<PAGE>
 
================================================================================
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                   FORM 10-K
 
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
                  For the Fiscal Year Ended December 31, 1996
 
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934
 
        For the transition period from                to
 
                        Commission file number: 0-27310
 
                            RED BRICK SYSTEMS, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                DELAWARE                             77-0145392
           (STATE OR OTHER JURISDICTION OF          (I.R.S. EMPLOYER
           INCORPORATION OR ORGANIZATION)           IDENTIFICATION NO.)
 
                                485 ALBERTO WAY
                          LOS GATOS, CALIFORNIA 95032
         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
 
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 399-3200
 
       SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
 
   SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock
 
  Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: Yes [X]   No [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
  The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of February 28, 1997, was approximately $161,106,695. Shares of
Common Stock held by each officer and director have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
 
  As of February 28, 1997, there were 11,467,908 shares of the Registrant's
Common Stock outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Portions of the definitive Proxy Statement to be delivered to stockholders
in connection with the Annual Meeting of Stockholders to be held May 21, 1997,
are incorporated by reference into Part III.
 
================================================================================
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
                                   FORM 10-K
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
 
                                     INDEX
 
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                                       PART I
 Item 1.  Business.......................................................     1
 Item 2.  Properties.....................................................    14
 Item 3.  Legal Proceedings..............................................    14
 Item 4.  Submission of Matters to a Vote of Security Holders............    15
 Item 4a. Executive Officers of the Registrant...........................    15
                                      PART II
             Market for Registrant's Common Stock and Related Stockholder
 Item 5.  Matters........................................................    16
 Item 6.  Selected Consolidated Financial Data...........................    16
          Management's Discussion and Analysis of Financial Condition and
 Item 7.  Results of Operations..........................................    17
 Item 8.  Consolidated Financial Statements and Supplementary Data.......    24
          Changes in and Disagreements with Accountants on Accounting and
 Item 9.  Financial Disclosure...........................................    43
                                      PART III
 Item 10. Directors and Executive Officers of the Registrant.............    43
 Item 11. Executive Compensation.........................................    43
 Item 12. Security Ownership of Certain Beneficial Owners and Management.    43
 Item 13. Certain Relationships and Related Transactions.................    43
                                      PART IV
          Exhibits, Financial Statement Schedules, and Reports on Form 8-
 Item 14. K..............................................................    44

Signatures...............................................................    47
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                                    PART I
 
  The discussion in this report contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in "Risk
Factors That May Affect Future Results" in item 1 of this report as well as
those discussed elsewhere in this report.
 
ITEM 1. BUSINESS
 
OVERVIEW
 
  Red Brick Systems, Inc. ("Red Brick" or the "Company") designs, develops,
markets and supports Red Brick Warehouse, a high performance, client/server
relational database management system ("RDBMS") software product specifically
designed for data warehousing, data mart, data mining, and on-line analytical
processing ("OLAP") applications. The Company assists customers in designing
and building data warehouse solutions. The Company's software enables IT
professionals and business managers to implement quickly and manage
effectively data warehouse applications and provides decision makers with easy
access to critical information necessary to make more informed decisions.
 
  The Company's products comprise a suite of data warehouse RDBMS servers,
data warehouse administration tools and connectivity software designed to
enable organizations to implement data warehouse solutions across their
organizations. The Company's products incorporate the three main components of
a data warehouse: load processing, warehouse data management and query
processing. The Company's client/server based products are designed to support
open industry standards, which provides its customers maximum flexibility in
selecting computing environments and data warehouse tools. The Company markets
its software and related services primarily through a direct sales
organization and through value-added resellers, system integrators, consulting
partners, and distributors worldwide. The Company's customers include: 3M, 360
Communications Group, AT&T, Barnes & Noble, Bell Atlantic Network Services,
BellSouth, Catalina Marketing, efficient market services, Estee Lauder,
General Mills, Healthsource, Hewlett-Packard, Holiday Inn, Mobil Oil, NASA,
Reuters Information Services, Sara Lee Corp., and Tenneco Packaging.
 
INDUSTRY BACKGROUND
 
  Business enterprises continually strive to improve the efficiency and
effectiveness of their operations in today's increasingly competitive global
business environment. The pace and complexity of business decision making has
increasingly become a greater challenge for organizations. Decision making
authority has generally become more distributed throughout all levels of an
organization, creating a need by more people to access information used for
making critical business decisions. In adapting to this new business
environment, organizations have implemented computer systems and technologies
that increase efficiency through automating transaction processing.
 
  On-line transaction processing ("OLTP") systems are used to automate those
business functions that generate records that can be processed and stored
electronically, such as automatic teller machines, reservation centers and
telephone calls. In today's organizations, many thousands of these
transactions may occur every second of every day, generating vast amounts of
business data. This dramatic increase in the quantity of transaction data has
led to the development of relational database management system ("RDBMS")
technologies designed and optimized for collecting and storing transaction
data.
 
  Organizations seek to make faster, more accurate and more confident business
decisions by effectively using the vast amount of data generated by these OLTP
systems. However, organizations have discovered limitations in using the same
OLTP system for both transaction processing and decision support. For example,
OLTP systems maintain on-line only recent operating data, making real-time
analysis of historical data very difficult. In addition, organizations
maintain separate OLTP systems for each specific business function, such as
 
                                       1
<PAGE>
 
purchasing, inventory management and point of sale transactions, making cross-
functional analysis of information contained in these separate databases
problematic. Furthermore, to process hundreds or thousands of transactions per
second, the transaction processing systems store data in formats designed for
transaction performance rather than for use by business people for decision
support. Finally, conducting analysis and transaction processing on the same
system substantially degrades the OLTP systems' performance, jeopardizing the
execution of routine business transactions that are critical to organizations.
As a result, organizations have found it difficult to utilize OLTP systems for
decision support.
 
  To enable more effective decision making, organizations have established
separate, dedicated databases for decision support. However, these
organizations have encountered limitations in applying traditional RDBMS
technologies, which have been optimized for OLTP applications, for decision
support. For example, OLTP RDBMSs have been designed to process thousands of
small, predetermined structured updates every second. Business analysis
applications, on the other hand, require performing relatively few, highly
unstructured, ad-hoc, read-intensive queries per minute. In addition, OLTP
RDBMS technologies have been optimized to access and update a small number of
records with every transaction, whereas a single query for business analysis
could require the access and retrieval of millions of records. OLTP RDBMSs are
optimized for continual collection and processing of transactional data,
whereas decision support systems require a methodology more focused on
extraction and analysis of data. OLTP RDBMSs are unable to store effectively
and manage the vast amounts of historical and cross-functional data required
by a decision support application. For all of the above reasons, it is
difficult to pose and answer business questions using traditional OLTP RDBMS
applications.
 
  To utilize transaction data effectively for better decision making,
organizations require a new RDBMS optimized for decision support and
maintained separately from OLTP RDBMSs. These separate RDBMSs, referred to as
data warehouses, must contain weeks, months, and even years of summary and
detailed historical business data that can amount to gigabytes and terabytes
of information necessary for analysis and decision making.
 
SOLUTION
 
  The Company designs, develops, markets and supports Red Brick Warehouse, an
RDBMS software product optimized to meet the new requirements of data
warehouse, data mart, data mining, and on-line analytical processing (OLAP)
applications. The Company believes it was the first to provide an open
database product designed specifically for these applications. The Company has
capitalized on more than ten years of experience in decision support systems
and technologies to assist customers in designing and building data warehouse
solutions.
 
  The Company's products incorporate the three main components of a data
warehouse: load processing, warehouse data management and query processing.
Load processing refers to the loading of information from disparate OLTP
RDBMSs into the data warehouse RDBMS. Warehouse data management consists of
the administration and management of very large databases for decision support
applications across a network of data warehouses. Query processing enables
users to rapidly retrieve and analyze critical business information for
decision making.
 
  Load Processing--Simplify Data Load Processing and Improve Data Load
Performance. An enormous problem for the information technology or MIS
department of an organization is loading current data into the warehouse,
indexing it for access, ensuring its quality and performing other operations
(such as summarizing sales by region). The Company's Red Brick Warehouse
simplifies and accelerates this critical process. The Company's load
processing subsystem offers load speeds typically at least ten times faster
than competing products, while at the same time automatically building indices
and summarizations and verifying data integrity.
 
  Warehouse Data Management--Cost Effectively Store and Manage Very Large
Amounts of Data. Data warehouse solutions typically store very large amounts
of data, are oriented by time and require periodic, large updates. The
Company's tools and technologies make managing the warehouse simple and cost
effective. Red
 
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Brick Warehouse is based on a modular storage model and provides simplified
administrative interfaces and systems management functions optimized for very
large data warehouse environments. The Company's tools and technologies enable
features such as disk failure management, implementation of backup and restore
procedures, movement of data throughout the warehouse network and end user
administration and monitoring.
 
  Query Processing--Quickly and Easily Analyze Large Volumes of Business
Information. Red Brick Warehouse is designed to provide easy, cost effective
access to either a single data warehouse or networked data warehouses of
information for tens to thousands of users. The Company believes that its
solution can substantially improve the quality and timeliness of an
organization's decision making. The Company's solution specifically addresses
the three key aspects required to ensure effective business analysis: posing
questions easily, getting answers fast and ensuring that the underlying data
is of the highest quality. The Company's solution can process business
questions typically ten times faster than traditional OLTP RDBMSs, and often
provides greater performance advantages for more complex questions. The
solution also offers query functions, called RISQL, that allow business
questions to be easily posed and processed and specialized functions that
verify data integrity.
 
  Faster Time to Implementation. The Company capitalizes on over nine years of
decision support expertise to assist customers in rapidly developing and
implementing Red Brick data warehouse solutions. The Company's professional
services organization focuses on developing data warehouse database designs
for customers, rather than on providing more general integration services. An
understandable, extensible database design is a major factor in the success of
a data warehouse. To further accelerate time to production, the Company
provides language tools that enable quick query development. In certain
industry segments, the Company offers "Quick Start" solution kits that include
prepackaged designs and business questions that can be quickly tailored to
meet specific customer needs. Finally, the Company's Partners and Value
Extended Reseller ("PaVER") program, which consists of over sixty companies
that support Red Brick Warehouse, gives the customer the flexibility to choose
best of class tools to complete their client/server data warehouse
implementations.
 
PRODUCTS
 
  The Company provides a suite of data warehouse RDBMS servers, data warehouse
administration tools and connectivity software designed to enable
organizations to implement data warehouse solutions across their
organizations. Customers are able to access their data warehouses through
private networks and over the world wide web. The Company's products have been
designed to address the three main elements of a data warehouse: load
processing, warehouse data management and query processing. All of the
Company's products are available on the industry leading UNIX platforms, which
include AT&T GIS, Digital, Hewlett-Packard, IBM, Sequent, Sun, and Unisys.
Pricing of the Company's products depends on a number of factors, including
the size of the computer system, number of named users and number of
processors. The Company's software products include:
 
  RDBMS Products. The RDBMS products are based on the Red Brick Warehouse
product and technologies and include:
 
  .  Red Brick Warehouse. Red Brick Warehouse is an RDBMS product
     specifically designed to meet the needs and requirements of a data
     warehouse environment. Red Brick Warehouse targets data warehouses
     implemented on symmetric multi-processing server systems, typically at
     the division or profit center level within an organization. In October,
     1996, the Company introduced Version 5.0 of the Red Brick Warehouse
     product. The 5.0 release features advances in performance, scalability,
     and functionality including data mining functionality fully integrated
     into the data warehouse RDBMS engine. Substantially all of the Company's
     installations to date have been the Red Brick Warehouse product.
 
  .  Red Brick Warehouse for Windows NT. Red Brick Warehouse for Windows NT
     is an RDBMS product designed for data warehouse and data mart
     applications running on Intel-based Windows NT servers.
 
  .  Red Brick Warehouse xPP. Red Brick Warehouse xPP is a specialized
     version of the Red Brick Warehouse product designed to be implemented on
     massively parallel systems, typically at the enterprise level of an
     organization.
 
                                       3
<PAGE>
 
  .  Red Brick Warehouse for Workgroups. Red Brick Warehouse for Workgroups
     is a version of the Red Brick Warehouse product designed to be
     implemented on single processor systems, typically at the workgroup
     level within an organization.
 
  Each of the Company's four RDBMS products can work together in a networked
configuration.
 
  Connectivity Software. The Company offers connectivity software to provide
efficient and effective client/server access to Red Brick Warehouse, ensuring
maximum flexibility in selecting computing environments, as well as
complementing existing investments in information technology. These products
include:
 
  .  Red Brick Warehouse Connect. Red Brick Warehouse Connect performs a
     single multi-threaded process on the server with Red Brick Warehouse,
     which establishes and manages client-to-server communications with Red
     Brick Warehouse.
 
  .  Red Brick ODBC. Red Brick ODBC is a connectivity software product which
     is installed on client machines connected to Red Brick RDBMS and
     provides complete access to the Red Brick Warehouse in accordance with
     Open Database Connectivity specifications.
 
  .  Sybase Open Client. Sybase Open Client, which the Company licenses from
     Sybase, Inc. ("Sybase"), is installed on client machines connected to
     the Red Brick RDBMS and provides for client/server access to Red Brick
     Warehouse.
 
  Administration Tools. These tools are designed for IT professionals and
business managers within organizations to implement their data warehouse
applications effectively and include:
 
  .  Auto Aggregate. Auto Aggregate provides the capability to create summary
     records for incoming OLTP data automatically, and is a tool for
     accepting or rejecting incoming records based on pre-determined
     criteria.
 
  .  RISQL Reporter. RISQL Reporter allows organizations to cope with batch
     reporting needs by quickly generating formatted "business intelligence"
     reports to enhance the use and understanding of query results.
 
  .  Backup/Restore. Backup/Restore provides for quick and easy recovery of
     data warehouse data in the event of a system failure.
 
  .  Enterprise Control & Coordination. Enterprise Control & Coordination
     enables the management of networked data warehouses with integrated and
     seamless control and coordination of data across any number of data
     warehouses around the world.
 
  .  Parallel Table Management Utility. Parallel Table Management Utility
     allows better utilization of multi-processor hardware systems for data
     loading, performs data conversion, index building and verification of
     referential integrity, and handles unexpected failure in the middle of
     multi-tape load processes, allowing efficient and effective recovery.
 
  A typical initial purchase by a customer includes the purchase of one or two
RDBMS product licenses and two or more of the administration tools offered by
the Company. While the tools are not required in an initial data warehouse
implementation, organizations realize the benefits gained by using these tools
in managing and optimizing their data warehouses as they begin to bring their
data warehouse implementations into production and as the number, size and
complexity of their data warehouse implementations grow. Customers are
required to purchase connectivity software, as well as first-year maintenance,
with Red Brick Warehouse, and many customers also purchase new computer
hardware and consulting services from third parties when implementing a data
warehouse. The Company often sells a customer additional data warehouse
applications as the customer implements additional data warehouse systems
across the organization.
 
                                       4
<PAGE>
 
TECHNOLOGY
 
  The Company has developed core proprietary technologies that effectively
address the three key components of data warehousing (load processing,
warehouse data management and query processing), and further directs efforts
toward a number of key requirements within each component area.
 
  STARindex and STARjoin. STARjoin is a critical technology for Red Brick
Warehouse performance. With STARjoin, multiple relational tables may be joined
at one time in a fast, single-pass operation as compared to conventional
technologies that join tables one pair at a time, requiring the creation of
many temporary tables for complex queries. The STARjoin technology allows Red
Brick Warehouse to join two or more tables in a single step. A typical query
in a Red Brick Warehouse application will join more than five tables in a
single step. The STARjoin algorithm uses the STARindex to accelerate join
processing. The STARindex relates rows in the various tables of a database
using a compact, easily-maintained structure. The STARindex is completely
transparent to end-users and is created and maintained by the database
administrator like any other standard B-Tree index used in most relational
database products.
 
