<PAGE>   1

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington D.C. 20549


                                    FORM 10-Q


[X]     Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
        Exchange Act of 1934

           For the quarter ended                      DECEMBER 31, 1998
                                                      -----------------


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

For the transition period from ______________ to ________________

                    Commission File No 0-15949 INTERNATIONAL
                          MICROCOMPUTER SOFTWARE, INC.
             (Exact name of registrant as specified in its charter)


                  CALIFORNIA                              94-2862863
        (State or other jurisdiction of                 (I.R.S. Employer
         incorporation or organization)                 identification No.)

         75 ROWLAND WAY, NOVATO, CA                          94945
    (Address of principal executive offices)               (Zip code)

                                 (415) 257-3000
               (Registrant's telephone number including area code)


Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.

                                 YES [X] NO [ ]


As of February 5, 1998, 6,116,600 shares of Registrant's Common Stock, no par
value, were outstanding.



<PAGE>   2

                   INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
                                AND SUBSIDIARIES

                                      INDEX

<TABLE>
<CAPTION>
                                                                                               Page
<S>                                                                                            <C>
PART I - FINANCIAL INFORMATION

Item 1.  Interim Consolidated Financial Statements

              Consolidated Balance Sheets at December 31, 1998 and  June 30, 1998                3

              Consolidated Statements of Operations for the three and six months ended
                    December 31, 1998 and 1997                                                   4

              Consolidated Statements of Cash Flows for the six months ended
                    December 31, 1998 and 1997                                                   5

              Notes to Consolidated Financial Statements                                         7


Item 2.  Management's Discussion and Analysis of Financial Condition and
                    Results of Operations                                                       12


Item 3.  Quantitative and Qualitative Disclosures About Market Risk                             21

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings                                                                      22
Item 2.  Changes in Securities and Use of Proceeds                                              22
Item 3.  Defaults upon Senior Securities                                                        22
Item 4.  Submission of Matters to a Vote of Security Holder                                     22
Item 5.  Other Information                                                                      22
Item 6.  Exhibits and Reports on Form 8-K                                                       22

SIGNATURES                                                                                      23
</TABLE>



                                       2
<PAGE>   3

                   INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
                                AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                         DECEMBER 31, 1998    JUNE 30, 1998
                                                         -----------------    -------------
<S>                                                      <C>                  <C>     
ASSETS
Current assets:
Cash and cash equivalents                                      $  3,569           $  2,093
Receivables, less allowances for doubtful
  accounts and returns of $8,137 and $4,231                       8,451             13,149
Inventories, net                                                  7,955              6,549
Prepaid royalties and licenses, net                               2,736              2,517
Deferred tax assets, net                                          4,995              1,762
Other                                                               818                759
                                                               --------           --------
     Total current assets                                        28,524             26,829
                                                               --------           --------

Furniture and equipment, net                                      3,527              3,430
Deferred tax assets, net                                          2,220              2,676
Capitalized software development costs, net                       4,032              2,101
Goodwill and other assets                                         2,265                314
                                                               ========           ========
     Total assets                                              $ 40,568           $ 35,350
                                                               ========           ========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities                       $ 14,365           $  9,468
Credit line payable                                               8,973              7,948
Short term debt and other obligations                               982                842
Current portion of notes payable                                  1,841              1,434
Income taxes payable                                                 --                313
                                                               --------           --------
     Total current liabilities                                   26,161             20,005

Long term debt and other obligations                              4,286              1,682
                                                               --------           --------
     Total liabilities                                           30,447             21,687

Shareholders' equity:
Common stock, no par value; 300,000,000 authorized;
issued and outstanding 5,889,912 and 5,684,179 shares            14,389             12,718
Retained earnings (accumulated deficit)                          (4,158)             1,255
Cumulative translation adjustment                                   175                (25)
Notes receivable from shareholders                                 (285)              (285)
                                                               --------           --------
     Total shareholders' equity                                  10,121             13,663
                                                               --------           --------
     Total liabilities and shareholders' equity                $ 40,568           $ 35,350
                                                               ========           ========
</TABLE>



                 See Notes to Consolidated Financial Statements



                                       3
<PAGE>   4

           INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                  (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                     THREE MONTHS ENDED DECEMBER 31,                     
                                                     -------------------------------                     
                                                     1998                            1997                
                                         ------------------------        ------------------------        
<S>                                      <C>               <C>           <C>               <C>           
Net revenues                             $    10,261        100.0%       $    16,380        100.0%       
Product costs                                  6,912         67.4%             5,932         36.2%       
                                         -----------       ------        -----------       ------        
Gross margin                                   3,349         32.6%            10,448         63.8%       
Costs and expenses:
   Sales and marketing                         5,407         52.7%             4,640         28.3%       
   General and administrative                  1,798         17.5%             1,278          7.8%       
   Research and development                    2,177         21.2%             2,390         14.6%       
   Write off of purchased in
       process research
        and development                                           
                                         -----------       ------        -----------       ------        
      Total operating expenses                 9,382         91.4%             8,308         50.7%       
                                         -----------       ------        -----------       ------        
Operating income (loss)                       (6,033)        58.8%             2,140         13.1%       
Other (expense), net                            (528)        (5.1)%             (234)        (1.4)%      
                                         -----------       ------        -----------       ------        
Income (loss) before taxes                    (6,561)       (63.9)%            1,906         11.6%       
Provision (benefit)for income taxes           (2,362)       (23.0)%              686          4.2%       
                                         -----------       ------        -----------       ------ 
Net income (loss)                        $    (4,199)       (40.9)%      $     1,220          7.4%       
                                         ===========       ======        ===========       ======        
Basic earnings (loss) per share:         $     (0.73)                    $      0.22                     
                                         ===========                     ===========                     
Diluted earnings (loss) per share:       $     (0.73)                    $      0.19                     
                                         ===========                     ===========                     
 Shares used in computing basic
   earnings (loss) per share:              5,778,000                       5,570,000                     
                                         ===========                     ===========                     
 Shares used in computing diluted
   earnings (loss) per share:              5,778,000                       6,572,000                     
                                         ===========                     ===========                     
</TABLE>

