued payroll and benefits .....................................      (226,109)        83,600
       Deferred revenue .................................................       122,377        265,980
                                                                            -----------    -----------

                  Net cash provided by  (used in) operating activities ..       983,025     (2,652,670)
                                                                            -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of property and equipment ...................................      (801,135)    (1,877,450)
   Proceeds from sale of property and equipment .........................          --          699,510
   Net investment in lease residuals ....................................    (1,034,236)      (105,323)
                                                                            -----------    -----------

                  Net cash used in investing activities .................    (1,835,371)    (1,283,263)
                                                                            -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from additional borrowings on notes payable .................       810,000           --
   Principal payments on notes payable ..................................      (113,000)      (946,436)
   Principal payments on capital lease obligations ......................      (204,534)       (55,867)
   Payments on line of credit ...........................................       311,555       (311,555)
   Net proceeds from borrowings from (payments to) officers and employees      (170,189)      (536,172)
   Proceeds from issuance of common stock ...............................          --        6,628,793
                                                                            -----------    -----------

                  Net cash provided by financing activities .............       633,832      4,778,763
                                                                            -----------    -----------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ....................      (218,514)       842,830

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ............................       311,916         93,402
                                                                            -----------    -----------

CASH AND CASH EQUIVALENTS, END OF YEAR ..................................   $    93,402    $   936,232
                                                                            ===========    ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
   Cash paid during the period for interest .............................   $   712,913    $   293,112
                                                                            ===========    ===========

   Cash paid during the period for income taxes .........................   $      --      $       800
                                                                            ===========    ===========

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
   FINANCING ACTIVITIES:
   Capital lease obligations incurrred ..................................   $      --      $    66,344
                                                                            ===========    ===========

   Conversion of notes payable and debentures payable to common stock ...   $ 1,224,655    $      --
                                                                            ===========    ===========

   Fair market value of stock issued to non-employee directors ..........   $    15,600    $      --
                                                                            ===========    ===========
</TABLE>
                 See notes to consolidated financial statements
                                      F-6
<PAGE>
                GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   SUMMARY OF OPERATIONS

     Operations -- Gateway Data Sciences  Corporation  (the  "Company")  and its
wholly owned subsidiary,  Gateway Credit Corporation ("GCC"),  design,  develop,
market,  and implement  software  products and provide related  customer support
services for retail and warehouse  management systems. The Company also provides
professional services including product installation, training, maintenance, and
customization in conjunction with sales of its software products.

     The Company historically has generated the majority of its revenue from the
resale of hardware and software  products  produced by third parties,  primarily
International  Business  Machines Corp.  ("IBM")  AS/400 and related  peripheral
equipment. The Company also has historically generated a portion of it's revenue
from the sale of its proprietary  software products,  primarily the Kinetics(TM)
warehouse  management  system,  which was developed  exclusively  for use on the
AS/400  platform,  and from  providing  professional  services  related to these
products. Sales of IBM products,  including hardware, software, and maintenance,
accounted for  approximately  66% and 56% of the Company's total revenue for the
years ended  January 31, 1996 and 1997,  respectively.  The  Company's  reseller
agreement with IBM expired in July 1997. During the year ended January 31, 1996,
the  Company  changed its  business  strategy  to focus on the  development  and
marketing of its proprietary software products.  In conjunction with this change
in  strategy,  the  Company has since  dedicated  many of its  resources  to the
development and marketing of new software products. The Company anticipates that
this will result in a change in its revenue  mix.  The  Company  believes  that,
although the change in revenue mix may initially  result in lower total revenue,
it should also  result in  improved  gross  profit  margins as software  revenue
increases as a percentage of total revenue. There can be no assurance,  however,
that the Company will be able to  successfully  complete this  transition in its
business focus.

         The accompanying  financial statements have been prepared assuming that
the Company will continue as a going concern.  However, the Company had negative
cash flow from  operations of $2,612,680 for the year ended January 31, 1997, is
in default of certain terms of its line of credit  agreement,  does not have any
readily  available  financing  ,  is  engaged  in  material  litigation  with  a
significant customer,  recorded a net loss of approximately $700,000 (unaudited)
for the six months ended July 31,  1997,  and has not yet  generated  sufficient
revenue from its software products to fund its ongoing operations. Additionally,
its IBM reseller agreement expired in July 1997. These factors raise substantial
doubt about the Company's ability to continue as a going concern.  The Company's
plans with  regards to these  matters  are  described  below.  The  consolidated
financial  statements  have been  prepared on a going  concern  basis and do not
include any adjustments  relating to the  recoverability  and  classification of
asset carrying  amounts or the amount and  classification  of  liabilities  that
might result should the Company be unable to continue as a going concern.

     The Company has marketed the  Kinetics(TM)  warehouse  management  software
product for several years and will continue its current sales efforts  dedicated
to this product and related services.  Kinetics  currently  operates only on the
IBM AS/400  family of  midrange  computers.  To date,  the  Company  has derived
substantially  all of its  software  revenue from  Kinetics and other  IBM-based
software  products.  Future revenue from sales of Kinetics and related  services
will depend upon continued widespread use of IBM midrange computers and upon the
continued  support of such  computers by IBM. In  addition,  the Company will be
required to adapt Kinetics to any changes made by IBM to the AS/400's  operating
system software.  A significant shift away from 
                                      F-7
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

IBM midrange  computer systems by the Company's  customers or the failure by IBM
to continue its support of these systems could have a material adverse effect on
the Company.