  Parallel Query. Red Brick Warehouse includes complete parallel query
processing technology. On parallel hardware systems, each query is
automatically divided into multiple sub-parts, each of which is processed at
the same time on different processors, which improves query performance time.
 
  Segmented Storage. The Company's Segmented Storage architecture allows
tables and indexes to be distributed intelligently across the many disks that
comprise a large data warehouse. As a result, the database is better
organized, easier to manage, more reliable and provides improved performance.
The ability to manage the sub-components of a very large data warehouse
separately makes the management of terabyte-sized warehouses achievable.
 
  Pipelined Parallel Load. The Load Data function is designed to perform
complete load processing. The loader not only places row data into a target
database table, but also performs data format conversions, referential
integrity checking and multiple index building as one concurrent, integrated
operation. The parallel loader uses an Adaptive Pipeline Parallel technology
that allows each row being loaded to move through a set of steps, with a
different processor performing each step.
 
  RISQL Extensions. Structured Query Language ("SQL") has long been
established as the standard for relational database access. The Company has
implemented a rich set of SQL extensions, called RISQL (Red Brick Intelligent
SQL), which allow Red Brick Warehouse users to ask many practical business
questions that cannot be asked with SQL alone. These RISQL extensions allow
the server to directly process queries involving rankings, moving averages,
running totals and a variety of other important business measures. Using RISQL
extensions, most business queries can be completely processed by the server,
thus eliminating the need for client-side post processing.
 
  TARGETindex. Based in part on bit-mapped index technologies, TARGETindex
provides for very fast selection of groups from large, multi-attribute lists,
such as targeting a micro market from a large customer list.
 
  Fast Group Calculations. Red Brick Warehouse contains technology to process
group calculations in memory. Specialized data structures are used to store
the group results in memory, eliminating significant disk input/output and
processing time.
 
  Dynamic Optimization. Red Brick Warehouse takes a fundamentally different
approach than traditional OLTP RDBMSs to query optimization, using Dynamic
Optimization to repeatedly re-evaluate its query execution strategy while the
query is running to produce substantially better performance.
 
  On Demand Parallel. The Company's On-Demand Parallel query processing
includes special technology that adapts and changes the degree of parallelism
used to dynamically achieve maximum throughput, assuring optimized performance
in changing multi-user environments with varying workloads.
 
                                       5
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  Integrated Data Mining. Red Brick Data Mine Option is server-based software
fully integrated into the Red Brick Warehouse RDBMS engine. It is used to read
very large volumes of data--hundreds of millions of rows and hundreds of
attributes to--find patterns, trends, and relationships that would be
difficult to find with traditional drill-down querying techniques. Using
models based on these relationships, users are better able to predict the
impact of decisions on their customers, businesses, and markets.
 
  Continually Adaptive Indexing. Red Brick's new Continually Adaptive Indexing
extends TARGETindex technology to provide indexes which automatically and
continually adapt to the data that is being indexed. Red Brick Warehouse
automatically selects the optimal index type on a per value, not per index
basis, which enables considerable speed and efficiency gains.
 
  Hybrid Hash Join. Red Brick's hybrid hash join includes sophisticated
optimizations such as full sub-join recursion (needed to efficiently handle
very large joins), role reversal (needed to efficiently join dissimilarly
sized tables) and bit filtering (needed to improve hash join efficiency). For
the end user, Red Brick's advanced hash join can more quickly process queries
against complex schemas.
 
CUSTOMERS AND MARKETS
 
  To date, the Company has issued more than 200 software licenses to customers
in a variety of industries. The Company's customers include: 3M, 360
Communications Group, AT&T, Barnes & Noble, Bell Atlantic Network Services,
BellSouth, Catalina Marketing, efficient market services, Estee Lauder,
General Mills, Healthsource, Hewlett-Packard, Holiday Inn, Mobil Oil, NASA,
Reuters Information Services, Sara Lee Corp., and Tenneco Packaging.
 
SALES AND MARKETING
 
  The Company markets its products primarily through its direct sales and
service force. The Company employs highly skilled engineers and technically
proficient sales persons capable of serving the sophisticated needs of its
customers' information and business management staffs. The Company has
domestic sales or support staff located in California, Colorado, Connecticut,
Delaware, Florida, Georgia, Illinois, Maryland, Massachusetts, Michigan,
Missouri, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Texas,
Virginia, and Washington, and international offices near London, England, and
in Sydney, Australia, and Tokyo, Japan. In addition to its direct sales and
marketing efforts, the Company utilizes advertising, direct mail and public
relations programs, participates in industry trade shows and organizes
seminars to promote the adoption of its products and methodologies.
 
  The Company provides customers maximum flexibility and choice in building
data warehouse applications, and has established a "PaVER" (Partner and Value-
Extended Reseller) Program to foster relationships with third parties whose
products and services are often used in conjunction with Red Brick Warehouse.
The PaVER program provides Red Brick Warehouse customers the ability to
utilize existing technologies or select from a broad group of front-end tools
when implementing data warehouse systems. The Company has more than 75 vendors
in its PaVER Program. During 1996, the Company implemented its PaVER Gold
Program, a technical certification initiative designed to provide Red Brick
Warehouse users with a choice of software products that exploit the
specialized decision support capabilities of Red Brick Warehouse. In the PaVER
Gold program, partners have committed to tight interoperability between their
software products and Red Brick Warehouse, to support future releases of Red
Brick Warehouse within a specified amount of time after each release, and to
establish reciprocal technical support links with the Company to quickly
resolve technical issues with joint customers.
 
  The Company recently expanded its reseller program in the United States,
Canada, Europe, and Asia/Pacific Rim to recruit, train and support value-added
resellers and system integrators on how to identify market opportunities and
use the Company's products, including RDBMS products, connectivity software
and administration tools, to build data warehouse applications. The Company
believes that such resellers could
 
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develop applications for targeted markets, such as healthcare, manufacturing,
finance and banking, insurance, legal, telecommunications and retail. The
Company offers the resellers discounts on products and training, and field
level assistance from the Company's direct sales force.
 
  In December 1996, the Company promoted Alexander Wilson, formerly Vice
President North American Sales, to the position of Vice President Worldwide
Sales, replacing Thomas Henn. Also in December 1996, Christopher Grejtak, who
had been serving as the Company's Vice President, Marketing, left the Company.
Mr. Erickson has been acting as the Company's Vice President, Marketing, until
the successful conclusion of an executive search for Mr. Grejtak's
replacement. This transition in sales and marketing management could have an
adverse effect on the Company's operating results for the quarter ending March
31, 1997, and the year ending December 31, 1997.
 
MAINTENANCE AND SERVICES
 
  The Company believes that providing superior customer service is critical
for customer success. The Company's strategy is to deliver technology and
services that enable its customers to implement data warehouse applications
quickly. Most of the Company's customers currently have maintenance agreements
that entitle them to technical support, training and periodic upgrades. The
Company also offers additional training and consulting services on a fee
basis.
 
  Technical Support. The Company has established a centralized corporate
technical service group that is supported by the consulting and field
engineering groups. The Company provides customers with a comprehensive array
of services, including software updates, documentation updates, telephone
support, product maintenance, emergency response and access to a product
enhancement request database. The Company offers up to 24 hours a day, 7 days
a week telephone coverage.
 
  Training. The Company offers customer training workshops on Red Brick
Warehouse and database modeling. Regularly scheduled courses are offered at
the Company's headquarters in Los Gatos, California. Individual customer
workshops are provided at the customers' facilities.
 
  Consulting. The Company offers a variety of solution-oriented consulting
services delivered either by specialists from the Company or through a network
of third-party consultants trained and certified on Red Brick Warehouse. These
services include data warehouse design and modeling, data preparation, data
loading, installation, implementation, systems maintenance and upgrading.
 
RESEARCH AND DEVELOPMENT
 
  The Company has made substantial investments in research and development.
The Company believes that its future performance will depend in large part on
its ability to maintain and enhance its current product line, develop new
products that achieve market acceptance, maintain technological
competitiveness and meet an expanding range of customer requirements. The
Company intends to expand its existing product offerings and to introduce new
products for the data warehouse software market. Although the Company expects
that certain of its new products will be developed internally, the Company
may, based on timing and cost considerations, acquire technology or products
from third parties.
 
  The Company currently plans to release new versions of its Red Brick
Warehouse at least annually and to continue to develop new administration
tools to be used with Red Brick Warehouse. These potential new versions and
administration tools are subject to significant technical risks. The Company
may experience delays in the commencement of commercial shipments of potential
new versions and administration tools, resulting in delay or loss of product
revenues. If the potential new versions of Red Brick Warehouse or the
potential new application tools do not achieve market acceptance, or the
Company is unable, for technological or other reasons, to develop, introduce
and sell such versions or application tools in a timely manner, the Company's
business, operating results and financial condition will be materially
adversely affected. Software products as complex as
 
                                       7
<PAGE>
 
those offered by the Company may contain undetected errors or failures when
first introduced or when new versions are released. The Company has in the
past discovered software errors in certain of its new products after their
introduction. When the Company discovers a software error in a product, the
Company's customer service and research and development organizations
typically work with the customer in an attempt to resolve the problem. In most
cases, the Company can provide a solution over the phone. Occasionally, a
Company representative may visit a customer site to assist the customer in
solving the problem. Although the Company has not experienced materially
adverse effects resulting from any such errors to date, there can be no
assurance that, despite testing by the Company and by current and potential
customers, errors will not be found in new versions of Red Brick Warehouse or
administration tools after commencement of commercial shipments, resulting in
loss of or delay in market acceptance, which could have a material adverse
effect upon the Company's business, operating results and financial condition.
 
  As of December 31, 1996, the Company's research and development staff
consisted of 56 employees. The Company's total expenses for research and
development for fiscal 1996 were $6.3 million. The Company believes that
research and development expenses will continue to increase in dollar amounts
in the future. To date, the Company's development efforts have not resulted in
any capitalized software development costs.
 
COMPETITION
 
  The market for the Company's products is intensely competitive and subject
to rapid change. The Company primarily encounters competition from large,
public companies, including Oracle Corporation ("Oracle"), Informix
Corporation ("Informix"), Sybase, International Business Machines Corporation
("IBM"), and NCR/Teradata. In addition, because there are relatively low
barriers to entry in the software market, the Company expects additional
competition from other established and emerging companies if the data
warehouse market continues to develop and expand. The Company believes that
the principal competitive factors affecting its market include first-to-market
product capabilities, product performance, price, support of industry
standards, ease of use, and customer and technical support and service.
Although the Company believes that its products currently compete favorably
with respect to such factors, there can be no assurance that the Company can
maintain its competitive position against current and potential competitors,
especially those with significantly greater financial, marketing, service,
support, technical and other resources.
 
  Most of the Company's competitors have longer operating histories,
significantly greater financial, technical, marketing and other resources than
the Company, significantly greater name recognition and a larger installed
base of customers. In addition, many of the Company's competitors have well-
established relationships with current and potential customers of the Company,
have extensive knowledge of the relational database industry and are capable
of offering a single vendor solution. As a result, the Company's competitors
may be able to respond more quickly to new or emerging technologies and
changes in customer requirements, or to devote greater resources to the
development, promotion and sale of their products than can the Company. In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase
the ability of their products to address customer needs. Accordingly, it is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. The Company also expects that
competition will increase as a result of software industry consolidations.
Increased competition is likely to result in price reductions, reduced gross
margins and loss of market share, any of which could materially adversely
affect the Company's business, operating results and financial condition.
There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, operating results and financial condition.
 
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
 
  The Company relies primarily on a combination of copyright and trademark
laws, trade secrets, confidentiality procedures and contractual provisions to
protect its proprietary technology. For example, the
 
                                       8
<PAGE>
 
Company licenses rather than sells its software and requires licensees to
enter into license agreements, which impose certain restrictions on licensees'
ability to utilize the software. In addition, the Company seeks to avoid
disclosure of its trade secrets, including but not limited to requiring those
persons with access to the Company's proprietary information to execute
confidentiality agreements with the Company and restricting access to the
Company's source code. The Company seeks to protect its software,
documentation and other written materials under trade secret and copyright
laws, which afford only limited protection. The Company presently has no
patents or patent applications pending. Despite the Company's efforts to
protect its proprietary rights, unauthorized parties may attempt to copy
aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult, and while the Company is unable to determine the extent
to which piracy of its software products exists, software piracy can be
expected to be a persistent problem. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights to as great an
extent as do the laws of the United States. There can be no assurance that the
Company's means of protecting its proprietary rights will be adequate or that
the Company's competitors will not independently develop similar technology.
The Company has not been notified that the Company's products infringe the
proprietary rights of third parties. There can be no assurance, however, that
third parties will not claim infringement by the Company with respect to
current or future products. The Company expects that software product
developers will increasingly be subject to infringement claims as the number
of products and competitors in the Company's industry segment grows and the
functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation, cause product shipment delays or require the Company to enter into
royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
 
  The Company licenses Open Server and Open Client products from Sybase, a
competitor of the Company, pursuant to a non-exclusive, royalty bearing
reseller agreement, which expires in November 1997. The Open Server and Open
Client products provide client/server access to the Company's data warehouse.
If the agreement is terminated prior to November 1997 or if the Company is
unable to renew the agreement in November 1997, the Company will have to
develop alternative technology. In July 1996 the Company announced the
acquisition of a perpetual worldwide source code license for client/server
connectivity software which the Company plans to use to provide an alternative
to the Sybase products. There can be no assurance that the Company will be
able to renew the agreement with Sybase, develop alternative technology or
license alternative technology from another source on a timely basis. If the
Company does not renew the agreement with Sybase, develop alternate technology
or license alternate technology from another source prior to the termination
of its arrangement with Sybase, the Company's business, operating results and
financial condition would be materially adversely affected.
 
EMPLOYEES
 
  As of December 31, 1996 the Company had a total of 248 employees, of which
236 were based in the United States, eight were based in the United Kingdom,
one was based in Canada, and three were based in Australia. Of the total, 135
were engaged in sales and marketing, 56 were in research and development, 14
were in customer support, and 43 were in finance, administration, and
operations. The Company's future performance depends in significant part upon
the continued service of its key technical, sales and senior management
personnel, none of whom is bound by an employment agreement. The loss of the
services of one or more of the Company's key employees could have a materially
adverse affect on the Company's business, operating results, and financial
condition. The Company's future success also depends on its continuing ability
to attract, train, and retain highly qualified technical, sales, and
managerial personnel. Competition for such personnel is intense, and there can
be no assurance that the Company can retain its key technical, sales, and
managerial employees or that it can attract, assimilate, or retain other
highly qualified technical, sales, and managerial personnel in the future.
None of the Company's employees is represented by a labor union. The Company
has not experienced any work stoppages and considers its relations with its
employees to be good.
 
                                       9
<PAGE>
 
                  RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
 
  The Company operates in a rapidly changing environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks.
 
