<PAGE>   1
 
     AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 22, 1998
 
                                                 REGISTRATION NO. 333-
================================================================================
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------
 
                                    FORM S-1
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933

                            ------------------------
 
                          EXCHANGE APPLICATIONS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                          <C>                                        <C>
               DELAWARE                                 7373                                04-3338916
   (STATE OR OTHER JURISDICTION OF          (PRIMARY STANDARD INDUSTRIAL                 (I.R.S. EMPLOYER
    INCORPORATION OR ORGANIZATION)          CLASSIFICATION CODE NUMBERS)               IDENTIFICATION NO.)
</TABLE>
 
                                89 SOUTH STREET
                          BOSTON, MASSACHUSETTS 02111
                                 (617) 737-2244
  (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
                   REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

                            ------------------------
 
                               ANDREW J. FRAWLEY
                        CHAIRMAN OF THE BOARD, PRESIDENT
                          AND CHIEF EXECUTIVE OFFICER
                          EXCHANGE APPLICATIONS, INC.
                                89 SOUTH STREET
                          BOSTON, MASSACHUSETTS 02111
                                 (617) 737-2244
 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
                             OF AGENT FOR SERVICE)
                            ------------------------
 
                                with copies to:
 <TABLE>
<S>                                                                       <C>
                 NEIL W. TOWNSEND, ESQ.                                   DAVID C. CHAPIN, ESQ.
                    BINGHAM DANA LLP                                           ROPES & GRAY
                   150 FEDERAL STREET                                    ONE INTERNATIONAL PLACE
              BOSTON, MASSACHUSETTS 02110                              BOSTON, MASSACHUSETTS 02110
                     (617) 951-8000                                           (617) 951-7000
              FACSIMILE NO. (617) 951-8736                             FACSIMILE NO. (617) 951-7050
</TABLE>
                             ------------------------
 
    APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:  As soon as
practicable after the effective date of this Registration Statement.
    If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box.  [ ]
    If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering.  [ ]
    If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the same
offering.  [ ]
    If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box.  [ ]

                            ------------------------
 
                        CALCULATION OF REGISTRATION FEE
 
<TABLE>
<CAPTION>
=================================================================================================================================
                                           AMOUNT             PROPOSED MAXIMUM        PROPOSED MAXIMUM
     TITLE OF EACH CLASS OF                TO BE               OFFERING PRICE        AGGREGATE OFFERING          AMOUNT OF
   SECURITIES TO BE REGISTERED         REGISTERED(1)            PER SHARE(2)              PRICE(2)            REGISTRATION FEE
---------------------------------------------------------------------------------------------------------------------------------
<S>                                      <C>                      <C>                   <C>                      <C>
Common Stock, $0.001 par value
  per share......................        3,450,000                 $16.00               $55,200,000               $16,284
=================================================================================================================================
</TABLE>
 
(1) Includes 450,000 shares subject to the Underwriters' over-allotment option.
    See "Underwriting."
 
(2) Estimated solely for the purpose of calculating the registration fee in
    accordance with Rule 457 under the Securities Act of 1933, as amended.

                            ------------------------
 
    THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
================================================================================
<PAGE>   2
 
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
 
                   SUBJECT TO COMPLETION, DATED JULY 22, 1998
 
                                3,000,000 SHARES
 
                          [EXCHANGE APPLICATION LOGO]

                                  COMMON STOCK
                          (PAR VALUE $.001 PER SHARE)

                             ----------------------
 
     Of the 3,000,000 shares of Common Stock offered hereby, 2,000,000 shares
are being sold by the Company and 1,000,000 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders". The Company will not
receive any of the proceeds from the sale of the shares being sold by the
Selling Stockholders.
 
     Prior to this Offering, there has been no public market for the Common
Stock of the Company. It is currently estimated that the initial public offering
price per share will be between $14.00 and $16.00. For factors considered in
determining the initial public offering price, see "Underwriting".
 
     SEE "RISK FACTORS" COMMENCING ON PAGE 4 FOR CERTAIN CONSIDERATIONS RELEVANT
TO AN INVESTMENT IN THE COMMON STOCK.
 
     The Company intends to apply for quotation and trading of the Common Stock
on the Nasdaq National Market under the symbol "EXAP".