     During  the  year  ended   January  31,   1997,   the  Company   introduced
Transact(TM), a point-of-sale software product developed in Java(TM) that can be
utilized on a wide variety of point-of-sale  hardware  platforms.  Subsequent to
January 31,  1997,  the Company  introduced  MarketBuilder(TM),  a  relationship
marketing  system for retailers,  and  Crossfire(TM),  an  Internet-based  store
communication  system,  both of which are also  developed  in Java.  The Company
intends  to  increase  the  resources  dedicated  to  software  development  and
marketing  in  support of its newly  introduced  retail  point-of-sale  software
products.  In conjunction  with its increased focus on software  development and
marketing  and its reduced  emphasis on reselling  the  products of others,  the
Company has streamlined its workforce such that  approximately 40 positions that
were not directly related to software  development and marketing were eliminated
in August 1997. Although the Company has not yet generated  significant sales of
its new  Java-based  products,  it  expects  that the  functionality  of its new
products, the flexibility of Java-based software, and the personnel changes that
have been made to focus on  software  development  and  marketing  efforts  will
result in sufficient future revenue to fund its ongoing operations.

      There can be no assurance that the Company's recently  introduced software
products  will  achieve  market  acceptance  or that the Company will be able to
develop new  products and services in a timely and  cost-effective  manner.  The
failure  of the  Company to  successfully  develop  and market its own  software
products  and to  overcome  the loss of revenue  from the sale of  hardware  and
software  products  developed by others could have a material  adverse effect on
the Company.

     The Company has hired a new Vice President - Marketing and Chief  Operating
Officer who has  considerable  experience  in the sale of  software  products to
retail enterprises and in the management of software development companies.  The
Company believes that this  individual's  expertise in the development of retail
software applications, his contacts in the retail industry, and his expertise in
the  management  of software  development  companies  will enhance the Company's
ability to successfully transition from a hardware reseller to a licenser of its
proprietary software products.

     The Company  operates in an industry that is characterized by fast-changing
technology.  As a result,  the Company  will be  required to expend  substantial
funds for continuing product  development,  including  expenses  associated with
research  and  development  activities  and  additional  engineering  and  other
technical personnel. There can be no assurance that such funds will be available
to the Company given its current financial  condition and results of operations.
Any failure by the Company to anticipate or respond  adequately to technological
developments, customer requirements, or new design and production techniques, or
any  significant  delays in product  development or  introduction,  could have a
material adverse effect on the operating results of the Company.

     Other factors that could  adversely  impact the Company's total revenue and
product mix include the  Company's  ability to maintain the software  design and
development   capabilities  necessary  to  design  and  produce  innovative  and
desirable products on a timely and  cost-effective  basis; the Company's ability
to penetrate new markets and attract new customers; the budgeting and purchasing
practices or  constraints of its  customers;  the length of the Company's  sales
cycles;  the  complicated  nature of the Company's  product  installations;  and
unanticipated postponement or cancellation of significant orders.

     The Company has entered into an agreement with Information Systems of North
Carolina,  Inc.  ("ISI") with respect to future sale of specified IBM AS/400 and
related products and services to certain of the Company's customers.  Under this
agreement,  the  Company  has ceased  selling,  and ISI has begun  selling,  the
specified  AS/400-related  products and services to the designated 
                                      F-8
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

customers (as defined).  The agreement provides that ISI will pay to the Company
50% of its operating  profits (as defined) from sales of the specified  products
to the designated  customers  during the four-year  term of the  agreement.  The
Company has the right to terminate  the agreement and resume direct sales of the
specified  AS/400-related  products and services to the designated  customers in
the event that ISI's  payments to the  Company are less than  $50,000 in each of
two consecutive  quarterly periods. In addition,  ISI has the right to terminate
the  agreement  upon  written  notice to the Company,  provided  that ISI ceases
selling the  specified  AS/400-related  products and services to the  designated
customers  for a period of two years after such  termination.  As of the date of
this Report, this arrangement has not provided the Company with any revenue, and
there can be no assurance that the Company will derive significant  revenue from
this arrangement in the future.

     The Company's  independent  public accountants have reported to the Company
that, in the course of their audit of the Company's financial statements for the
fiscal year ended January 31, 1997 and their review of the  unaudited  financial
statements  for the six months  ended July 31,  1997,  they  discovered  various
conditions  that they believe  constitute  material  weaknesses in the Company's
internal  controls.  These  conditions  consist of (i) weaknesses in forecasting
internal cash requirements; (ii) weaknesses in policies and procedures to ensure
the accurate timing, classification,  and recording of significant transactions;
and (iii) weaknesses in maintaining formal documentation  regarding acquisitions
and  dispositions of assets.  The Company has been taking various steps intended
to  strengthen  its financial  controls,  including  engaging  more  experienced
personnel in both operational and financial positions.