  Potential Fluctuations in Quarterly Results; Seasonality. The Company's
quarterly operating results have in the past, and may in the future, varied
significantly depending on factors such as increased competition, size and
timing of significant orders, timing of new product announcements and pricing
policy changes by the Company and its competitors, market acceptance of new
and enhanced versions of the Company's products, changes in operating
expenses, changes in personnel, mix of direct and indirect sales, general
economic factors, and foreign currency exchange rates. The Company currently
operates with virtually no order backlog because its software products
typically are shipped shortly after orders are received. The Company derives a
substantial portion of its revenues from licenses of its Red Brick Warehouse,
a relational database management system that is specifically designed for
serving data warehouse applications and typically has a selling price in
excess of $100,000. As a result, the timing of the receipt and shipment of a
single order can have a significant impact on the Company's revenues and
results of operations for a particular period. Historically, the Company has
often recognized a substantial portion of its revenues in the last month of a
quarter, with these revenues frequently concentrated in the last two weeks of
a quarter. As a result, product revenues in any quarter are substantially
dependent on orders booked and shipped in that quarter, and revenues for any
future quarter are not predictable with any significant degree of certainty.
Product revenues are also difficult to forecast because the market for data
warehouse software products is rapidly evolving, and the Company's sales
cycle, which may last many months, varies substantially from customer to
customer. The Company's expense levels are relatively fixed and are based, in
part, on expectations as to future revenues. Consequently, if revenue levels
fall below expectations, operating results will likely be adversely affected,
and net income may be disproportionately affected because a proportionately
smaller amount of the Company's expenses varies with its revenues. In
addition, the Company expects that sales derived through indirect channels,
which are harder to forecast and have lower gross margins than direct sales,
will increase as a percentage of total revenues. Due to all of the foregoing
factors, the Company believes that period-to-period comparisons of its results
of operations are not necessarily meaningful and should not be relied upon as
indications of future performance. It is likely that in some future quarter
the Company's operating results will be below the expectations of public
market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially adversely affected.
 
  The Company's business has experienced, and is expected to continue to
experience, significant seasonality, largely due to customer buying patterns.
In recent years, the Company has generally had stronger demand for its
software products during the quarters ending in June and December, and weaker
demand in the quarters ending in March and September. The Company believes
this pattern will continue and, accordingly, anticipates that total revenues
and net income, if any, in the quarter ending March 31, 1997, may be lower
than in the quarter ended December 31, 1996.
 
  Competition. The market for the Company's products is intensely competitive
and subject to rapid change. The Company primarily encounters competition from
large public companies, including Oracle, Informix, Sybase, IBM, and
NCR/Teradata. In addition, because there are relatively low barriers to entry
in the software market, the Company expects additional competition from other
established and emerging companies if the data warehouse software market
continues to develop and expand. Most of the Company's competitors have longer
operating histories, significantly greater financial, technical, marketing,
and other resources, significantly greater name recognition, and a larger
installed base of customers. In addition, many of the Company's competitors
have well-established relationships with current and potential customers of
the Company, have extensive knowledge of the relational database industry, and
are capable of offering a single vendor solution. As a result, the Company's
competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, and sale of their products than can
the Company. In addition, current and potential competitors have established
or may establish cooperative relationships among themselves or with third
parties to increase the ability of their products to
 
                                      10
<PAGE>
 
address customer needs. Accordingly, it is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market
share. The Company also expects that competition will increase as a result of
software industry consolidations. Increased competition is likely to result in
price reductions, reduced gross margins, and loss of market share, any of
which could materially adversely affect the Company's business, operating
results, and financial condition. There can be no assurance that the Company
will be able to compete successfully against current and future competitors or
that competitive pressures faced by the Company will not materially adversely
affect its business, operating results and financial condition.
 
  Limited Profitability; Accumulated Deficit; Future Operating Results
Uncertain. As of December 31, 1996, the Company had an accumulated deficit of
$8.5 million. The Company's profitability has been marginal and there can be
no assurance that the Company will remain profitable on a quarterly basis or
on an annual basis. The Company's limited operating history makes the
prediction of future operating results difficult. The Company began shipping
its principal product, Red Brick Warehouse, in December 1991. Although the
Company has experienced significant percentage growth in revenues in recent
periods, the Company does not believe prior percentage growth rates are
sustainable or indicative of future operating results. Future operating
results will depend on many factors, including the demand for the Company's
products, the level of product and price competition, the Company's success in
expanding its direct sales force and indirect distribution channels, the
ability of the Company to develop and market new products and control costs,
and the percentage of the Company's revenues derived from indirect channels,
which have lower gross margins than direct sales, and general economic
conditions.
 
  Dependence on Continued Growth of the Data Warehouse Market. Although demand
for data warehouse software has grown in recent years, the market is still
emerging. The Company's future financial performance will depend to a large
extent on continued growth in the number of organizations adopting data
warehouses. There can be no assurance that the market for data warehouses will
continue to grow. If the data warehouse market fails to grow, or grows more
slowly than the Company currently anticipates, the Company's business,
operating results, and financial condition would be materially adversely
affected.
 
  Product Concentration. Substantially all of the Company's revenues have been
attributable to sales of licenses of Red Brick Warehouse. These products are
currently expected to account for a significant part of the Company's revenues
for the foreseeable future. As a result, a decline in demand for, or failure
to achieve broad market acceptance of, Red Brick Warehouse as a result of
competition, technological change or otherwise, would have a materially
adverse effect on the business, operating results, and financial condition of
the Company. A decline in sales of Red Brick Warehouse would also have a
materially adverse effect on licensing of other Company products that may be
licensed to Red Brick Warehouse customers. The Company's future financial
performance will depend in part on the successful development, introduction,
and customer acceptance of new and enhanced versions of Red Brick Warehouse
and other products. There can be no assurance that the Company will continue
to be successful in marketing Red Brick Warehouse or any new or enhanced
products.
 
  Dependence on New Products and Rapid Technological Change. The market for
the Company's software is characterized by rapid technological change,
frequent new product introductions, and evolving industry standards. The
introduction by others of products embodying new technologies and the
emergence of new industry standards can render the Company's existing products
obsolete and unmarketable. The life cycles of the Company's products are
difficult to estimate. The Company's future success depends on its ability to
enhance its current products, to develop and introduce new products that keep
pace with technological developments and emerging industry standards on a
timely basis, and to address the increasingly sophisticated needs of its
customers. There can be no assurance that the Company will be successful in
developing and marketing product enhancements or new products that respond to
technological change or evolving industry standards, that the Company will not
experience difficulties that could delay or prevent the successful
development, introduction, and marketing of these new products and product
enhancements, or that the Company's new products and product enhancements will
adequately meet the requirements of the marketplace and achieve market
acceptance. Any potential new products or product enhancements would likely be
subject to significant technical risks. If the Company experiences delays in
the commencement of commercial shipments of new products and
 
                                      11
<PAGE>
 
enhancements, the Company could experience delays or loss of product revenues.
If the Company is unable, for technological or other reasons, to develop and
introduce new products or enhancements of existing products in a timely manner
in response to changing market conditions or customer requirements, the
Company's business, operating results, and financial condition will be
materially adversely affected.
 
  Customer Concentration. A relatively small number of customers and resellers
account for a significant percentage of the Company's revenues. In 1994, sales
to Digital Equipment Corporation and efficient market services accounted for
12% and 11% of total revenues, respectively. In 1995, sales to Unisys
Corporation ("Unisys"), a reseller of the Company's products, accounted for
21% of total revenues. The Company expects that licenses of its products to a
limited number of customers and resellers may continue to account for a high
percentage of revenue for the foreseeable future. There can be no assurance
that any customer or reseller will continue to purchase the Company's
products. The Company believes that additional purchases of software licenses
from Unisys during 1997 will account for little, if any, incremental revenue.
The loss of a major customer or reseller or any reduction in orders by such
customers or resellers, including reductions due to market or competitive
conditions, would have a materially adverse effect on the Company's business,
financial condition, and results of operations.
 
  Risk of Product Defects. Software products as complex as those offered by
the Company may contain undetected errors or failures when first introduced or
when new versions are released. The Company has previously discovered software
errors in certain of its new products after their introduction. Although the
Company has not experienced materially adverse effects resulting from any such
errors to date, there can be no assurance that, despite testing by the Company
and by current and potential customers, errors will not be found in new
versions of Red Brick Warehouse or administration tools after commencement of
commercial shipments, resulting in loss of or delay in market acceptance,
which could have a materially adverse effect upon the Company's business,
operating results and financial condition.
 
  Dependence Upon Key Personnel; Need to Increase Sales and Technical
Personnel. The Company's future performance depends in a significant part upon
the continued service of its key technical, sales, and senior management
personnel, none of whom is bound by an employment agreement. In December 1996,
Thomas Henn, who had been serving as the Company's Vice President of Worldwide
Sales, and Christopher Grejtak, who had been serving as the Company's Vice
President of Marketing, decided to leave the Company. Also in December 1996,
the Company promoted Alexander Wilson, formerly Vice President North American
Sales, to the position of Vice President Worldwide Sales, and Mr. Erickson
began acting as the Company's Vice President Marketing until the successful
conclusion of an executive search for Mr. Grejtak's replacement. The Company
believes that there may be a transition period before the new sales management
team becomes fully productive. These changes in sales and marketing management
as well as the loss of the services of one or more of the Company's key
employees in the future could have a materially adverse effect on the
Company's business, operating results, and financial condition. The Company's
future success also depends on its continuing ability to attract, train, and
retain highly qualified technical, sales, and managerial personnel.
The Company intends to hire a significant number of additional sales and
technical personnel in 1997. Competition for such personnel is intense, and
there can be no assurance that the Company can retain its key technical,
sales, and managerial employees or that it can attract, assimilate, or retain
other highly qualified technical, sales, and managerial personnel in the
future. Because of the complexity of RDBMS technology and the differences
between OLTP and data warehouse systems, the Company has experienced in the
past, and expects to experience in the future, a time lag between the date
technical and sales personnel are hired and the date such personnel become
fully productive. Although the Company increased the size of its direct sales
force and its research and development groups in 1995 and 1996, the Company
experienced difficulty in recruiting a sufficient number of sales and
technical personnel during this period. If the Company is unable to hire such
personnel on a timely basis in the future, the Company's business, operating
results, and financial condition could be materially adversely affected.
 
  Management of Changing Business. The Company has recently experienced a
period of significant growth in revenues that has placed a serious strain upon
its management systems and resources. The Company implemented and expanded
upon a number of financial and management controls, reporting systems, and
 
                                      12
<PAGE>
 
procedures. The Company's ability to compete effectively and to manage future
growth, if any, will require the Company to continually improve its financial
and management controls, reporting systems, and procedures on a timely basis,
implementing new systems as necessary, and expanding, training, and managing
its employee work force. There can be no assurance that the Company will be
able to do so successfully. The Company's failure to do so could have a
materially adverse effect upon the Company's business, operating results, and
financial condition.
 
  Expansion of Indirect Channels. An integral part of the Company's strategy is
to further develop a channel of distributors, value added resellers (VARs), and
system integrators, and to increase the proportion of the Company's customers
licensed through this indirect channel. The Company is currently investing, and
intends to continue to invest, significant resources to develop this channel,
which could adversely affect the Company's operating results if the Company's
efforts do not generate significant license revenues. There can be no assurance
that the Company will be able to attract distributors, VARs, and system
integrators that will be able to market the Company's products effectively and
will be qualified to provide timely and cost-effective customer support and
service. The inability to recruit important distributors, VARs, or system
integrators could adversely affect the Company's results of operations. In
addition, if it is successful in selling products through this channel, the
Company's gross margins will be negatively affected due to the lower unit
prices the Company expects to receive when selling through indirect channels.
 
  International Operations. The Company's international revenues in 1996
accounted for 10% of total revenues and in 1995 accounted for less than 10% of
total revenues. The Company intends to continue to expand and maximize the
sales potential of its existing international operations and enter additional
international markets. This will require significant management attention and
financial resources, and could adversely affect the Company's business,
operating results, and financial condition. In order to expand international
sales successfully in 1997 and subsequent periods, the Company believes it may
need to restructure some of its existing international operations, establish
additional foreign operations, hire additional personnel, and recruit
additional international resellers and distributors. To the extent that the
Company is unable to do so in a timely manner, the Company's growth in
international sales, if any, will be limited, and the Company's business,
operating results, and financial condition could be materially adversely
affected. In addition, there can be no assurance that the Company will be able
to maintain or increase international market demand for the Company's products.
Additional risks inherent in the Company's international business activities
generally include unexpected changes in regulatory requirements, tariffs and
other trade barriers, costs of localizing products for foreign countries, lack
of acceptance of localized products in foreign countries, longer accounts
receivable payment cycles, difficulties in managing international operations,
potentially adverse tax consequences including restrictions on the repatriation
of earnings, weaker intellectual property protection, and the burdens of
complying with a wide variety of foreign laws. There can be no assurance that
such factors will not have a materially adverse effect on the Company's future
international sales and, consequently, the Company's results of operations.
 
  Limited Protection of Proprietary Technology; Risks of Infringement. The
Company relies primarily on a combination of copyright and trademark laws,
trade secrets, confidentiality procedures, and contractual provisions to
protect its proprietary technology. For example, the Company licenses rather
than sells its software and requires licensees to enter into license
agreements, which impose certain restrictions on licensees' ability to utilize
the software. In addition, the Company seeks to avoid disclosure of its trade
secrets, including, but not limited to, requiring those persons with access to
the Company's proprietary information to execute confidentiality agreements
with the Company and restricting access to the Company's source code. The
Company seeks to protect its software, documentation, and other written
materials under trade secret and copyright laws, which afford only limited
protection. The Company presently has no patents or patent applications
pending. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
to obtain and use information that the Company regards as proprietary. Policing
unauthorized use of the Company's products is difficult, and while the Company
is unable to determine the extent to which piracy of its software products
exists, software piracy can be expected to be a persistent problem. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that the Company's means of protecting its
 
                                       13
<PAGE>
 
proprietary rights will be adequate or that the Company's competitors will not
independently develop similar technology. There can be no assurance that third
parties will not claim infringement by the Company with respect to current or
future products. The Company expects that software product developers will
increasingly be subject to infringement claims as the number of products and
competitors in the Company's industry segment grows and the functionality of
products in different industry segments overlaps. Any such claims, with or
without merit, could be time-consuming, result in costly litigation, cause
product shipment delays, or require the Company to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if required, may
not be available on terms acceptable to the Company, or at all, which could
have a materially adverse effect upon the Company's business, operating
results and financial condition.
 
  The Company licenses Open Server and Open Client products from Sybase, a
competitor of the Company, pursuant to a non-exclusive, royalty bearing
reseller agreement, which expires in November 1997. The Open Server and Open
Client products provide client/server access to the Company's data warehouse.
If the agreement is terminated prior to November 1997, or if the Company is
unable to renew the agreement in November 1997, the Company will have to
develop alternative technology or license alternative technology from another
source. During the second quarter of 1996, the Company acquired a license to
further develop and offer an alternative connectivity product. There can be no
assurances that this alternative product will be available in the near future
or will perform adequately as a replacement to the products licensed to the
Company by Sybase. If the Company does not renew the Sybase agreement or is
not able to adequately develop this alternative product prior to the
termination of its arrangement with Sybase, the Company's business, operating
results, and financial condition could be materially adversely affected.
 
  Product Liability. The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. Although the Company has not experienced
product liability claims to date, the license and support of products by the
Company may entail the risk of such claims. A successful product liability
claim brought against the Company could have a materially adverse effect on
the Company's business, operating results, and financial condition.
 
  Potential Volatility of Stock Price. The trading price of the Company's
Common Stock is highly volatile and may be subject to wide fluctuations in
response to quarterly variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
changes in financial estimates by securities analysts, and other events or
factors. In addition, the stock market has experienced volatility, often
unrelated to operating performance, that particularly affected market prices
of equity securities of many high technology companies. There can be no
assurance that prices and price/earnings ratios will be sustained. Market
fluctuations may adversely affect the market price of the Company's Common
Stock.
 
ITEM 2. PROPERTIES
 
  The Company's principal administrative, sales, marketing, support, and
research and development facility is located in approximately 37,700 square
feet of space in Los Gatos, California. The lease on this office space expires
in May 1998. The Company has experienced significant growth in the number of
employees during 1996. As a result of such growth, the Company is currently
seeking additional facilities in which to operate in the greater Los Gatos and
South Bay community. The Company believes that suitable additional or
alternative space will be available in the future on commercially reasonable
terms as needed. The Company currently leases other domestic sales offices
throughout the United States, as well as international offices in the United
Kingdom, Australia, and Japan.
 
