<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549
 
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                                  FORM 10-KSB
 
[X] Annual Report under Section 13 or 15(d) of the Securities Exchange Act of
    1934 for the fiscal year ended January 31, 1998
 
                                   -- or --
 
[_] Transition Report under Section 13 or 15(d) of the Securities Exchange Act
    of 1934 for the transition period from    to
 
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                         FINE.COM INTERNATIONAL CORP.
           Name of small business issuer as specified in its charter
 
                                    0-22805
                            Commission File Number
 
          State of Washington                        91-1657402
    State or Other Jurisdiction of      I.R.S. Employer Identification Number
     Incorporation or Organization
 
                         1525 Fourth Avenue, Suite 800
                           Seattle, Washington 98101
                    Address of Principal Executive Offices
 
                                (206) 292-2888
                            Issuer Telephone Number
 
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Securities registered under Section 12(b) of the Exchange Act:  Common Stock,
no par value
 
Securities registered under Section 12(g) of the Exchange Act:        [None]
 
Check whether the registrant (1) filed all reports required to   Yes [X]  No [_]
be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past
90 days.
 
Check if disclosure of delinquent filers in response to Item     Yes [X]  No [_]
405 of Regulation S-B is not contained in this form, and no
disclosure will be contained, to the best of Registrant's
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or
any amendment to this Form 10-KSB.
 
The registrant's revenues for its most recent fiscal year were $3,448,084
 
As of April 21, 1998, there were 2,415,935 shares of the Registrant's common
stock issued and outstanding and the aggregate market value of such common
stock held by non-affiliates was approximately $8,343,188 based on a price of
$6.188 per share, representing the average of the bid ($5.875) and ask ($6.50)
prices on that date.
 
Transitional Small Business Disclosure Format (check one):  Yes [_]  No [X]
 
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                      DOCUMENTS INCORPORATED BY REFERENCE
 
(1) Issuer's registration statement on Form SB-2, as amended and declared
effective on August 11, 1997 (No. 333-26855) (the "Form SB-2"); (2) final
prospectus dated August 11, 1997 and filed with the Commission pursuant to
Rule 424(b) (the "Prospectus"); and (3) Proxy Statement relating to its June
11, 1998 Annual Meeting of Shareholders and to be filed with the Commission on
or about the date hereof (the "Proxy Statement").
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                          FINE.COM INTERNATIONAL CORP.
 
                                  FORM 10-KSB
 
                               TABLE OF CONTENTS
 
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 <C>         <S>                                                           <C>
 PART I
    ITEM  1. DESCRIPTION OF BUSINESS....................................     1
               Overview.................................................     1
               Business Strategy........................................     1
               The Internet and the Web.................................     2
               Internet Commerce and the Marketing Communications
              Industry..................................................     3
               Clients and Services.....................................     5
               Company Response To One Client's Needs...................     7
               Relationship with Microsoft..............................     8
               Competition..............................................     9
               Employees................................................    10
               Risk Factors.............................................    10
    ITEM  2. PROPERTIES.................................................    13
    ITEM  3. LEGAL PROCEEDINGS..........................................    13
    ITEM  4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........    13
 PART II
    ITEM  5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...    13
    ITEM  6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
              AND RESULTS OF OPERATIONS.................................    14
               Overview.................................................    14
               Results of Operations....................................    15
               Capital Resources and Liquidity..........................    18
               Seasonality and Inflation................................    19
               Year 2000 Compliance.....................................    19
    ITEM  7. FINANCIAL STATEMENTS.......................................    20
    ITEM  8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
              AND FINANCIAL DISCLOSURE..................................    34
 PART III
    ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K...........................    34
</TABLE>
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                                    PART I
 
ITEM 1. DESCRIPTION OF BUSINESS
 
  The following discussion contains forward-looking statements regarding the
Company, its business, prospects and results of operations that are subject to
risks and uncertainties posed by many factors and events that could cause the
Company's actual business, prospects and results of operations to differ
materially from those that may be anticipated by such forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed herein as well as those discussed under the
captions "Risk Factors" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" as well as those discussed elsewhere in
this Report. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this Report.
The Company undertakes no obligation to revise any forward-looking statements
in order to reflect events or circumstances that may subsequently arise.
Readers are urged to carefully review and consider the various disclosures
made by the Company in this Report and in the Company's other reports filed
with the Securities and Exchange Commission that attempt to advise interested
parties of the risks and factors that may affect the Company's business.
 
  Further information in satisfaction of Item 1 of Form 10-KSB is incorporated
herein by reference to the sections of the Prospectus under the captions
"Prospectus Summary," "Risk Factors," and "Business." In addition, in further
satisfaction of Item 1 of Form 10-KSB and in satisfaction of the requirements
of Rule 14a-3(b), the following information is provided as to the business of
the Company.
 
OVERVIEW
 
  The Company plans, develops, maintains and hosts Web sites for major
national and international corporate clients and others. The Company's Web
site development process utilizes marketing expertise and state of the art
interactive database compilation and dissemination techniques and
technologies. Through the planning, development, maintenance and hosting of
interactive Web presentations, the Company enhances clients' marketing
campaigns, fosters the collection of demographic data which is utilized by
clients when allocating marketing resources and facilitates both internal and
external corporate communications for clients.
 
  The Company develops marketing driven, database oriented sites for
businesses to establish a commercial presence on, or conduct Internet commerce
over, the Web. Corporate clients for whom the Company has built and
implemented such Web sites include Marriott International, Inc., The Nasdaq
Stock Market, Twentieth Century Fox Home Entertainment, Inc., Safeway Inc. and
Microsoft Corporation. Through the planning and development of Intranet Web
sites, the Company also serves businesses seeking to establish efficient,
confidential internal corporate communication systems. Intranet clients of the
Company include Microsoft Corporation and Marriott International, Inc. Other
clients for which the Company has developed Web sites include Fluke
Corporation, Intel Corporation, Mann Packing Company, Mitsui Intermodal
Terminal Inc., Optiva Corporation, the State of Washington, Wall Data, Inc.
and Windermere Services Company. See "--Clients and Services."
 
BUSINESS STRATEGY
 
  The Company specializes in producing complex, database driven and
relationship marketing oriented Web sites. The Company believes that such
state of the art Web sites--as compared to traditional, one-way broadcast
media (such as television) or many first-generation Web sites--will become an
essential means of conducting business for many commercial organizations. The
Company's business strategy is to derive and maximize revenue from the
planning and development of such Web sites. In addition, the Company believes
that, as commercial Internet and internal corporate markets for Intranet sites
develop, ongoing maintenance and hosting of Web sites will become a more
important aspect of the Company's business.
 
  The Company believes that there are thousands of Web site developers who
have created hundreds of thousands of Web sites, but that only a small
percentage of current commercial Web
 
                                       1
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sites effectively utilize database integration technologies or interactive
database marketing techniques. Relying upon its knowledge of marketing
principles as well as its specific expertise in custom programming and the
development of relational databases, the Company consults with each of its
commercial Web site clients, first to establish specific database driven
relationship marketing strategies, and then to develop unique Web site
features designed to entice visitors to provide information useful to the
client regarding the visitor's identity, interests and position in the
customer life cycle. Through such Web sites, the Company's clients may obtain
information-rich databases for use in the clients' overall sales and marketing
efforts. Similar techniques and strategies are also applied to the collection,
distribution and analysis of information for Intranet sites developed by the
Company.
 
  The Company's project managers, programmers, media designers, graphic
artists, writers and other personnel use third party software (primarily from
Microsoft), third party hardware and internally developed and customized
software to plan, develop, maintain and host Web sites for the Company's
clients. The Company works with Microsoft to demonstrate to third parties the
manner in which Microsoft products can be used to establish a commercial
presence on the Web. As a result of this relationship, Microsoft has provided
the Company with marketing materials, assisted the Company with new business
development and given recognition to the Company on the Microsoft Web site
(www.microsoft.com). See "--Relationship with Microsoft."
 
THE INTERNET AND THE WEB
 
  OVERVIEW. The Company believes that the Internet and the Web offer new and
powerful mediums for commercial organizations to rapidly, economically and
productively target and manage a wider and better defined customer base.
Companies from many industries are publishing product and company information
for their vendors and customers, providing customer support, allowing
customers to buy products and permitting companies to collect customer
feedback and demographic information online. User friendly software now
permits businesses to offer multimedia content such as audio files and video
clips, as well as text, spreadsheet and graphical data, over the Web. These
enhanced means of communication are also being used by businesses internally
for confidential corporate communications via Intranets.
 
  THE WEB. The recent growth in Internet use by businesses and individuals is
largely due to the emergence of a network of servers and information available
on the Web. The Web is a client/server system of multimedia data files
introduced in 1992, in which certain computers ("servers" or "home pages")
store files and respond to requests issued by remote computers ("clients") to
download files, thus allowing multiple, geographically dispersed users to view
information stored on a single server.
 
  GROWTH OF THE INTERNET AND THE WEB. Internet use has grown rapidly since the
early 1990s, fueled by increasing use of personal computers and modems, the
development of the Web, the introduction of easy-to-use Web browsers and the
availability of informational, entertainment and commercial software
applications. Technological advances relating to the Internet have occurred
and continue to occur rapidly, resulting in a more robust, lower-cost
infrastructure, improved security and increased value-added services and
content. According to a recent industry report, the number of people using the
Internet is, at a minimum, doubling every year.(1) Industry sources expect
this rate of growth to continue until at least the year 2000, at which time
the number of Internet users is expected to exceed 700 million, an increase
from approximately 57 million users in 1997.(2)
 
  According to another industry source, Internet user growth is occurring at a
rapid pace in both households and businesses. That industry source estimates
that by the year 2000, the number of U.S. households with ready access to the
Internet will increase to 33 million, from 10 million in 1996, and the
percentage of U.S. businesses connected to the Internet will rise to 33% from
4% in
--------
 1 John S. Quarterman, 1997 Users and Hosts of the Internet and the Matrix,
   MATRIX NEWS (January 1997); Press Release: Size of the Internet in October
   1995, from the Third MIDS Internet Demographic Survey, MATRIX INFORMATION
   AND DIRECTORY SERVICES, INC. (February 3, 1996) (hereinafter Demographic
   Survey).
 2 Quarterman, supra note 1.
 
                                       2
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November 1996.(3) Noting that the numbers represent U.S. estimates only, that
industry source concludes that worldwide growth presents significant
opportunities for the transaction of business over the Internet.(4) In
anticipation of such growth, commercial Internet sites are being created at an
explosive pace. According to other industry sources, the number of commercial
Internet sites, defined as domain names ending in ".com," has increased from
171,738 in June 1996 to 609,275 in April 1997 to 1,339,513 in April 1998.(5)
See "--Internet Commerce and the Marketing Communications Industry."
 
INTERNET COMMERCE AND THE MARKETING COMMUNICATIONS INDUSTRY
 
  INTERNET COMMERCE OVERVIEW. The Internet provides companies, individuals and
others with new means to conduct business and other activities rapidly,
economically and productively. According to industry sources, in 1996,
Internet commerce, defined as business-to-business and business-to-consumer
transactions, product marketing, advertising, entertainment, electronic
publishing, electronic services and customer support, accounted for $9.6
billion in revenues(6) and such industry sources estimated that the Internet
business-to-business trade alone would exceed $8 billion in 1997.(7) This
industry source projects that Internet commerce will generate approximately
$196 billion in revenues by the year 2000.(8) Another industry source
estimates that $66 billion of the aggregate $196 billion is expected to result
from business-to-business Internet commerce and the remaining $140 billion is
expected to be allocated among business and professional information services
($37 billion), financial services ($22 billion), consumer retail ($7 billion)
and technical services relating to Internet infrastructure and access ($74
billion).(9) The Company believes that the planning, development, maintenance
and hosting of Web sites comprise services that are fundamental to all of
these areas of Internet commerce. As a result, the Company believes that it is
strategically positioned to profit from growth in all areas of Internet
commerce.
 
  INTERACTIVE MARKETING COMMUNICATIONS. The Company believes that the Internet
enables businesses to reach and establish personalized two-way communication
with well-defined target audiences without paying the significant costs
required to buy traditional media (e.g. paper, print space, broadcast media
time and mail). The Internet thereby enables such businesses to target and
track customers with specific brand messages, to capture customer and
corporate constituent preferences, opinions, needs and desires, to have
instant access to consumer feedback and to continuously sharpen marketing
plans to address the current marketplace.
 
  Early adopters of Web sites considered such sites to be a relatively
inexpensive way to signal a technologically sophisticated image without
requiring the expenditure of a significant portion of their overall marketing
communications budget. The Company believes, however, that as businesses
become more familiar with interactive marketing techniques and opportunities,
the amounts spent to utilize the new media will increase rapidly. According to
an industry source, Web site growth in total pages will triple in size by the
end of 1998 from 1996.(10) Industry sources have estimated that online
spending for advertising alone will grow from $312 million in 1996 to $5
billion by 2000.(11) Approximately $161 billion was spent on advertising in
the United States in 1995, according to a leading advertising agency.(12) The
Company believes that over the next few years the rate of growth of
expenditures on new media will greatly exceed that of expenditures for
traditional media as more households and businesses connect to the Web and
marketers come to understand the potential benefits of communicating through
that media.
--------
 /3/ News Release, Business-to-Business E-Commerce Explodes in 2000, FORRESTER
     RESEARCH, INC. (November 29, 1996) (hereinafter E-Commerce).
 /4/ E-Commerce, supra Note 3.
 /5/ Netcraft Ltd. Web Survey (June 1, 1996); Netcraft Ltd. Web Survey (April
     1997) Netcraft Ltd. Web Survey (April 1998) (hereinafter collectively
     Netcraft Surveys).
 /6/ Stan Gibson, Attention Shoppers: E-Commerce Is Here!, PC WEEK (November 25,
     1996).
 /7/ Forrester Report, "Business Trade and Technology Strategies" (July 1997).
 /8/ Forrester Report, supra Note 7.
 /9/ E-Commerce, supra note 3.
/10/ Forrester Research, "Web Sites Triple in Size" May 19, 1997.
/11/ Glenn Hasek, Web's Ad Revenues Rise, CYBERMANAGEMENT (October 7, 1996).
/12/ McCann-Erickson, Insider's Report (December 4, 1995).
 