<TABLE>
<CAPTION>
                                                   SIX MONTHS ENDED DECEMBER 31,
                                                   -----------------------------
                                                     1998                            1997
                                         ------------------------        ------------------------
<S>                                      <C>               <C>           <C>                <C>   
Net revenues                             $    23,621        100.0%       $    28,891        100.0%
Product costs                                 12,283         52.0%            10,463         36.2%
                                         -----------       ------        -----------       ------
Gross margin                                  11,338         48.0%            18,428         63.8%
Costs and expenses:
   Sales and marketing                        11,090         46.9%             8,294         28.8%
   General and administrative                  3,542         15.0%             2,270          7.9%
   Research and development                    4,458         18.9%             4,025         13.9%
   Write off of purchased in
       process research
        and development                                                        6,367         22.0%
                                         -----------       ------        -----------       ------
      Total operating expenses                19,090         80.8%            20,956         72.6%
                                         -----------       ------        -----------       ------
Operating income (loss)                       (7,752)       (32.8)%           (2,528)        (8.8)%
Other (expense), net                            (705)        (3.0)%             (431)        (1.5)%
                                         -----------       ------        -----------       ------
Income (loss) before taxes                    (8,457)       (35.8)%           (2,959)       (10.3)%
Provision (benefit)for income taxes           (3,045)       (12.9)%           (1,065)        (3.7)%
                                         -----------       ------        -----------       ------
Net income (loss)                        $    (5,412)       (22.9)%      $    (1,894)        (6.6)%
                                         ===========       ======        ===========       ======
Basic earnings (loss) per share:         $     (0.95)                    $     (0.35)            
                                         ===========                     ===========               
Diluted earnings (loss) per share:       $     (0.95)                    $     (0.35)            
                                         ===========                     ===========               
 Shares used in computing basic
   earnings (loss) per share:              5,722,000                       5,377,000             
                                         ===========                     ===========               
 Shares used in computing diluted
   earnings (loss) per share:              5,722,000                       5,377,000             
                                         ===========                     ===========               
</TABLE>



                 See Notes to Consolidated Financial Statements



                                       4
<PAGE>   5

                   INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
                                AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                   SIX MONTHS ENDED
                                                                   ----------------
                                                               DECEMBER 31,   DECEMBER 31,
                                                               ------------   ------------
                                                                   1998         1997
                                                                  -------      -------
<S>                                                            <C>            <C>
Cash flows from operating activities:
   Net loss                                                       $(5,412)     $(1,894)
    Adjustments to reconcile net income loss to net
       cash provided (used) by operating activities
  Depreciation and amortization                                     1,900          954
  Deferred taxes                                                   (2,777)      (2,290)
   Write-off of purchased in-process research and development                    6,367
   Write off of deferred offering costs                               215
Changes in:
    Receivables, net                                                4,698       (2,923)
    Inventories, net                                               (1,406)      (2,208)
    Prepaid royalties and licenses, net                              (219)        (617)
    Other current assets                                              (92)        (194)
    Accounts payable and accrued liabilities                        4,897        1,691
    Income taxes payable                                             (313)        (525)
    Foreign currency translation                                      200           60
                                                                  -------      -------
         Net cash provided (used) by operating activities           1,691       (1,579)
                                                                  -------      -------

Cash flows from investing activities:
    Purchase of equipment                                            (482)        (478)
    Acquisition of software development and in-
        process technologies                                       (1,834)      (1,556)
   Purchase of Zedcor and Org Plus                                   (300)
    Other                                                             (98)         (16)
                                                                  -------      -------
         Net cash used by investing activities                     (2,714)      (2,050)
                                                                  -------      -------

 Cash flows from financing activities:
    Credit line borrowings                                          2,025        6,170
    Credit line repayments                                         (1,000)      (1,855)
    Borrowings (repayments) under term loan, net                    1,938         (772)
    Capital lease and other obligations repayments                   (464)        (242)
    Proceeds from issuance of common stock                                         178
                                                                  -------      -------
    Net cash provided by financing activities                       2,499        3,479
                                                                  -------      -------

Net increase (decrease) in cash and cash equivalents                1,476         (150)
Cash and cash equivalents at beginning of period                    2,093        1,126
                                                                  -------      -------
Cash and cash equivalents at end of the period                    $ 3,569      $   976
                                                                  =======      =======
</TABLE>



                 See Notes to Consolidated Financial Statements



                                       5
<PAGE>   6

                   INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
                                AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)



<TABLE>
<CAPTION>
SUPPLEMENTAL SCHEDULE OF NON-CASH                                   SIX MONTHS ENDED
FINANCING AND INVESTING INFORMATION                                   DECEMBER 31,
                                                                  --------------------
                                                                  1998            1997
                                                                  ----            ----
<S>                                                               <C>             <C>
PURCHASE OF TECHNOLOGY AND ASSETS IN EXCHANGE FOR:
   TRADE PAYABLES                                                                 $  383
   NOTES PAYABLE                                                  $4,030          $1,034
   LONG TERM DEBT                                                                 $  300
   COMMON STOCK                                                   $  970          $5,240

EQUIPMENT ACQUIRED THROUGH CAPITAL LEASE OBLIGATIONS              $  239          $  305


IMSI COMMON STOCK RECEIVED IN SATISFACTION OF RECEIVABLE          $  320
</TABLE>



                        See Notes to Consolidated Financial Statements



                                       6
<PAGE>   7

                   INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
                                AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  BASIS OF PRESENTATION

The interim condensed consolidated financial statements have been prepared from
the records of International Microcomputer Software, Inc. and Subsidiaries (the
"Company" or "IMSI") without audit. In the opinion of management, all
adjustments (which consist only of normal recurring adjustments, other than
described below) necessary to present fairly the financial position, results of
operations and cash flows as of and for the periods ended December 31, 1998 and
December 31, 1997, have been made. The interim condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto contained in the Company's Annual Report on Form
10-K for the fiscal year ended June 30, 1998. The results of operations for the
three and six months ended December 31, 1998 and 1997 are not necessarily
indicative of the results to be expected for any other interim period or for the
full year.


2. DEFERRED REVENUE

Revenue received from subscriptions is deferred and recognized over the life of
the subscription agreement, generally 12 to 15 months.


3. ACQUISITIONS

Zedcor, Inc.

In October, 1998, the Company acquired all the outstanding common stock of
Zedcor, Inc., an internet provider of art and animations. The total purchase
price of $3,500,000 consisted of $970,000 in IMSI stock (176,455 shares at $5.50
per share), $300,000 in cash (paid by the Company in November 1998), and
$2,230,000 payable pursuant to an eight percent secured promissory note.
Payments under the note are due in twelve quarterly payments. The purchase price
for Zedcor, Inc. was allocated as follows:

<TABLE>
<S>                                                                       <C>   
Net working capital                                                           93,000
Capitalized software development costs (visual content products)           3,000,000(1)
Goodwill                                                                     407,000
                                                                          ----------
                                                                          $3,500,000
</TABLE>

(1) Capitalized software development costs (visual content products) are being
amortized over five years.