ITEM 3. LEGAL PROCEEDINGS
 
  There are no pending material legal proceedings, other than ordinary routine
litigation incidental to the business, to which the Company or any of its
subsidiaries is a party or of which any of their property is the subject.
 
 
                                      14
<PAGE>
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  No matters were submitted to a vote of the Company's security holders during
the fourth quarter of fiscal year 1996.
 
ITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT
 
  The following sets forth certain information regarding the current executive
officers of the Company as of February 28, 1997:
 
<TABLE>
<CAPTION>
             NAME           AGE                   POSITION
             ----           ---                   --------
   <C>                      <C> <S>
   Christopher G. Erickson.  48 President, Chief Executive Officer, and
                                 Chairman of the Board
   Phillip M. Fernandez....  36 Senior Vice President, Products and Services
   Robert C. Hausmann......  33 Vice President, Finance and Administration,
                                 Chief Financial Officer, and Secretary
   Alexander Wilson........  47 Vice President, Worldwide Sales
</TABLE>
 
  Mr. Erickson joined the Company in February 1993 as President and Chief
Executive Officer and as director. In September 1995, Mr. Erickson was also
elected Chairman of the Board of the Company. From November 1980 to January
1993, Mr. Erickson was employed by Tandem Computers Incorporated ("Tandem"), a
manufacturer of computers and related products, where he served as President
of Tandem Telecommunications Systems and most recently as Vice President and
General Manager, Tandem Division. Prior to joining Tandem, Mr. Erickson was
employed by Wells Fargo Bank, N.T. & S.A., a banking institution. Mr. Erickson
holds a BA degree in economics from the University of California, Santa
Barbara and an MBA from the University of California, Berkeley.
 
  Mr. Fernandez joined the Company in December 1991 as Vice President,
Engineering. In November 1996, Mr. Fernandez was promoted to Senior Vice
President, Products and Service. From March 1989 to November 1991, Mr.
Fernandez was employed by Metaphor Computer Systems, a computer software
company, most recently as Director, Systems Software Development. Prior to
that time, Mr. Fernandez was employed by Stanford University from March 1986
to March 1989, most recently as Director of Data and Technology Resources. Mr.
Fernandez holds a B.A. in history from Stanford University.
 
  Mr. Hausmann joined the Company in October 1991 as Director, Finance and
Administration and Secretary, and in October 1992 became Vice President,
Finance and Administration and Chief Financial Officer. From September 1990 to
September 1991, Mr. Hausmann was employed by Cadence Design Systems, Inc., an
electronic design automation software company, as Controller and Director of
Finance of the I.C. Division. Prior to that time, Mr. Hausmann was employed
for more than five years at Centura Software, a developer of programmer
productivity tools, most recently as Controller. Mr. Hausmann holds a B.A. in
finance and accounting from Bethel College and an MBA from Santa Clara
University.
 
  Mr. Wilson joined the Company as Area Director in 1994. In 1995 he was
promoted to Vice President North American Sales. From August 1988, to July
1994, Mr. Wilson was employed by Computer Associates International, Inc., a
software company, most recently as vice president of the Midwest Division.
Prior to that time. Mr. Wilson worked for Applied Data Research, a software
company, where he was responsible for international distributions through the
Asia-Pacific Rim. Mr. Wilson holds a degree from the Institute of Marketing
Management in Capetown, South Africa.
 
                                      15
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
 
  The Company's common stock has been traded on the Nasdaq National Market
under the symbol REDB since the Company's initial public offering on January
22, 1996. According to the records of the Company's transfer agent, the
Company had approximately 173 stockholders of record as of February 28, 1997.
Because many of such shares are held by brokers and other institutions on
behalf of stockholders, the Company is unable to estimate the total number of
stockholders represented by these record holders. The following table sets
forth the high and low sale price as of the close of market of the Company's
Common Stock in each of the Company's last four fiscal quarters.
 
<TABLE>
<CAPTION>
                                                                   HIGH   LOW
                                                                  ------ ------
     <S>                                                          <C>    <C>
     FISCAL 1996:
       First Quarter (from January 22, 1996)..................... $53.75 $18.00
       Second Quarter............................................ $60.75 $33.50
       Third Quarter............................................. $35.25 $19.00
       Fourth Quarter............................................ $27.50 $18.75
</TABLE>
 
  The Company has not paid any cash dividends since its inception and does not
intend to pay any cash dividends in the foreseeable future. The Company is
restricted by its line of credit agreement in its ability to pay cash
dividends.
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                         YEAR ENDED DECEMBER 31,
                                ----------------------------------------------
                                 1996      1995      1994      1993     1992
                                -------  --------  --------  --------  -------
                                  (AMOUNTS IN THOUSANDS EXCEPT PER SHARE
                                                  DATA)
<S>                             <C>      <C>       <C>       <C>       <C>
STATEMENT OF OPERATIONS DATA:
 Total revenue................. $36,035  $ 20,605  $  8,502  $  2,564  $ 1,691
 Income (loss) from operations.   1,537       579    (1,416)   (2,862)  (3,025)
 Net income (loss).............   3,818       308  $ (1,481) $ (2,935) $(3,170)
 Net income per share(1)....... $  0.30  $   0.03
 Shares used in computing net
  income per share(1)..........  12,668     9,965
BALANCE SHEET DATA:
 Cash and equivalents.......... $14,552  $  2,998  $  1,958  $  2,747  $   560
 Working capital...............  40,308     2,613     1,554     3,553      139
 Total assets..................  53,368    10,977     6,510     4,887    1,576
 Long-term obligations.........     396     1,068     1,131       194      324
 Accumulated deficit...........  (8,507)  (12,325)  (12,633)  (11,152)  (8,217)
 Total stockholders' equity.... $42,924  $  3,720  $  2,262  $  3,741  $   417
</TABLE>
--------
(1) Prior to 1995, statement of operations data omit the historical net income
    per share, as it was not presented in the initial public offering
    registration statement pursuant to SEC guidelines. Pro forma net income
    per share is presented for 1995. See Note 1 of Notes to Consolidated
    Financial Statements.
 
                                      16
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS
 
  The discussion in this report contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in the
section above entitled "Risk Factors That May Affect Future Results," in Item
1 of this report as well as those risks discussed in this section and
elsewhere in this report.
 
                                   OVERVIEW
 
  The Company develops, markets and supports Red Brick Warehouse, a high-
performance, client/server RDBMS that is specifically designed for data
warehouse applications. The Company was founded in July 1986 as a consulting
company to address the issues associated with gaining access to large data
stores. During the period from inception to late 1989, the Company developed
various tools and technologies intended to address these issues. In late 1989,
the Company began to develop technology for a new RDBMS focused on decision
support and data warehouse applications. The Company made its initial product
shipments of Red Brick Warehouse in December 1991. Since that time, the
Company has released new versions of Red Brick Warehouse at least annually, as
well as administration tools that are sold as options to Red Brick Warehouse.
The Company's administration tools enable IT professionals and business
managers within organizations to implement their data warehouse applications
effectively.
 
  As of December 31, 1996, the Company had an accumulated deficit of $8.5
million. There can be no assurance that the Company will remain profitable on
a quarterly basis or achieve profitability on an annual basis. The Company's
limited operating history makes the prediction of future operating results
difficult. Although the Company has experienced significant percentage growth
in revenues in recent periods, the Company does not believe prior percentage
growth rates are sustainable or indicative of future operating results. Future
operating results will depend on many factors, including the demand for the
Company's products, the level of product and price competition, the Company's
success in expanding its direct sales force and indirect distribution
channels, the ability of the Company to develop and market new products and
control costs, the percentage of the Company's revenues derived from indirect
channels, which have lower gross margins than direct sales, and general
economic conditions.
 
  Substantially all of the Company's revenues have been attributable to sales
of licenses of Red Brick Warehouse. This product is currently expected to
account for a significant part of the Company's revenues for the foreseeable
future. As a result, a decline in demand for or failure to achieve broad
market acceptance of Red Brick Warehouse as a result of competition,
technological change or otherwise, would have a materially adverse effect on
the business, operating results, and financial condition of the Company. A
decline in sales of Red Brick Warehouse would also have a materially adverse
effect on sales of other Company products that may be sold to Red Brick
Warehouse customers. The Company's future financial performance will depend in
part on the successful development, introduction, and customer acceptance of
new and enhanced versions of Red Brick Warehouse and other products. There can
be no assurance that the Company will continue to be successful in marketing
Red Brick Warehouse or any new or enhanced products.
 
  A relatively small number of customers and resellers account for a
significant percentage of the Company's revenues. The Company expects that
licenses of its products to a limited number of customers and resellers may
continue to account for a high percentage of revenues for the foreseeable
future. There can be no assurance that any customer or reseller will continue
to purchase the Company's products. The loss of a major customer or reseller
or any reduction in orders by such customers or resellers, including
reductions due to market or competitive conditions, would have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
                                      17
<PAGE>
 
  The Company believes that its products are priced competitively with most of
its competitors' products. The market for the Company's products is highly
competitive, and the Company expects that it could face increasing pricing
pressures from its current competitors and new market entrants. Any material
reduction in the price of the Company's products would negatively affect gross
margins and could materially adversely affect the Company's business,
operating results, and financial condition if the Company were unable to
increase unit sales.
 
                             RESULTS OF OPERATIONS
 
REVENUES
 
<TABLE>
<CAPTION>
                                           FOR THE YEAR ENDED DECEMBER 31,
                                         --------------------------------------
                                          1996    CHANGE  1995    CHANGE  1994
                                         -------  ------ -------  ------ ------
                                                (DOLLARS IN THOUSANDS)
<S>                                      <C>      <C>    <C>      <C>    <C>
Software license........................ $29,242    86%  $15,742   153%  $6,218
Percentage of total revenues............    81.1%           76.4%          73.1%
Maintenance and service................. $ 6,793    40%  $ 4,863   113%  $2,284
Percentage of total revenues............    18.9%           23.6%          26.9%
  Total revenues........................ $36,035    75%  $20,065   142%  $8,502
</TABLE>
 
  The Company's revenues are derived from (i) license fees for its software
products and (ii) fees for services complementing its products, including
software maintenance and support, training, consulting and development
agreements. Fees for service revenues are charged separately from the
Company's software products. The Company recognizes revenue in accordance with
the American Institute of Certified Public Accountants Statement of Position
91-1 on Software Revenue Recognition. Revenue from software licensing is
generally recognized after execution of a licensing agreement and shipment of
the product. Maintenance revenue is recognized ratably over the term of the
contract. Consulting and training revenues are recognized at the time the
service is performed. Revenue under software development agreements is
recognized using the percentage-of-completion method based on the ratio that
incurred costs bear to total estimated costs. The Company's license agreements
generally do not provide a right of return. However, reserves are maintained
for potential credit losses.
 
  Software License Revenues. The Company currently derives substantially all
of its software license revenues from licenses of Red Brick Warehouse, a
relational database management system that is specifically designed for
serving data warehouse applications, and typically has a selling price in
excess of $100,000. The increases in software license revenues in 1996 and
1995 were primarily attributable to increases in the number of units sold. The
Company intends to continue to enhance its current software products, as well
as to develop new products. The Company expects that prior growth rates of the
Company's software license revenues will not be sustainable in the future.
 
  The Company's indirect channels have accounted for approximately 12% of
total revenue in 1996. The Company is currently investing, and intends to
continue to invest, significant resources in developing indirect channels,
which could adversely affect the Company's operating results if the Company's
efforts do not generate additional license revenues. There can be no assurance
that the Company will be able to attract distributors, VARs and system
integrators that will be able to market the Company's products effectively and
will be qualified to provide timely and cost-effective customer support and
service. The inability to recruit important distributors, VARs or system
integrators could adversely affect the Company's results of operations. In
addition, if the Company is successful in selling its products through this
channel, the Company expects that any material increase in the Company's
indirect sales as a percentage of total revenues will adversely affect the
Company's average selling prices and gross margins due to the lower unit
prices that the Company receives when selling through indirect channels.
 
  Maintenance and Service Revenues. The growth in maintenance and service
revenues is primarily attributable to increased licensing activity and the
renewal of maintenance contracts after the initial one-year
 
                                      18
<PAGE>
 
term. The Company expects that prior growth rates of the Company's maintenance
and service revenues will not be sustainable in the future.
 
  For the year ended December 31, 1996, sales to no one customer accounted for
more than 10% of total revenues. For the year ended December 31, 1995, sales
to Unisys accounted for 21% of total revenues. For the year ended December 31,
1994, sales to Digital Equipment and efficient market services accounted for
12% and 11% of total revenues, respectively. The Company expects that licenses
of its products to a limited number of customers and resellers will continue
to account for a significant percentage of revenue for the foreseeable future.
The Company believes that additional purchases of software licenses from
Unisys during 1997 will not account for little, if any, incremental revenue.
There can be no assurance that any customer or reseller will continue to
license the Company's products. The loss of a major customer or reseller or
any reduction in orders by such customers or resellers, including reductions
due to market or competitive conditions, would have a materially adverse
effect on the Company's business, financial condition, and results of
operations.
 
  The Company's international revenues for the year ended December 31, 1996,
were 10% of revenues and less than 10% of total revenues for the years ended
December 31, 1995 and 1994. The 1996 sales were attributable to seven
customers, the 1995 sales to ten customers, and the 1994 sales to one
customer. The Company intends to continue to expand its international
operations and to enter additional international markets.
 
COST OF REVENUES
 
<TABLE>
<CAPTION>
                                             FOR THE YEAR ENDED DECEMBER 31,
                                             ----------------------------------
                                              1996   CHANGE  1995   CHANGE 1994
                                             ------  ------ ------  ------ ----
                                                  (DOLLARS IN THOUSANDS)
<S>                                          <C>     <C>    <C>     <C>    <C>
Software license............................ $1,136    66%  $  685   117%  $316
Percentage of total revenues................    3.2%           3.3%         3.7%
Maintenance and service..................... $3,357   108%  $1,615   213%  $516
Percentage of total revenues................    9.3%           7.8%         6.1%
Total cost of revenues...................... $4,493    95%  $2,300   176%  $832
Percentage of total revenues................   12.5%          11.2%         9.8%
</TABLE>
 
  Cost of Software License Revenues. Cost of software license revenues
consisted primarily of the cost of royalties paid to third-party vendors,
product media and duplication, shipping expenses, manuals and packaging
materials. The increase in the dollar amount of cost of software license
revenues reflected the higher volume of product shipped. The Company believes
that the cost of software license revenues will increase in dollars and may
increase as a percentage of revenues.
 
  Cost of Maintenance and Service Revenues. Cost of maintenance and service
revenues consisted primarily of personnel-related costs incurred in providing
telephone support, consulting services, and training to customers. Cost of
maintenance and service revenues for the year ended December 31, 1996,
increased over such costs for the year ended December 31, 1995, as a result of
increased personnel-related costs as the Company continued to expand its
customer service organizations to support the increase in sales. The increase
in costs as a percentage of the related maintenance and service revenues for
the year ended December 31, 1995 over the year ended December 31, 1994 was
primarily attributable to the growth in personnel-related costs associated
with building the customer support and training organizations, which outpaced
the growth in maintenance and service revenues during such period. The Company
believes that the cost of maintenance and service revenues will increase in
dollars and may increase as a percentage of revenues in the future as the
Company continues to build its customers service organizations.
 