                                       3
<PAGE>
 
  THE INTRANET MARKET. Once a corporation provides its employees with Web
access from their desktops, it may then have an internal corporate Web site
installed to distribute information internally within the corporation and to
host corporate applications. The Company believes that, in addition to the
development of publicly accessible Internet sites, the planning, development,
maintenance and hosting of Intranets will provide significant business
opportunities for Web site developers.(13) Although the exact number of
corporate Intranets presently in existence is unknown, an industry source
estimates that the private Intranet market is far larger than its public
counterpart. According to this industry source, the number of publicly
accessible Internet sites, estimated at over 1 million, may be only a quarter
of the number of Intranets installed.(14) This market is expected to
experience rapid growth and development over the next several years(15) and
Intranet development services revenues are projected to increase to $19.6
billion by the year 2002.(16) As of March 1996, corporate Intranets allowed
employees to use the Web only for internal document sharing.(17) New
applications, however, have been developing monthly.(18) By 2000, a "Full
Service Intranet" is anticipated, which is expected to provide five core
applications consisting of directory services, electronic mail, file
management, print services and network management.(19)
 
  Through Intranets, corporations may utilize the Web to extend their internal
information systems and applications to geographically dispersed facilities,
remote offices and mobile employees. An Intranet can yield significant
operational efficiencies and cost reductions by (a) lowering or eliminating
the costs of long distance telephone charges and leased telephone lines that
connect decentralized offices and staff, (b) permitting the delivery and
receipt of information more quickly, and (c) reducing paper, printing and
postage or delivery costs. Because security concerns have been, and continue
to be, addressed by improving technology, companies are now beginning to
utilize Intranets for confidential communications within the enterprise.
Intranets are also now being used by organizations for confidential
communications to customers and vendors (when used in this manner, Intranets
may be referred to as "Extranets"). An industry source predicts that, as
corporations begin to take advantage of the expanding benefits of Intranets,
the total Intranet market will grow from $12 billion in 1997 to $28 billion by
1999.(20)
 
  PRODUCTION AND HOSTING OF WEB SITES. As the number of Internet users
increases, the need by businesses to obtain effective and engaging Web sites
is expected to create significant opportunities for Web site developers. It
has been estimated that by 2000, fees paid to third party developers for
building Web sites will exceed $10 billion, compared to $1.2 billion paid to
third party developers of Web sites in 1996.(21) Of this $10 billion, it is
estimated that approximately $8.9 billion will be used for building
promotional and commercial Web sites, principally sites that advertise a
company's products or services or provide interactive shopping, banking or
customer services.(22) The $10 billion estimate, however, does not include
estimated expenditures relating to Intranet development.
 
  An industry source has noted that most companies lack the internal resources
necessary to develop their own Web sites or effectively capture commercial
opportunities made available through utilization of the Web.(23) As a result,
businesses are relying upon Web site developers to define and implement unique
Web strategies and to keep businesses current with Internet technology.(24)
According to an industry source, businesses spend in the range of $24,000 to
$120,000 for outsourcing Web site development and services.(25)
--------
/13/ Ellis Booker, Change in Market Shares; Microsoft Server Tops Netscape's,
     WEB WEEK (April 7, 1997).
/14/ Booker, supra Note 13.
/15/ Forrester Report, FORRESTER RESEARCH, INC. (March 1, 1996).
/16/ Forrester Report, "Sizing Technology Services" (June 1997).
/17/ Forrester Report, supra Note 15.
/18/ Paul Korzeniowski, Intranet Bets Pay Off Corporations are Leaping
     Headfirst into Intranet Waters, Eschewing Traditional Return on
     Investment Research, INFOWORLD ELECTRIC (January 13, 1997).
/19/ Forrester Report, supra Note 15.
/20/ Next-Generation Nets, INTERNETWORK (January 1997).
/21/ News Release, Web Outsourcing to Reach $10 Billion by 2000, FORRESTER
     RESEARCH, INC. (February 5, 1997 (hereinafter Web Outsourcing).
/22/ Web Outsourcing, supra note 18.
/23/ News Release, Most Businesses Outsourcing Web Site Hosting, FORRESTER
     RESEARCH, INC. (January 15, 1997) (hereinafter Site Hosting).
/24/ Web Outsourcing, supra note 18.
/25/ Nick Wreden, "The Intranet/Internet 100 Outsourcing," Information Week
     (Nov. 19, 1997).
 
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<PAGE>
 
  The planning and development of Web sites represent only a part of the Web
site industry. Businesses are also utilizing Web site development firms to
host their Web sites. An industry source reports that two-thirds of Fortune
1000 companies currently use outside entities to host their Web sites, a
service which is estimated to cost 20% less than a comparable, internally
hosted site.(26) The Company believes that businesses may continue to
outsource hosting to acquire the technical expertise, increased reliability
and reported savings associated with outside hosting.
 
CLIENTS AND SERVICES
 
  The Web permits real time, one-to-one communication with consumers, allowing
users to respond to questions and messages on a Web site. The Company believes
that the Web provides commercial enterprises with unique opportunities to
gather valuable demographic data, including information regarding users'
identities and preferences. Accordingly, the Company has created a Web site
development process involving marketing strategies, interactive communications
strategies and Web site design elements. For example, in creating Web sites
that compile user-provided information, the Company works with its clients,
first to establish specific database driven marketing strategies, and then to
create unique Web site features designed to entice visitors to provide
information useful to the client regarding the visitor's identity, interests
and position in the customer life cycle. Through such Web sites, the Company's
clients may obtain information-rich databases for use in the clients' overall
sales and marketing efforts. The Company also services certain clients by
maintaining and hosting such clients' Web sites.
 
  COMPANY CLIENTS. Since it began operations in 1994, the Company has designed
and created more than 100 Web sites. The Company's clients to date include The
Nasdaq Stock Market, Marriott International, Inc., Twentieth Century Fox Home
Entertainment, Inc., Safeway Inc., Microsoft Corporation, Optiva Corporation,
Fluke Corporation, Intel Corporation, Wall Data, Inc., The DeWolfe Company,
Mitsui Intermodal Terminal Inc., Frank Russell Company, the State of
Washington, Continental Bank, PEMCO Insurance Company, Windermere Services
Company, Amway Corporation and Mann Packing Company.
 
  WEB SITE PRODUCTION AND SUPPORT. The Company has expertise in custom
programming, relational databases and computer graphics. The Company attempts
to provide each of its clients with the appropriate product or service for its
particular need. The Company's services with respect to a particular client's
interactive Web site may fall within any combination of up to four major
areas: Web site planning; Web site development; Web site maintenance; and Web
site hosting.
 
  Web Site Planning. The Company's process of developing a Web site begins
with planning. Web site planning generally consists of: 1) high level
marketing and business process consultation called the Scope Analysis; and, 2)
the detailed specifications of a site's feature set and functionality called
the Blueprint.
 
  1. Scope Analysis. The Scope Analysis is the first step in the Planning
Phase and an integral part of the overall development process. In the Scope
Analysis, the client's business case is documented; goals, objectives and
priorities are outlined; the development team is identified; roles within the
team are agreed upon; and an initial architectural plan is presented. An
essential component of the Scope Analysis is the review or creation of the
client's strategic plan for their online endeavor. The Company engages in two
principle forms of strategic consultation.
 
  . Internet Marketing Consultation. The Company believes that one of its
    strengths is its knowledge and utilization of online marketing
    principles. Every Internet Web site created by the Company is designed
    with the idea that the end product should be an integrated part of the
    client's overall marketing plan. The Company believes that its use of
    marketing principles, in the context of developing Web sites and
    designing the manner in which such Web sites are capable of interacting
    with users, differentiates the Company from its competitors.
 
  . Intranet Business Process Consultation. Many of the marketing principles
    used in designing an Internet Web site are also applied by the Company in
    designing Intranet Web sites for its
--------
/26/ Site Hosting, supra note 23.
 
                                       5
<PAGE>
 
   clients. Utilizing online marketing principles, the Company and client
   identify the target audience and match applicable information with the
   appropriate recipient. In addition, the Company consults with its clients
   as to utilization of the Web for extensions of the client's internal
   information systems and enterprise applications to geographically
   dispersed facilities, remote offices and mobile employees. The Company
   seeks to design Web sites in a manner that will enable its clients to
   achieve operational efficiencies and cost reductions.
 
  2. Web Site Blueprint. The technical plan, or Blueprint, prepared by the
Company for each client describes in detail the Web site objectives, design
strategy and tactics, reporting requirements, technical specifications, review
and testing processes, program management and communication protocols, site
promotion, future site enhancements and project timeline. In particular, the
Company focuses its resources to design Web sites that will provide
measurements of actual performance relative to each client's desired
measurable results. The Company compiles these Blueprints and attempts, by
leveraging the information and experiences gained from each project completed
by the Company, to further enhance its development processes routinely
utilized for formulation of client proposals and projects.
 
  Web Site Development. The Company's process of developing interactive Web
sites combines up to five elements: graphic design; multimedia production;
custom programming; database development; and systems integration. The Company
believes that the Web sites it creates are unique and among only a small
percentage of Web sites that effectively utilize database integration
technologies or interactive database marketing techniques.
 
  . Graphic Design. The Internet and the Web allow the Company to produce for
    its clients a Web site that communicates with the site visitor using both
    text and graphic design. The Company employs personnel skilled in
    presenting text which is consistent with the client's overall marketing
    strategy and in providing sophisticated art direction that is visually
    stimulating and capable of capturing the target audience's attention.
 
  . Multimedia Production. The Company develops Web sites utilizing still
    photographs, full motion video, dynamically generated charts and graphs,
    animation and sound. Any or all of these features may be used to appeal
    to a client's target audience on a Web site. Although these features are
    used routinely for marketing to parties external to the client, such
    features may also be used as part of a client's internal communications
    strategy.
 
  . Custom Web Application Interface Development. Developing Web sites that
    permit real time one-to-one interaction with site visitors requires
    specialized computer programming beyond simple HTML development skills.
    The Company therefore employs a team of highly trained developers and
    information designers with specific expertise in developing customized
    Web applications, creating and testing the usability of web applications
    and providing information design evaluation and implementation services.
    In addition to HTML development skills, Company personnel have expertise
    in and regularly use such tools as Microsoft(R) Visual Basic(R)
    programming language, Sun's Java(R) programming language, Microsoft
    Visual Basic(R) Scripting Edition, Backweb BALI programming platform,
    Microsoft Internet Information Server(R) Active Server Pages, Microsoft
    Component Object Model (COM) Middleware platform, W3C Document Object
    Model (DOM) client scripting platform, Microsoft Visual J++(TM),
    Microsoft Visual C++(R), Microsoft FrontPage(R) and Microsoft Visual
    SourceSafe(R).
 
  . Custom Database Design and Development. Modern Web design requires the
    collection and manipulation of online database information. To meet this
    need, the Company employs highly skilled personnel with specific
    expertise in analyzing business information needs, creating complex data
    models, mining databases for information that supports business
    objectives and implementing complex relational database designs using the
    Microsoft(R) SQL Server(R) DBMS. These database systems are designed to
    function in conjunction with other server products including Microsoft
    Internet Information Server(R) Integrated with Microsoft Windows NT(R),
    Microsoft Exchange Server(R), Microsoft Transaction Server(R), Microsoft
    Site Server(R) Enterprise Edition (including Microsoft Commerce Server(R)
    and the Microsoft Personalization Server(R)), Microsoft Internet Finance
    Server Toolkit(R) and Backweb Channel Server.
 
                                       6
<PAGE>
 
  . Systems Integration. A key component of a Web site is its ability to be
    integrated into a client's internal legacy information systems, both as
    those systems exist currently and as they change over time. The Company
    employs technical personnel with expertise in analyzing and documenting
    clients' existing internal systems, defining and developing data feeds as
    both output from and input to legacy systems and creating Web site
    designs that are versatile enough to facilitate a changing information
    landscape.
 
  Web Site Maintenance. Maintaining and updating a Web site serves to protect
a client's investment in its site. Such maintenance may include supporting,
augmenting and enhancing the information collection and analysis efforts
provided for in the Web site's Blueprint. In some cases, certain maintenance
activities may be performed directly by the client due to features designed
and implemented by the Company when creating the Web site. The Company,
pursuant to written agreements in addition to the original Web site
development agreement, will frequently provide ongoing marketing and business
process consultation, Web site content updates, refreshment of graphic and
multimedia content and database management.
 
  . Content Updates. Web sites often require event driven or regularly
    scheduled modifications of site content. Examples of such updating
    includes posting of new properties on a real estate company's Web site
    (e.g., Windermere Services Corporation), replacing outdated coupons with
    new coupons promoting different merchandise (e.g., Safeway Inc.) or
    changing employment listings on a company's Intranet human resources Web
    site (e.g., Microsoft Corporation).
 
  . Graphic and Multimedia Refreshes. Both content updates and graphic
    refreshment are driven by the interactive nature of the Web site. As an
    interactive media, the Web site provides a virtually instantaneous gauge
    of the site's communications effectiveness. This feedback allows the
    client to continuously modify the form and content of a Web site message
    to improve its effectiveness.
 