2.   SIGNIFICANT ACCOUNTING POLICIES

     a. Principles of  Consolidation -- The  consolidated  financial  statements
include the accounts of the Company and its  subsidiary,  GCC.  All  significant
intercompany accounts and transactions have been eliminated in consolidation.

     b. Cash and Cash Equivalents -- Cash and cash equivalents  include all bank
accounts and short-term investments with a maturity of three months or less when
purchased.

     c.  Inventories  --  Inventories  are stated at the lower of cost (specific
identification)  or market.  Inventories  at January  31,  1997,  consist of the
following:

     New equipment........................................          $ 1,247,789
     Used equipment.......................................            1,172,604
                                                                    -----------
     
              Total inventories                                     $ 2,420,393
                                                                    ===========

     The Company  purchases  substantially  all new hardware,  certain  software
applications,  and certain  maintenance from IBM. During the years ended January
31, 1996 and 1997, approximately $15,635,000,  and $15,259,300,  or 66% and 56%,
respectively,  of total revenue resulted from sales of such hardware,  software,
and maintenance purchased from IBM .

     d.  Property and  Equipment -- Property and equipment are recorded at cost.
Depreciation and amortization are provided using the  straight-line  method over
the estimated useful lives of the assets as follows:  leasehold  improvements --
over  the  term  of the  respective  lease  or life of the  asset,  if  shorter;
furniture  and fixtures -- five years;  computer and office  equipment and other
assets -- three to five years.
                                      F-9
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

     e. Income  Taxes --  Effective  February 1, 1993,  the Company  adopted the
provisions  of  Statement of Financial  Accounting  Standards  ("SFAS") No. 109,
Accounting  for Income  Taxes,  which,  among  other  things,  provides  for the
establishment  of deferred  income taxes for temporary  differences  between the
financial and income tax basis of reporting.

     f. Accrued  Liabilities -- Included in accrued  liabilities is a payable of
approximately $2,580,300 representing amounts due for the termination of certain
customer-related third-party leases.

     g. Revenue  Recognition -- Product  revenue in the  accompanying  financial
statements includes hardware,  third-party software, and third-party maintenance
sold to the Company's  customers.  Product and third-party  software  revenue is
recognized upon the shipment of merchandise from the vendor (principally IBM) to
the end user,  or when  shipped  from the  Company,  whichever  is  appropriate.
Third-party  maintenance  revenue is deferred and recognized  straight-line over
the  term  of  the  maintenance  contract.   Software  license  revenue  in  the
accompanying  financial  statements  includes  revenue from the licensing of the
Company's   proprietary   software   offerings  as  well  as  revenue  from  the
customization  and  modification  of the Company's  software for its  customers.
Software  license revenue is recognized in accordance with Statement of Position
91-1, Software Revenue Recognition. Accordingly, revenue from software licensing
is  recognized  when (i) shipment of the software  has  occurred,  (ii) a signed
non-cancelable  license agreement has been received from the customer and, (iii)
any  remaining  obligations  under the license  agreement  have been  completed.
Revenue related to  insignificant  obligations is deferred and recognized as the
obligations  are fulfilled.  Revenue from software  licensing  agreements  which
involve significant customization,  modification,  or production of the licensed
software is deferred and recognized using the percentage of completion method of
accounting.  Revenue  from  software  license  fees  related  to  the  Company's
obligation to provide certain  post-contract  customer support without charge is
unbundled  from the  software  license fee at its fair value and is deferred and
recognized  straight-line over the contract support period.  Revenue from annual
or  other  renewals  of   maintenance   contracts  is  deferred  and  recognized
straight-line over the term of the contracts. Revenue from professional services
is generally  billed on a time and materials basis and recognized as the related
services are provided.

     h. Product Development -- SFAS No. 86, Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise  Marketed,  requires the capitalization
of  certain  software  development  costs  subsequent  to the  establishment  of
technological  feasibility.  Based on the Company's product development process,
technological feasibility is established upon the completion of a working model.
Costs  incurred by the Company  between the  completion of the working model and
the  point at  which  the  product  is  ready  for  general  release  have  been
insignificant.  Accordingly, the Company has expensed all such costs of software
development expenses in the accompanying consolidated statements of operations.

     i. Net Income Per  Common  and  Common  Equivalent  Share -- Net income per
common and common equivalent share is computed using the weighted average number
of common and common equivalent shares  outstanding  during each period.  Common
stock equivalents consist of stock options and warrants.  SFAS NO. 128, Earnings
Per Share, was issued by the Financial  Accounting Standard Board in March 1997.
SFAS No. 128 is effective for fiscal years ending after  December 15, 1997,  and
when adopted,  will require restatement of earnings per share for prior periods.
The pro forma  disclosures  of earnings  per share  under SFAS.  No. 128 for the
years ending January 31, 1996
                                      F-10
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

and 1997 are:

                                                       Year Ended January 31,
                                                       ----------------------
                                                        1996            1997
                                                        ----            ----
Net Income per Common and Common Equivalent Share
                 As reported                             .71             .81
                 Pro forma                               .73             .87
Common and Common Equivalent Shares Outstanding
                 As reported                          1,601,180       2,842,760
                 Pro forma                            1,543,199       2,651,964

     j. Concentrations of Credit Risk -- Financial instruments which potentially
expose the Company to concentrations of credit risk, as defined by SFAS No. 105,
Disclosure of Information  About Financial  Instruments  with  Off-Balance-Sheet
Risk and  Financial  Instruments  with  Concentrations  of Credit Risk,  consist
primarily of trade accounts receivable.  The Company does not require collateral
upon  delivery of its  products or  services.  The Company has a  receivable  of
$2,870,630  from  one  customer,   of  which   approximately   $1.5  million  is
approximately  364 days past due as a result of certain  disputed  amounts.  The
Company intends to pursue  collection of this  receivable  since it believes all
services  were  provided  in  accordance  with its  written  contract  with this
customer.  Accordingly,  no reserve has been established against the receivable.
On May 30, 1997,  this customer  filed a lawsuit  against the Company,  claiming
unspecified  damages  resulting from breach of contract and fraud related to the
Company's  performance under its contract.  The Company has filed a counterclaim
for the amounts  that it claims the  customer  owes under the  contract  and has
filed an answer denying the customer's  claims in the lawsuit.  (See Note 8). In
the event that the  Company  is unable to obtain a  successful  decision  on its
counterclaim  or a decision  adverse to the Company is rendered  with respect to
the claims by the customer,  the resolution of this matter could have a material
adverse effect on the Company.