 
                                      19
<PAGE>
 
OPERATING EXPENSES
 
<TABLE>
<CAPTION>
                                           FOR THE YEAR ENDED DECEMBER 31,
                                         --------------------------------------
                                          1996    CHANGE  1995    CHANGE  1994
                                         -------  ------ -------  ------ ------
                                                (DOLLARS IN THOUSANDS)
<S>                                      <C>      <C>    <C>      <C>    <C>
Sales and marketing..................... $20,410    85%  $11,011    95%  $5,650
Percentage of total revenues............    56.6%           53.4%          66.5%
Research and development................ $ 6,256    24%  $ 5,033    77%  $2,848
Percentage of total revenues............    17.4%           24.4%          33.5%
General and administrative.............. $ 2,839    69%  $ 1,682   186%  $  588
Percentage of total revenues............     7.9%            8.2%           6.9%
In-process technology................... $   500     *   $   --      *   $  --
Percentage of total revenues............     1.4%            --             --
Total operating expenses................ $30,005    69%  $17,726    95%  $9,086
Percentage of total revenues............    83.3%           86.0%         106.9%
</TABLE>
--------
*  Not meaningful.
 
  Sales and Marketing. Sales and marketing expenses consisted primarily of
personnel-related costs, including sales commissions of all personnel involved
in the sales process, as well as promotional expenses including advertising,
public relations, seminars, and trade shows. The 1996 over 1995 and 1995 over
1994 increases in sales and marketing expenses were primarily due to the
expansion of the Company's sales operations and increased marketing
activities, including promotional expenses. The Company believes that such
expenses will increase in dollar amount and may increase as a percentage of
revenues in the future as the Company expands its sales and marketing
activities.
 
  Research and Development. Research and development expenses consisted
primarily of salaries and other personnel-related expenses, and depreciation
of development equipment. The increases in research and development expenses
were primarily attributable to the increased staffing of software engineers
required to expand and enhance the Company's product line. The Company
believes that research and development expenses will continue to increase in
dollar amounts in the future.
 
  In accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," the Company capitalizes eligible computer software costs upon the
achievement of technological feasibility, subject to net realizable value
considerations. The Company has defined technological feasibility as
completion of a working model. As of December 31, 1996, such capitalizable
costs were insignificant. Accordingly, the Company has charged all such costs
to research and development expense in the accompanying consolidated
statements of operations.
 
  General and Administrative. General and administrative expenses consisted
primarily of personnel costs for finance and general management, as well as
insurance and professional expenses. The increase in dollar amount from 1994
through 1996 in general and administrative expenses was primarily attributable
to hiring of additional personnel. The Company believes that its general and
administrative expenses will increase in dollar amount in the future and may
increase as a percentage of revenues in the future as the Company continues
expanding its staffing and incurring costs associated with requirements
operating as a public company.
 
  In-process technology. In the second quarter of 1996, the Company acquired
in-process technology associated with a $500,000 licensing arrangement. The
acquired in-process technology had not reached technological feasibility and
did not have alternative future uses.
 
 
                                      20
<PAGE>
 
INTEREST AND OTHER INCOME AND INTEREST EXPENSE
 
<TABLE>
<CAPTION>
                                           FOR THE YEAR ENDED DECEMBER 31,
                                           -----------------------------------
                                            1996   CHANGE  1995   CHANGE 1994
                                           ------  ------  -----  ------ -----
                                                (DOLLARS IN THOUSANDS)
   <S>                                     <C>     <C>     <C>    <C>    <C>
   Interest and other income.............. $1,743  1,754%  $  94    68%  $  56
   Interest expense....................... $ (234)     5%  $(222)   83%  $(121)
</TABLE>
 
  Interest and other income primarily represents interest income earned on the
Company's cash, cash equivalents, and short-term investments. Interest and
other income increased during the year ended December 31, 1996, due to the
investment of the proceeds received from the Company's initial public
offering. The Company's interest expense was due primarily to capital leases
of computer equipment.
 
PROVISION (BENEFIT) FOR INCOME TAXES
 
<TABLE>
<CAPTION>
                                             FOR THE YEAR ENDED DECEMBER 31,
                                             ------------------------------
                                             1996   CHANGE 1995 CHANGE 1994
                                             -----  ------ ---- ------ ----
                                                (DOLLARS IN THOUSANDS)
   <S>                                       <C>    <C>    <C>  <C>    <C>  <C>
   Provision (benefit) for income taxes..... $(687)   *    $143   *    $--
</TABLE>
--------
*  Not meaningful.
 
  The 1996 tax benefit reflects a new-time adjustments of $1,000,000 to
recognize a deferred tax asset for the anticipated future benefit of tax
operating loss and credit carryforwards. Although realization is not assured,
the Company believes that it is now more likely than not that it will generate
future taxable income sufficient to realize the benefit of this deferred tax
asset. The amount of the net deferred tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable
income are reduced. Management intends to evaluate the realizability of the
net deferred tax asset each quarter to assess the need for the valuation
allowance.
 
  After adjusting for this tax benefit, the effective tax rate for 1996 was
10%, which compares with an effective tax rate of 32% for 1995. There was no
tax provision for 1994 as the Company incurred an operating loss. The adjusted
provision for income taxes for 1996 differs from a provision calculated by
applying the federal income tax rate (34%), primarily due to the utilization
of net operating loss carryforwards, offset by domestic alternative minimum
taxes and foreign taxes. The effective tax rate for 1996 was lower than for
1995 due to the reduction in the impact of domestic alternative minimum taxes
relative to pre-tax book income.
 
  The Company anticipates that its effective tax rate for 1997 will increase,
but will be less than the statutory rate due to the anticipated utilization of
tax operating loss and credit carryforwards.
 
  As of December 31, 1996, the Company had federal and state net operating
loss carryforwards of approximately $4.4 million and $3.6 million,
respectively, and federal and state research credit carryforwards of $430,000
and $290,000, respectively. Utilization of approximately $1.5 million of the
net operating loss carryforwards is limited to approximately $100,000 per
year, due to the ownership change provisions provided by the Tax Reform Act of
1986 and similar state provisions. These carryforwards will expire from 1998
through 2009.
 
                                      21
<PAGE>
 
MINORITY INTEREST, NET INCOME (LOSS), AND EARNINGS PER SHARE
 
<TABLE>
<CAPTION>
                                          FOR THE YEAR ENDED DECEMBER 31,
                                         -------------------------------------
                                          1996   CHANGE  1995   CHANGE  1994
                                         ------  ------  -----  ------ -------
                                               (DOLLARS IN THOUSANDS)
   <S>                                   <C>     <C>     <C>    <C>    <C>
   Minority Interest.................... $   85      *   $ --      *   $   --
   Percentage of total revenues.........    0.2%           --              --
   Net income (loss).................... $3,818  1,140%  $ 308     *   $(1,481)
   Percentage of total revenues.........   10.6%           1.5%          (17.4)%
   Net income per share(1).............. $ 0.30    875%  $0.03     *       n/a
</TABLE>
--------
 * Not meaningful.
(1) Prior to 1995, statement of operations data omit the historical net income
    per share, as it was not presented in the initial public offering
    registration statement pursuant to SEC guidelines. Pro forma net income
    per share is presented for 1995.
 
OTHER
 
  The Company has experienced virtually no gains or losses on foreign currency
translation since substantially all of its International sales to date have
been billed and collected in U.S. dollars. The Company pays the expenses of
its international operations in local currencies and does not engage in
hedging transactions with respect to such obligations.
 
                        LIQUIDITY AND CAPITAL RESOURCES
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                           ---------------------
                                                            1996    1995   1994
                                                           ------- ------ ------
                                                                (DOLLARS IN
                                                                THOUSANDS)
   <S>                                                     <C>     <C>    <C>
   Working capital........................................ $40,308 $2,613 $1,554
   Cash and cash equivalents and short-term investments... $35,151 $2,998 $1,958
</TABLE>
 
  Working capital increased at December 31, 1996 over that at December 31,
1995, primarily due to the proceeds received from the initial public offering,
and an increase in accounts receivable. Working capital increased at December
31, 1995 over that at December 31, 1994, primarily due to an increase in cash
and cash equivalents and accounts receivable.
 
<TABLE>
<CAPTION>
                                                           FOR THE YEAR
                                                        ENDED DECEMBER 31,
                                                      ------------------------
                                                        1996    1995    1994
                                                      --------  -----  -------
                                                      (DOLLARS IN THOUSANDS)
   <S>                                                <C>       <C>    <C>
   Cash provided by (used in) operating activities... $   (158) $ 796  $(1,714)
   Cash used in investing activities................. $(22,357) $(112) $  (168)
   Cash provided by financing activities............. $ 34,069  $ 356  $ 1,093
</TABLE>
 
  For the year ended December 31, 1996, net cash used in operating activities
resulted primarily from an increase in accounts receivable and prepaid
expenses and other current assets, and a decrease in accounts payable, offset
by increases in accrued expenses and compensation and deferred revenue, and by
net income adjusted for non-cash items. For the year ended December 31, 1995,
net cash provided by operations was primarily from net income and increases in
accrued expenses and compensation, deferred revenue, and accounts payable
partially offset by an increase in accounts receivable. For the year ended
December 31, 1994, net cash used in operations was primarily due to a net loss
and an increase in accounts receivable, partially offset by an increase in
deferred revenue and accrued expenses and compensation.
 
  For the year ended December 31, 1996, the Company's investing activities
consisted of purchases of investment grade, interest-bearing securities, as
well as purchases of property and equipment. Capital
 
                                      22
<PAGE>
 
expenditures were approximately $1.7 million for 1996, compared to $85,000 for
1995, and $71,000 for 1994. The Company's 1995 and 1994 investing activities
consisted primarily of purchases of property and equipment for the Company's
growing employee base. The Company expects that its capital expenditures will
remain constant or increase as the Company's employee base grows. The
Company's principal commitments consist primarily of leases on facilities and
equipment.
 
  The cash provided by financing activities during the year ended December 31,
1996, was primarily from the initial public offering in January 1996. The cash
provided by financing activities during the year ended December 31, 1995, was
primarily from the sale of preferred and common stock, partially offset by
principal payments made on capital lease obligations. The cash provided by
financing activities during the year ended December 31, 1994, was primarily
from proceeds from sale and leaseback agreements.
 
  The Company has available a $3.0 million bank line of credit agreement that
expires on April 30, 1997, is secured by the assets of the Company, and
permits borrowings of 80% of eligible accounts receivable. Eligible accounts
receivable include accounts receivable that have been outstanding less than 90
days from the date of the invoice (excluding foreign, government, contra, and
intercompany accounts and excluding accounts in which more than 50% of the
account is outstanding more than 90 days from the invoice date). There are
currently no borrowings outstanding under the line of credit.
 
  The Company believes that its current cash balance, its credit facility, and
the expected cash flow provided by operations, if any, will be sufficient to
meet its anticipated working capital and capital expenditure requirements for
at least the next 12 months. Thereafter, the Company may find it necessary to
obtain additional equity or debt financing. There can be no assurance that, in
the event additional financing is required, the Company will be able to raise
such additional financing on acceptable terms or at all.
 
                                      23
<PAGE>
 
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                            RED BRICK SYSTEMS, INC.
 
                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
   <S>                                                                       <C>
   Report of Ernst & Young LLP, Independent Auditors........................  25
   Consolidated Balance Sheets as of December 31, 1996 and 1995.............  26
   Consolidated Statements of Operations for the Years ended December 31,
    1996, 1995, and 1994....................................................  27
   Consolidated Statements of Stockholders' Equity for the Years ended
    December 31, 1996, 1995, and 1994.......................................  28
   Consolidated Statements of Cash Flows for the Years ended December 31,
    1996, 1995, and 1994....................................................  29
   Notes to Consolidated Financial Statements...............................  30
   The following financial statement schedule of The Registrant is filed as
    part of this report:
     Schedule II--Valuation and Qualifying Accounts.........................  42
</TABLE>
 
  All other schedules are omitted because they are not applicable or the
required information is shown in the Consolidated Financial Statements or
notes thereto.
 
                                      24
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Red Brick Systems, Inc.
 
  We have audited the accompanying consolidated balance sheets of Red Brick
Systems, Inc. as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1996. Our audits also included
the financial statement schedule listed in the Index at Item 14(a). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Red Brick Systems, Inc. at December 31, 1996 and 1995, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.
 
                                          Ernst & Young LLP
 
San Jose, California
January 14, 1997
 
                                      25
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                             -----------------
                                                              1996      1995
                                                             -------  --------
                           ASSETS
                           ------
<S>                                                          <C>      <C>
Current assets:
  Cash and cash equivalents................................. $14,552  $  2,998
  Short-term investments....................................  20,559       --
  Accounts receivable, net of allowances of $958 in 1996 and
   $670 in 1995.............................................  13,106     5,511
  Prepaid expenses and other current assets.................   1,213       293
  Deferred tax assets.......................................     850       --
                                                             -------  --------
    Total current assets....................................  50,320     8,802
Property and equipment, net.................................   2,693     1,980
Other assets................................................     205       195
Deferred tax assets.........................................     150       --
                                                             -------  --------
    Total assets............................................ $53,368  $ 10,977
                                                             =======  ========
<CAPTION>
            LIABILITIES AND STOCKHOLDERS' EQUITY
            ------------------------------------
<S>                                                          <C>      <C>
Current liabilities:
  Note payable to stockholder............................... $   --   $     33
  Accounts payable..........................................     316       658
  Accrued expenses..........................................   2,565     1,251
  Accrued compensation......................................   2,191     1,258
  Deferred revenue..........................................   4,180     2,015
  Capital lease obligations due within one year.............     760       974
                                                             -------  --------
    Total current liabilities...............................  10,012     6,189
                                                             -------  --------
Capital lease obligations...................................     396     1,068
Minority interest...........................................      36       --
Commitments
Stockholders' equity:
  Preferred stock, $.0001 par value; 2,000 shares authorized
   in 1996; no shares outstanding...........................     --        --
  Convertible preferred stock, $.0001 par value; 10,000
   shares authorized; none and 5,863 shares issued and
   outstanding in 1996 and 1995, respectively...............     --          1
  Common stock, $.0001 par value; 20,000 shares authorized;
   11,346 and 2,556 shares issued and outstanding in 1996
   and 1995, respectively...................................       1         1
  Additional paid in capital................................  51,570    16,269
  Accumulated deficit.......................................  (8,507)  (12,325)
  Deferred compensation.....................................     (36)      (49)
  Translation adjustment....................................       4       --
                                                             -------  --------
                                                              43,032     3,897
  Notes receivable from stockholders........................    (108)     (177)
                                                             -------  --------
    Total stockholders' equity..............................  42,924     3,720
                                                             -------  --------
    Total liabilities and stockholders' equity.............. $53,368  $ 10,977
                                                             =======  ========
</TABLE>
 
          See accompanying notes to Consolidated Financial Statements
 
                                       26
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                                     -------------------------
                                                      1996     1995     1994
                                                     -------  -------  -------
<S>                                                  <C>      <C>      <C>
Revenues:
  Software license.................................. $29,242  $15,742  $ 6,218
  Maintenance and service...........................   6,793    4,863    2,284
                                                     -------  -------  -------
    Total revenues..................................  36,035   20,605    8,502
Cost of revenues:
  Software license..................................   1,136      685      316
  Maintenance and service...........................   3,357    1,615      516
                                                     -------  -------  -------
    Total cost of revenues..........................   4,493    2,300      832
                                                     -------  -------  -------
     Gross margin...................................  31,542   18,305    7,670
Operating expenses:
  Sales and marketing...............................  20,410   11,011    5,650
  Research and development..........................   6,256    5,033    2,848
  General and administrative........................   2,839    1,682      588
  In-process technology.............................     500      --       --
                                                     -------  -------  -------
    Total operating expenses........................  30,005   17,726    9,086
                                                     -------  -------  -------
     Income (loss) from operations..................   1,537      579   (1,416)
Interest and other income...........................   1,743       94       56
Interest expense....................................    (234)    (222)    (121)
                                                     -------  -------  -------
   Income (loss) before provision (benefit) for
    income taxes and minority interest..............   3,046      451   (1,481)
Provision (benefit) for income taxes ...............    (687)     143      --
                                                     -------  -------  -------
   Income (loss) before minority interest...........   3,733      308   (1,481)
Minority interest in net loss of consolidated
 subsidiary.........................................      85      --       --
                                                     -------  -------  -------
    Net income (loss)............................... $ 3,818  $   308  $(1,481)
                                                     =======  =======  =======
Net income per share (pro forma for 1995)........... $  0.30  $  0.03
                                                     =======  =======
Shares used to compute net income per share (pro
 forma for 1995)....................................  12,668    9,965
                                                     =======  =======
</TABLE>
 
 
          See accompanying notes to Consolidated Financial Statements.
 