  . Database Management. Databases experiencing large volumes of original
    input normally require periodic maintenance to ensure the integrity and
    usefulness of the data. The Company performs such functions for certain
    of its clients.
 
  Web Site Hosting. The Company also serves certain clients by hosting the Web
sites it has planned, developed or maintained. In addition, the Company
provides hosting services for Web sites other than those it has planned,
developed or maintained. The primary elements of Web site hosting are
reporting and Internet connectivity.
 
  . Reporting. The Company serves certain clients by periodically analyzing
    the client's Web site traffic and reporting the results.
 
  . Internet Connectivity. Every Web site must be made accessible to the
    Internet in order to be viable. The Company serves as a host for certain
    clients' Web sites. The Company provides the computers and/or the
    connection to the Internet necessary to allow the client's Web site to be
    accessed by users of the Internet.
 
COMPANY RESPONSE TO ONE CLIENT'S NEEDS
 
  One example of the services performed by the Company is the initial project
undertaken for Twentieth Century Fox Home Entertainment, Inc. For this client,
the Company planned, developed and currently maintains a brand-intensive,
highly interactive Web site supporting the release of the home video version
of the film Independence Day as it is distributed into retail outlets outside
of the United States. The Company believes that the Web site created for
Twentieth Century Fox is representative of the Company's ability to create
sophisticated Web sites for its clients.
 
  The objectives of Twentieth Century Fox's Independence Day Web site included
generating public awareness of the video's availability, stimulating store
traffic, reinforcing the positioning and branding of the movie, cross-
promoting other movies, driving consumer traffic to related promotional events
and encouraging both word-of-mouth site referrals and repeat site visits.
Twentieth Century
 
                                       7
<PAGE>
 
Fox desired a highly interactive database to run the Web site as well as
provide timely feedback on the results of the various programs and events
promoted on the site. The complex database implemented by the Company for this
site enables analysis of the consumer profile information collected on the
site, site image statistics and consumer segmentation data.
 
  The Company made extensive use of several programming applications to create
the custom features used to capture the attention of the site's target
audience. The Independence Day Web site contains three games for site visitors
to play. Each game was paired with a promotion or sweepstakes. The site was
configured to allow online postcards to be sent from a site visitor to anyone
in the world with an electronic mail address. The postcard recipient may then
go to the site's "post office" and retrieve the message that was sent. The
site is available in multiple languages for various international audiences.
 
  The Independence Day Web site was designed to be an ongoing resource for the
client. The site's database is capable of handling the information related to
additional videos as they are released and promoted via the Web. The Company
has already created an additional site (Aliens Trilogy) for the client to take
advantage of this resource.
 
RELATIONSHIP WITH MICROSOFT
 
  Since its formation in 1994, the Company has developed technical expertise
in planning, developing, maintaining and hosting Web sites for clients. To
date, the Company has developed such Web sites principally through the
application of Microsoft products and has developed specialized training for
its production personnel in the use of Microsoft products. The Company is a
beta tester, and is sometimes an alpha tester, of new software products
developed by Microsoft and other software developers. As a result, Company
personnel have historically been regularly informed of the latest developments
in interactive technology.
 
  WORKING WITH MICROSOFT AS A PAID VENDOR. The Company serves Microsoft as a
paid vendor, developing various components of both Internet and Intranet Web
sites for Microsoft. During fiscal 1998, fiscal 1997 and fiscal 1996, the
Company created over 30 Web sites for various Microsoft units including its
Enterprise Customer Unit, Organization Customer Unit, Human Resources
Department, Product Groups (including Exchange, Project, Publisher/Works, and
Word) and The Microsoft Network. Total services rendered by the Company to
Microsoft accounted for 22%, 19%, and 34% of the Company's gross revenue for
fiscal 1998, fiscal 1997, and fiscal 1996, respectively.
 
  MICROSOFT SPONSORED MARKETING PROGRAMS. The Company is an active participant
in two Microsoft sponsored marketing programs: the Microsoft Solution Provider
Partner program and the Microsoft Site Builder Network program:
 
  . Microsoft Solution Provider Partner Program. Microsoft Solution Provider
    Partners are individual companies that provide consulting, integration,
    customization, development, training, technical support or other services
    utilizing Microsoft products. Through the Microsoft Solution Provider
    Partner program, Microsoft works with companies to provide information,
    tools and business development assistance to successfully implement
    business solutions and provide services using the Microsoft Solutions
    platform and technologies. The Microsoft Solution Provider Partner
    program clearly identifies companies as having a special relationship
    with Microsoft.
 
  . Microsoft Site Builder Network Program. Participants in this program
    receive national marketing materials, including a four-color printed
    brochure that promotes the participants and their services, a featured
    client case study on the Microsoft Web site, and a listing on the
    Microsoft Web site within a directory of site builders. In addition,
    Microsoft offers technical support and training opportunities, including
    free training at a Microsoft Authorized Technical Education Center and
    special participant-only technical briefings. Microsoft also provides to
    participants the latest development information and tools and sales leads
    of businesses requesting assistance implementing Microsoft technology.
 
  The Company is a Level Three Microsoft Site Builder (the highest attainable
service level) and was the first entity to achieve this designation. The
Company believes it was the first site builder featured
 
                                       8
<PAGE>
 
in a direct mail campaign conducted by Microsoft. The Company has developed
several significant client relationships from this association.
 
  JOINT MARKETING PRESENTATIONS. In conjunction with both the Microsoft
Solution Provider Partner and the Microsoft Site Builder Network programs,
representatives of the Company have been invited to take part in several joint
marketing opportunities with Microsoft. These include:
 
  . co-authored a Microsoft Level 3 SiteBuilder book, "The Wild, Wild Web"
    being published by Microsoft Press in June 1998.
 
  . the International Franchise Association/Microsoft, "International
    Franchise Summit" held in March 1998 in Las Vegas, Nevada.
 
 
  . the Microsoft/fine.com Corporation/International Franchise Association,
    "Franchise of the Future" held in December 1997 in Atlanta, Georgia, and
    in New York, New York.
 
  . participated in Skills 2000 Career Expos, a job fair sponsored by
    Microsoft in Bellevue, Washington in October 1997.
 
  . the Microsoft/fine.com Corporation/XcellNet/Successful
    Franchising/Hewlett Packard seminar, "Franchise of the Future," held at
    the Microsoft Redmond, Washington campus in April 1997.
 
  . the fine.com Corporation/Microsoft seminar, "Retailing on the Internet,"
    held at the Microsoft Boston, Massachusetts offices in April 1997; and
 
  . as co-developer and presenter of a Microsoft/Hewlett Packard/fine.com
    Corporation "Consumer Solutions Briefing" made available on CD ROM in
    March 1997;
 
  . the Microsoft/fine.com Corporation/Polaris Group seminar, "Microsoft
    Intranet Solutions," at the Microsoft Bellevue, Washington campus in
    February 1997;
 
  . the Microsoft/Onyx Software/fine.com Corporation seminar, "How to
    Successfully Market Products and Services on the Web," at the Microsoft
    Bellevue, Washington campus in January 1997;
 
  . the Microsoft/Ernst & Young LLP "Small Business Summit 1996" held in San
    Francisco, California in October 1996;
 
COMPETITION
 
  The Internet-related interactive marketing industry is highly competitive.
The Company expects competition for its services to intensify in the future.
Due to the rapidly evolving nature of the Internet, competition also is
characterized by pressures to adopt and utilize new capabilities and
technologies to respond rapidly to evolving client requirements.
 
  The Company faces competition from a number of competitors, some or all of
which may provide Web site planning, creation, maintenance or hosting
services. Direct competitors include: (1) prospective clients that perform Web
site development services in-house; (2) Web site service firms, such as K2
Design Inc., Free Range Media, Razorfish Inc., Red Sky Interactive, Inc. and
USWeb Corp.; (3) Internet-oriented advertising agencies such as The Leap
Group, CKS Group and The Martin Agency; (4) communications, telephone and
telecommunications companies such as UUNET Technologies and US West; and (5)
established online service companies, advertising agencies, direct Internet
access providers as well as specialized and integrated marketing communication
firms, all of which are entering the Web site planning, creation, maintenance
or hosting markets in varying degrees and are competing with the Company, and
many of which have announced plans to offer expanded Web site planning,
development, maintenance and/or hosting services. Many of the Company's
competitors or potential competitors have longer operating histories, longer
customer relationships and significantly greater financial, management,
technological, development, sales, marketing and other resources than the
Company. The Company also competes on the basis of creative and technical
talent, price, customer service and responsiveness. There can be no assurance
that the Company will be able to compete effectively and its inability to do
so would have a material adverse impact on the Company.
 
                                       9
<PAGE>
 
EMPLOYEES
 
  As of January 31, 1998, the Company had 43 full time employees. The Company
has no labor contracts or collective bargaining agreements. The Company
considers its relations with its employees to be good.
 
RISK FACTORS
 
  In addition to the other information in this Report, the following risk
factors should be considered carefully in evaluating the Company and its
business. This Report may contain forward-looking statements that involve
risks and uncertainties. When used in this Report, the words "anticipate,"
"believe," "effect," "estimate," "expect" and similar expressions as they
relate to the Company or its management are intended to identify such forward-
looking statements. The Company's actual results, performance or achievements
could differ materially from the results expressed in or implied by these
forward-looking statements. Factors that might cause such differences include,
but are not limited to, those discussed in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business" as
well as those discussed elsewhere in this Report.
 
  UNCERTAINTIES REGARDING ADOPTION OF NEW MEDIA BY MARKETING COMMUNICATIONS
INDUSTRY; LIMITED OPERATING HISTORY. The market for information gathering and
dissemination through new electronic media such as the Internet has only
recently begun to develop, is rapidly evolving and is characterized by an
increasing number of market entrants who have introduced or developed products
and services for communication and commerce through new electronic media.
Demand and market acceptance for recently introduced products and services are
subject to a high level of uncertainty. Additionally, the Company commenced
operations in October 1994 and, as a result, has a limited operating history
upon which an evaluation of the Company's prospects can be made. There can be
no assurance that commerce and communication through new electronic media will
continue to grow or that the Company will be successful in addressing the
risks encountered by companies which are operating in rapidly evolving
markets. The use of new electronic media in marketing, information gathering
and dissemination, particularly by businesses that have historically relied
upon traditional means of marketing, generally requires the acceptance of new
methods of conducting business and exchanging information. If commerce and
communication through new electronic media fail to gain widespread acceptance
or develop more slowly than expected, the Company would be materially
adversely affected. See "Business--Internet Commerce and the Marketing
Communications Industry."
 
  RELIANCE ON MANAGEMENT AND KEY EMPLOYEES. The Company is dependent upon the
services of certain key management personnel, the loss of whose services would
have a material adverse effect on the Company. In particular, the Company
depends on the services of Daniel M. Fine, Chairman and Chief Executive
Officer and James P. Chamberlin, Chief Financial Officer and Chief Operating
Officer. The Company has obtained $100,000 of key person insurance on the
lives of each of Messrs. Fine and Chamberlin. In addition, the Company is
dependent upon the services of qualified and experienced marketing, technical
and creative personnel. There can be no assurance that any of these persons
will remain employed by the Company or that these persons will not participate
in businesses that compete with the Company in the future. In seeking
qualified personnel, the Company is required to compete with companies having
greater financial and other resources than the Company. Since the Company's
future success will be dependent on its ability to attract and retain
qualified personnel, the inability to do so would have a material adverse
affect on the Company.
 
  COMPETITION. The market for the Company's services is highly competitive and
is characterized by demands to adopt and utilize new capabilities and
technologies, and to respond rapidly to evolving client requirements. The
Company faces competition from a number of sources, including potential
clients that perform Web site planning, creation, maintenance and hosting
services in-house. Other sources of competition include Web site service
firms, communications, telephone and telecommunications companies, computer
hardware and software companies, established online services companies, direct
Internet access providers, advertising agencies and specialized and integrated
marketing communication firms, all of which are entering the Web site
planning, creation, maintenance and hosting markets in varying degrees. Many
of the Company's competitors have
 
                                      10
<PAGE>
 
announced plans to offer expanded Web site planning, creation, maintenance
and/or hosting services and many of such competitors or potential competitors
have longer operating histories, longer customer relationships and
significantly greater financial, management, technological, development,
sales, marketing and other resources than the Company. The Company expects
competition to intensify in the future, as anticipated growth in the industry
attracts other participants. There can be no assurance that the Company will
be able to compete effectively, if at all, and its inability to do so would
have a material adverse effect on the Company. See "Business--Competition."
 
  LACK OF PROPRIETARY PROTECTION; INTELLECTUAL PROPERTY RIGHTS; RISK OF
INFRINGEMENT; POSSIBLE LITIGATION. The Company does not believe that its
business is dependent upon any patents, copyrights or trademarks, and the
Company does not currently have any registered patents, copyrights or
trademarks. Consequently, the Company relies solely on a combination of common
law and statutory law to protect its trademarks, proprietary information and
know-how. The majority of the Company's current agreements with its clients
contain provisions granting to the client intellectual property rights to
certain of the Company's work product, including customized programming that
is created during the course of a project. The Company anticipates that
agreements with future clients may contain similar provisions. Other existing
agreements to which the Company is a party are, and future agreements may be,
silent as to the ownership of such rights. To the extent that the ownership of
such intellectual property rights is expressly granted to a client or is
ambiguous, the Company's ability to reuse or resell such rights will or may be
limited. See "Business--Clients and Services."
 