     k. Fair Value of Financial  Instruments  -- The Company  estimates the fair
value of its monetary assets and liabilities  based upon existing interest rates
related to such assets and liabilities compared to current rates of interest for
instruments with a similar nature and degree of risk. The Company estimates that
the carrying value of all of its monetary  assets and  liabilities  approximates
fair value as of January 31, 1997.

     l. Risks and Uncertainties -- The Company intends to develop and market new
software  products  and  services  to  address  customer  needs and  changes  in
computing technology and methodology.  There can be no assurance,  however, that
the Company will be able to successfully complete the transition of its business
focus, that the Company's  internally  developed products will achieve increased
market  acceptance,  that the Company  will be able to develop new  products and
services in a timely and  cost-effective  manner, or that such products that are
developed will be accepted in the marketplace.

      m. Recently Issued  Accounting  Standards -- SFAS No. 121,  Accounting for
the  Impairment of Long- Lived Assets and for  Long-Lived  Assets to Be Disposed
Of,  which  was also  adopted  by the  Company  in fiscal  1997,  did not have a
material effect on the Company's financial position or its results of operations
upon adoption. SFAS No. 123, Accounting for Stock-Based  Compensation,  was also
adopted by the Company in fiscal 1997.  Pursuant to the  provisions  of SFAS No.
123, the Company will  continue to account for  transactions  with its employees
pursuant to Accounting  Principles  Board Opinion No. 25,  Accounting  for Stock
Issued To Employees  (Note 8). SFAS NO. 128,  Earnings Per Share,  was issued by
the Financial Accounting Standard Board in March 1997. SFAS No. 128 is effective
for fiscal years ending after December 15, 1997, and when adopted,  will require
restatement of earnings per share for prior periods.
                                      F-11
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

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

3.   PROPERTY AND EQUIPMENT

     Property and equipment at January 31, 1997, consist of the following:

     Computer and office equipment............................    $  1,945,864 
     Furniture and fixtures...................................         785,673
     Leasehold improvements...................................          74,475
     Other....................................................         354,051
                                                                  ------------
     
                                                                     3,160,063
     Less accumulated depreciation and amortization...........      (1,365,169)
                                                                  ------------
     
     Property and equipment, net..............................    $  1,794,894
                                                                  ============

     Computer and office equipment  includes  $224,300,  net, of equipment under
capital leases. Depreciation expense amounted to $586,000 in the current year.

4.   NET INVESTMENT IN LEASE RESIDUALS

     The  Company  frequently  assists  its  customers  by  arranging  long-term
financing for the purchase of hardware,  software, and third-party  maintenance.
The  Company  generally  uses an  affiliate  of IBM for these  transactions.  In
certain of these  transactions,  the Company may choose to accept the assignment
of the customer's end-of-lease purchase option as consideration for a portion of
the  sales  price.  The  consideration  given  by  the  Company  to  obtain  the
end-of-lease  purchase  option,  which  represents the discount  provided to the
customer  from the fair market  value of the products  sold,  is recorded as net
investment in lease residuals. Net investment in lease residuals represents less
than 10%,  measured on a present  value basis,  of the fair value of the related
hardware sold.

5.     LINE OF CREDIT

     In August 1995,  the Company  obtained a line of credit from Concord Growth
Corporation  for  borrowings in an amount that is the lower of $2,000,000 or 75%
of eligible accounts receivable as defined in the line of credit agreement. This
line of credit was secured by all of the Company's  assets and was guaranteed by
the Company's President. The line of credit bore interest at the prime rate plus
8% and provided for a term expiring on August 22, 1997. The Company was required
to pay a monthly minimum fee of $5,000 along with an administrative fee based on
the average daily balance  outstanding each month. A facility fee of 1.5% of the
maximum credit was due annually.  The Company had no outstanding balance on this
line of credit at January 31, 1997. The average outstanding balance was $841,400
and $550,000 for the years ended  January 31, 1996 and 1997,  respectively.  The
weighted  average  interest  rate was 16% and 16.25% for the years ended January
31, 1996 and 1997,  respectively.  In February 1997, the Company terminated this
line of credit and replaced it with the line of credit discussed below.

     On February  21, 1997,  the Company  obtained a line of credit from Norwest
Business Credit, Inc.  ("Norwest") for borrowings in an amount that is the lower
of $3,000,000 or 80% of eligible accounts receivable, plus the lower of $250,000
or 50% of eligible  inventory,  as defined in the line of credit agreement.  The
line of credit, as subsequently amended, bears interest at the base lending rate
(prime rate - 8.25% at January 31,  1997) plus 2.0% and matures on February  21,
2000. The Company 
                                      F-12
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

is required to pay a monthly  minimum fee of $5,000  consisting  of interest and
unused credit facility fees.  Borrowings under the line of credit are secured by
substantially all of the Company's tangible and intangible assets. As of October
27, 1997,  the Company was in default  under  certain  covenants on this line of
credit.  Accordingly,  Norwest  has the right to demand  payment of all  amounts
outstanding,  which amounted to approximately $1,137,000 at October 27, 1997. In
addition, in October 1997 Norwest exercised its right to not provide any further
advances under the line. In July 1997, Michael M. Gordon, the Company's Chairman
of the Board,  President,  and Chief  Executive  Officer and Mr. Gordon's spouse
personally guaranteed the Company's  indebtedness under this line of credit. The
Company currently is seeking additional sources of financing,  which may include
one or more private  placements  of debt or equity  securities.  There can be no
assurance that any  additional  financing will be available to the Company or as
to the terms of any such  financing  that is available.  The inability to obtain
such  financing  could  result in the  inability of the Company to continue as a
going concern.  If such  financing is not available in sufficient  amounts or on
satisfactory  terms, the Company also may be unable to expand its business or to
develop  new  customers  at the rate  desired and its  operating  results may be
adversely affected.