                                       27
<PAGE>
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                    CONVERTIBLE
                     PREFERRED                                                          NOTES
                       STOCK      COMMON STOCK   ADDITIONAL                           RECEIVABLE                  TOTAL
                   -------------- --------------  PAID-IN   ACCUMULATED   DEFERRED       FROM     TRANSLATION STOCKHOLDERS'
                   SHARES  AMOUNT SHARES  AMOUNT  CAPITAL     DEFICIT   COMPENSATION STOCKHOLDERS ADJUSTMENT     EQUITY
                   ------  ------ ------  ------ ---------- ----------- ------------ ------------ ----------- -------------
<S>                <C>     <C>    <C>     <C>    <C>        <C>         <C>          <C>          <C>         <C>
Balance at
December 31,
1993.............   5,450   $  1     592   $--    $14,892    $(11,152)      $--         $ --         $--         $ 3,741
 Issuance of
 common stock....     --     --      775    --        124         --         --          (124)        --             --
 Exercise of
 stock options...     --     --       11    --          2         --         --                       --               2
 Net loss........     --     --      --     --        --       (1,481)       --                       --          (1,481)
                   ------   ----  ------   ----   -------    --------       ----        -----        ----        -------
Balance at
December 31,
1994.............   5,450      1   1,378    --     15,018     (12,633)       --          (124)        --           2,262
 Issuance of
 common stock....     --     --      220    --         70         --         --           (70)        --             --
 Exercise of
 stock options...     --     --    1,017    --        250         --         --           --          --             250
 Repurchase of
 common stock....     --     --      (59)   --        (12)        --         --           --          --             (12)
 Sale of
 preferred stock
 on exercise of
 warrants........     413    --      --     --        859         --         --           --          --             859
 Deferred
 compensation....     --     --      --     --         55         --         (55)         --          --             --
 Amortization of
 deferred
 compensation....     --     --      --     --        --          --           6          --          --               6
 Issuance of
 common stock
 warrants in
 connection with
 the sale of note
 receivable......     --     --      --     --         30         --         --           --          --              30
 Note receivable
 payment.........     --     --      --     --        --          --         --            17         --              17
 Net income......     --     --      --     --        --          308        --           --          --             308
                   ------   ----  ------   ----   -------    --------       ----        -----        ----        -------
Balance at
December 31,
1995.............   5,863      1   2,556    --     16,270     (12,325)       (49)        (177)        --           3,720
 Conversion of
 preferred to
 common..........  (5,863)    (1)  5,863      1       --          --         --           --          --             --
 Net exercise of
 warrants........     --     --      264    --        --          --         --           --          --             --
 Issuance of
 common stock,
 net of issuance
 costs...........     --     --    2,070    --     33,684         --         --           --          --          33,684
 Exercise of
 stock options,
 net of
 repurchases.....     --     --      217    --        244         --         --           --          --             244
 ESPP
 distribution....     --     --       90    --      1,372         --         --           --          --           1,372
 Sale of common
 stock on
 exercise of
 warrants........     --     --      286    --        --          --         --           --          --             --
 Amortization of
 deferred
 compensation....     --     --      --     --        --          --          13          --          --              13
 Translation
 adjustment......     --     --      --     --        --          --         --           --            4              4
 Note receivable
 payment.........     --     --      --     --        --          --         --            69         --              69
 Net income......     --     --      --     --        --        3,818        --           --          --           3,818
                   ------   ----  ------   ----   -------    --------       ----        -----        ----        -------
 Balance at
 December 31,
 1996............     --     --   11,346   $  1   $ 1,570    $ (8,507)      $(36)       $(108)       $  4        $42,924
                   ======   ====  ======   ====   =======    ========       ====        =====        ====        =======
</TABLE>
 
          See accompanying notes to Consolidated Financial Statements
 
                                       28
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                                     --------------------------
                                                       1996     1995     1994
                                                     --------  -------  -------
<S>                                                  <C>       <C>      <C>
Cash flows from operating activities:
  Net income (loss)................................  $  3,818  $   308  $(1,481)
  Adjustments to reconcile net income (loss) to net
   cash provided by (used in) operating activities:
    Depreciation...................................     1,314      781      486
    Amortization...................................       119       76       13
    Deferred tax benefit...........................    (1,000)     --       --
    Loss on disposal of property and equipment.....       --         6        5
    Equipment received in exchange for product
     development and licenses......................       --       --      (835)
    Minority interest in subsidiary................        36      --       --
    Issuance of common stock warrants in connection
     with the sale of note receivable..............       --        30      --
    Changes in assets and liabilities:
      Accounts receivable..........................    (7,595)  (2,871)  (1,603)
      Prepaid expenses and other current assets....      (920)    (219)     (27)
      Accounts payable.............................      (342)     495      (93)
      Accrued expenses and compensation............     2,247    1,318      849
      Deferred revenue.............................     2,165      872      972
                                                     --------  -------  -------
        Net cash provided by (used in) operating
         activities................................      (158)     796   (1,714)
                                                     --------  -------  -------
Cash flows from investing activities:
  Purchases of short-term investments..............   (50,906)     --       --
  Proceeds from sales of short-term investments....    30,307      --       --
  Acquisition of property and equipment............    (1,748)     (85)     (71)
  Deposits and other assets........................       (10)     (27)     (97)
                                                     --------  -------  -------
        Net cash used in investing activities......   (22,357)    (112)    (168)
                                                     --------  -------  -------
Cash flows from financing activities:
  Proceeds from issuance of common stock, net of
   issuance costs..................................    35,300      320      126
  Proceeds from issuance of preferred stock, net of
   issuance costs..................................       --       859      --
  Payment on notes receivable......................        69       17      --
  Repurchase of common stock.......................       --       (12)     --
  Payment on notes payable to stockholders.........       (33)     (45)     (42)
  Advances to stockholders.........................       --       (70)    (124)
  Proceeds from sale of equipment under sale and
   leaseback agreements............................       --       --     1,510
  Principal payments on capital lease obligations..    (1,271)    (713)    (377)
  Translation adjustment...........................         4      --       --
                                                     --------  -------  -------
        Net cash provided by financing activities..    34,069      356    1,093
                                                     --------  -------  -------
Net increase (decrease) in cash and cash
 equivalents.......................................    11,554    1,040     (789)
Cash and cash equivalents at beginning of year.....     2,998    1,958    2,747
                                                     --------  -------  -------
Cash and cash equivalents at end of year...........  $ 14,552  $ 2,998  $ 1,958
                                                     ========  =======  =======
SUPPLEMENTAL SCHEDULES OF CASH FLOW INFORMATION
Cash paid during the year for:
  Interest.........................................  $    233  $   222  $   121
  Income taxes.....................................  $    114  $    54  $     3
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING
 ACTIVITIES
Property and equipment acquired under capital lease
 financings........................................  $    385  $ 1,082  $ 1,793
Receipt of equipment for accounts receivable.......  $    --   $   --   $   674
</TABLE>
 
          See accompanying notes to Consolidated Financial Statements
 
                                       29
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Organization
 
  Red Brick Systems, Inc. (the Company), a Delaware corporation, was
originally incorporated in California in July 1986. The Company designs,
develops, markets and supports a high performance client/server relational
database management system and related software and services for data
warehouse applications.
 
 Basis of Presentation
 
  The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, as well as Red Brick Systems
Australasia Pty. Ltd. ("RBA"). All significant intercompany accounts and
transactions have been eliminated.
 
 Red Brick Systems Australasia Pty. Ltd.
 
  On July 1, 1996, the Company entered into an agreement with Productivity
Software Group Limited (PSG) to form a joint venture to distribute the
Company's products and services in Australia and New Zealand. The Company owns
approximately 50.1% of the voting stock of the joint venture and is
consolidating this entity. The minority interest shown on the financial
statements represents PSG's proportionate share in the net assets and
operating activity of the Australian subsidiary. Beginning in 1999, the
Company may be obligated to purchase the remaining stock owned by PSG at a
pre-determined price based on 1998 revenue for the joint venture, not to
exceed $5 million.
 
 Foreign Currency Translation
 
  The functional currency of the Company's foreign subsidiary is the U.S.
dollar. Subsidiary financial statements are remeasured into U.S. dollars for
consolidation. Foreign currency transaction gains and losses are included in
other (income) expense and were immaterial for all periods presented. The
functional currency of RBA is the Australian dollar. Translation gains or
losses are shown as a component of stockholders' equity.
 
 In-Process Technology
 
  The Company acquired in-process technology associated with a $500,000
licensing arrangement during the second quarter of 1996. The acquired in-
process technology had not yet reached technological feasibility and did not
have alternative future uses.
 
 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
the disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Such estimates related to the useful lives of fixed
assets, allowances for doubtful accounts and customer returns, other reserves,
and income tax valuation allowances. Actual results inevitably will differ
from those estimates, and such differences may be material to the financial
statements.
 
 Cash, Cash Equivalents, and Short-Term Investments
 
  Management determines the appropriate classifications of debt securities at
the time of purchase. All of the Company's debt securities are classified as
available-for-sale. Available-for-sale securities are carried at fair
 
                                      30
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
value, with the unrealized gains and losses reported in a separate component
of stockholders' equity. As of December 31, 1996 and 1995, unrealized gains or
losses on such investments were not significant. Realized gains and losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in interest income. The cost of securities sold is
based on the specific identification method. Interest on securities classified
as available-for-sale is included in interest income.
 
  All cash equivalents, by contractual maturity, mature in three months or
less. Short-term investments mature in from three to fifteen months. The fair
value of the Company's investments held at December 31, 1996 and 1995, is
summarized as follows.
 
<TABLE>
<CAPTION>
                                                                 FAIR VALUE AT
                                                                  DECEMBER 31,
                                                                 --------------
                                                                  1996    1995
                                                                 ------- ------
                                                                 (IN THOUSANDS)
     <S>                                                         <C>     <C>
     Money Market............................................... $    52 $  756
     Corporate bonds and notes..................................  15,412    --
     Commercial paper...........................................  12,195  1,984
     Government debt securities.................................   4,200    --
     International bond.........................................     750    --
                                                                 ------- ------
       Total investments........................................ $32,609 $2,740
                                                                 ======= ======
</TABLE>
 
  The following is a reconciliation of the Company's investments to the
balance sheet classifications.
 
<TABLE>
<CAPTION>
                                                                  FAIR VALUE AT
                                                                   DECEMBER 31,
                                                                  --------------
                                                                   1996    1995
                                                                  ------- ------
                                                                  (IN THOUSANDS)
     <S>                                                          <C>     <C>
     Amounts included in cash and cash equivalents..............  $12,010 $2,740
     Short-term investments.....................................   20,599    --
                                                                  ------- ------
       Total investments........................................   32,609  2,740
     Demand deposits............................................    2,542    258
                                                                  ------- ------
       Total cash, cash equivalents, and short-term investments.  $35,151 $2,998
                                                                  ======= ======
</TABLE>
 
  At December 31, 1996, $23,588,517 of the investments were due in one year or
less, with the remainder due in one year to fifteen months.
 
 Depreciation and Amortization
 
  Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally three to five years. Assets acquired
under capital leases and leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful lives of the
assets or the terms of the leases.
 
 Revenue Recognition
 
  The Company recognizes revenue in accordance with the American Institute of
Certified Public Accountants' Statement of Position 91-1 on Software Revenue
Recognition. Revenue from product licensing and the portion of royalty
revenues not subject to future obligations is generally recognized after
execution of a licensing agreement and shipment of the product, provided that
no significant vendor obligations remain and the resulting receivable is
deemed collectible by management. Service revenue includes training,
consulting, and
 
                                      31
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
maintenance. Maintenance revenue is recognized ratably over the term of the
contract. Other service revenues, primarily consulting and training, are
recognized at the time the service is performed. The Company has entered into
several software development and license agreements with third parties.
Revenue under software development agreements is recognized using the
percentage-of-completion method based on the ratio that incurred costs bear to
total estimated costs.
 
 Warranty
 
  The Company provides for the costs of warranty when specific problems are
identified. The Company has not experienced significant warranty claims to
date.
 
CONCENTRATIONS
 
  Credit Risk/Customer
 
  The Company operates in one business segment, the development and licensing
of high-performance query software, which it sells to various companies across
several industries. The Company performs ongoing credit evaluations of its
customers and generally requires no collateral. A relatively small number of
customers and resellers account for a significant percentage of the Company's
revenues. The Company expects that licenses of its products to a limited
number of customers and resellers may continue to account for a high
percentage of revenues for the foreseeable future. The loss of a major
customer or reseller would affect operating results adversely. In 1996, sales
to no one customer accounted for more than 10% of total revenues. In 1995, one
customer accounted for 21% of total revenues. Two customers accounted for 12%
and 11% of total revenues in 1994.
 
  Product
 
  Substantially all of the Company's revenues have been attributable to sales
of Red Brick Warehouse. This product is currently expected to account for a
significant part of the Company's revenues for the foreseeable future. As a
result, a decline in demand for, or failure to achieve broad market acceptance
of, Red Brick Warehouse would affect operating results adversely.
 
  The Company licenses Open Server and Open Client products from Sybase, a
competitor of the Company, pursuant to a non-exclusive, royalty bearing
reseller agreement, which expires in November 1997. The Open Server and Open
Client products provide client/server access to the Company's data warehouse.
If the agreement is terminated prior to November 1997 or if the Company is
unable to renew the agreement in November 1997, the Company will have to
develop alternative technology. In July 1996 the Company announced the
acquisition of a worldwide unlimited source license for client/server
connectivity software which the Company plans to use to provide an alternative
to the Sybase products. There can be no assurance that the Company will be
able to renew the agreement with Sybase, develop alternative technology or
license alternative technology from another source on a timely basis. If the
Company does not renew the agreement with Sybase, develop alternate technology
or license alternate technology from another source prior to the termination
of its arrangement with Sybase, the Company's business, operating results and
financial condition would be materially adversely affected.
 
  Software Development Costs
 
  Software development costs have been accounted for in accordance with
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased or Otherwise Marketed" ("FAS 86").
Under the standard, capitalization of software development costs begins upon
the establishment of
 
                                      32
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
technological feasibility, subject to net realizable value considerations. In
the Company's case, capitalization would begin upon completion of a working
model as the Company does not prepare detail program designs as part of the
development process. As of December 31, 1996, such capitalizable costs were
insignificant. Accordingly, the Company has charged all such costs to research
and development expenses in the accompanying statements of operations.
 
 Net Income (Loss) Per Share
 
  Net income (loss) per share is computed using the weighted average number of
shares of common stock and common equivalent shares, when dilutive, from
convertible preferred stock (using the if-converted method) and from stock
options and warrants (using the treasury stock method). Pursuant to the
Securities and Exchange Commission Staff Accounting Bulletins, common and
common equivalent shares issued by the Company at prices below the initial
public offering price during the twelve-month period prior to the offering
have been included in the calculation as if they were outstanding for all
periods presented (using the treasury stock method at the public offering
price). Pro forma net income per share is presented for 1995. The 1994
statement of operations omits the historical net loss per share as it was not
presented in the Company's initial public offering registration statement.
 