  The Company utilizes technology owned, and may seek to use technology
developed in the future, by third parties. Although the Company believes that
there are currently sufficient alternative sources of third-party technology
which would be available to it, if any particular third-party technology that
it is currently using were to be discontinued or otherwise become unavailable,
there can be no assurance that licenses for any technology owned or developed
by third parties that might be required for provision of the Company's
services will be available in the future on reasonable terms, or at all, and
the inability to obtain any such licenses could have a material adverse effect
on the Company. Although the Company does not believe that either its services
or its utilization of technology owned by third parties infringes the
proprietary rights of any third parties, there can be no assurance that third
parties will not in the future assert claims against the Company based on such
services or utilization or that any of those claims would not be successful.
In addition, litigation may be necessary in the future to enforce the
Company's intellectual property rights and to protect its proprietary
information, to determine the validity and scope of the proprietary rights of
third parties or to defend against claims of infringement or invalidity.
Litigation of this nature, whether or not successful, could result in
substantial costs and diversion of resources, which could have a material
adverse effect on the Company. Furthermore, third parties making claims
against the Company could secure a judgment awarding substantial damages, as
well as injunctive or other equitable relief that could directly or indirectly
prohibit the Company from providing certain services. A judgment of this
nature could have a material adverse effect on the Company.
 
  Additionally, the Company and other Web site developers face potential
liability for the actions of clients and others using their services,
including liability for infringement of intellectual property rights, rights
of publicity, defamation, libel and criminal activity under the laws of the
United States and foreign jurisdictions. The Company has obtained errors and
omissions insurance, although there can be no assurance that such insurance
will be adequate. Any imposition of liability based on the actions of clients
and others using the Company's services could have a material adverse effect
on the Company.
 
  DEPENDENCE UPON CONTINUED DEVELOPMENT OF ACCESS TO AND INFRASTRUCTURE OF THE
INTERNET. The Company's ability to generate revenues from the planning,
development, maintenance and hosting of commercial Web sites will depend upon
the continued development of an infrastructure for providing Internet access
and carrying Internet traffic. The Internet may not prove to be a viable
commercial marketplace due to inadequate development of the necessary
infrastructure or delays in the development of complementary products.
Moreover, other critical issues concerning the commercial use of the Internet
(including security, reliability, cost, ease of use and access, and quality of
service) remain unresolved and may adversely impact the anticipated growth of
Internet use. It is difficult to
 
                                      11
<PAGE>
 
predict whether the Internet will prove to be and remain a viable commercial
marketplace. If the infrastructure and complementary products necessary to
support the Internet's commercial viability are not developed or if the
Internet does not become a viable marketplace, the Company would be materially
adversely affected. See "Business--The Internet and the Web."
 
  FLUCTUATIONS IN FOREIGN CURRENCIES; UNCERTAINTIES IN INTERNATIONAL
OPERATIONS. The Company recently opened an office in the United Kingdom, and
intends to continue to expand its services internationally. As an increased
percentage of the Company's revenues is derived from international operations,
which are conducted in foreign currencies, changes in the value of these
foreign currencies relative to the U.S. dollar may affect the Company's
results of operations and financial position. The Company may engage in
currency-hedging transactions or other means intended to reduce the effect of
fluctuations in foreign currency exchange rates on the Company's results of
operations, although there can be no assurance that such transactions will
materially reduce the effect of fluctuations in foreign exchange rates on the
Company's business. Such fluctuations may have a material adverse affect on
the Company's international operations and the Company's overall business,
financial condition and results of operations. Other potential risks inherent
in the Company's international operations include difficulties in staffing and
managing foreign operations, longer payment cycles, greater difficulties in
accounts receivable collection, unexpected changes in regulatory requirements,
market acceptance in foreign countries, reduced protection for intellectual
property rights in some countries, seasonal reductions in business activity
during the summer months in Europe, and potentially adverse tax consequences,
any one or more of which could adversely impact the Company's international
operations and the Company's overall business, financial condition and results
of operations.
 
  RISK OF CHANGING TECHNOLOGY. The services that the Company offers, and the
services that the Company expects to offer in the future, are impacted by
rapidly changing technology, evolving industry standards, emerging competition
and frequent service, software and other product introductions. There can be
no assurance that the Company will be able to successfully identify new
business opportunities and develop and bring new services to market in a
timely and cost-effective manner or that services, products or technologies
developed by others will not render the Company's services noncompetitive or
obsolete. See "Business--Competition."
 
  DEPENDENCE ON MICROSOFT. The Company has historically been dependent upon
Microsoft for new business referrals and for work as a paid Microsoft vendor.
In addition, the Company is dependent upon its expertise with Microsoft
software and relies upon such software in creating Web sites for the Company's
clients. Although the Company participates in the Microsoft Solution Provider
Partner and Site Builders Network programs, there can be no assurance that its
relationship with Microsoft will continue or that the Company will continue to
derive benefits from that relationship. In addition, if Microsoft's products,
standards or approach to the Internet or other markets were to fall into
disfavor or other parties were able to develop products, standards or
approaches which had greater market acceptance than those offered by
Microsoft, the Company could be materially adversely affected. See "Business--
Relationship with Microsoft."
 
  GOVERNMENT REGULATION. The Company is not currently subject to direct
regulation by any government agency, other than regulations applicable to
businesses generally. However, it is possible that laws and regulations may be
adopted with respect to the Internet, covering issues such as user privacy and
pricing, characteristics and quality of products and services. The adoption of
any such laws or regulations may decrease the growth of the Internet (which
could in turn decrease the demand for the Company's services), increase the
Company's cost of doing business, cause the Company to modify its operations
or otherwise have an adverse effect on the Company. Moreover, the
applicability to the Internet of existing laws governing issues such as
property ownership, libel and personal privacy is uncertain. The Company
cannot predict the impact, if any, that any future laws or regulations, or the
applicability of such existing laws, may have on its business.
 
  FLUCTUATIONS IN MARKET PRICE. The market price of the Company's common
stock, like that of other Web site development companies, is highly volatile
and is subject to wide fluctuations in response to quarterly variations in
operating results, announcements of activities by competitors and
 
                                      12
<PAGE>
 
other events and factors. The Company's stock price may also be effected by
broader market trends unrelated to the Company's performance.
 
ITEM 2. PROPERTIES
 
  The Company's headquarters currently occupies approximately 15,650 square
feet of an office building at 1525 Fourth Avenue, Seattle, Washington 98101 at
a monthly rent of approximately $22,100. Such payments include the Company's
allocable share of certain real property taxes and building operating
expenses. The remaining lease term expires on April 30, 2005.
 
  The Company continues to lease approximately 8,000 square feet at its prior
headquarters at 1118 Post Avenue, Seattle, Washington at an annual rent of
approximately $80,000. The remaining lease term expires in April 2001. The
Company has sublet all of this space to a third party for the remainder of the
term of the lease. In addition, pursuant to the Company's acquisition of
Pacific Analysis and Computing Corporation in February 1998, the Company
assumed Pacific Analysis' office lease for approximately 3,355 square feet in
Bellevue, Washington at a monthly rent of approximately $5,044. The term of
such lease expires on October 31, 2002. The Company has sublet a portion of
this office space to a third party for the remainder of the term of the lease.
See Note 6 in "Notes to Financial Statements."
 
  The Company also leases approximately 1,250 square feet of office space in
Santa Monica, California and approximately 550 square feet of office space in
Bethesda, Maryland. The Santa Monica lease expires on February 29, 1999 and
provides for annual rent of approximately $36,000. The Bethesda lease expires
on July 31, 1998 and provides for annual rent of approximately $13,080. In
addition, the Company shares office space in Tokyo, Japan with Mitsui & Co.,
Ltd. as part of the feasibility study with Mitsui.
 
ITEM 3. LEGAL PROCEEDINGS
 
  The Company is not a party to any legal proceedings.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended January 31, 1998.
 
                                    PART II
 
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
  The Company's common stock is traded on The Nasdaq SmallCap Market
("Nasdaq") under the symbol "FDOT." The common stock first began trading on
August 11, 1997, the effective date of the Company's initial public offering
of common stock. The following table contains the high and low closing sales
price as reported by Nasdaq for each quarter of fiscal 1998.
 
<TABLE>
<CAPTION>
                              1ST QUARTER 2ND QUARTER    3RD QUARTER 4TH QUARTER
                              ----------- ----------- -------------- -----------
                                                        (BEGINNING
                                                      AUG. 11, 1997)
<S>                           <C>         <C>         <C>            <C>
Common Stock
  High.......................     --          --          $8.875       $7.250
  Low........................     --          --           6.625        4.375
</TABLE>
 
  At January 31, 1998, there were 2,380,065 shares of common stock
outstanding. As of such date, the approximate number of record holders of its
common stock was 27, not including beneficial owners whose shares are held by
banks, brokers and other nominees.
 
 
                                      13
<PAGE>
 
  No cash dividends have been paid on the capital stock of the Company and no
dividends are currently contemplated by management. The Company's Revolving
Line of Credit places certain restrictions on the Company's ability to pay
cash dividends.
 
  The Company's Form SB-2 (File No. 333-26855) relating to the Company's
initial public offering of the Company's common stock, was declared effective
by the Commission on August 11, 1997. Total gross proceeds from the offering
were $8,222,500, of which the Company received proceeds of $7,400,250; after
deducting underwriting discounts and commissions of $822,250.
 
  From the effective date of the Registration Statement through the Company's
fiscal year ended January 31, 1998, the Company incurred an estimated
$1,994,458 in expenses for the Company's account in connection with the
issuance and distribution of the securities registered, including underwriting
discounts and commissions ($822,250), expenses paid to or for the underwriters
($346,738) and other expenses ($825,470). The Company believes that none of
these payments were made, directly or indirectly, to: (i) directors or
officers of the Company or their affiliates; (ii) persons owning ten percent
or more of the Company's common stock; or (iii) affiliates of the Company.
 
  From the effective date of the Registration Statement through January 31,
1998, the Company has applied its net proceeds as follows:
 
<TABLE>
   <S>                                                             <C>
   Net proceeds from IPO.......................................... $6,228,042
   Accounts receivable, work-in-process and other working capital
    requirements..................................................   (191,368)
   Capital expenditures for fixed assets..........................   (308,949)
   Repayment of indebtedness......................................   (467,615)
                                                                   ----------
   Unapplied proceeds held in money market funds and marketable
    securities at January 31, 1998................................ $5,260,110
                                                                   ==========
</TABLE>
 
  The Company believes that none of these payments were made, directly or
indirectly, to: (i) directors or officers of the Company or their affiliates;
(ii) persons owning ten percent or more of the Company's common stock; or
(iii) affiliates of the Company. To date, the Company believes that it has
used the offering proceeds in a manner consistent with the use of proceeds
described in the Registration Statement and Prospectus.
 
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS
 
  The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Financial
Statements and accompanying notes and the other financial information
appearing elsewhere in this Report.
 
OVERVIEW
 
  fine.com plans, develops, maintains and hosts Web sites for major national
and international corporate clients and others. The Company's Web site
development process utilizes marketing expertise and state of the art
interactive database compilation and dissemination techniques and
technologies. Through the planning, development, maintenance and hosting of
interactive Web presentations, the Company enhances clients' marketing
campaigns, fosters the collection of demographic data which is utilized by
clients when allocating marketing resources, and facilitates both internal and
external corporate communications for clients.
 
  The Company generates substantially all of its revenues from fees associated
with the planning and development of commercial Web sites for clients. These
fees are generally earned pursuant to long-term fixed fee contracts (with
terms typically ranging from two to seven months). Revenues generated from
long-term contracts are recognized under the percentage-of-completion method.
Percentage-of-completion is generally measured on the attainment of specific
contract milestones (based on the ratio of costs incurred to total estimated
project costs). Estimated earnings from long-term contracts are reviewed
periodically as work progresses. All other revenue is recorded on the
 
                                      14
<PAGE>
 
basis of performance of services. The Company assumes greater financial risk
on fixed fee contracts than on either time-and-material or cost-reimbursable
contracts. Failure to anticipate technical problems, estimate costs accurately
or control costs during performance of a fixed fee contract may reduce the
Company's profit or cause a loss individually on a particular project and in
the aggregate. The Company has generated a net profit for each of the past
three fiscal years.
 
  The Company has recently initiated efforts to generate recurring revenues
from Web site maintenance and Web site hosting fees. The amount of revenue
generated to date from the Company's provision of such services has not been
significant. Even if revenues from such sources increase, fees for maintenance
and hosting services may not become a significant percentage of the Company's
revenues, if and to the extent that revenues increase from the planning and
development of Web sites. No assurance can be given that revenues from
maintenance and hosting fees, or from other new methods of generating
recurring revenues, will be sufficient to offset the costs incurred by the
Company in performing such services.
 
  Historically, the Company has been dependent upon Microsoft for work as a
paid vendor. The aggregate revenues generated from the multiple departments
and divisions at Microsoft for which the Company performed services accounted
for 22%, 19%, and 34% of the Company's gross revenue in the fiscal year ended
January 31, 1998 ("fiscal 1998"), the fiscal year ended January 31, 1997
("fiscal 1997") and the fiscal year ended January 31, 1996 ("fiscal 1996"),
respectively. Additionally, Marriott International, Inc., The Nasdaq Stock
Market, and Safeway Inc. accounted for 15%, 12% and 12% of the Company's gross
revenue during fiscal 1998, respectively. In addition, Twentieth Century Fox
Home Entertainment, Inc. and Safeway Inc. accounted for 11% and 14% of the
Company's gross revenue during fiscal 1997, respectively. Neither Twentieth
Century Fox Home Entertainment, Inc. nor Safeway Inc. were clients of the
Company during fiscal 1996. Management believes that the long-term success of
the Company is not dependent on any one or a few major customers.
 