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

    THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
       AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
               UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
           ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

                             ----------------------
 <TABLE>
<CAPTION>
                                 INITIAL PUBLIC       UNDERWRITING         PROCEEDS TO      PROCEEDS TO SELLING
                                 OFFERING PRICE        DISCOUNT(1)         COMPANY(2)           STOCKHOLDERS
                                 --------------       ------------         -----------      -------------------
<S>                                   <C>                 <C>                 <C>                  <C>
Per Share....................           $                   $                   $                    $
Total(3).....................         $                   $                   $                    $
</TABLE>
 
---------------
(1) The Company and the Selling Stockholders have agreed to indemnify the
    Underwriters against certain liabilities, including liabilities under the
    Securities Act of 1933.
(2) Before deducting estimated expenses of $1,000,000 payable by the Company.
(3) The Company has granted the Underwriters an option for 30 days to purchase
    up to an additional 450,000 shares at the initial public offering price per
    share, less the underwriting discount, solely to cover over-allotments. If
    such option is exercised in full, the total initial public offering price,
    underwriting discount and proceeds to Company will be $          ,
    $          and $          , respectively. See "Underwriting".

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

     The shares offered hereby are offered severally by the Underwriters, as
specified herein, subject to receipt and acceptance by them and subject to their
right to reject any order in whole or in part. It is expected that certificates
for the shares will be ready for delivery in New York, New York on or about
               , 1998, against payment therefor in immediately available funds.

GOLDMAN, SACHS & CO.
                                     BT ALEX. BROWN
                                                               HAMBRECHT & QUIST

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

               The date of this Prospectus is             , 1998.
<PAGE>   3
 
                         CONTINUOUS CUSTOMER MANAGEMENT
                   OPTIMIZING CUSTOMER VALUE THROUGH PROCESS,
                           APPLICATIONS & TECHNOLOGY
 
                                   [ART WORK]
 
[This graphic is a series of diagrams showing the VALEX architecture interfacing
with customer databases and customer touchpoints surrounded by figures depicting
the functional benefits of VALEX.]
 
Continuous Customer Management (CCM) is Exchange Applications' enterprise-wide
offering for customer optimization. The CCM solution, including the Company's
VALEX software and related consulting and integration services, enables
businesses to:
 
 - analyze enterprise-wide databases of customer information
 
 - conduct customer planning to prioritize for opportunity identification
   investment
 
 - execute targeted, real-time and event-triggered customer communication
 
 - select the most effective methods of customer interaction
 
 - perform measurement and analysis to continuously evaluate and refine
   marketing campaigns and their impact on customer profitability







 
Exchange Applications, VALEX, Continuous Customer Management, CCM, Value
Exchange Optimization, Metrics Repository and the Exchange Applications logo are
trademarks of the Company. All other trademarks or tradenames referred to in
this Prospectus are the property of their respective owners.
 
The Company intends to furnish to its stockholders annual reports containing
audited financial statements examined by its independent auditors.
 
     CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE OFFERING.
FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".
<PAGE>   4
OPTIMIZING CUSTOMER VALUE        MANAGING CUSTOMER RELATIONSHIPS OVER TIME
 THROUGH CONTINUOUS CUSTOMER
      MANAGEMENT                      Exchange Applications' Continuous Customer
                                 Management solution enables businesses to
                                 maximize the profitability of their customer 
                                 relationships. Full potential is achieved by 
                                 allocating marketing investments to most 
                                 effectively aquire new customers, expand the 
         [ART WORK]              profitability of existing customers and retain
[This graphic is a               customers longer.
representation of the three
aspects of the Company's
Continuous Customer Management                      [ART WORK]
offering. The graphic is a
dramatization of the use of
VALEX to acquire new customers,
expand purchasing of existing
customers and retain customers        Businesses use VALEX to run campaigns that
longer thereby optimizing        maximize profitability by focusing on key
customer value.]                 elements of a customer relationship. In
                                 the "ACQUIRE" cycle, a prospect is contacted
                                 via direct mail, resulting in the acquisition 
                                 of a new customer. In the "EXPAND" cycle, 
                                 VALEX identifies high potential cross-
                                 selling opportunities to expand customer
                                 relationships with additional product sales.
                                 In the "RETAIN" cycle, VALEX automatically
                                 executes a statistical model, notifying a
                                 customer-care organization that the
                                 customer is at risk of leaving, and enabling 
                                 that customer to be contacted and encouraged
                                 to stay. Customer optimization is achieved by 
                                 simultaneously executing hundreds of these 
                                 campaigns and continuously monitoring customers
                                 to maximize their profitability across the
                                 enterprise.