6.   NOTES PAYABLE

     Notes payable at January 31, 1997, consists of the following:

Note payable, interest at 15%, principal and interest of $18,682
     due monthly through June 1999..................................   $ 442,038

Less current portion................................................   (161,438)
                                                                       ---------

                                                                       $ 280,600
                                                                       =========

     At January 31, 1997,  scheduled  maturities for the years ending January 31
are as follows:

     1998.......................................................     $ 161,438
     1999.......................................................       191,021
     2000.......................................................        89,579
                                                                     ---------
                                                    
                                                                     $ 442,038
                                                                     =========
                                                  
     In connection  with the  Company's  initial  public  offering in March 1996
(Note 9) the  Company  retired  $810,000  of notes  payable  that were issued in
connection  with the  issuance  of bridge  notes  payable  in October  1997.  In
conjunction  with those  bridge  notes,  the  Company  also  issued  warrants to
purchase a total of 335,338 shares of the Company's  common stock,  as adjusted,
at an  exercise  price of $5.09 per share to the  holders of the  bridge  notes.
Bridge notes payable in the amount of $660,000 and warrants to purchase  252,997
shares of the  Company's  common  stock were issued to certain of the  Company's
officers, members of the Company's Board of Directors, and an affiliated party.


7.   LEASE COMMITMENTS

     Operating   Leases  --  The  Company  conducts  its  operations  in  leased
facilities and also leases certain property and equipment. The aggregate minimum
rental commitments under the non-cancelable operating leases for the years ended
January 31 are as follows:

        1998....................................................   $   690,781
        1999....................................................       377,957
        2000....................................................       234,442
                                                                   -----------
        
                 Total..........................................   $ 1,303,180
                                                                   ===========
                                      F-13
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

     Rental expense on operating  leases was $507,676 and $442,500 for the years
ended  January 31, 1996 and 1997,  respectively.  Included in these  amounts are
operating  lease  expenses of $108,595  and $21,250 paid to an officer and other
employees for the years ended January 31, 1996 and 1997, respectively.

     Included in operating  lease  commitments is a  sale-leaseback  transaction
which  the  Company   entered  into  in  1996.   The  Company  sold  assets  for
approximately  $700,000  and has  agreed  to  lease  back  the  same  items  for
approximately $20,000 per month over a 36-month term. The lease contract matures
in November 1999.

     Capital Leases -- The Company leases computer and telephone equipment under
capital leases (Note 3). Capital lease  obligations  bear interest rates ranging
from 9% to 17% and are due in varying monthly installments through January 2001.

         At January 31, 1997,  maturities for the years ending January 31 are as
follows:

           1998 .............................................        $  82,774
           1999 .............................................           19,269
           2000 .............................................           19,269
           2001 .............................................           19,269
           2002 .............................................           11,240
                                                                     ---------
                                                            
                    Total ...................................          151,821
           Less amount representing interest ................          (21,001)
                                                                     ---------
                                                            
                    Total ...................................          130,820
           Less current portion .............................          (74,375)
                                                                     ---------
                                                            
                    Total ...................................        $  56,445
                                                                     =========
     
8.     OTHER

      The  Company  is party to  various  legal and  administrative  proceedings
arising  in the  ordinary  course  of  business.  Management  believes  that the
eventual outcome of these proceedings will not have a material adverse affect on
the Company's financial position, results of operations or liquidity.

      As discussed in Note 2, the Company is involved in a material dispute with
a customer. The dispute involves a receivable of $2,870,630 at January 31, 1997,
of which  approximately  $1.5 million was one year past due at that date.  As of
May 30, 1997,  the  receivable  balance was  $3,683,575.  On May 30,  1997,  the
customer filed suit against the Company in the United States  District Court for
the Eastern District of Wisconsin (Case No.  97-C-0635).  The complaint  alleges
that the  Company  breached  its  contract  with the  customer by (i) failing to
deliver and install  certain  software  products,  (ii)  failing to use its best
efforts to achieve productive use of the Company's software products,  and (iii)
failing  to  provide  its  professional  consulting  services  in a  reasonable,
workmanlike manner. The customer is seeking an unspecified amount of damages and
a declaratory  judgment with respect to the parties' respective rights and legal
obligations.  The complaint  also alleged that the Company acted in a fraudulent
manner by making false  representations  to the customer in connection  with the
contractual  agreements  between the Company  and the  customer.  On October 15,
1997, the court dismissed the customer's  fraud claims against the Company.  The
Company has filed a  counterclaim  for the amounts  that the Company  claims the
customer owes under the contract and has filed an answer  denying the customer's
claims  in  the  complaint.   The  Company  intends  to  vigorously  pursue  its
counterclaim and to vigorously defend the lawsuit by the customer.  In the event
that the Company is unable to obtain a successful  decision on its  counterclaim
or a decision  adverse to the
                                      F-14
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

Company is rendered with respect to the claims by the customer,  the  resolution
of this matter could have a material  adverse effect on the Company.  