Org Plus

On March 13, 1998, the Company sold the rights to Family Heritage, one of the
completed products acquired from Corel, to Mindscape, Inc., which was
subsequently acquired by The Learning



                                       7
<PAGE>   8

Company ("TLC"), for a purchase price of $2,500,000 (plus $115,000 for
inventories and prepaid royalties). The purchase price was split into four equal
payments of $625,000, the first of which was paid upon closing, and the second
payment was paid July 15, 1998. The remaining $625,000 payments were due October
15, 1998, and January 15, 1999, pursuant to the sale agreement with Mindscape.
However, no separate notes payable for such amounts were issued by Mindscape. On
September 29, 1998, TLC paid the Company approximately $1,700,000, representing
amounts due to the Company, after discount, from the Family Heritage sale and
other existing contractual agreements ($430,000). On October 2, 1998, TLC and
the Company entered into a software license agreement whereby TLC sold Org Plus
to the Company in exchange for $3,500,000 as follows: $1,700,000 paid by the
Company on October 2, 1998, and $450,000 payments due on each of January 1,
1999, April 1, 1999, July 1, 1999, and October 1, 1999. In January 1999, the
Company and TLC agreed to amend the terms of the Org Plus agreement to allow the
Company to settle the $1,800,000 obligation by the issuance of 200,000 shares of
the Company's common stock.

The September 29, 1998 $1,700,000 cash receipt from the TLC and the $3,500,000
October 2, 1998 purchase of Org Plus from TLC were accounted for as one
transaction; accordingly, the Company recorded the acquisition of Org Plus at a
net amount of $1,800,000. No revenue was recognized by the Company as a result
of these transactions.

Fiscal Year 1998

During the first quarter of fiscal year 1998, the Company completed the
following four acquisitions of products, in-process technologies or companies.
Each was accounted for using purchase accounting. The aggregate purchase prices
for the acquisitions were comprised, and allocated, as follows:

                        COMPONENTS OF PURCHASE PRICES FOR ACQUISITIONS

<TABLE>
<CAPTION>
                      NUMBER OF
                      SHARES OF           VALUE OF                                                  ASSUMPTION            AGGREGATE
                       COMMON             COMMON                NOTES                                  OF NET              PURCHASE
SELLER                  STOCK              STOCK               PAYABLE              CASH            LIABILITIES              PRICE
------                  -----              -----               -------              ----            -----------              -----
                                                                     
<S>                  <C>                 <C>                 <C>                 <C>                <C>                  <C>
Quarterdeck                  --                  --                 $--          $1,000,000                 $--          $1,000,000
MapLinx ...                  --                  --             233,500             233,500             383,000             850,000
Mediapaq ..              20,000          $  240,000                  --                  --             160,000             400,000
Corel .....             346,020           5,000,000             640,000                  --                  --           5,640,000
                     ----------          ----------          ----------          ----------          ----------          ----------
                        366,020          $5,240,000          $  873,500          $1,233,500          $  543,000          $7,890,000
                     ==========          ==========          ==========          ==========          ==========          ==========
</TABLE>


             ALLOCATION OF AGGREGATE PURCHASE PRICES OF ACQUISITIONS

<TABLE>
<CAPTION>
                 PURCHASED IN-PROCESS
                    RESEARCH AND
SELLER               DEVELOPMENT      CAPITALIZED SOFTWARE    GOODWILL
<S>              <C>                  <C>                    <C>
Quarterdeck          $  517,000          $  483,000                  --
MapLinx ...             506,000             331,000          $   13,000
Mediapaq ..             300,000             100,000                  --
Corel .....           5,044,000             517,000              79,000
                     ----------          ----------          ----------
                     $6,367,000          $1,431,000          $   92,000
                     ==========          ==========          ==========
</TABLE>



                                       8
<PAGE>   9

See notes 2, 4, 5 and 6 to the consolidated financial statements included in the
Company's Annual Report on Form 10-K for the Fiscal Year Ended June 30, 1998 for
a further description of these acquisitions and the write-off of purchased
in-process research and development.

4.  INVENTORIES

Inventories consist primarily of CD ROMs, diskettes, manuals, hardware,
freight-in, production costs and packing supplies for the Company's software
products. Inventories are valued at the lower of cost or market, on a first-in,
first-out basis, and consist of:

<TABLE>
<CAPTION>
                                December 31, 1998       June 30, 1998
                                -----------------       -------------
<S>                             <C>                     <C>        
Raw materials                      $ 3,271,000           $ 2,882,000
Finished goods                       5,486,000             4,282,000
                                   -----------           -----------
                                     8,757,000             7,164,000
Reserves for obsolescence             (802,000)             (615,000)
                                   -----------           -----------
                                   $ 7,955,000           $ 6,549,000
                                   ===========           ===========
</TABLE>

The Company evaluates the estimated net realizable value of inventories at each
balance sheet date and records write downs to net realizable value and reserves
for obsolescence for any finished goods or raw materials for which the carrying
value is in excess of the estimated net realizable value.

5.  CAPITALIZED SOFTWARE DEVELOPMENT COSTS

Costs incurred in the initial design phase of software development are expensed
as incurred as research and development. Once the point of technological
feasibility is reached, direct production costs are capitalized. The Company
ceases capitalizing computer software costs when the product is available for
general release to customers. Costs associated with acquired completed software
are capitalized. Total capitalized software development costs were $8,395,000
and $5,261,000 at December 31, 1998 and June 30, 1998, respectively, less
accumulated amortization of $4,363,000 and $3,160,000, respectively.

The Company amortizes capitalized software development costs on a
product-by-product basis. The amortization for each product is the greater of
the amount computed using (a) the ratio of current gross revenues to the total
of current and anticipated future gross revenues for the product or (b) 18
months or 60 months in the case of visual content products. In addition, the
Company evaluates the net realizable value of each software product at each
balance sheet date and records write-downs to net realizable value for any
products for which the carrying value is in excess of the estimated net
realizable value.

6.      BASIC AND DILUTED EARNINGS PER SHARE

Basic EPS is computed by dividing net income (loss) by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur from common shares issuable as a result of
the exercise or conversion of stock options, restricted stock warrants or other
convertible securities.



                                       9
<PAGE>   10

Net income (loss) and the weighted average numbers of shares outstanding
(denominator) used to calculate basic earnings per share are reconciled to the
numbers of shares used in calculating diluted earnings per share as follows:

<TABLE>
<CAPTION>
                                            Three Months Ended                       Six Months Ended
                                                December 31,                           December 31,
                                       ------------------------------        ------------------------------
                                          1998               1997               1998               1997
                                       -----------        -----------        -----------        -----------
<S>                                    <C>                <C>                <C>                <C>         
Net income (loss)                      $(4,199,000)       $ 1,220,000        $(5,412,000)       $(1,894,000)
                                       ===========        ===========        ===========        ===========
Shares used to compute basic EPS         5,778,000          5,570,000          5,722,000          5,377,000
Add effect of dilutive
securities:
   Warrants                                 30,000
   Stock options                           469,000          1,002,000            571,000            895,000
                                       -----------        -----------        -----------        -----------
Shares used to compute diluted
   EPS                                   6,277,000          6,572,000          6,293,000          6,272,000
                                       ===========        ===========        ===========        ===========
                                                (1)                                   (1)                (1)
</TABLE>

(1) Not presented as results were anti-dilutive

7.  AMENDED BANK LINE OF CREDIT

The Company has a line of credit agreement with Union Bank under which it can
borrow the lesser of $13,500,000 or 80% of eligible accounts receivable, at
Union Bank's reference rate plus 1/2 % or LIBOR plus 2%, at the Company's
option. The line of credit agreement requires the Company to comply with certain
financial covenants including maintenance of net worth and working capital
requirements. Under the terms of the agreement, all assets not subject to liens
of other financial institutions have been pledged as collateral against the line
of credit. The credit line expires October 31, 1999.