RESULTS OF OPERATIONS
 
 FISCAL YEARS ENDED JANUARY 31, 1998 AND 1997
 
  GROSS REVENUE. Gross revenue for fiscal 1998 and fiscal 1997 was $3,448,084
and $1,485,869, respectively. During each of these fiscal years, substantially
all of the Company's revenue was generated by its Web site planning and
development services. The 132% increase in fiscal 1998 gross revenue over
fiscal 1997 gross revenue is attributable primarily to the number of clients
contracting with the Company for such services increasing from approximately
25 clients in fiscal 1997 to approximately 29 clients in fiscal 1998, as well
as an increase in the average amount billed per client from approximately
$56,000 per client in fiscal 1997 to approximately $102,000 in fiscal 1998 for
such services. The Company believes that the increase in number of such
clients was attributable to increased levels of marketing, advertising and new
business development activities. The average amount billed per client during
fiscal 1998 for Web site planning and development services increased from
fiscal 1997 primarily due to the Company's clients generally undertaking more
sophisticated levels of Web site development. See "Business--Internet Commerce
and the Marketing Communications Industry" and "--Clients and Services."
 
  DIRECT SALARIES AND COSTS. Direct salaries and costs include all internal
labor costs and other direct costs related to project performance, such as
project specific independent contractor fees, supplies and specific project
related expenditures. The Company's direct salaries and costs for fiscal 1998
were $2,292,206, and consisted primarily of $1,451,760 paid as direct
salaries, taxes and benefits and, secondarily, of $840,446 as other direct
costs of goods sold related to specific projects. The Company hired additional
employees during fiscal 1998 to meet increased demand and had 43 full time
employees at January 31, 1998. The increase in direct salaries and costs was
directly attributable to the increase in the number of employees. The Company
expects that it will hire additional staff if and as needed to meet demand
from current clients and prospective clients whose projects are anticipated to
commence within ninety days after such hiring. The Company engages independent
contractors and subcontractors to service unanticipated projects or supplement
in-house production capability. The Company's direct salaries and costs for
fiscal 1997 were $774,242 and
 
                                      15
<PAGE>
 
consisted, primarily, of $619,884 of direct salaries, taxes and benefits and,
secondarily, of $154,358 of other direct costs of goods sold related to
specific projects. The Company had 21 full time employees at January 31, 1997.
 
  As a percentage of gross revenue, total direct salaries and costs increased
14% from fiscal 1997 to fiscal 1998. Such increase was due primarily to
increases in the number of employees and secondarily to the increased level of
contract labor expenses incurred to service the increased number of client
projects and to the increase in costs associated with serving clients outside
of the Seattle, Washington area. The Company has undertaken efforts to hire
additional in-house production staff as well as open regional offices to more
effectively serve clients in the Mid-Atlantic and Southern California areas.
 
  SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $1,168,776 and $514,059 for fiscal 1998 and
fiscal 1997, respectively. In each period, these expenses consisted primarily
of administrative salaries, professional fees, occupancy costs, telephone and
related Internet connectivity fees, computer network costs, office expenses
and supplies, marketing, advertising and new business development costs. The
increase in selling, general and administrative expenses for fiscal 1998 over
fiscal 1997 was due primarily to the costs of relocating the Company's
corporate headquarters into new office space and the leasing of additional
offices in Bethesda, Maryland and Santa Monica, California, depreciation of
new computer equipment purchases and the costs involved with being a public
reporting company.
 
  Marketing, advertising and new business development costs increased as a
percentage of gross revenue in fiscal 1998 from fiscal 1997. Marketing,
advertising and new business development costs were $189,968 representing 6%
of gross revenue in fiscal 1998 as compared to $68,687 representing 5% of
gross revenue in fiscal 1997. The Company believes that the increase in
marketing, advertising and new business development costs was instrumental in
the 132% increase in gross revenue from fiscal 1997 to fiscal 1998. A
substantial portion of these costs were incurred as part of the Company's
efforts in establishing an office in the United Kingdom and participating in a
feasibility study in Japan. Management believes that these costs will continue
to increase as a percentage of gross revenue in future periods and may reach
approximately 7% of gross revenue.
 
  Overall, selling, general and administrative expenses as a percentage of
gross revenue were 34% for fiscal 1998 as compared to 35% for fiscal 1997.
This overall decrease in selling, general, and administrative expenses as a
percentage of gross revenue was a result of the Company's ongoing effort to
control expenses and effectively assimilate higher volumes of business using
existing resources, offset by increased marketing, advertising and new
business development, and administrative expenses due to new office spaces,
depreciation of equipment purchases and the compliance and reporting
obligations associated with being a publicly held company.
 
  INTEREST INCOME. Interest income increased during fiscal 1998 due to an
increase in the average level of funds available for investment as a result of
the net proceeds received from the Company's initial public offering in August
1997.
 
  NET INCOME. The Company recognized net income of $80,682 (representing 2% of
gross revenue) for fiscal 1998 as compared to $124,274 (representing 8% of
gross revenue) for fiscal 1997. The decrease in profitability (as a percentage
of gross revenue) is due to the factors discussed above.
 
 FISCAL YEARS ENDED JANUARY 31, 1997 AND 1996
 
  GROSS REVENUE. Gross revenue for fiscal 1997 and fiscal 1996 was $1,458,869
and $531,800, respectively. During each of these fiscal years, substantially
all of the Company's revenue was generated by its Web site planning and
development services. The 179% increase in fiscal 1997 gross revenue over
fiscal 1996 gross revenue is attributable primarily to the number of clients
contracting with the Company for such services increasing from approximately
18 clients in fiscal 1996 to approximately 25 clients in fiscal 1997 as well
as an increase in the average amount billed per client
 
                                      16
<PAGE>
 
from approximately $25,000 per client in fiscal 1996 to approximately $56,000
in fiscal 1997 for such services. The Company believes that the increase in
number of such clients was attributable to increased levels of marketing,
advertising and new business development activities. The average amount billed
per client during fiscal 1997 for Web site planning and development services
increased from fiscal 1996 primarily due to the Company's clients generally
undertaking more sophisticated levels of Web site development.
 
  DIRECT SALARIES AND COSTS. Direct salaries and costs include all internal
labor costs and other direct costs related to project performance, such as
project specific independent contractor fees, supplies and specific project
related expenditures. The Company's direct salaries and costs for fiscal 1997
were $774,242, and consisted primarily of $619,884 paid as direct salaries,
taxes and benefits and, secondarily, of $154,358 as other direct costs of good
sold related to specific projects. The Company hired additional employees
during fiscal 1997 to meet increased demand and had 21 full time employees at
January 31, 1997. The Company engages independent contractors and
subcontractors to service unanticipated projects. The Company's direct
salaries and costs for fiscal 1996 were $258,532 and consisted, primarily, of
$178,803 of direct salaries, taxes and benefits and, secondarily, of $79,729
of other direct costs of goods sold related to specific projects. The Company
had 13 full time employees at January 31, 1996.
 
  As a percentage of gross revenue, total direct salaries and costs increased
4% from fiscal 1996 to fiscal 1997. Such increase was due primarily to the
increased level of salaries paid to production employees. This increase,
combined with a greater reliance on production employees as compared to
independent contractors and/or subcontractors, resulted in the salaries, taxes
and benefits component of direct salaries and costs increasing from 69% in
fiscal 1996 to 80% in fiscal 1997.
 
  SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $514,059 and $225,517 for fiscal 1997 and fiscal
1996, respectively. In each period, these expenses consisted primarily of
administrative salaries, professional fees, occupancy costs, telephone and
related Internet connectivity fees, computer network costs, office expenses
and supplies, marketing, advertising and new business development costs.
 
  Marketing, advertising and new business development costs increased as a
percentage of gross revenue in fiscal 1997 from fiscal 1996. Marketing,
advertising and new business development costs were $68,687 representing 5% of
gross revenue in fiscal 1997 as compared to $10,237 representing 2% of gross
revenue in fiscal 1996. The Company believes that the increase in marketing,
advertising and new business development costs was instrumental in the 179%
increase in gross revenue from fiscal 1996 to fiscal 1997.
 
  Overall, selling, general and administrative expenses as a percentage of
gross revenue were 35% for fiscal 1997 as compared to 42% for fiscal 1996.
This overall decrease in selling, general, and administrative expenses as a
percentage of gross revenue was a result of the Company's ongoing effort to
control expenses and effectively assimilate higher volumes of business using
existing resources, offset by increased marketing, advertising and new
business development.
 
  NET INCOME. The Company recognized net income of $124,274 (representing 8%
of gross revenue) for fiscal 1997 as compared to $30,082 (representing 6% of
gross revenue) for fiscal 1996. The increase in profitability (as a percentage
of gross revenue) is due to the factors discussed above.
 
                                      17
<PAGE>
 
CAPITAL RESOURCES AND LIQUIDITY
 
  Historically, the Company has funded its capital requirements through
earnings, borrowings from affiliates and commercial lenders, and equity
financing and private placements of its capital stock. The Company had cash
and cash equivalents in the aggregate amount of $1,419,591 at January 31,
1998.
 
  The Company's working capital increased $3,390,055, from $301,728 at January
31, 1997 to $3,691,783 at January 31, 1998. Operating activities for fiscal
1998 required net cash in the amount of $433,294, primarily due to increases
in work in process, accounts receivable and prepaid expenses, and offset by
increases in accounts payable and advance payments. Work in process increased
$179,505 from $0 at January 31, 1997. Accounts receivable increased $465,477,
from $476,766 at January 31, 1997 to $942,243 at January 31, 1998, primarily
due to the increase in gross revenue during the 12 months ended January 31,
1998. Prepaid expenses and other assets increased $138,259 due to deposits
made for future consulting and marketing services. Accounts payable increased
$55,209, from $117,459 at January 31, 1997 to $172,668 at January 31, 1998.
Deferred revenue decreased from $36,722 at January 31, 1997 to $0 at January
31, 1998.
 
  The purchase of equipment and furniture required cash in the amount of
$443,180 during fiscal 1998. These expenditures were made primarily for
computer hardware and software, furniture, fixtures and leasehold improvements
necessary to accommodate an increase in Company personnel. The Company
believes that the increase in personnel was a principal factor enabling the
Company to generate higher gross revenue in fiscal 1998. Net cash provided
from financing activities was $6,120,670, primarily due to net proceeds in the
amount of $6,228,042 from the initial public offering of its common stock in
August 1997.
 
  During fiscal 1998, the Company had a Revolving Line of Credit from a
commercial bank. At January 31, 1998, the maximum amount available under this
Revolving Line of Credit was $750,000 and there were no amounts outstanding
under such line of credit as of such date. The Revolving Line of Credit has
been extended through June 30, 1998 and the Company is negotiating for renewal
of the Revolving Line of Credit through the 1999 fiscal year. Amounts
outstanding under the Revolving Line of Credit bear interest at such bank's
prime interest rate plus .25% (8.75% at January 31, 1998). Amounts outstanding
under the Revolving Line of Credit are secured by all of the Company's
accounts receivable and the personal guaranty of the Company's Chairman and
Chief Executive Officer. The Revolving Line of Credit requires that the
Company maintain working capital amounts (as calculated therein), tangible net
worth, and the maximum capital expenditures (as defined therein). The
Revolving Line of Credit limits the Company's ability to incur additional
debt, to repurchase the Company's capital stock or amend its capital
structure, to pay cash dividends or to undergo a merger, consolidation or
liquidation. In addition, a change in ownership of twenty-five percent of the
common stock constitutes an event of default.
 
  During the 1998 fiscal year, the Company also had an equipment line of
credit (the "Equipment Line of Credit") from the commercial bank which made
the Revolving Line of Credit available. The maximum amount available under the
Equipment Line of Credit was $400,000 and at January 31, 1998, there were no
amounts outstanding under the Equipment Line of Credit. Amounts drawn by the
Company pursuant to the Equipment Line of Credit were to be used exclusively
for the purchase of computer hardware and software, furniture and fixtures,
and leasehold improvements. Amounts outstanding under the Equipment Line of
Credit bore interest at the same rate of interest as applicable to the
Revolving Line of Credit. The Equipment Line of Credit expired on December 31,
1997 and has not been renewed.
 
  As of April 30, 1998, the Company's principal commitments consisted of
obligations outstanding under operating leases. Although the Company currently
has no material commitments for capital expenditures, it anticipates that its
capital expenditures and lease commitments will increase consistent with
anticipated growth in operations, infrastructure and personnel. The Company
may acquire additional office space or fixed assets through capital leases,
which will require it to commit to additional lease obligations.
 
                                      18
<PAGE>
 
  On August 15, 1997, the Company completed its initial public offering and
issued 1,100,000 shares of common stock to the public at an initial public
offering price of $6.50 per share. On August 25, 1997, pursuant to the
exercise of an over-allotment option granted to the underwriters in the
Company's initial public offering, the Company issued an additional 165,000
shares of common stock at a price of $6.50 per share. Proceeds to the Company,
net of offering expenses of $1,994,458, amounted to $6,228,042. Pending
ultimate application of the net proceeds from the offering, the Company
invested such proceeds primarily in certain interest bearing securities issued
or guaranteed by the United States government or its agencies and secondarily
in money market funds.
 
  The Company believes that existing cash and cash equivalent balances, cash
generated from operations and the funds available to it under credit
facilities, together with the remaining proceeds from the initial public
offering, will be sufficient to fund its capital requirements for the
foreseeable future.
 
SEASONALITY AND INFLATION
 
  The Company does not believe that inflation or seasonality has had a
significant effect on the Company's operations to date.
 
YEAR 2000 COMPLIANCE
 
  The Company's services and products are designed to be Year 2000 compliant
and do not contain any date or time dependent code strings, fields, variables
or other mechanisms that inhibit their use or reliability following the turn
of the century. In addition, the Company believes that its internal systems
are Year 2000 compliant. However, there can be no guarantee that the systems
of other companies on which the Company relies or does business with are Year
2000 compliant and would not have an adverse effect on the Company's business.
 