9.    CAPITAL STOCK

     Reverse  Stock  Split  --  Share  amounts  in  the  accompanying  financial
statements  and  notes to  financial  statements  give  retroactive  effect to a
one-for-two  reverse stock split  effected on October 25, 1995, a  two-for-three
stock split effected on December 28, 1995, and a 1.15-for-1 stock split effected
on February  14,  1996,  as well as a change in the par value of common stock to
$.01 per share.

     Initial Public Offering.  -- In March 1996 the Company completed an initial
public  offering of its common stock.  The Company sold 1,250,000  shares of its
common  stock at $6.75 per share,  resulting  in net  proceeds to the Company of
approximately  $6.9 million.  The Company used the proceeds to pay down the line
of credit (Note 5) and to retire the bridge notes  payable (Note 6). The Company
has used a portion of the net proceeds to develop new software  applications and
enhancements  to  existing  applications,  to modify its  software  products  to
operate  on  open  architecture   platforms,   to  expand  marketing  and  sales
operations,  to make  additional  capital  investments,  and for working capital
purposes.

     1990 Stock Option Plan -- In fiscal 1991,  the Company  adopted the Gateway
Data Sciences Corporation Stock Option Plan (the "1990 Plan") which provides for
the grant of  options  intended  to  qualify  as  incentive  stock  options  and
nonstatutory  stock  options  within the meaning of Section 422 of the  Internal
Revenue  Code of 1986,  as amended  (the  Code).  Incentive  stock  options  are
issuable only to eligible  officers and  employees of the Company.  Nonstatutory
options may be granted to employees,  officers,  directors or consultants of the
Company.  The Company has reserved  306,665  shares of common stock for issuance
under the Plan.  There were 100,381 and 148,903  shares  available  for issuance
under the 1990 Plan as of January 31, 1996 and 1997, respectively.

     1995 Stock  Option Plan -- In October  1995,  the Company  adopted the 1995
Stock Option Plan (the "1995 Plan").  The 1995 Plan provides for the granting of
options to purchase  common  stock  ("Options"),  the direct  granting of common
stock, and the granting of stock  appreciation  rights ("SARs") and cash awards,
up to a  maximum  of  800,000  shares  of  common  stock.  If any  Option or SAR
terminates or expires  without having been  exercised in full,  stock not issued
under such Option or SAR will again be  available  for the  purposes of the 1995
Plan.  There were 787,736 and 232,442  shares  available for issuance  under the
1995 Plan at January 31, 1996 and 1997, respectively.

     The Company's 1995 Plan includes an automatic program that provides for the
automatic grant of restricted stock and stock options to non-employee directors.
The  automatic  program  provides  that each person who first becomes an outside
director of the Company is  automatically  granted  1,532  shares of  restricted
Common  Stock and an option to purchase  4,600 shares upon the date on which the
optionee first becomes a director of the Company.  A  non-employee  director may
not sell or otherwise  transfer  the 1,532 shares of Common Stock  granted for a
period of one year  after the date of the  grant.  In  addition,  each  director
receives an additional  4,600 stock  options on the date of each annual  meeting
thereafter  so long as the optionee  remains an outside  director.  The exercise
price of all  non-employee  director options granted is equal to the fair market
value  of a share  of the  Company's  common  stock  on the date of grant of the
option.  Options to purchase  9,200 and 13,800  shares of common  stock had been
granted to  directors  at January  31,  1996 and 1997,  respectively,  at prices
ranging  from $4.63 to $5.09 per share,  of which  options to  purchase  -0- and
9,200 shares were exercisable at January 31, 1996 and 1997, respectively.
                                      F-15
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

     Under  the 1990 Plan and 1995  Plan,  the per  share  exercise  price of an
incentive  stock option may not be less than the fair market value of the common
stock on the date the  option is  granted.  No  person  who  owns,  directly  or
indirectly,  at the time of the granting of an incentive stock option, more than
10% of the total combined voting power of all classes of stock of the Company is
eligible to receive  incentive  stock  options under the 1990 Plan and 1995 Plan
unless the option  price is at least 110% of the fair market value of the common
stock  subject to the  option on the date of the grant.  Under the 1990 Plan and
1995 Plan,  incentive  stock options may be exercised  only if the option holder
remains  continuously  associated  with the Company  from the date of grant to a
date not less than 60 days prior to the date of exercise.  Options granted under
the  1990  Plan or the 1995  Plan  must be  granted  within  10  years  from the
effective  date of the  respective  plan. The exercise date of an option granted
under the 1990 Plan and 1995 Plan cannot be later than 10 years from the date of
grant,  provided  that the term of an incentive  stock option is limited to five
years if the optionee is a person who owns stock  representing  more than 10% of
the voting power of the capital  stock of the Company on the date of grant.  Any
options that expire  unexercised or that terminate upon an optionee's ceasing to
be employed by the Company  become  available  for  re-issuance  pursuant to the
terms of the plan under which such options were originally issued.

A summary of the status of the Company's  stock option plans at January 31, 1996
and 1997, and changes during the years then ended is presented below.