As of December 31, 1998, as a result of covenant violations, certain events of
default have occurred and are continuing, that among other things, entitle Union
Bank to declare all loans and other obligations of the Company under the line of
credit to be immediately due and payable and to commence immediate enforcement
and collection actions. On February 12, 1999, the Company and Union Bank
executed a forbearance agreement, whereby Union Bank has agreed to forbear
taking any enforcement actions until March 5, 1999. Management intends to
negotiate new terms with Union Bank prior to this date and to take the resultant
necessary actions needed to cure the events of default.

8.      SUBORDINATED LOAN FACILITY WITH WARRANTS

On November 3, 1998, the Company borrowed $2,500,000 under a three-year
subordinated loan facility with Silicon Valley Bank. The interest rate is 12%.
As part of the loan facility, the Company issued detachable warrants, which have
a five-year term, to purchase shares of the Company's common stock. On November
3, 1998, the Company issued 30,000 warrants to purchase common stock at $7.00
per share. As part of the original loan agreement dated November 3, 1998, the
Company was required to register shares by February 1, 1999. On January 26,
1999, Silicon Valley Bank and the Company agreed to extend this deadline until
May 5, 1999. Additional warrants are required to be granted, as amounts advanced
under this facility remain outstanding as follows:



                                       10
<PAGE>   11

<TABLE>
<CAPTION>
   If not paid in full prior to:   Additional warrants to be issued   Exercise price per share
   -----------------------------   --------------------------------   ------------------------
<S>                                <C>                                <C>
          October 31, 1999                      5,000                    $   7.00
          January 31, 2000                     25,000                        7.00
          April 30, 2001                       65,000                        6.00
          October 31, 2001                    125,000                        5.00
</TABLE>

Management estimated that the fair value of the warrants was $776,000, which
will be recorded as additional interest expense over the life of the loan. The
Company recorded interest expense of $43,000 in the quarter ended December 31,
1998. The estimate assumes the loan will not be repaid until November 3, 2001
and all warrants will be issued

9. CHARGES IN THE PERIOD ENDING DECEMBER 31, 1998

In the quarter ended December 31, 1998 the Company recorded a provision for
product returns of $3,332,000 due to an increase in the inventory held by the
Company's distributors and large software retailers. In addition, in the quarter
ended December 31, 1998, reserves for price reductions of inventory held by
distributors or retailers was increased by approximately $350,000 and reserves
for cooperative advertising commitments increased by approximately $105,000. For
the six months ended December 31, 1998 this cooperative advertising reserve was
increased by approximately $562,000.

In the first quarter of fiscal 1999, the Company incurred approximately $350,000
of expenses related to the move of its corporate headquarters from San Rafael to
Novato, California, and wrote off approximately $250,000 of deferred offering
costs related to the preparation of an aborted S-1 filing incurred in fiscal
year 1998.

10. COMPREHENSIVE INCOME (LOSS)

Comprehensive income includes changes in the balance of items that are reported
directly in a separate component of stockholders' equity on the consolidated
balance sheets. The reconciliation of net income (loss) to comprehensive income
(loss) is as follows.

<TABLE>
<CAPTION>
                                           Three Months Ended                          Six Months Ended
                                               December 31,                               December 31,
                                    ---------------------------------           ---------------------------------
                                       1998                   1997                 1998                  1997
                                    -----------           -----------           -----------           -----------
<S>                                 <C>                   <C>                   <C>                   <C>         
Net income (loss)                   $(4,199,000)          $ 1,220,000           $(5,412,000)          $(1,894,000)
Other comprehensive income
(loss):
  Foreign currency
  translation adjustments                46,000               (85,000)              199,000                60,000
                                    -----------           -----------           -----------           -----------
Total comprehensive income
(loss)                              $(4,153,000)          $ 1,135,000           $(5,213,000)          $(1,834,000)
                                    ===========           ===========           ===========           ===========
</TABLE>



                                       11
<PAGE>   12

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

The following information should be read in conjunction with the consolidated
financial statements and the notes thereto and in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's Form 10-K for the year ended June 30, 1998 (the "Form 10-K"). This
quarterly report on Form 10-Q, and in particular Management's Discussion and
Analysis of Financial Condition and Results of Operations, may contain
forward-looking statements regarding future events or the future performance of
the Company that involve certain risks and uncertainties including those
discussed in the "Other factors that May Affect Future Operating Results"
section of this Form 10-Q, as well as on the Company's Form 10-K. Actual events
or the actual future results of the Company may differ materially from any
forward-looking statements due to such risks and uncertainties. The Company
assumes no obligation to update these forward-looking statements to reflect
actual results or changes in factors or assumptions affecting such
forward-looking statements. This analysis is not intended to serve as a basis
for projection of future events.

OVERVIEW

IMSI is a leading developer and publisher of PC productivity software in the
business applications, utilities and visual content categories. The Company's PC
applications are sold to a broad variety of users, particularly small to medium
sized businesses, in categories under served by major software vendors. IMSI
markets its products in up to 13 languages and 60 countries. Historically, the
Company has sold its products through the retail channel primarily through large
wholesale distributors. Pursuant to requests of certain large software
retailers, the company anticipates shipping directly to these customers
beginning in the fourth quarter of fiscal 1999. As a result of an increase in
inventory held by the Company's distributors and large software retailers (above
historical trends) and the anticipated process change of selling directly to
certain large software retailers, the Company has significantly increased
reserves for returns, discounts, and rebates as of December 31, 1998.

During the three and six months ended December 31, 1998, the Company has
experienced a significant decline in sales volume from the same periods in the
previous year. The recording of additional reserves for returns, discounts, and
rebates has increased the negative effect on gross margins and net income (loss)
associated with the decline in sales volume.

The Company has made a strategic decision to invest a significant part of its
resources toward an effort to transition much of its business onto the internet.
During the quarter ended December 31, 1998, the Company completed its
acquisition of Zedcor, Inc. with its retail website, ArtToday.com. The purchase
price of $3,500,000 consisted of $970,000 in IMSI stock (176,455 shares at $5.50
per share), $300,000 in cash (paid by the Company in November 1998), and
$2,230,000 payable pursuant to a secured promissory note.