                                      19
<PAGE>
 
ITEM 7. FINANCIAL STATEMENTS
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Shareholders fine.com International Corp.
 
  We have audited the accompanying balance sheets of fine.com International
Corp. as of January 31, 1998 and 1997, and the related statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended January 31, 1998. These financial statements are the responsibility for
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of fine.com International
Corp. at January 31, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended January 31, 1998,
in conformity with generally accepted accounting principles.
 
                                            ERNST & YOUNG LLP
 
Seattle, Washington
March 27, 1998
 
                                      20
<PAGE>
 
                          FINE.COM INTERNATIONAL CORP.
 
                                 BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                               JANUARY 31,
                                                           --------------------
                                                                 1998      1997
-------------------------------------------------------------------------------
<S>                                                        <C>         <C>
ASSETS
Current assets:
  Cash and cash equivalents............................... $1,419,591  $198,317
  Marketable Securities (Note 2)..........................  1,593,032        --
  Accounts receivable, less allowances (Note 3)...........    942,243   476,766
  Work-in-process.........................................    179,505        --
  Income taxes refundable.................................        784       784
  Prepaid expenses and other..............................    147,668     9,409
  Notes receivable from officer...........................     26,686    30,435
-------------------------------------------------------------------------------
    Total current assets..................................  4,309,509   715,711
Marketable Securities (Note 2)............................  2,325,236        --
Other long-term assets....................................     60,724        --
Deferred offering costs...................................         --    41,116
Deferred income tax asset (Note 7)........................    220,318    30,883
Equipment and furniture, net (Note 4).....................    435,721    80,827
-------------------------------------------------------------------------------
    Total assets.......................................... $7,351,508  $868,537
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Note payable to bank (Note 5)........................... $       --  $ 90,286
  Accounts payable........................................    172,668   117,459
  Accrued offering costs..................................         --    16,002
  Accrued expenses........................................     48,357    28,046
  Advance payments........................................     70,500        --
  Deferred revenue........................................         --    36,722
  Note payable to director................................         --    15,000
  Deferred income tax liabilities (Note 7)................    322,337   100,769
  Capitalized lease obligations...........................      3,864     9,699
-------------------------------------------------------------------------------
    Total current liabilities.............................    617,726   413,983
Shareholders' equity:
  Convertible preferred stock, no par value:
   No shares authorized, issued or outstanding at January
    31, 1998 and 1,000,000 shares authorized, 59,524
    shares issued and outstanding at January 31, 1997.....         --   239,918
  Common stock, no par value:
   10,000,000 shares authorized, 2,380,065 shares issued
    and outstanding at January 31, 1998; and 9,000,000
    shares authorized, 1,055,541 shares issued and
    outstanding at January 31, 1997.......................  6,542,960    75,000
  Retained earnings.......................................    220,318   139,636
  Unrealized loss on marketable securities................    (29,496)       --
-------------------------------------------------------------------------------
  Total shareholders' equity..............................  6,733,782   454,554
-------------------------------------------------------------------------------
    Total liabilities and shareholders' equity............ $7,351,508  $868,537
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
 
                            See accompanying notes.
 
                                       21
<PAGE>
 
                          FINE.COM INTERNATIONAL CORP.
 
                              STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                             FISCAL YEAR ENDED JANUARY 31,
                                            ---------------------------------
                                                  1998        1997       1996
------------------------------------------------------------------------------
<S>                                         <C>         <C>         <C>
Gross revenue.............................. $3,448,084  $1,485,869  $ 531,800
Direct salaries and costs..................  2,292,206     774,242    258,532
------------------------------------------------------------------------------
Gross profit...............................  1,155,878     711,627    273,268
Selling, general and administrative ex-
 penses....................................  1,168,776     514,059    225,517
------------------------------------------------------------------------------
Operating income (loss)....................    (12,898)    197,568     47,751
Interest income............................    176,535          --         --
Interest expense...........................    (36,388)     (8,840)    (2,721)
------------------------------------------------------------------------------
Income before income taxes.................    127,249     188,728     45,030
Provision for income taxes (Note 7)........     46,567      64,454     14,948
------------------------------------------------------------------------------
Net income................................. $   80,682  $  124,274  $  30,082
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Net income per share (Notes 1 and 10):
  Basic.................................... $     0.05  $     0.12  $    0.03
------------------------------------------------------------------------------
------------------------------------------------------------------------------
  Diluted.................................. $     0.05  $     0.12  $    0.03
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Shares used in computation of net income
 per share:
  Basic....................................  1,669,303   1,055,541  1,055,541
------------------------------------------------------------------------------
------------------------------------------------------------------------------
  Diluted..................................  1,763,975   1,072,788  1,055,541
------------------------------------------------------------------------------
------------------------------------------------------------------------------
</TABLE>
 
 
 
                            See accompanying notes.
 
                                       22
<PAGE>
 
                          FINE.COM INTERNATIONAL CORP.
 
                       STATEMENTS OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                            CONVERTIBLE
                             PREFERRED
                          STOCK--SERIES A        COMMON STOCK
                         ------------------  --------------------
                                                                         COMMON               UNREALIZED
                                                                          STOCK    RETAINED      LOSS ON           TOTAL
                                                                   SUBSCRIPTION    EARNINGS   MARKETABLE   SHAREHOLDERS'
                          SHARES     AMOUNT     SHARES     AMOUNT    RECEIVABLE   (DEFICIT)   SECURITIES          EQUITY
-------------------------------------------------------------------------------------------------------------------------
<S>                      <C>      <C>        <C>       <C>        <C>            <C>         <C>          <C>
Balance at February 1,
 1995...................      --  $      --  1,055,541 $   75,000      $(25,000)   $(14,720)    $     --      $   35,280
 Payment of common stock
  subscription
  receivable............      --         --         --         --        25,000          --           --          25,000
 Net income.............      --         --         --         --            --      30,082           --          30,082
-------------------------------------------------------------------------------------------------------------------------
Balance at January 31,
 1996...................      --         --  1,055,541     75,000            --      15,362           --          90,362
 Sale of Series A
  convertible preferred
  stock, net of offering
  costs of $10,082......  59,524    239,918         --         --            --          --           --         239,918
 Net income.............      --         --         --         --            --     124,274           --         124,274
-------------------------------------------------------------------------------------------------------------------------
Balance at January 31,
 1997...................  59,524    239,918  1,055,541     75,000            --     139,636           --         454,554
 Conversion of Series A
  convertible preferred
  stock into 59,524
  shares of common
  stock................. (59,524)  (239,918)    59,524    239,918            --          --           --              --
 Issuance of shares in
  initial public
  offering, net of
  offering costs of
  $1,994,458............      --         --  1,265,000  6,228,042            --          --           --       6,228,042
 Unrealized loss on
  marketable securities,
  net of taxes of
  $14,434...............      --         --         --         --            --          --      (29,496)        (29,496)
 Net income.............      --         --         --         --            --      80,682           --          80,682
-------------------------------------------------------------------------------------------------------------------------
Balance at January 31,
 1998...................      --  $      --  2,380,065 $6,542,960      $     --    $220,318     $(29,496)     $6,733,782
-------------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
 
 
 
                            See accompanying notes.
 
                                       23
<PAGE>
 
                          FINE.COM INTERNATIONAL CORP.
 
                            STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                             FISCAL YEAR ENDED JANUARY 31,
                                            ----------------------------------
                                                   1998        1997       1996
-------------------------------------------------------------------------------
<S>                                         <C>          <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................  $    80,682  $  124,274  $  30,082
Adjustments to reconcile net income to net
 cash provided by (used in) operating ac-
 tivities:
  Depreciation and amortization...........       88,286      29,791     25,475
  Deferred income taxes...................       46,567      64,458     13,728
Net changes in operating assets and lia-
 bilities:
  Accounts receivable.....................     (465,477)   (412,911)   (44,638)
  Work-in-process.........................     (179,505)         --         --
  Prepaid expenses and other assets.......     (138,259)     (9,409)        --
  Deferred offering costs.................       25,114     (25,114)        --
  Accounts payable........................       55,209      65,542      2,531
  Accrued expenses........................       20,311      27,428        618
  Advance payments........................       70,500          --         --
  Deferred revenue........................      (36,722)     36,722         --
  Current income taxes....................           --      (2,061)     1,277
-------------------------------------------------------------------------------
Net cash provided by (used in) operating
 activities...............................     (433,294)   (101,280)    29,073
-------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of marketable securities........   (3,962,198)         --         --
Purchases of equipment and furniture......     (443,180)    (50,372)   (29,409)
Other assets..............................      (60,724)         --         --
-------------------------------------------------------------------------------
Net cash used in investing activities.....   (4,466,102)    (50,372)   (29,409)
-------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock,
 net of issuance costs....................    6,228,042          --         --
Increase (decrease) in notes payable to
 bank.....................................      (90,286)     90,286         --
Payments on capital lease obligations.....       (5,835)     (4,381)        --
Increase (decrease) in note receivable
 from officer.............................        3,749      (6,522)   (18,065)
(Decrease) Increase in note payable to di-
 rector...................................      (15,000)     15,000         --
Cash received on collection of common
 stock subscription receivable............           --          --     25,000
Net cash received from sale of preferred
 stock....................................           --     239,918         --
-------------------------------------------------------------------------------
Net cash provided by financing activi-
 ties.....................................    6,120,670     334,301      6,935
-------------------------------------------------------------------------------
Net increase in cash and cash equiva-
 lents....................................    1,221,274     182,649      6,599
Cash and cash equivalents at beginning of
 period...................................      198,317      15,668      9,069
-------------------------------------------------------------------------------
Cash and cash equivalents at end of peri-
 od.......................................  $ 1,419,591  $  198,317  $  15,668
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Income taxes paid.........................  $        --  $    2,000  $      --
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Interest paid.............................  $    36,388  $    8,840  $   2,721
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Equipment acquired through capitalized
 lease obligations........................  $        --  $   14,080  $      --
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
 
                            See accompanying notes.
 
                                       24
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                         NOTES TO FINANCIAL STATEMENTS
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
DESCRIPTION OF BUSINESS
 
  fine.com International Corp. (the "Company"), formerly fine.com Corporation,
was incorporated in the State of Washington on October 15, 1994. The Company
plans, develops, maintains and hosts World Wide Web ("Web") sites for major
national and international corporate clients and others, utilizing marketing
expertise and state of the art interactive database compilation and
dissemination techniques and technologies.
 
USE OF ESTIMATES
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
REVENUE RECOGNITION
 
  The Company accounts for long-term contracts under the percentage-of-
completion method. Estimated contract earnings are reviewed periodically as
work progresses. If such estimates indicate a loss would be incurred on the
contract, the estimated amount of such loss would be recognized in the period
the estimated loss was determined. All other revenue is recorded on the basis
of time and material for the performance of services.
 
RISKS AND UNCERTAINTIES
 
  Financial instruments which potentially subject the Company to a
concentration of credit risk consist principally of accounts receivable. The
Company's customer base is dispersed across many different geographic areas
throughout the United States in a variety of industries. The Company does not
require collateral or other security to support credit sales, but provides an
allowance for bad debts based on historical experience and specific
identification. The following is a detail of customers which accounted for
greater than 10% of gross revenue in the respective fiscal years:
 
<TABLE>
<CAPTION>
                                            FISCAL YEAR ENDED JANUARY 31,
                                          ---------------------------------
CUSTOMER                                     1998        1997        1996
---------------------------------------------------------------------------
<S>                                       <C>         <C>         <C>
Microsoft Corporation..................        22%         19%         34%
Marriott International, Inc............        15          --          --
The Nasdaq Stock Market, Inc...........        12          --          --
Safeway Inc............................        12          14          --
Twentieth Century Fox Home
 Entertainment, Inc. ..................          4          11          --
</TABLE>
 
CASH AND CASH EQUIVALENTS
 
  The Company considers highly liquid investments with an original maturity of
three months or less to be cash equivalents. Excess cash is primarily invested
in treasury bills, securities of government agencies, and commercial paper.
Cash equivalents are carried at amortized cost, which approximates fair market
value.
 
MARKETABLE SECURITIES
 
  Marketable securities, which consist primarily of U.S. Government agency
securities, are carried at market value. Market values are determined based on
quoted prices. Marketable securities are classified in the balance sheet as
current and non-current based on maturity dates and the Company's expectation
of sales and redemptions in the following year.
 
                                      25
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
EQUIPMENT AND FURNITURE
 
  Equipment and furniture are recorded at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of three to seven years. Leasehold improvements are amortized
over the lesser of the lease term or estimated useful life. Repairs and
maintenance that do not improve or extend the lives of the respective assets
are expensed in the period incurred.
 
INCOME TAXES
 
  The Company accounts for income taxes under the liability method. Under the
liability method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and
liabilities, and are measured using the enacted tax rates and laws that will
be in effect when the differences are expected to reverse. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amounts expected to be realized.
 
STOCK-BASED COMPENSATION
 
  The Company has elected to apply the disclosure only provisions of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (Statement No. 123) (see Note 8). Accordingly, the Company
accounts for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Compensation cost for
stock options is measured as the excess, if any, of the fair value of the
Company's common stock at the date of grant over the stock option exercise
price.
 
ADVERTISING
 
  Advertising costs are expensed as incurred. Advertising expense was $24,382,
$20,805 and $5,438 in the fiscal years ended January 31, 1998, 1997 and 1996,
respectively.
 
NET INCOME PER SHARE
 
  In February 1997, the Financial Accounting Standards Board issued a
Statement No. 128, "Earnings Per Share." Statement No. 128 replaced the
calculation of the primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. Common equivalent shares are
excluded from the computation if their effect is antidilutive. All earnings
per share amounts for all periods have been presented, and where appropriate,
restated to conform to the Statement No. 128 requirements.
 