<TABLE>
<CAPTION>
                                                               1996                      1997
                                                   -------------------------  ------------------------
                                                                   Weighted                  Weighted 
                                                                   Average                   Average
                                                                   Exercise                  Exercise
                                                      Shares       Price         Shares      Price
                                                   --------------  ---------  -------------  ---------

<S>                                                <C>               <C>      <C>              <C>  
Outstanding, beginning of year                        151,435        $5.91       206,284       $6.16
    Granted...................................        113,678        $6.38       457,500       $5.27
    Exercised.................................           --            --         (8,536)      $5.07
    Forfeited.................................        (58,829)       $6.12       (92,286)      $5.66
                                                      -------                    -------

Outstanding at end of year                            206,284        $6.16       562,962       $5.91
                                                      =======                    =======

Exercisable at end of year                             42,916        $5.72        54,676       $5.84
                                                      =======                    =======

Range of exercise prices......................     $4.88 -  $7.83             $4.63 -  $6.52
                                                   ==============             ==============

Weighted average fair value of options granted         $5.30                      $4.75
                                                     =========                  =========
</TABLE>

  The weighted average remaining contractual life of all options is 8.85 years.

     Employee Stock Purchase Plan -- The Company's  employee stock purchase plan
(the  "Purchase  Plan") was  adopted by the  Company's  Board of  Directors  and
approved by the shareholders of the Company in February 1996. A total of 200,000
shares of the Company's  common stock have been reserved for issuance  under the
Purchase Plan. The Purchase Plan permits  eligible  employees to purchase shares
of the Company's common stock during  concurrent  24-month  offering periods (an
"Offering  Period").  Each  Offering  Period is  divided  into four  consecutive
six-month purchase periods (a "Purchase Period").  Employees may purchase shares
of common stock  pursuant to the Purchase Plan at a purchase  price equal to 85%
of the lower of (i) the fair market  value of the common  stock on the first day
of the Offering Period, or (ii) the fair market value of the common stock on the
last day of the Purchase  Period.  The initial  Offering Period commenced on the
date of the initial public  offering of the Company's  common stock.  During the
period ended January 31, 1997,  10,045 shares of common stock were  purchased by
employees at prices ranging between $5.42 and $5.53 per share.
                                      F-16
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

      Common  Stock  Warrants  --  At  January  31,  1997,  there  are  warrants
outstanding for the purchase of 335,338 shares of the Company's  common stock at
$5.09 per  share.  These  warrants  were  issued in  connection  with the bridge
financing  discussed in Note 6. The warrants  became  exercisable on October 13,
1996.

     On September  13, 1993, in connection  with related debt  obligations,  the
Company entered into Stock Warrant  Agreements with Sundance  Venture  Partners,
L.P.  ("SVP") and El Dorado  Investment  Company  ("El  Dorado")  that grant the
holders the right to purchase up to 24,958 and 30,748 shares,  respectively,  of
common stock at a price of $4.88 per share,  which was considered to be the fair
market value at the date of grant.  The warrants are  exercisable  by SVP and El
Dorado at any time until their expiration on December 31, 1999. No warrants have
been exercised as of January 31, 1997.

     In conjunction with the Company's initial public offering on March 25, 1996
the  Company  sold  to  National  Securities   Corporation,   the  underwriters'
representative,  warrants  to  purchase  125,000  shares  of Common  Stock.  The
warrants have an exercise price of $10.13 (150% of the initial  public  offering
price),  will be exercisable  for a period of four years  beginning on March 25,
1997, and contain certain  anti-dilution,  registration rights, net issuance and
exercise provisions.

     Statement  of Financial  Accounting  Standards  No. 123 - During 1995,  the
Financial  Accounting  Standards  Board  issued  SFAS No.  123,  Accounting  for
Stock-Based Compensation,  which defines a fair value based method of accounting
for an employee  stock option or similar  equity  instrument  and encourages all
entities  to adopt that method of  accounting  for all of their  employee  stock
compensation  plans.  However,  it also  allows an entity to continue to measure
compensation cost related to stock options issued to employees under these plans
using the method of accounting  prescribed by the  Accounting  Principles  Board
Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees.  Entities
electing  to  remain  with the  accounting  in APB No.  25 must make a pro forma
disclosures  of net income and  earnings  per share,  as if the fair value based
method of accounting defined in SFAS No.
123 has been applied.

The Company has elected to account for its stock-based  compensation plans under
APB No. 25;  therefore,  the  Company  has  computed  for  pro-forma  disclosure
purposes  the value of all options and  warrants  granted  during 1995 and 1996;
using the following weighted average assumptions:

         Risk free interest rate                              6.49%
         Expected dividend yield                              N/A
         Expected lives                                       8 years
         Expected volatility                                  96%

Options were assumed to be exercised  over the eight year  expected life for the
purpose of this valuation.  Adjustments are made for options  forfeited prior to
vesting.  The total value of options and warrants granted was computed to be the
following  approximate  amounts,  which would be amortized on the  straight-line
basis over the vesting period of options and warrants:
         
         Year ended January 31, 1996                          $  307,840
         Year ended January 31, 1997                          $1,652,073
                                      F-17
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

If the Company had accounted for stock options issued to employees  using a fair
value based method of  accounting,  the  Company's net income and net income per
common and common equivalent share would have been as follows:

<TABLE>
<CAPTION>
                                                                        Year Ended January 31,
                                                                        ----------------------
                                                                         1996            1997
                                                                         ----            ----
<S>                                                                 <C>             <C>          
         Net Income:
                As reported                                         $   1,083,481   $   2,313,163
                Pro forma                                           $     923,488   $   1,195,676
         Net income per common share and common share equivalent:
                As reported                                                   .71   $         .81
                Pro forma                                           $         .61   $         .42
</TABLE>

     The effects of applying SFAS No. 123 for  providing  pro forma  disclosures
for 1996 and 1997 are not likely to be representative of the effects on reported
net income and net  income  per  common and common  equivalent  share for future
years,  because options vest over several years and additional  awards generally
are made each year.