RESULTS OF OPERATIONS

NET REVENUES

Net revenues for the three and six months ended December 31, 1998 were
$10,261,000 and $23,621,000 respectively, compared to $16,380,000 and
$28,891,000 for the comparable periods



                                       12
<PAGE>   13

in the previous year. Contributing to the drop in revenues was an increase in
provisions for product rebates, returns, and price discounts. As of December 31,
1998, reserves for product rebates, returns, and price discounts increased
$3,780,000 to $7,242,000. The following table details the net change in sales
reserves for the periods indicated:

<TABLE>
<CAPTION>
                                            Three Months Ended                         Six Months Ended
                                                December 31,                             December 31,
                                     --------------------------------           --------------------------------
                                         1998                 1997                  1998                1997
                                     -----------          -----------           -----------          -----------
<S>                                  <C>                          <C>           <C>                          <C>
Reserve for rebates                  $    98,000                  $--           $   211,000                  $--
Reserve for returns                    3,332,000              975,000             3,250,000            1,081,000
Reserve for price discounts              350,000             (160,000)              350,000             (246,000)
                                     -----------          -----------           -----------          -----------
   Total                             $ 3,780,000          $   815,000           $ 3,811,000          $   835,000
                                     ===========          ===========           ===========          ===========
</TABLE>

The Company recognizes revenue, net of estimated returns and allowances, upon
shipment of a product and only when no significant obligations remain and
collectability is probable. The Company's return policy allows its distributors,
subject to certain limitations, to return purchased products in exchange for new
products or for credit towards future purchases as part of stock balancing
programs. In addition, the Company provides price protection to its distributors
when it reduces the prices of its products. End users may return products
through dealers and distributors within a reasonable period from the date of
purchase for a full refund, and retailers may return older versions of products
for a full refund. Various distributors and resellers may have different return
practices that adversely affect the number of products that are returned to the
Company. Product returns often occur when the Company introduces upgrades and
new versions of products or when distributors or resellers overestimate demand.
The Company's allowances for doubtful accounts, returns, and price protection
are based upon its best judgment and estimates at the time. Reserves for
doubtful accounts, expected sales returns, and price protection is based
primarily on historical experience, adjusted for current situations, and were in
total, 49.1% and 26.2%, of gross receivables at December 31, 1998 and June 30,
1998, respectively.

Net revenues in absolute dollars, and as a percentage of total net revenues, for
each of the Company's principal product categories were as follows for the
periods indicated (in thousands, except for percentage amounts) :

<TABLE>
<CAPTION>
                                          Three Months Ended                                   Six Months Ended
                                             December 31,                                       December 31,
                         ------------------------------------------------      ------------------------------------------------
                                    1998                       1997                     1998                        1997
                         ---------------------      ---------------------      ---------------------      ---------------------
<S>                      <C>          <C>           <C>          <C>           <C>          <C>           <C>          <C>
Business applications    $  5,001           49%     $  5,416           33%     $ 11,097           47%     $ 11,622           40%
Utilities                   1,370           13%        2,798           17%        2,947           12%        5,110           18%
Visual content              6,685           65%        7,495           46%       10,594           45%       10,300           36%
Other products                985           10%        1,485            9%        2,794           12%        2,625            9%
Reserves                   (3,780)         (37%)        (814)          (5%)      (3,811)         (16%)        (766)          (3%)
                         --------     --------      --------     --------      --------     --------      --------     --------
Total                    $ 10,261          100%     $ 16,380          100%     $ 23,621          100%     $ 28,891          100%
                         ========     ========      ========     ========      ========     ========      ========     ========
</TABLE>

Net revenues in the business applications category for the three month period
ended December 31, 1998 decreased by $415,000 or 8% from the comparable period
of fiscal 1998. For the six months ended December 31, 1998, net revenues in the
business applications category decreased by $525,000 or 5%. In general, the
Company experienced a broad decline in many of its business



                                       13
<PAGE>   14

application products, including TurboCad, TurboProject, HiJaak, Master
Publisher, FloorPlan, and Graphics Converter.

Net revenues in the utilities category for the three month period ended December
31, 1998 decreased by $1,428,000, or 51%, from the comparable period of fiscal
1998. For the six months ended December 31, 1998, net revenues in the utilities
category decreased $2,163,000 or 42%. Drops in product sales of WinDelete and
Net Accelerator were primarily responsible for the declines.

Net revenues in the visual content category for the three month period ended
December 31, 1998 decreased by $810,000, or 11%, respectively, from the
comparable period of fiscal 1998. For the six months ended December 31, 1998,
net revenues in the visual content category increased $294,000 or 3%. The
decrease in revenue during the quarter ended December 31, 1998 is due primarily
to the decline in sales of the MasterClips product line. MasterClips sales were
approximately even with the six month period in the prior year. The better
performance in the six month period is primarily due to added revenue from
WebArt sales and ArtToday.

Net revenues in the other products category for the three month period ended
December 31, 1998 decreased by $500,000 or 34%, from the comparable period of
fiscal 1998. For the six months ended December 31, 1998, net revenues in the
other products category increased $169,000 or 6%. The net revenue decrease in
the quarter ending December 31, 1998 is primarily due to a decline in sales of
Easy Language, Micro Cookbook, and Family Heritage. The increase in net revenues
in the other products category for the six month period is related to a decline
in product returns in this category.

Net revenues from domestic sales decreased by 30% to $6,227,000, or 61% of net
revenues, for the three month period ended December 31, 1998 as compared to
$8,900,000, or 54% of net revenues, for the same period in the previous fiscal
year. For the six months ended December 31, 1998, net revenues from domestic
sales decreased by 8% to $15,851,000, or 67% of net revenues, as compared to
$17,184,000, or 59% of net revenues, for the same period in the previous fiscal
year. Net revenues from international sales were $4,034,00, or 39% of net
revenues, for the three month period ended December 31, 1998, compared to
$7,480,000, or 46% net revenues, for the three months ended December 31, 1997.
For the six months ended December 31, 1998, net revenues from international
sales decreased by 34% to $7,771,000, or 33% of net revenues, as compared to
$11,707,000, or 41% of net revenues, for the six months ended December 31, 1997.

The Company's international net revenues in the three and six month periods
ended December 31, 1998 were generated primarily from Germany, the United
Kingdom and Australia. Although the Company believes that the risks associated
with transactions in foreign currencies are mitigated by diversified exposure to
multiple currencies, the Company's operating results may be affected by the
risks customarily associated with international operations, including a
devaluation of the U.S. dollar, increases in duty rates, exchange or price
controls, longer collection cycles, government regulations, political
instability, and changes in international tax laws.