  In February 1998, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 98 ("SAB 98"). SAB 98 changed the rules related to the
way a company calculates earnings per share prior to the time of an initial
public offering ("IPO"). Accordingly, the Company has restated all earnings
per share calculations for all periods prior to its IPO in August 1997. Fully
diluted earnings per share calculated under the old rules were $0.11 and $0.03
in fiscal 1997 and 1996, respectively.
 
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
 
  The FASB issued Statement No. 130, "Reporting Comprehensive Income" and
Statement No. 131, "Disclosures About Segments of an Enterprise and Related
Information." Statement No. 130 established standards for reporting
comprehensive income in annual and interim financial statements. Statement
No. 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those
 
                                      26
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. The Company will adopt Statement No. 130 and 131 in fiscal 1999 and
does not anticipate any impact on the Company's consolidated results of
operations, financial position or cash flows.
 
2. MARKETABLE SECURITIES
 
  Management determines the appropriate classification of debt securities at
the time of purchase and reevaluates such designation as of each balance sheet
date. Management has classified the Company's marketable securities as
available-for-sale, in accordance with the provisions of Statement No. 115.
Accordingly the securities are carried at fair value, with unrealized holding
gains and losses, net of income taxes, excluded from net income and recorded
as an adjustment to shareholder's equity. Interest, dividends and realized
gains and losses are included in net income.
 
  The following is a summary of marketable securities at January 31, 1998, all
of which are classified as available-for-sale:
 
<TABLE>
<CAPTION>
                                                  GROSS      GROSS
                                   AMORTIZED UNREALIZED UNREALIZED   ESTIMATED
                                        COST      GAINS     LOSSES  FAIR VALUE
------------------------------------------------------------------------------
<S>                               <C>        <C>        <C>         <C>
Due in one year or less.......... $1,621,144     $   --   $(28,112) $1,593,032
Due after one year through three
 years...........................  2,341,815      5,147    (21,726)  2,325,236
------------------------------------------------------------------------------
                                  $3,962,959     $5,147   $(49,838) $3,918,268
------------------------------------------------------------------------------
------------------------------------------------------------------------------
</TABLE>
 
3. ALLOWANCE FOR DOUBTFUL ACCOUNTS
 
  Activity in the allowance for doubtful accounts is summarized as follows:
 
<TABLE>
<CAPTION>
                                                               JANUARY 31,
                                                          ---------------------
                                                             1997   1996   1995
-------------------------------------------------------------------------------
<S>                                                       <C>     <C>    <C>
Beginning balance........................................ $ 5,000 $5,000 $5,000
Additions charged to expense.............................  30,583     --     --
Write-offs, net..........................................      --     --     --
-------------------------------------------------------------------------------
Ending balance........................................... $35,583 $5,000 $5,000
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
 
4. EQUIPMENT AND FURNITURE
 
  Equipment and furniture consist of the following:
 
<TABLE>
<CAPTION>
                                                               JANUARY 31,
                                                            -------------------
                                                                 1998      1997
--------------------------------------------------------------------------------
<S>                                                         <C>        <C>
Computer equipment......................................... $ 384,647  $129,765
Office furniture and equipment.............................   136,537    13,047
Leasehold Improvements.....................................    64,808        --
--------------------------------------------------------------------------------
                                                              585,992   142,812
Accumulated depreciation and amortization..................  (150,271)  (61,985)
--------------------------------------------------------------------------------
                                                            $ 435,721  $ 80,827
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
 
 
                                      27
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
5. NOTE PAYABLE TO BANK
 
  The Company has a Revolving Line of Credit with a commercial bank for
$750,000 which expires on June 30, 1998, and is secured by all accounts
receivable and the personal guarantee of the Company's Chairman and Chief
Executive Officer. The Company is negotiating for renewal of the Revolving
Line of Credit through fiscal 1999. Amounts outstanding under the Revolving
Line of Credit bear interest at the bank's prime interest rate plus 0.25%
(effective rate of 8.75% at January 31, 1998). At January 31, 1998, no amounts
were outstanding under the Revolving Line of Credit.
 
  At January 31, 1997, the Company had a $200,000 Revolving Line of Credit
which expired on March 31, 1997, and was replaced with the new $750,000 credit
agreement. Borrowings under this agreement bore interest at the bank's prime
interest rate plus 2% (effective rate of 10.25% at January 31, 1997). At
January 31, 1997, $90,286 was outstanding under this agreement. This
obligation was collateralized by eligible accounts receivable.
 
  The Revolving Line of Credit requires that the Company maintain working
capital amounts (as calculated therein), tangible net worth and the maximum
capital expenditures (as defined therein). The Revolving Line of Credit limits
the Company's ability to incur additional debt, to repurchase the Company's
capital stock or amend its capital structure, to pay cash dividends or to
undergo a merger, consolidation or liquidation. In addition, a change in
ownership of twenty-five percent of the common stock constitutes an event of
default. The Company met all Revolving Line of Credit covenants at January 31,
1998.
 
6. LEASE COMMITMENTS
 
  The Company leases certain equipment and facilities under capital and
operating leases. The operating leases contain annual escalation clauses based
on inflation.
 
  The Company sublets a portion of its office space and offsets rent expense
through sublease billings. Net rent expense under the operating lease amounted
to $74,326, $60,230 and $15,996 in fiscal 1998, 1997 and 1996, respectively.
 
  Future minimum lease payments under noncancelable leases with terms in
excess of one year and premises with contractual subleases at January 31,
1998, are as follows:
 
<TABLE>
<CAPTION>
                                                    LEASES  SUBLEASE         NET
--------------------------------------------------------------------------------
<S>                                             <C>        <C>        <C>
1999........................................... $  238,118 $ (95,995) $  142,123
2000...........................................    271,849   (97,893)    173,956
2001...........................................    274,733   (97,893)    176,840
2002...........................................    200,957   (18,110)    182,847
2003...........................................    182,595        --     182,595
Thereafter.....................................    446,923        --     446,923
--------------------------------------------------------------------------------
                                                $1,615,175 $(309,891) $1,305,284
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
 
                                      28
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
7. INCOME TAXES
 
  The provision for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                                  FISCAL YEAR ENDED JANUARY 31,
                                                  ------------------------------
                                                       1998      1997       1996
--------------------------------------------------------------------------------
<S>                                               <C>       <C>        <C>
Current.......................................... $      -- $      (4) $   1,220
Deferred.........................................    46,567    64,458     13,728
--------------------------------------------------------------------------------
                                                  $  46,567 $  64,454  $  14,948
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
 
  The provision for income taxes differs from the amount computed by applying
the federal statutory income tax rate to income before taxes as follows:
 
<TABLE>
<CAPTION>
                                                  FISCAL YEAR ENDED JANUARY 31,
                                                  -----------------------------
                                                       1998      1997      1996
--------------------------------------------------------------------------------
<S>                                               <C>       <C>       <C>
Computed tax at federal statutory rate........... $  43,265 $  64,168 $  15,310
Other items, net.................................     3,302       286      (362)
--------------------------------------------------------------------------------
                                                  $  46,567 $  64,454 $  14,948
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
 
  The Company has elected to use the cash method of accounting for income tax
purposes because it currently qualifies for the small business exception. This
exception allows corporate taxpayers to use the cash method of accounting if
their gross receipts over the three immediately preceding taxable years do not
exceed $5,000,000 and they meet certain other requirements. The Company will
convert to the accrual method for income tax purposes when it no longer
satisfies the criteria for this exception. Deferred 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 net deferred income tax liabilities
are as follows:
 
<TABLE>
<CAPTION>
                                                              JANUARY 31,
                                                          --------------------
                                                               1998       1997
-------------------------------------------------------------------------------
<S>                                                       <C>        <C>
Deferred tax liabilities:
  Tax over book depreciation............................. $  (4,402) $  (3,354)
  Accrual to cash basis adjustments......................  (336,771)  (100,769)
-------------------------------------------------------------------------------
                                                           (341,173)  (104,123)
Deferred tax assets:
  Net operating loss carryforward........................   224,720     34,237
  Unrealized loss on marketable securities...............    14,434         --
-------------------------------------------------------------------------------
                                                            239,154     34,237
-------------------------------------------------------------------------------
Net deferred tax liabilities............................. $(102,019) $ (69,886)
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Balance sheet classification:
  Non-current assets..................................... $ 220,318  $  30,883
  Current liabilities....................................  (322,337)  (100,769)
-------------------------------------------------------------------------------
Net deferred tax liabilities............................. $(102,019) $ (69,886)
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
 
  At January 31, 1998, the Company had net operating loss carryforwards of
approximately $695,000 which begin to expire in 2011. Utilization of net
operating loss carryforwards may be subject to certain limitations under
Section 382 of the Internal Revenue Code of 1986, as amended.
 
                                      29
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
8. SHAREHOLDERS' EQUITY
 
CONVERTIBLE PREFERRED STOCK
 
  On January 31, 1997, the Company completed a private placement for the
issuance and sale of 59,524 shares of Series A Convertible Preferred Stock of
the Company for $250,000 less offering costs of $10,082. Upon the
effectiveness of the Company's Registration Statement relating to the
Company's initial public offering of the common stock, all outstanding shares
of the Series A Convertible Preferred Stock automatically converted into
shares of common stock, at a one-to-one conversion ratio. In addition, upon
the effective date of the Registration Statement, the authority of the Company
to issue preferred stock terminated and the number of authorized shares of
preferred stock were converted into additional authorized shares of common
stock.
 
INITIAL PUBLIC OFFERING
 
  On August 15, 1997, the Company completed its initial public offering and
issued 1,100,000 shares of common stock to the public at an initial public
offering price of $6.50 per share. On August 25, 1997, pursuant to the
exercise of an over-allotment option granted to the underwriters in the
Company's initial public offering, the Company issued an additional 165,000
shares of common stock at a price of $6.50 per share. Proceeds to the Company,
net of offering expenses of $1,994,458, amounted to $6,228,042.
 
  Immediately prior to the date of the initial public offering of the
Company's common stock, the Company had authorized capital stock consisting of
9,000,000 shares of common stock, of which 1,055,541 shares were issued and
outstanding, and 1,000,000 shares of preferred stock, of which 59,524 shares
were designated as Series A Convertible Preferred Stock, all of which were
issued and outstanding. On the effective date of the Registration Statement
relating to the initial public offering of the Company's common stock, the
issued and outstanding shares of Series A Convertible Preferred Stock
automatically converted into 59,524 shares of common stock. Additionally, on
such date, all authorized shares of preferred stock automatically converted
into additional authorized shares of common stock and, as a result, the
Company's authorized capital stock, on such date, consisted solely of
10,000,000 shares of common stock.
 
  In connection with the initial public offering, the Company agreed to sell
warrants to the underwriters for $110. The underwriters' warrants entitle them
to purchase 110,000 shares at $8.775 per share. The warrants are limited to a
term of five years beginning August 11, 1997, and are exercisable for a four
year period commencing August 11, 1998.
 
STOCK OPTION PLAN
 
  In February 1996, the Board of Directors approved the 1996 Incentive Stock
Option Plan (the "1996 Plan") that provides for the issuance of nonqualified
and incentive stock options to officers, employees, and consultants. In April
1997, the Company adopted the 1997 Option Plan (the "1997 Plan") and reserved
200,000 shares of common stock for issuance thereunder. The 1997 Plan provides
for the grant of both incentive stock options and nonqualified stock options.
A committee of the Board of Directors determines the terms and conditions of
options granted under the Plans, including the exercise price. The exercise
price for incentive stock options shall not be less than the fair market value
of common stock at the date of grant unless the incentive stock option is
granted to a person who owns greater than 10% of the Company for which the
exercise price shall not be less than 110% of the fair market value at the
date of grant. The exercise price of nonqualified stock options shall not be
less than 85% of the fair market value of the common stock at the date of
grant. Pursuant to the terms of the Underwriting Agreement with the Company's
underwriters in the initial public offering, the Company has agreed to grant
options under the 1997 Plan at not less than the IPO price per share of $6.50
for a period of 18 months following the effective date of the Registration
Statement.
 
                                      30
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
  Options expire between 5 and 10 years from the date of grant. Subject to the
maintenance of a continuous relationship from the date of grant, options vest
according to a schedule which provides that 5% of the total number of shares
granted will vest after one year, 15% will vest after two years, 30% after
three years, 50% is vested after four years, and the option grant is fully
vested after five years from the date of grant. Options granted under the 1996
Plan and which are subsequently canceled, do not revert back to the option
pool. Options which are granted under the 1997 Plan and are subsequently
canceled, revert back to the option pool.
 