10.  INCOME TAXES

     A reconciliation  of the difference  between the provision for income taxes
and the amount that would be computed using  statutory  federal income tax rates
is as follows:

                                                         Year Ended January 31,
                                                         ----------------------
                                                           1996          1997
                                                           ----          ----
   
   Provision computed at the statutory federal rate .   $ 368,000     $ 792,000
   State income tax provision .......................      65,000       140,000
   Penalties ........................................     111,000         1,000
   Other ............................................      10,000        20,000
   Federal Alternative Minimum Tax ..................        --            --
   Utilization of  net operating loss carryover .....    (554,000)     (855,500)
                                                        ---------     ---------
       Total ........................................   $    --       $  97,500
                                                        =========     =========

     A detail  of the net  deferred  tax  asset  as of  January  31,  1997 is as
follows:


    Current:
        Reserves not currently deductible .....................     $  33,000
        Other expenses not currently deductible ...............        47,000
    Non Current:
        Accelerated tax depreciation ..........................       (36,000)
        Tax effect of net operating loss carry forwards .......       346,000
        Other .................................................        95,000
                                                                    ---------
                                                                      485,000
    Valuation allowance .......................................      (403,000)
                                                                    ---------
    
    Net deferred tax asset ....................................     $  82,000
                                                                    =========

     The net  deferred  tax  asset  is  included  under  "Other  Assets"  in the
accompanying balance sheet.

     SFAS No. 109 requires  the  reduction of deferred tax assets by a valuation
allowance if, based on the weight of available evidence,  it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
                                      F-18
<PAGE>
            GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY NOTES TO
                CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

     The Company's net operating  loss ("NOL")  carryovers  expire through 2009.
Stock  issuances  by the  Company  may  cause a change  in  ownership  under the
provisions of Internal Revenue Code Section 382; accordingly, the utilization of
the  Company's  net  operating  loss  carry  forwards  may be  subject to annual
limitations. Management does not believe that any NOL limitations resulting from
a change in the ownership  will have a material  adverse effect on the Company's
results of operations or its financial condition.

11.  EMPLOYEE BENEFIT PLANS

     Profit  Sharing  Plan -- The  Company  has a  profit  sharing  plan  and an
executive  compensation  plan.  Employees  are  eligible  immediately  to earn a
contribution  based on  their  qualified  annual  compensation,  if the  Company
achieves its net income  objective.  For purposes of this plan,  the Company did
not meet its net income  objectives  during the years ended January 31, 1996 and
1997.

     401(k)  Profit  Sharing Plan -- In May 1992,  the Company  adopted a profit
sharing  plan  pursuant to Section  401(k) (the  "401(k)  Plan") of the Internal
Revenue  Code of 1986,  as amended.  Pursuant to the 401(k)  Plan,  all eligible
employees  may  make  elective  contributions  through  payroll  deductions.  In
addition,  the 401(k)  Plan  provides  that the Company  may make  matching  and
discretionary contributions in such amounts as may be determined by the Board of
Directors.  During the fiscal years ended January 31, 1996 and 1997, the Company
expensed discretionary  contributions pursuant to the 401(k) Plan in the amounts
of $51,800 and $125,300 respectively.

12.  TRANSACTIONS WITH RELATED PARTIES

     In addition to related party transactions and balances disclosed  elsewhere
in these financial  statements and the notes thereto,  the Company has remaining
lease  commitments  due to  officers  and  employees  by the Company for various
computer  operating  leases expiring  through the year ended January 31, 1998 in
the amount of approximately $23,000.

     Included  in Other  Assets is a  receivable  due from a  related  entity of
approximately  $182,000. The receivable is due to the Company for management and
consulting  services provided during the year. Certain executives of the Company
maintain a direct  interest  and  managerial  role in the  related  entity.  The
receivable is recorded as an arms-length transaction at the estimated fair value
of services  performed.  In addition,  management  believes the balance is fully
collectible and a valuation allowance has not been recorded.

     In January 1997, the Company entered into an equipment lease agreement with
Anderson & Wells Investment  Companies,  an affiliate of Gregory S. Anderson and
Larry J.  Wells,  who are  directors  of the  Company.  The lease  provides  for
payments  totaling   approximately  $675,700  to  Anderson  &  Wells  Investment
Companies during the period from January 1997 to November 1999.
                                      F-19

<PAGE>

13.  SIGNIFICANT CUSTOMERS

The Company  derives a significant  portion of its total revenue from relatively
few customers. The percentage of total revenue of customers to whom sales exceed
10% of total revenue were as follows:

                                         Year Ended January 31,
                                         ----------------------
                                           1996         1997
                                         --------     ---------
    
    Customer #1....................        18.2%        31.2%
    Customer #2....................        --           21.6
    Customer #3....................        12.1         --
    Customer #4....................        10.2         --

Because  of the  nature  of  the  Company's  business  operations,  the  Company
anticipates  that  customers  that represent more than 10% of total revenue will
vary from period to period  depending on the placement of orders by a particular
customer or customers in any given period.
                                      F-20