                                       14
<PAGE>   15

PRODUCT COSTS

For the three months ended December 31, 1998, product costs increased $980,000
to $6,912,000 and increased as a percent of revenue from 36.2% to 67.4% when
compared to the same period in the previous fiscal year. For the six months
ended December 31, 1998, product costs increased $1,820,000 to $12,283,000 and
increased as a percent of revenue from 36.2% to 52.0% when compared to the same
period in the previous fiscal year. A portion of labor and overhead included in
product costs is fixed in nature and does not decrease proportionally when a
decline in sales volume occurs. Primarily due to an increase in this type of
manufacturing burden and overhead, despite a drop in sales volume, product costs
increased during the three and six months ending December 31, 1998 when compared
to the previous year.

During the quarter ended December 31, 1998, the Company relocated its principal
warehouse facility from Richmond, California to Vacaville, California. The
increase in product costs for the quarter ended December 31, 1998 is associated
with the inefficiencies and added expense associated with setting up the new
warehouse facility. During this relocation period, the Company maintained staffs
at both warehouse facilities. Other factors contributing to the increase in
product costs in the three and six months periods ended December 31, 1998
include higher per unit material and labor costs and increased amortization
costs of capitalized software from acquisitions made in the fiscal year ended
June 30, 1998.

The Company amortizes capitalized software development costs on a
product-by-product basis. The amortization for each product is the greater of
the amount computed using (a) the ratio of current gross revenues to the total
of current and anticipated future gross revenues for the product or (b) 18
months or 60 months in the case of visual content products.

SALES AND MARKETING

Sales and marketing expenses for the three months ending December 31, 1998
increased $767,000 or 16.5% to $5,407,000. Sales and marketing expenses for the
six months ending December 31, 1998 increased $2,796,000 or 33.7% to
$11,090,000. As a percentage of net revenues, sales and marketing expenses for
the three and six month periods ending December 31, 1998, were 52.7% and 46.9%,
respectively, as compared with 28.3% and 28.8%, respectively, for the previous
fiscal year. The increase in sales and marketing expense in both the three and
six month periods is primarily due to the booking of additional reserves for
cooperative advertising. The smaller percentage increase in sales and marketing
expense for quarter ending December 31, 1998, versus the six months ending
December 31, 1998, reflects cost containment efforts, including a reduction in
headcount, initiated by the Company in October 1998.

GENERAL AND ADMINISTRATIVE

General and administrative expenses for the three and six month periods ending
December 31, 1998 increased $520,000 or 40.7% to $1,798,000 and $1,272,000 or
56.0% to $3,542,000, respectively, as compared to the same periods in the
previous year. These increases are primarily due to increased amortization of
acquired intangible assets. For the three and six months ended December 31,
1998, the Company had amortization from intangible assets of $811,000 and
$1,335,000, respectively. This compares with the three and six months ended
December 31, 1997 amounts of $371,000 and $632,000, respectively. Also
contributing to the increase was the 



                                       15
<PAGE>   16

Company's write-off of deferred offering costs of $250,000 relating to the
preparation of an S-1 filing, the Company's move to its new corporate
headquarters, continued infrastructure improvements, and headcount additions
(primarily in the areas of information systems, human resources, accounting and
operations).

As a percentage of net revenues, general and administrative expenses for the
three and six month periods ending December 31, 1998, were 17.5% and 15.0%,
respectively, as compared with 7.8% and 7.9%, respectively, for the previous
fiscal year. The large increases in general and administrative expenses as a
percent of net revenue are partly attributable to a lower net revenue base and
the fixed nature of these expenses.


RESEARCH AND DEVELOPMENT

Research and development expenses for the three months ended December 31, 1998
decreased $213,000 or 8.9% to $2,177,000. For the six month period ending
December 31, 1998, research and development expenses increased $433,000 or 10.8%
to $4,458,000. As a percentage of net revenues, research and development
expenses for the three and six month periods ending December 31, 1998, were
21.2% and 18.9%, respectively, as compared with 14.6% and 13.9%, respectively,
for the previous fiscal year. The increase for the six months ended December 31,
1998 can be attributed to the utilization of additional contractors and other
third party development costs relating to the development and expansion of the
Company's product offerings The decrease in research and development expenses
for the quarter ending December 31, 1998 reflects cost containment efforts,
including a reduction in headcount, initiated by the Company in October 1998.

OTHER EXPENSE, NET

Other expense, net, which consists of interest expense on short and long-term
borrowings, as well as net gains or losses on foreign currency transactions,
increased from $234,000 to $528,000 for the three month period ended December
31, 1998 compared to the same period of the previous fiscal year. For the six
months ended December 31, 1998, other expense, net, increased $274,000 to
$705,000 from the previous fiscal year. The increase in other expense, net, is
primarily due to an increase in interest expense which is directly related to
the Company's increased borrowings.

PROVISION FOR INCOME TAXES

The Company's effective tax rate is 36% for the three and six month periods
ended December 31, 1998 and for the three and six month periods ended December
31, 1997.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents as of December 31, 1998 increased by $1,476,000 to
$3,569,000 from $2,093,000 at June 30, 1998. However, working capital decreased
by $4,461,000 to $2,363,000 from $6,824,000 at December 31, 1998. The increase
in cash and cash equivalents is primarily due to the increase in accounts
payable and accrued liabilities of $4,897,000. Primarily due to the collection
of receivables and the increases in accounts payable and accrued liabilities,
net cash provided by operating activities for the six months ended December 31,
1998 was $1,691,000.



                                       16
<PAGE>   17

In October, 1998, the Company acquired all the outstanding common stock of
Zedcor, Inc., an internet provider of art and animations. The total purchase
price of $3,500,000 consisted of $970,000 in IMSI stock (176,455 shares at $5.50
per share), $300,000 in cash (paid by the Company in November 1998), and
$2,230,000 payable pursuant to an eight percent secured promissory note.
Payments under the note are due in twelve quarterly payments. The purchase price
for Zedcor, Inc. was allocated as follows:

<TABLE>
<S>                                                                       <C>   
Net working capital                                                           93,000
Capitalized software development costs (visual content products)           3,000,000
Goodwill                                                                     407,000
                                                                          ----------
                                                                          $3,500,000
                                                                          ==========
</TABLE>

On March 13, 1998, the Company sold the rights to Family Heritage, one of the
completed products acquired from Corel, to Mindscape, Inc. (which was
subsequently acquired by TLC) for a purchase price of $2,500,000 (plus $115,000
for inventories and prepaid royalties). The purchase price was split into four
equal payments of $625,000, the first of which was paid upon closing, and the
second payment was paid July 15, 1998. The remaining $625,000 payments were due
October 15, 1998, and January 15, 1999, pursuant to the sale agreement with
Mindscape. However, no separate notes payable for such amounts were issued by
Mindscape.