  Per share information calculated on the above noted basis is as follows (in
thousands except for net income (loss) per share information):
 
<TABLE>
<CAPTION>
                                               FOR THE YEAR ENDED DECEMBER 31,
                                               -------------------------------
                                                  1996      1995       1994
                                               ---------- --------------------
     <S>                                       <C>        <C>       <C>
     Net income (loss) per share.............. $     0.30 $    0.03 $    (0.51)
                                               ========== ========= ==========
     Shares used in computing net income
     (loss) per share.........................     12,668     9,965      2,923
                                               ========== ========= ==========
</TABLE>
 
 Pro Forma Net Income Per Share
 
  Pro forma net income per share was computed as described above and also gave
effect to common equivalent shares from convertible preferred stock that
automatically converted upon the closing of the Company's initial public
offering (using if-converted method).
 
2. NOTE RECEIVABLE SALE
 
  In September 1995, the Company recognized product revenue of $1,710,000 and
recorded deferred maintenance revenue of $90,000 in connection with a license
agreement with efficient market services, inc. ("ems"), a related party. The
license agreement stated that if the Company granted a similar license for an
equivalent application to A.C. Nielsen, who was a major provider of data to
ems and a stockholder of ems, then ems could elect to terminate the agreement
and cease making future payments. The event that caused the cancellation
privilege was under the control of the Company and the Company believed that
the likelihood of cancellation was remote. As part of this transaction, the
Company recorded a long-term note receivable. In December 1995, the Company
sold, on a non-recourse basis, the remaining balance on the note receivable of
$1,652,830 to Comdisco, Inc. ("Comdisco") for approximately $1,362,136 and
issued a warrant valued at $30,000 to purchase shares of the Company's common
stock. The Company recorded a loss on sale of the note receivable of $320,694,
which was included in general and administrative expenses. In addition, the
Company signed a remarketing agreement with Comdisco that provided that the
Company would assist Comdisco on a best efforts basis in the remarketing of
the software under license to ems should ems default on the note. The Company
sold the note receivable primarily to provide cash for operations.
 
                                      33
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
3. PROPERTY AND EQUIPMENT
 
  Property and equipment, at cost, consist of the following.
 
<TABLE>
<CAPTION>
                                                                  FOR THE YEAR
                                                                      ENDED
                                                                  DECEMBER 31,
                                                                  -------------
                                                                   1996   1995
                                                                  ------ ------
                                                                       (IN
                                                                   THOUSANDS)
     <S>                                                          <C>    <C>
     Computer equipment and software............................. $3,846 $2,464
     Furniture and equipment.....................................  1,240    863
     Leasehold improvements......................................    567    293
                                                                  ------ ------
                                                                   5,653  3,520
     Less accumulated depreciation and amortization..............  2,960  1,540
                                                                  ------ ------
                                                                  $2,693 $1,980
                                                                  ====== ======
</TABLE>
 
4. BANK LINE OF CREDIT
 
  The Company has a $3,000,000 line of credit that expires April 30, 1997.
Borrowings under this line are limited to 80% of eligible accounts receivable,
bear interest at the lender's current index (8.25% at December 31, 1996), and
are secured by substantially all of the assets of the Company. The credit
agreement requires the Company to maintain certain financial ratios, minimum
working capital, and minimum tangible net worth. The agreement also restricts
the payment of dividends. At December 31, 1996, there were no borrowings
outstanding.
 
5. COMMITMENTS
 
  The Company leases its facilities under operating leases expiring at various
dates through May 1999. In addition to base rent, the Company is responsible
for certain taxes, utilities, and maintenance costs.
 
  The Company leases certain equipment under noncancelable lease agreements
that are accounted for as capital leases. Equipment under capital lease
arrangements and included in property and equipment aggregated approximately
$3,579,283 and $3,193,512 at December 31, 1996 and 1995, respectively. Related
accumulated amortization was approximately $2,337,593 and $1,317,312 at
December 31, 1996 and 1995, respectively. In addition, the capital leases are
secured by the related equipment, and the Company is required to maintain
liability and property damage insurance.
 
  Future minimum lease payments under noncancelable operating leases and
capital leases are as follows:
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31, 1996
                                                               -----------------
                                                               CAPITAL OPERATING
                                                               LEASES   LEASES
                                                               ------- ---------
                                                                (IN THOUSANDS)
   <S>                                                         <C>     <C>
   1997.......................................................  $ 803   $  915
   1998.......................................................    428      406
   1999.......................................................     65       39
                                                                -----   ------
   Total minimum lease payments...............................  1,296   $1,360
                                                                        ======
   Less amount representing interest..........................    140
                                                                -----
   Present value of minimum lease payments....................  1,156
   Less current obligations...................................    760
                                                                -----
   Long-term obligations......................................  $ 396
                                                                =====
</TABLE>
 
                                      34
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Total rental expense for 1996, 1995, and 1994 was approximately $1,005,000,
$515,000, and $311,000, respectively.
 
6. STOCKHOLDERS' EQUITY
 
 Initial Public Offering
 
  On January 23, 1996, the Company commenced its initial public offering and
its Common Stock began trading on the NASDAQ National Market under the symbol
REDB. The Company sold 2,070,000 shares in the offering and generated
approximately $33.7 million of cash, net of underwriting discounts and
commissions, and other offering costs. Upon completion of the offering, all
outstanding shares of Series A, Series B, Series C, and Series D Preferred
Stock (a total of approximately 5,863,000 shares) were converted into shares
of Common Stock on a one-for-one basis.
 
 Preferred Stock
 
  The Company's Certificate of Incorporation authorizes 2,000,000 shares of
preferred stock. The Board of Directors has the authority to issue the
preferred stock in one or more series and to fix the rights, preferences,
privileges, and restrictions thereof, including dividend rights, dividend
rates, conversion rights, voting rights, terms of redemption, redemption
prices, liquidation preferences, and the number of shares constituting any
series or the designation of such series without further vote or action by the
stockholders.
 
 Warrants
 
  In February 1993 and November 1993, the Company sold warrants to purchase
908,805 shares of Series D preferred stock at an exercise price of $2.08 per
share. The majority of warrants expire in November 1998. Warrants to purchase
378,834 shares of the Company's common stock were exercised in connection with
the initial public offering of the Company's common stock. In 1995, warrants
to purchase 340,465 shares of Series D preferred stock were exercised.
 
  In December 1995, as part of the sale of the ems note receivable, the
Company issued a warrant to Comdisco for the purchase of the Company's common
stock and recorded additional expense of $30,000 based on using the minimum
value method. The number of shares to be issued under the warrant agreement is
15,555 at an exercise price of $18 per share. At December 31, 1996, the
warrant to purchase 15,555 shares of common stock is outstanding and expires
January 22, 1999.
 
 Notes Receivable from Stockholders
 
  During January 1994 and February 1995, certain officers of the Company were
provided cash advances totaling $194,488 for the purpose of purchasing the
Company's common stock. The underlying full recourse notes are due in January
1998 and February 1999, bear interest at 5.32% and 7.96% per annum,
respectively, and are secured by the purchased common stock. The common stock
sold in January 1994 and February 1995 vests at a rate of 25% one year after
the commencement date (January 1, 1993 and January 1, 1995, respectively) and
ratably over thirty-six months thereafter. Unvested shares may be repurchased
by the Company within 60 days of termination. As of December 31, 1996, a total
of 120,137 shares of such common stock are unvested.
 
 Common Stock
 
  At December 31, 1996, common stock was reserved for issuance as follows (in
thousands):
 
<TABLE>
     <S>                                                                   <C>
     Stock options........................................................ 2,174
     Warrants.............................................................   190
     Purchase Plan........................................................   410
                                                                           -----
                                                                           2,774
                                                                           =====
</TABLE>
 
 
                                      35
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
7. STOCK-BASED COMPENSATION PLANS
 
 1991 Stock Option Plan
 
  Under the Company's 1991 Stock Option Plan (the "1991 Plan"), options may be
granted at prices not less than 85% of the fair market value at the date of
grant (110% of fair market value in certain instances), as determined by the
Board of Directors. Options are generally exercisable upon grant, expire ten
years from the date of grant (five years in certain instances), and the shares
issued upon exercise of the options may be subject to a right of repurchase by
the Company upon the participants' termination of employment with the Company.
The options generally vest at a rate of 25% one year after the date of grant
and ratably over thirty-six months thereafter.
 
 1995 Stock Option Plan
 
  The Company's 1995 Stock Option Plan (the "1995 Plan") was adopted by the
Board of Directors on September 20, 1995, as the successor to the 1991 Plan.
Under the 1995 Plan, employees (including officers) and independent
consultants may, at the discretion of the plan administrator, be granted
options to purchase shares of Common Stock at an exercise price not less than
85% of the fair market value of such shares on the grant date. Non-employee
members of the board of Directors are eligible solely for automatic option
grants under the 1995 Plan. Pre-IPO options are generally exercisable upon
grant and post-IPO options are exercisable upon vesting. Options granted under
the 1991 Plan are immediately exercisable for all the option shares
outstanding but any unvested shares purchased under the Plan are subject to
repurchase by the Company at the original exercise price per share upon the
employees cessation of service. Options expire ten years from the date of
grant (five years in certain instances), and the shares issued upon exercise
of the options may be subject to a right of repurchase by the Company upon the
participants' termination of employment with the Company. The options
generally vest at a rate of 25% one year after the date of grant and ratably
over thirty-six months thereafter.
 
  The Company has entered into agreements with certain officers of the Company
that provide for acceleration of vesting of certain option shares or
restricted stock as if the officer remained employed for up to an additional
two years in the event the officer's employment is involuntarily terminated
following certain acquisitions or changes in control of the Company.
 
  At December 31, 1996, a total of 1,485,809 shares of common stock had been
purchased by the exercise of options, of which 184,321 shares are subject to
repurchase.
 
  At December 31, 1996, the maximum number of common shares available under
the 1995 Plan was 2,707,199. The 1995 Plan also incorporates special
provisions (such as stock appreciation rights) which may be provided in the
future as additional employee benefits without requiring shareholder approval.
 
  The Company has reserved the shares eligible under the 1991 Plan, as of
December 31, 1996, including the shares subject to outstanding options
thereunder, plus (i) an addition of 600,000 shares, plus (ii) an additional
number of shares equal to 5% of the number of shares of common stock
outstanding on the first day of 1997 and 1998.
 
  The Company granted 133,750 shares of common stock at $8.00 per share
outside the 1991 Plan in 1995, of which 72,813 were outstanding at December
31, 1996.
 
 Repricing
 
  In July 1996, the Company offered employees, excluding executive officers,
the option to exchange options to purchase 164,450 shares of common stock with
an aggregate exercise price of $7,093,288 for new options to
 
                                      36
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
purchase 164,450 shares with an exercise price of $25.50 per share. All vested
options that are repriced will vest monthly over an additional one year period
and the unvested repriced options will vest under the original terms of the
option grant.
 
  A summary of the Company's stock option activity, and related information
for the years ended December 31, 1996, 1995, and 1994 follows.
 
<TABLE>
<CAPTION>
                                 1996              1995               1994
                           ----------------- ------------------ -----------------
                                   WEIGHTED-          WEIGHTED-         WEIGHTED-
                                    AVERAGE            AVERAGE           AVERAGE
                           OPTIONS EXERCISE  OPTIONS  EXERCISE  OPTIONS EXERCISE
                            (000)    PRICE    (000)     PRICE    (000)    PRICE
                           ------- --------- -------  --------- ------- ---------
<S>                        <C>     <C>       <C>      <C>       <C>     <C>
Outstanding--beginning of
 year....................   1,696   $ 2.94    1,766     $0.22    1,433    $0.21
Options granted..........     728   $27.94    1,307     $3.83      473    $0.16
Options exercised........    (224)  $ 1.09   (1,237)    $0.26      (11)   $0.16
Options canceled.........    (325)  $28.14     (140)    $0.59     (129)   $0.18
                            -----            ------              -----
Outstanding--end of year.   1,875   $ 8.50    1,696     $2.94    1,766    $0.22
                            =====            ======              =====
Exercisable at end of
 year....................   1,611             1,696              1,766
                            =====            ======              =====
</TABLE>
 
  The weighted-average fair value of options granted during 1996 was $15.13.
 
  Exercise prices for options outstanding as of December 31, 1996, and
weighted-average remaining contractual life is as follows:
 
<TABLE>
<CAPTION>
                              OPTIONS OUTSTANDING          OPTIONS EXERCISABLE
                     ------------------------------------- --------------------
                       NUMBER                     WEIGHTED   NUMBER    WEIGHTED
                     OUTSTANDING WEIGHTED AVERAGE AVERAGE  EXERCISABLE AVERAGE
       RANGE OF      AT 12/31/96    REMAINING     EXERCISE AT 12/31/96 EXERCISE
    EXERCISE PRICES     (000)    CONTRACTUAL LIFE  PRICE      (000)     PRICE
    ---------------  ----------- ---------------- -------- ----------- --------
   <S>               <C>         <C>              <C>      <C>         <C>
   $ 0.16-$ 0.16....      178          7.55        $ 0.16       178     $ 0.16
   $ 0.24-$ 0.24....      440          6.08        $ 0.24       440     $ 0.24
   $ 0.32-$ 6.00....      533          8.41        $ 4.26       533     $ 4.26
   $ 7.20-$24.25....      460          9.23        $14.73       460     $14.73
   $24.44-$25.50....      264          9.64        $25.27       --         --
                        -----          ----        ------     -----     ------
   $ 0.16-$25.50....    1,875          8.16        $ 8.50     1,611     $ 5.70
                        =====          ====        ======     =====     ======
</TABLE>
 
 Employee Stock Purchase Plan
 
  In 1995, the Board of Directors and stockholders approved an Employee Stock
Purchase Plan (the "Purchase Plan"). The Purchase Plan, which is intended to
qualify under Section 423 of the Internal Revenue Code, will be implemented by
24-month offerings with purchases occurring at six-month intervals. Under the
Purchase Plan, eligible employees are entitled to purchase shares at 85% of
the lower of fair market value of the common stock at the beginning of the 24-
month offering period or on the applicable semiannual purchase date. Under the
Purchase Plan, 410,276 shares of common stock are reserved for issuance under
the plan at December 31, 1996. Under the Purchase Plan, 89,724 and no shares
were issued in 1996 and 1995, respectively. The weighted average fair value of
shares granted under the Purchase Plan during 1996 was $7.59.
 
 Accounting for Stock-Based Compensation
 
  The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock-based awards
 
                                      37
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
because, as discussed below, the alternative fair value accounting provided
for under Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123) requires use of option valuation models
that were not developed for use in valuing employee stock-based awards. Under
APB 25, the Company generally recognizes no compensation expense with respect
to such awards.
 
  Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock-based awards granted subsequently to December 31, 1994,
under the fair value method of that Statement. The fair value for these awards
was estimated at the date of grant using the minimum value method prior to the
Company's initial filing with the SEC in connection with the IPO and,
subsequently to the IPO, the Black-Scholes options pricing model. The Black-
Scholes option valuation model was developed for use in estimating the fair
value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock-based awards have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock-based awards.
 
  The fair value of the Company's stock-based awards to employees was
estimated using no expected dividends and the following weighted-average
assumptions.
 
<TABLE>
<CAPTION>
                                                     OPTIONS               ESPP
                                         --------------------------------- ----
                                                JANUARY 1-   SETPEMBER 27-
                                               SEPTEMBER 26, DECEMBER 31,
                                         1996      1995          1995      1996
                                         ----  ------------- ------------- ----
     <S>                                 <C>   <C>           <C>           <C>
     Expected life (years)..............    5         5             5      0.50
     Expected volatility................ 0.55      0.00          0.55      0.79
     Risk-Free Interest Rate............ 6.18%     5.69%         5.69%     5.08%
</TABLE>
 
  For purposes of pro forma disclosures, the estimated fair value of the above
stock-based awards is amortized to expense over the awards' vesting period.
The Company's pro forma information follows (in thousands except for net
income per share information):
 
<TABLE>
<CAPTION>
                                                                    1996  1995
                                                                   ------ -----
     <S>                                                           <C>    <C>
     Pro forma net income......................................... $1,268 $ 199
     Pro forma earnings per share................................. $ 0.10 $0.02
</TABLE>
 
  Because SFAS 123 is applicable only to options granted subsequently to
December 31, 1994, its pro forma effects will not be fully reflected until the
year 2000. In addition the effects of applying SFAS 123 for providing pro
forma disclosures are not likely to be representative of the effects on
reported net income for future years.
 