  A summary of stock option activity follows:
 
<TABLE>
<CAPTION>
                                                       OUTSTANDING OPTIONS
                                                     -------------------------
                                                                      WEIGHTED
                                             SHARES                    AVERAGE
                                      AVAILABLE FOR     NUMBER OF     EXERCISE
                                              GRANT        SHARES       PRICES
------------------------------------------------------------------------------
<S>                                   <C>            <C>            <C>
Balance at February 1, 1996..........            --            --           --
1996 Plan introduction...............       107,157            --           --
Granted in fiscal 1997...............      (107,157)      107,157     $   2.05
------------------------------------------------------------------------------
Balance at January 31, 1997
 (exercisable 4,028).................            --       107,157         2.05
1997 Plan introduction...............       200,000            --           --
Granted in fiscal 1998...............       (90,793)       90,793         6.50
Canceled in fiscal 1998..............        15,000       (31,642)        4.16
------------------------------------------------------------------------------
Outstanding at January 31, 1998
 (exercisable 4,525).................       124,207       166,308         4.08
------------------------------------------------------------------------------
------------------------------------------------------------------------------
</TABLE>
 
  The following table summarizes information concerning currently outstanding
and exercisable options at January 31, 1998:
 
<TABLE>
<CAPTION>
                                                                 WEIGHTED
                              WEIGHTED WEIGHTED                   AVERAGE
                               AVERAGE  AVERAGE                  EXERCISE
EXERCISE       NUMBER        REMAINING EXERCISE      NUMBER    PRICES FOR
  PRICES  OUTSTANDING CONTRACTUAL LIFE   PRICES EXERCISABLE SHARES VESTED
-------------------------------------------------------------------------
<S>       <C>         <C>              <C>      <C>         <C>
   $2.05       90,515        8.5 years    $2.05       4,525         $2.05
    6.50       75,793        9.7 years     6.50          --          6.50
-------------------------------------------------------------------------
              166,308        9.1 years     4.08       4,525          2.05
-------------------------------------------------------------------------
-------------------------------------------------------------------------
</TABLE>
 
COMMON STOCK RESERVED
 
  Common stock reserved for future issuance was as follows:
 
<TABLE>
<CAPTION>
                                                                JANUARY 31, 1998
                                                                ----------------
     <S>                                                        <C>
     Stock options............................................           290,515
     Common stock warrants....................................           110,000
--------------------------------------------------------------------------------
                                                                         400,515
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
 
PRO FORMA INFORMATION FOR STOCK-BASED COMPENSATION
 
  Pro forma information regarding net income per share is required by
Statement No. 123, and has been determined as if the Company had accounted for
its employee stock options under the fair value method of that Statement. The
value for these options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted average assumptions:
 
<TABLE>
<CAPTION>
                                                                   1998    1997
-------------------------------------------------------------------------------
<S>                                                         <C>           <C>
Expected dividend yield....................................           0%     0%
Expected stock price volatility............................ 0.437-0.676    N/A
Risk-free interest rate....................................    5.7%-6.5%   6.5%
Expected life of options in years..........................         5.0    7.0
</TABLE>
 
                                      31
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
  For purposes of pro forma disclosures, the estimated weighted average value
of the options granted of $2.32 and $0.75 per share during 1998 and 1997,
respectively, is amortized to expense over the options' vesting period. During
the phase in period of Statement No. 123, which has been applied only for
options granted beginning in 1997, the effects of applying the Statement for
providing pro forma disclosure are not indicative of future amounts until the
new rules are applied to all outstanding nonvested awards. The Company's pro
forma information is as follows (in thousands except per share amounts):
 
<TABLE>
<CAPTION>
                                                                 JANUARY 31,
                                                               ----------------
                                                                  1998     1997
-------------------------------------------------------------------------------
<S>                                                            <C>     <C>
Net income-as reported........................................ $80,682 $124,274
Net income-pro forma..........................................  51,682  112,274
Diluted earnings per share-as reported........................ $  0.05 $   0.11
Diluted earnings per share-pro forma..........................    0.03     0.10
</TABLE>
 
9. TRANSACTIONS WITH OFFICERS AND DIRECTORS
 
  At January 31, 1998 and 1997, the Company had a note receivable from an
officer which was non-interest bearing. Additionally, the Company had a note
payable to a director bearing interest at 9%; this note was repaid in March
1997.
 
10. EARNINGS PER SHARE
 
  The following table sets forth the computation of basic and diluted earnings
per share:
 
<TABLE>
<CAPTION>
                                                FISCAL YEAR ENDED JANUARY 31,
                                               --------------------------------
                                                     1998       1997       1996
-------------------------------------------------------------------------------
<S>                                            <C>        <C>        <C>
Numerators:
  Net income.................................  $   80,682 $  124,274 $   30,082
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Denominators:
Denominator for basic earnings per share--
 Weighted average common stock...............   1,669,303  1,055,541  1,055,541
 
Effect of dilutive securities:
 Weighted average convertible preferred
 stock.......................................      31,234        163         --
 Employee stock options......................      63,438     17,084         --
-------------------------------------------------------------------------------
Denominator for diluted earnings per share--
 Adjusted weighted average shares and assumed
 conversions.................................   1,763,975  1,072,788  1,055,541
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Basic earnings per share.....................  $     0.05 $     0.12 $     0.03
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Diluted earnings per share...................  $     0.05 $     0.12 $     0.03
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
 
                                      32
<PAGE>
 
                         FINE.COM INTERNATIONAL CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
11. SUBSEQUENT EVENT
 
ACQUISITION OF PACIFIC ANALYSIS AND COMPUTING CORPORATION
 
  On February 13, 1998, the Company entered into an agreement for the merger
of Pacific Analysis and Computing Corporation with and into the Company. The
Company issued 35,870 shares of its common stock valued at $143,480 in
exchange for all outstanding Pacific Analysis shares. The transaction was a
tax-free reorganization and will be accounted for under the purchase method of
accounting. The purchase price is expected to be allocated to assets acquired
and liabilities assumed based on their fair value at the date of acquisition
as follows:
 
<TABLE>
<S>                                                                    <C>
Property and equipment................................................ $ 85,630
Net current assets....................................................   27,850
Other.................................................................   30,000
-------------------------------------------------------------------------------
                                                                       $143,480
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
 
 
12. QUARTERLY FINANCIAL DATA (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                               EARNINGS (LOSS)
                                                                  PER SHARE(1)
                                                   NET INCOME -----------------
                        GROSS REVENUE GROSS PROFIT     (LOSS)   BASIC   DILUTED
-------------------------------------------------------------------------------
<S>                     <C>           <C>          <C>        <C>      <C>
Fiscal 1998:
  1st Quarter..........  $  811,433    $  257,491   $ 43,424  $  0.04  $  0.04
  2nd Quarter..........     752,966       205,913     27,868     0.03     0.02
  3rd Quarter..........   1,001,146       401,344     79,637     0.04     0.03
  4th Quarter..........     882,539       291,130    (70,247)   (0.03)   (0.03)
-------------------------------------------------------------------------------
                         $3,448,084    $1,155,878   $ 80,682
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Fiscal 1997:
  1st Quarter..........  $  225,737    $   96,808   $  3,891  $  0.00  $  0.00
  2nd Quarter..........     266,391       123,414      2,652     0.00     0.00
  3rd Quarter..........     318,006       125,831      1,228     0.00     0.00
  4th Quarter..........     675,735       365,574    116,503     0.11     0.11
-------------------------------------------------------------------------------
                         $1,485,869    $  711,627   $124,274
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
(1) The sum of earnings (loss) per share on a quarterly basis will not
    necessarily equal the earnings per share reported for the year since the
    average shares and share equivalents used in the earnings per share
    computation changes throughout the year.
 
                                      33
<PAGE>
 
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE
 
  None.
 
                                   PART III
 
  The information called for by Items 9 through 12 of Part III is included in
the Registrant's Proxy Statement and is incorporated herein by reference. The
information appears in the Proxy Statement under the captions "Election of
Directors," "Security Ownership of Directors, Executive Officers and Certain
Beneficial Owners," "Executive Compensation" and "Certain Transactions."
 
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
 
  (a) Exhibits
 
<TABLE>
<CAPTION>
   EXHIBIT NUMBER                         DESCRIPTION
   --------------                         -----------
   <C>            <S>
       3.1*       Articles of Incorporation, as amended
       3.1A**     Amendment to Articles of Incorporation filed April 2, 1998
       3.2*       Bylaws
       4.1*       Specimen Common Stock Certificate
       4.2*       Form of Representative's Warrant (included as Exhibit A to
                  Representative's Warrant Agreement filed as Exhibit 10.9)
      10.1*       Incentive Stock Option Plan
      10.2*       1997 Stock Option Plan
      10.3*       Employment Agreement dated May 9, 1997 with Daniel M. Fine
      10.4*       Employment Agreement dated May 9, 1997 with James P.
                  Chamberlin
      10.5A*      Loan Agreement dated March 31, 1997 with U.S. Bank of
                  Washington
      10.5B*      Promissory Note in principal amount of $750,000 dated March
                  31, 1997
      10.5C*      Commercial Security Agreement dated March 31, 1997 for
                  $750,000 revolving line of credit
      10.5D*      Commercial Guaranty of Daniel M. Fine dated March 22, 1997
                  with U.S. Bank of Washington
      10.6A*      Office Lease Agreement dated February 28, 1996 with Grand
                  Pacific Limited Partnership (former corporate headquarters)
      10.6B*      Personal Guaranty of Daniel M. Fine dated February 29, 1997
      10.6C*      First Amendment to Office Lease Agreement dated March 1997
      10.6D       Sublease Agreement dated September 15, 1997 with Data Base
                  Designs, Inc.
      10.7A       Lease Agreement dated November 19, 1997 with Third Avenue
                  Associates (current corporate headquarters)
      10.7B       Amendment No. 1 to Lease Agreement, dated December 29, 1997
      10.7C       Personal Guaranty of Daniel M. Fine for Office Lease, dated
                  November 20, 1997
      10.8A       Lease Agreement dated August 31, 1995 between Pacific
                  Analysis and Computer Corporation and Amber Jack Ltd.
      10.8B       Sublease Agreement dated July 31, 1997 with Haralson & Co.,
                  P.C.
      10.9*       Form of Representative's Warrant Agreement
</TABLE>
 
                                      34
<PAGE>
 
<TABLE>
<CAPTION>
   EXHIBIT NUMBER                        DESCRIPTION
   --------------                        -----------
   <C>            <S>
        11.1      Statement Regarding Computation of Net Income per Share
                  (included in Note 10 to "Notes to Financial Statements.")
        21.1      List of Subsidiaries of fine.com International Corp.
 
 
        27.1      Financial Data Schedule
</TABLE>
--------
 * Incorporated herein by reference from Item 27 of Registrant's Form SB-2
   (No. 333-26855).
** Incorporated herein by reference from Exhibit to Form 8-K filed April 13,
   1998.
 
  (b) No reports on Form 8-K were filed during the last quarter of the fiscal
year ended January 31, 1998.
 
                                      35
<PAGE>
 
                                  SIGNATURES
 
  IN ACCORDANCE WITH SECTION 13 OR 15(d) OF THE EXCHANGE ACT, THE REGISTRANT
CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO
DULY AUTHORIZED ON APRIL 30, 1998.
 
                                          fine.com International Corp.
 
                                                     /s/ Daniel M. Fine
                                          By: _________________________________
                                             Daniel M. Fine, Chief Executive
                                                         Officer
 
  IN ACCORDANCE WITH THE EXCHANGE ACT, THIS REPORT HAS BEEN SIGNED BELOW BY
THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES
INDICATED ON APRIL 30, 1998.
 
 /s/ Daniel M. Fine                        /s/ James P. Chamberlin
-------------------------------------     -------------------------------------
Daniel M. Fine                            James P. Chamberlin
Chairman, Chief Executive Officer         Chief Financial Officer, Chief
 and Director                              Operating Officer and Director
(principal executive officer)             (principal financial and accounting
                                           officer)                           
 
                                       
 /s/ Herbert L. Fine                       /s/ Frank Hadam
-------------------------------------     -------------------------------------
Herbert L. Fine                           Frank Hadam
Director                                  Director
 
                                       
 /s/ Norman W. Lauchner                    /s/ Anthony C. Naughtin
-------------------------------------     -------------------------------------
Norman W. Lauchner                        Anthony C. Naughtin
Director                                  Director
 
 
                                      36
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                               DESCRIPTION
-----------------------------------------------------------------------------
 <C>     <S>
  3.1*   Articles of Incorporation, as amended
  3.1A** Amendment to Articles of Incorporation filed April 2, 1998
  3.2*   Bylaws
  4.1*   Specimen Common Stock Certificate
  4.2*   Form of Representative's Warrant (included as Exhibit A to
         Representative's Warrant Agreement filed as Exhibit 10.9)
 10.1*   Incentive Stock Option Plan
 10.2*   1997 Stock Option Plan
 10.3*   Employment Agreement dated May 9, 1997 with Daniel M. Fine
 10.4*   Employment Agreement dated May 9, 1997 with James P. Chamberlin
 10.5A*  Loan Agreement dated March 31, 1997 with U.S. Bank of Washington
 10.5B*  Promissory Note in principal amount of $750,000 dated March 31, 1997
 10.5C*  Commercial Security Agreement dated March 31, 1997 for $750,000
         revolving line of credit
 10.5D*  Commercial Guaranty of Daniel M. Fine dated March 22, 1997 with U.S.
         Bank of Washington
 10.6A*  Office Lease Agreement dated February 28, 1996 with Grand Pacific
         Limited Partnership (former corporate headquarters)
 10.6B*  Personal Guaranty of Daniel M. Fine dated February 29, 1997
 10.6C*  First Amendment to Office Lease Agreement dated March 1997
 10.6D   Sublease Agreement dated September 15, 1997 with Data Base Designs,
         Inc.
 10.7A   Lease Agreement dated November 19, 1997 with Third Avenue Associates
         (current corporate headquarters)
 10.7B   Amendment No. 1 to Lease Agreement, dated December 29, 1997
 10.7C   Personal Guaranty of Daniel M. Fine for Office Lease, dated November
         20, 1997
 10.8A   Lease Agreement dated August 31, 1995 between Pacific Analysis and
         Computer Corporation and Amber Jack Ltd.
 10.8B   Sublease Agreement dated July 31, 1997 with Haralson & Co., PC
 10.9*   Form of Representative's Warrant Agreement
 11.1    Statement Regarding Computation of Net Income per Share (included in
         Note 10 to "Notes to Financial Statements.")
 21.1    List of Subsidiaries of fine.com International Corp.
 27.1    Financial Data Schedule
</TABLE>
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 * Incorporated herein by reference from Item 27 of Registrant's Form SB-2 (No.
   333-26855).
** Incorporated herein by reference from Exhibit to Form 8-K filed April 13,
   1998.