On September 29, 1998, TLC paid the Company approximately $1,700,000,
representing amounts due to the Company, after discount, from the Family
Heritage sale and other existing contractual agreements ($430,000). On October
2, 1998, TLC and the Company entered into a software license agreement whereby
TLC sold Org Plus to the Company in exchange for $3,500,000 as follows:
$1,700,000 paid by the Company on October 2, 1998, and $450,000 due on each of
January 1, 1999, April 1, 1999, July 1, 1999, and October 1, 1999. In January
1999, the Company and TLC agreed to amend the terms of the Org Plus agreement to
allow the Company to settle the $1,800,000 obligation by the issuance of 200,000
shares of the Company's common stock.

The September 29, 1998 $1,700,000 cash receipt from the TLC and the October 2,
1998 $3,500,000 purchase of Org Plus from TLC were accounted for as one
transaction; accordingly, the Company recorded the acquisition of Org Plus at a
net amount of $1,800,000. No revenue was recognized by the Company as a result
of these transactions.

For the six months ended December 31, 1998, investing activities used total net
cash of $2,714,000.

The source of funds for investing activities was primarily financing activities.
During the six months ended December 31, 1998, the Company increased borrowings
under its line of credit by $2,025,000, obtained $2,500,000 under a new three
year subordinated loan facility from Silicon Valley Bank and issued notes of
$2,230,000 and common stock of $970,000 as part of its Zedcor, Inc. acquisition.
Financing activities for the six months ended December 31, 1998 provided total
net cash of $2,499,000.

In January 1999, the Company finalized an agreement with The Learning Company to
issue approximately $1,800,000 in common stock to satisfy its remaining
obligation in the Org Plus acquisition. This liability is reflected within
accrued liabilities on the Company's Consolidated Balance Sheet as of December
31, 1998.



                                       17
<PAGE>   18

The Company has a line of credit agreement with Union Bank under which it can
borrow the lesser of $13,500,000 or 80% of eligible accounts receivable, at
Union Bank's reference rate plus 1/2 % or LIBOR plus 2%, at the Company's
option. The line of credit agreement requires the Company to comply with certain
financial covenants including maintenance of net worth and working capital
requirements. Under the terms of the agreement, all assets not subject to liens
of other financial institutions have been pledged as collateral against the line
of credit. The credit line expires October 31, 1999.

As of December 31, 1998, as a result of covenant violations, certain events of
default have occurred and are continuing, that among other things, entitle the
bank to declare all loans and other obligations of the Company under the line of
credit to be immediately due and payable and to commence immediate enforcement
and collection actions. On February 12, 1999, the Company and Union Bank
executed a forbearance agreement, whereby Union Bank has agreed to forbear
taking any enforcement actions until March 5, 1999. Management intends to
negotiate new terms with Union Bank prior to this date and to take the resultant
necessary actions needed to cure the events of default.

On November 3, 1998, the Company borrowed $2,500,000 under a three-year
subordinated loan facility with Silicon Valley Bank. The interest rate is 12%.
As part of the loan facility, the Company issued detachable warrants, which have
a five-year term, to purchase shares of the Company's common stock. On November
3, 1998, the Company issued 30,000 warrants to purchase common stock at $7.00
per share. As part of the original loan agreement dated November 3, 1998, the
Company was required to register shares by February 1, 1999. On January 26,
1999, Silicon Valley Bank and the Company agreed to extend this deadline until
May 1, 1999. Additional warrants are required to be granted, as amounts advanced
under this facility remain outstanding as follows:


<TABLE>
<CAPTION>
      If not paid in full prior to:    Additional warrants to be issued  Exercise price per share
      -----------------------------    --------------------------------  ------------------------
<S>                                    <C>                               <C>
               October 31, 1999                      5,000                    $   7.00
               January 31, 2000                     25,000                        7.00
               April 30, 2001                       65,000                        6.00
               October 31, 2001                    125,000                        5.00
</TABLE>

Management estimated that the fair value of the warrants was $776,000, which
will be recorded as additional interest expense over the life of the loan. The
Company recorded interest expense of $43,000 in the quarter ended December 31,
1998. The estimate assumes the loan will not be repaid until November 3, 2001
and all warrants will be issued.

In January 1999, IMSI signed a term sheet for a $5,000,000 private common stock
and warrants investment that it expects to close in the third quarter of fiscal
1999. In order to satisfy the Company's near term working capital and capital
expenditure requirements, planned transition to the internet, expansion of the
Company's operations, future acquisitions of products or companies, increases in
expenses or other factors, the Company will seek additional debt or equity
financing in the near term. The Company's forecast period of time through which
its financial resources will be adequate to support its working capital and
capital expenditure requirements is a forward-looking statement that involves
risks and uncertainties, and actual results could vary. There can be no
assurance that such funding will be available on terms 



                                       18
<PAGE>   19

attractive to the Company, or at all. Furthermore, any additional equity
financing may be dilutive to shareholders, and debt financing, if available, may
involve restrictive covenants. The failure of the Company to raise capital when
needed could have a material adverse effect on the Company's business, operating
results and financial condition.

While the Company believes it will be able to raise any necessary funds, there
can be no assurances that the Company will be able to do so, and failure to
obtain sufficient capital could have a material adverse effect on the Company or
adversely affect the Company's ability to continue to grow. In order to finance
future growth, transition to the Internet, or for other reasons, the Company may
consider an offering of its equity securities within the next year or
thereafter. The decision to undertake such an offering and the size of such an
offering, would depend upon many factors, such as the market price of the common
stock, the working capital and capital expenditure needs of the Company, the
availability of alternative sources of capital, and general market conditions.

OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

The Company has experienced, and expects to continue to experience, significant
fluctuations in operating results due to a variety of factors. The Company
experienced growth during fiscal 1998, 1997 and 1996. However, during fiscal
year 1999, the Company suffered a significant decline in revenue. This decline
in revenue has resulted in the Company reporting net losses for both quarters of
fiscal 1999. During fiscal year 1999, the Company has embarked on an effort to
transition much of its business onto the internet. The success or failure of
this effort will significantly impact future operating results.

Factors that may cause fluctuations in operating results in the future include,
but are not limited to, market acceptance of the Company's products or those of
its competitors; the timing of introductions of new products and new versions of
existing products; expenses relating to the development and promotion of such
new product and new version introductions; product returns and reserves;
difficulty in securing retail shelf space for the Company's products; changes in
pricing policies by the Company or its competitors; changes in product mix;
projected and actual changes in platforms and technologies; timely and
successful adaptation to such platforms or technologies; the accuracy of
forecasts of, and fluctuations in, consumer demand; the extent of third party
royalty payments; market seasonality; the rate of growth of the consumer
software market; fluctuations in foreign exchange rates; the timing of orders or
order cancellation from major customers; order cancellations; changes or
disruptions in the consumer software distribution channels; the successful
acquisition and integration of new businesses, products and technologies; the
timing of any write-offs in connection with such acquisitions; and economic
conditions, both generally and within the Company's industry. In addition, the
Company's strategy is to increase the focus of its sales efforts on volume
licensing to corporate accounts, and the timing of such licenses could
significantly affect quarterly results of operations. The Company may also be
required to pay fees in advance or to guarantee royalties, which may be
substantial, or to obtain software licenses from third parties before the
commercial viability of such software has been determined, which could cause
operating results to fluctuate. As a result of these and other factors, the
Company's operating results in any given period are inherently difficult to
predict. Any significant shortfall in revenues and earnings from the levels
expected by securities analysts and shareholders could result in a substantial
decline in the trading price of the Company's common stock.