8. EMPLOYEE BENEFIT PLAN
 
  In October 1991, the Company adopted a plan to provide retirement and
incidental benefits for its employees, known as the Red Brick Systems 401(k)
Retirement Savings Plan. As allowed under Section 401(k) of the Internal
Revenue Code, the plan provides tax-deferred salary deductions for eligible
employees. Employees are eligible to participate after a sixty-day service
requirement. Participants may make voluntary contributions to the plan of up
to 20% of their compensation. The plan permits for company contributions;
however, none have been made as of December 31, 1996.
 
                                      38
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
9. INCOME TAXES
 
  The components of the provision (benefit) for income taxes consist of the
following:
 
<TABLE>
<CAPTION>
                                                               FOR THE YEAR
                                                                  ENDED
                                                               DECEMBER 31,
                                                               -------------
                                                                1996    1995
                                                               -------  ----
                                                                   (IN
                                                                THOUSANDS)
     <S>                                                       <C>      <C>  <C>
     Current:
       Federal................................................ $    75  $ 98
       State..................................................      86    28
       Foreign................................................     152    17
                                                               -------  ----
         Total current........................................     313   143
                                                               -------  ----
     Deferred:
       Federal................................................    (900)  --
       State..................................................    (100)  --
       Foreign................................................     --    --
                                                               -------  ----
         Total Deferred.......................................  (1,000)  --
                                                               -------  ----
           Provision (benefit) for income taxes............... $  (687) $143
                                                               =======  ====
</TABLE>
 
  The difference between the provision (benefit) for income taxes and the
amount computed by applying the federal statutory income tax rate of 34% to
income (loss) before provision (benefit) for income taxes is explained below:
<TABLE>
<CAPTION>
                                                        FOR THE YEAR ENDED
                                                           DECEMBER 31,
                                                        ---------------------
                                                         1996    1995   1994
                                                        -------  -----  -----
                                                          (IN THOUSANDS)
   <S>                                                  <C>      <C>    <C>
   Income tax (benefit) computed at the federal
    statutory rate..................................... $ 1,036  $ 153  $(504)
   State taxes.........................................      86     28    --
   Foreign taxes.......................................     152    --     --
   Losses for which no tax benefit was recognized......     --     --     124
   Tax benefits of net operating loss carryforwards....  (1,015)  (773)   --
   Adjustment of the valuation allowance...............  (1,000)   717    380
   Other...............................................      54     18    --
                                                        -------  -----  -----
       Provision (benefit) for income taxes............ $  (687) $ 143  $ --
                                                        =======  =====  =====
</TABLE>
 
                                      39
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets are as follows:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                           ----------------
                                                            1996     1995
                                                           -------  -------
                                                           (IN THOUSANDS)
   <S>                                                     <C>      <C>      
   Deferred tax assets:
     Net operating loss carryforwards..................... $ 2,092  $ 2,454
     Research credit carryforwards........................     618      401
     Reserves and accruals................................     703      486
     Deferred revenue.....................................     138      786
     Other................................................      58       65
                                                           -------  -------
   Total deferred tax assets..............................   3,609    4,192
   Valuation allowance....................................  (2,609)  (4,192)
                                                           -------  -------
   Net deferred tax assets................................ $ 1,000  $   --
                                                           =======  =======
</TABLE>
 
  The valuation allowance decreased by $1,583,000 during 1996 and by $247,000
during 1995. Approximately $495,000 of the valuation allowance at December 31,
1996, is attributable to the tax benefits of disqualifying dispositions of
stock received through incentive stock options and the Company's employee
stock purchase plan, the benefit of which will be credited to additional paid
in capital when realized.
 
  The realization of the Company's net deferred tax asset is dependent on
generating sufficient future taxable income. Although realization is not
assured, management believes it is more likely than not that the net deferred
tax asset will be realized. The amount of the net deferred tax asset
considered realizable, however, could be reduced in the near term if estimates
of future taxable income are reduced. Management intends to evaluate the
realizability of the net deferred tax asset each quarter to assess the need
for a valuation allowance.
 
  At December 31, 1996, the Company has federal and state net operating loss
carryforwards of approximately $4,400,000 and $3,600,000, respectively, and
federal and state research credit carryforwards of approximately $430,000 and
$290,000, respectively. These carryforwards will expire beginning in the years
1998 through 2009. Utilization of approximately $1,500,000 of the net
operating losses is limited to approximately $100,000 per year due to the
ownership change provisions provided by the Tax Reform Act of 1986 and similar
state provisions.
 
10. NONMONETARY TRANSACTIONS
 
  During 1994, the Company entered into separate transactions to sell certain
of its products and services in exchange for computer equipment manufactured
by two customers along with related support services. The Company recognized
product license revenues of approximately $835,500 in 1994 based on the fair
market value of the equipment received in the exchanges. The value of the
equipment received was comparable to the sales prices of similar products sold
to other customers of the Company.
 
11. RELATED PARTY REVENUES
 
  During 1995 and 1994, the Company recorded revenue of $1,719,732 and
$930,270, respectively, for sales to ems. ems is a related party of the
Company due to the fact that venture capital funds affiliated with Asset
Management Associates 1989, L.P. and Menlo Ventures IV, L.P., two principal
stockholders of the Company at the time of the transactions, are also
principal stockholders of ems. Gross margins realized on related party
 
                                      40
<PAGE>
 
                            RED BRICK SYSTEMS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
transactions have not been materially different from the gross margins
realized on similar types of transactions with unaffiliated customers.
 
12. EXPORT SALES
 
  The company markets its products in the United States and foreign countries
through its sales personnel, value added resellers, and its subsidiaries.
Export sales accounted for ten percent of the Company's revenues in 1996.
Export sales were $3,657,201, $1,680,307, and $293,840 in 1996, 1995, and
1994, respectively.
 
                                      41
<PAGE>
 
                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
                        ALLOWANCE FOR DOUBTFUL ACCOUNTS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                  BALANCE AT                        BALANCE AT
                                  BEGINNING                           END OF
                                  OF PERIOD  ADDITIONS DEDUCTIONS     PERIOD
                                  ---------- --------- ----------   ----------
<S>                               <C>        <C>       <C>          <C>
Allowance for doubtful accounts
 receivable
  Year ended December 31, 1994...    $ --      $125      $ --          $125
  Year ended December 31, 1995...    $125      $545      $ --          $670
  Year ended December 31, 1996...    $670      $519      $(231)(1)     $958
</TABLE>
--------
(1) Uncollectible accounts written off
 
                                       42
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE
 
  None
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
  The information required by this item relating to the Company's directors
and nominees and disclosure relating to compliance with Section 16(a) of the
Securities Exchange Act of 1934 is included under the captions "Election of
Directors" and "Compliance with Section 16(a) of the Securities Exchange Act
of 1934" in the Company's Proxy Statement for the 1997 Annual Meeting of
Stockholders and is incorporated herein by reference. The information required
by this item relating to the Company's executive officers is included under
the caption "Executive Officers of the Registrant" in Part I of the Report on
Form 10-K.
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The information required by this Item is included under the caption
"Executive Compensation and Related Information" in the Company's Proxy
Statement for the 1997 Annual Meeting of Stockholders and is incorporated
herein by reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The information required by this item is included under the caption "Stock
Ownership of Certain Beneficial Owners and Management" in the Company's Proxy
Statement for the 1997 Annual Meeting of Stockholders and is incorporated
herein by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  The information required by this item is included under the caption "Certain
Relationships and Related Transactions" in the Company's Proxy Statement for
the 1997 Annual Meeting of Stockholders and is incorporated herein by
reference.
 
                                      43
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
(a) Documents filed as part of this report
 
  (1) Financial statements
 
    INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
     <S>                                                                    <C>
     Report of Ernst & Young LLP, Independent Auditors.....................  25
     Consolidated Balance Sheets...........................................  26
     Consolidated Statements of Operations.................................  27
     Consolidated Statements of Stockholders Equity........................  28
     Consolidated Statements of Cash Flows.................................  29
     Notes to Consolidated Financial Statements............................  30
</TABLE>
 
  (2) Financial statement schedules
 
    INDEX TO FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
     <S>                                                                    <C>
     Financial Statement Schedules
      II. Valuation and Qualifying Accounts................................  41
</TABLE>
 
  All other schedules have been omitted because the required information is
not present or not present in amounts sufficient to require submission of the
schedules, or because the information required is included in the consolidated
financial statements or notes thereto.
 
  The independent auditors' report with respect to the above listed financial
statements and schedule appears on page 25 of this report on Form 10-K.
 
                                      44
<PAGE>
 
  (3) Exhibits required by Item 601 of Regulation S-K
 
<TABLE>
<CAPTION>
 EXHIBIT NO.                           EXHIBIT TITLE
 -----------                           -------------
 <C>         <S>
  1.1(1)     Form of Underwriting Agreement.
  2.1(1)     Agreement and Plan of Merger, dated December 7, 1995, effecting
             the reincorporation of Red Brick Systems, a California
             corporation, into Red Brick Systems, Inc., a Delaware corporation
             (the "Registrant").
  3.1(1)     Certificate of Incorporation of the Registrant.
  3.2(1)     Amended and Restated Certificate of Incorporation of the
             Registrant filed in connection with the reincorporation of the
             Registrant.
  3.3(1)     Form of Restated Certificate of Incorporation of the Registrant
             filed after the closing of the offering made pursuant to this
             Registration Statement.
  3.4(1)     Amended and Restated Bylaws of the Registrant.
  4.1(1)     Amended and Restated Investor Rights Agreement, dated November 5,
             1993, among the Registrant and the investors and founders named
             therein, as amended.
  4.2(1)     Specimen Certificate of the Registrant's Common Stock.
  5.1(1)     Opinion of Gunderson Dettmer Stough Villeneuve Franklin &
             Hachigian, LLP, counsel to the Registrant.
 10.1(1)     Form of Indemnification Agreement entered into between the
             Registrant and its directors and officers.
 10.2(1)(2)  1991 Stock Option Plan.
 10.3(1)(2)  1995 Stock Option Plan.
 10.4(1)(2)  Employee Stock Purchase Plan.
 10.5(1)(3)  Porting/Software License Agreement between Unisys Corporation and
             the Registrant, dated December 1, 1994.
 10.6(1)(3)  Value Added Remarketer Agreement between Sybase, Inc. and the
             Registrant, dated November 27, 1991.
 10.7(1)     Business Loan Agreement between Silicon Valley Bank and the
             Registrant, dated September 28, 1993.
 10.8(1)     Loan Modification Agreement between Silicon Valley Bank and the
             Registrant, dated May 1, 1995.
 10.9(1)     Lease Agreement, dated October 24, 1994, between the Registrant
             and Alberto Oaks Investors, regarding the space located at 485
             Alberto Way, Los Gatos, California, as amended.
 10.10(1)    Note and Warrant Purchase Agreement, dated March 11, 1992, among
             the Registrant and the lenders named therein, as amended.
 10.11(1)    Series D Preferred Stock Purchase agreement, dated November 11,
             1992, among the Registrant and the investors named therein.
 10.12(1)    Note and Warrant Purchase Agreement, dated February 17, 1993,
             among the Registrant and the lenders named therein, as amended.
</TABLE>
 
                                       45
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT NO.                            EXHIBIT TITLE
 -----------                            -------------
 <C>         <S>
 10.13(1)    Series D Preferred Stock Purchase Agreement, dated August 2, 1993,
             among the Registrant and the investors named therein.
 10.14(1)    Series D Preferred Stock Purchase Agreement, dated November 5,
             1993, among the Registrant and the investors named therein.
 10.15(1)    Form of Stock Purchase Agreement, dated January 24, 1994, used to
             sell Common Stock to certain officers of the Company.
 10.16(1)    Form of Stock Purchase Agreement, dated February 14, 1995, used to
             sell Common Stock to certain officers of the Company.
 10.17(1)(3) End User Software License Agreement No. 95-159, dated June 30,
             1994, and Related Product Order and Financing Agreement, dated
             September 26, 1995, between efficient market services, inc. and
             the Registrant.
 10.18(1)    Letter, dated March 12, 1993, from the Registrant to Thomas W.
             Henn.
 10.19(1)    Letters, dated April 30, 1993 and January 24, 1994, from the
             Registrant to Robert C. Hausmann.
 10.20(1)    1995 Executive Bonus Program, as amended.
 10.21(1)    Assignment Agreement, dated December 18, 1995, between the
             Registrant and Comdisco, Inc.
 10.22(1)    Third Amendment of Lease, dated October 10, 1995, between the
             Registrant and Alberto Oaks Investors, Ltd.
 10.23       Loan Modification Agreement between Silicon Valley Bank and the
             Registrant, dated April 30, 1996.
 11.1        Statement regarding computation of earnings (loss) per share.
 16.1(1)     Letter regarding change in certifying accountant.
 21.1(1)     List of Subsidiaries of the Registrant.
 23.1        Consent of Ernst & Young LLP, independent auditors.
 24.1(1)     Power of Attorney.
 27.1        Financial Data Schedule.
</TABLE>
--------
(1) Incorporated by reference to the exhibit of the same number filed with
    Registrant's Form S-1 Registration Statement (Reg. No. 33-97430) declared
    effective by the Securities and Exchange Commission on January 22, 1996.
(2) Compensatory plan or arrangement.
(3) Confidential treatment has been requested as to certain portions of these
    exhibits. Omitted portions have been filed separately with the Securities
    and Exchange Commission.
 
(b) Reports on Form 8-K
 
    No reports on Form 8-K were filed during the last quarter of fiscal 1996.
 
(c) Exhibits. See list of exhibits under "Item 14(a)(3)" above.
 
(d) Financial Statement Schedules. See list of schedules under "Item 14(a)(2)"
    above.
 
                                       46
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Los Gatos, State of California, on this 17th day of March, 1997.
 
                                          RED BRICK SYSTEMS, INC.
 
                                          By:  /s/ Christopher G. Erickson
                                            ___________________________________
                                                  Christopher G. Erickson
                                                 President, Chief Executive
                                                          Officer,
                                                 and Chairman of the Board
 
  Pursuant to the requirements of the Securities Act of 1934, this report has
been signed by the following persons on behalf of the registrant and in the
capacity and on the dates indicated:
 
<TABLE>
<CAPTION>
             SIGNATURE                           TITLE                    DATE
             ---------                           -----                    ----
 
<S>                                  <C>                           <C>
  /s/ Christopher G. Erickson        President, Chief Executive      March 17, 1997
____________________________________  Officer, and Chairman of
      Christopher G. Erickson         the Board (Principal
                                      Executive Officer)
 
     /s/ Robert C. Hausmann          Vice President, Finance and     March 17, 1997
____________________________________  Administration, Chief
         Robert C. Hausmann           Financial Officer
                                      (Principal Financial and
                                      Accounting Officer), and
                                      Secretary
 
       /s/ Thomas H. Bredt           Director                        March 17, 1997
____________________________________
          Thomas H. Bredt
 
      /s/ Andrew K. Ludwick          Director                        March 17, 1997
____________________________________
         Andrew K. Ludwick
 
        /s/ John F. Shoch            Director                        March 17, 1997
____________________________________
           John F. Shoch

       /s/ John E. Warnock           Director                        March 17, 1997
____________________________________
          John E. Warnock
</TABLE>
 
                                      47