                                       19
<PAGE>   20

While the Company's business has not generally been materially affected by
seasonal trends, the seasonality of the European, Asia/Pacific and other
international markets could impact the Company's operating results and financial
condition in a particular quarter given the significant portion of net revenues
contributed by international operations. These seasonal patterns may be
overshadowed in particular quarters by the timing of new product introductions,
expansion into international markets and other factors affecting the Company's
business. Furthermore, the markets for the Company's products are characterized
by significant price competition, which may cause the Company's operating
results to fluctuate. In addition to seasonal and product pricing factors, the
Company anticipates that its operating results for the remainder of fiscal 1999
and fiscal 2000 will be affected by the timing and the number of new product
releases or upgraded versions of existing products, as well as marketing and
promotional expenditures in connection with the product releases and the timing
of product announcements or introductions by the Company's competitors.

Products are generally shipped as orders are received. The Company has
historically operated with little order backlog and sales and operating results
for any quarter have depended on the volume and timing of orders received during
that quarter, which cannot be predicted with any degree of certainty. A
significant portion of the Company's operating expenses is relatively fixed, and
planned expenditures are based on sales forecasts. Thus, if revenue levels are
below expectations due to either the timing of orders received or delays in
product releases, operating results are likely to be materially adversely
affected. Without growth in revenues in any particular quarter, the Company's
increasing fixed operating expenses could cause net income to decline or net
loss to increase when compared to the same period in the previous year or the
immediately preceding quarter. In such event, the market price of the Company's
common stock may be materially adversely affected. Due to the foregoing factors,
the Company believes that quarter to quarter comparisons of its operating
results are not necessarily meaningful and should not be relied upon as
indications of future performance.


YEAR 2000 RISKS. The Company recognizes the need to ensure its operations will
not be adversely impacted by Year 2000 software failures. Software failures due
to processing errors potentially arising from calculations using the Year 2000
date are a known risk. The Company has established procedures for evaluating and
managing the risks and costs associated with this problem, and, as part of the
general upgrade of the Company's information systems, the Company is putting in
place systems which will be Year 2000 compliant.

The Company has initiated a Year 2000 Compliance Plan that addresses three types
of systems that must be Year 2000 compliant. Products: The Company's software
products have been undergoing Year 2000 Compliance testing since January 1998.
Approximately 75% of the Company's currently supported products have been
verified as Year 2000 Compliant; the remaining products will be verified as
compliant by June 1999. IT SYSTEMS: The Company has identified all internal data
processing and networking systems that are at risk from the Year 2000 problem
and is currently reviewing the manufacturer's Year 2000 Compliance statement for
each system. Any systems that are determined to be non-compliant will be
upgraded or replaced. Internal testing will be initiated for any missing
critical system for which the manufacturer's Year 2000 Compliance statement is
not adequate to ensure the reliability of the system. All IT systems will be
verified as Year 2000 Compliant by July 1999. In addition, no new IT systems
will be implemented without first ensuring that they are Year 2000 Compliant.
NON-IT-SYSTEMS: The Company has identified a wide range of general computing and
facilities systems that must be verified as Year 2000 Compliant. The majority of
these systems will be upgraded or replaced as necessary during normal
maintenance if they are not compliant. The manufacturer's Year 2000 Compliance
statements are currently under review for the remaining systems and will be
upgraded or replaced if necessary. Because new systems are continually being
integrated into the Company, the effort to ensure Year 2000 Compliance for these
systems is an ongoing effort.

The Company has communicated with others with whom it does significant business
to determine their Year 2000 compliance readiness and the extent to which the
Company is vulnerable to any third party Year 2000 issues. However, there can be
no guarantee that the systems of other companies on which the Company's systems
rely will be timely converted, or that a failure to convert by another company,
or a conversion that is incompatible with the Company's systems, would not have
a material adverse effect on the Company.

For further discussion please refer to the subheading "Future Performance and
Additional Risk Factors" in the Company's Annual Report on Form 10-K for the
Fiscal Year Ended June 30, 1998.



                                       20
<PAGE>   21

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to the impact of interest rate and foreign currency
fluctuations. The Company's objective in managing its exposure to interest rate
changes and foreign currency fluctuations is to limit the impact of interest
rate changes on earnings and cash flow and to lower its overall borrowing costs.
The Company's major market risk exposure is changing interest rates in the
United States, which would change interest expense on the Company's line of
credit and term loan.

Most of the Company's international revenues are denominated in foreign
currencies. Consequently a decrease in the value of a relevant foreign currency
in relation to the U.S. dollar could adversely affect the Company's net
revenues. The Company's foreign currency transactional exposures exist primarily
with the U.K. pound and German mark.

The Company does not utilize interest rate swaps or hedge exposures with foreign
currency forward contracts.



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<PAGE>   22

PART II - OTHER INFORMATION


ITEM 1.   Legal Proceedings
Not Applicable

ITEM 2.   Changes in Securities and Use of Proceeds
Not Applicable

ITEM 3.   Defaults upon Senior Securities

As of December 31, 1998, certain events of default have occurred and are
continuing under the Company's line of credit ("Loan Agreement") with Union
Bank, that among other things, entitle Union Bank to declare all loans and other
obligations of the Company under the Loan Agreement to be immediately due and
payable and to commence immediate enforcement and collection actions. On
February 12, 1999, the Company and Union Bank have executed a forbearance
agreement, whereby Union Bank has agreed to forbear taking any enforcement
actions until March 5, 1999. Management intends to negotiate new terms with
Union Bank prior to this date and to take the resultant necessary actions needed
to cure the events of default under the Loan Agreement.

ITEM 4.  Submission of Matters to a Vote of Security Holders
  Not Applicable

ITEM 5.   Other Information
Not Applicable

ITEM 6.  Exhibits and Reports on Form 8-K

Exhibits
        27.1     Financial Data Schedule

No report on Form 8-K was filed during the six months ended December 31, 1998.



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<PAGE>   23

                                   SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

DATE: February 16, 1999             INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.





                                        By:   /s/  MARTIN SACKS
                                           -------------------------------------
                                           Martin Sacks
                                           President & Chief Executive Officer
                                           (Principal Executive Officer)


                                        By:   /s/  KENNETH R. FINEMAN
                                           -------------------------------------
                                            Kenneth R. Fineman
                                            V.P. Finance & Chief Financial
                                            Officer
                                            (Principal Financial Officer)




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