<PAGE>   5
 
                               PROSPECTUS SUMMARY
 
     The following summary should be read in conjunction with, and is qualified
in its entirety by, the more detailed information and the Consolidated Financial
Statements and Notes thereto appearing elsewhere in this Prospectus. Except as
otherwise noted, all information in this Prospectus, including share and per
share information, assumes: (i) the mandatory conversion into Common Stock of
all outstanding shares of Series B Redeemable Convertible Preferred Stock and
Series C Convertible Preferred Stock (the "Convertible Preferred Stock") upon
the consummation of the Offering; (ii) the cancellation of all outstanding
shares of Series A Redeemable Preferred Stock (the "Series A Preferred Stock")
upon consummation of the Offering; (iii) no exercise of stock options after June
30, 1998; (iv) no exercise of the Underwriters' over-allotment option; and (v)
the amendment and restatement of the Company's Certificate of Incorporation and
By-laws immediately prior to the consummation of the Offering. See "Description
of Capital Stock" and "Underwriting".
 
                                  THE COMPANY
 
     Exchange Applications, Inc. (the "Company") is a leading provider of
customer optimization software and solutions that enable businesses to maximize
profitability and revenue growth from new and existing customers through
marketing automation and enterprise-wide customer management. The Company's
Continuous Customer Management ("CCM") solution, including its VALEX software
and related consulting and integration services, enables businesses to
profitably retain and expand existing customer relationships and acquire new
customers by: (i) analyzing enterprise-wide databases of customer information to
identify profitable growth opportunities; (ii) planning and prioritizing
investments in high potential customers; (iii) creating targeted, real-time and
event-triggered marketing campaigns and other customer communications; (iv)
selecting the most effective channels for customer communications, such as
direct mail, call centers, sales forces and the Internet; and (v) continuously
evaluating the impact of these marketing campaigns and other communications on
profitability. CCM allows businesses to measure the value of these campaigns
against their associated costs, and to use this information to make investment
decisions that maximize customer profitability. The Company has deployed CCM and
VALEX across multiple industries, with installations in over 40 businesses in
North America and Europe. Its customers include Federal Express, Fleet Bank,
NatWest Bank (U.K.) and US West. The Company's products and services are
distributed through its direct sales force, through re-seller relationships with
IBM, NCR and others, and through co-marketing arrangements with companies such
as Compaq, Ernst & Young, KPMG Peat Marwick, PricewaterhouseCoopers, SAS
Institute and Sun Microsystems.
 
     While enterprise resource planning ("ERP"), supply chain management and
other software applications aimed at reducing costs have generally been
successful, businesses have begun to invest in a new class of applications
designed to increase profitability through revenue growth. Many of these new
applications are aimed at enabling businesses to increase revenue by acquiring
new customers and retaining and expanding relationships with existing customers.
These applications facilitate cross-selling and the marketing of bundled
products, new service offerings and differentiated service relationships. The
success of these efforts depends on the ability of businesses to allocate
resources based not only on functional area and product profitability, but also
on current and potential customer profitability. The Company believes there are
significant opportunities in many industries for solutions that realign
businesses' existing marketing and customer management capabilities with new
technologies and processes that utilize complete economic profiles of customers
to optimize customer relationships across the enterprise.
 
     The Company believes that CCM and VALEX represent a fundamentally new
approach to customer optimization. VALEX enables businesses to maximize
profitability by: (i) providing a complete view of the relationship between a
business and its customers; (ii) leveraging a range of data mining, reporting
and modeling products to identify high-value customers; (iii) providing powerful
marketing automation and campaign management software that lets end users define
and
 
                                        1
<PAGE>   6
 
execute targeted customer communication streams; and (iv) integrating with
customer interaction software ("CIS") and data warehouses to perform
enterprise-wide customer management. Through its consulting and integration
services, the Company provides assistance in adopting the CCM solution across
business functions and in rapidly implementing the core VALEX modules. The
Company also provides Metrics Repository, a custom software application that
leverages VALEX to track the success or failure of marketing campaigns across
customer segments and across the enterprise.
 
     The Company's objective is to be the leading provider of customer
optimization software and solutions globally. Key elements of the Company's
strategy include extending VALEX, developing additional customer optimization
solutions, expanding vertical industry focus, broadening distribution channels
and building alliances, and increasing direct sales globally.
 
     The Company commenced operations in November 1994 and was incorporated in
Delaware in November 1996. Unless the context otherwise requires, references in
this Prospectus to the Company refer to Exchange Applications, Inc. and its
subsidiaries. The Company's principal executive offices are located at 89 South
Street, Boston, Massachusetts 02111, and its telephone number is (617) 737-2244.
 
                                  THE OFFERING
 
Common Stock offered by the
Company............................    2,000,000 shares
 
Common Stock offered by the Selling
  Stockholders.....................    1,000,000 shares
 
Common Stock outstanding after the
  Offering(1)......................    9,716,740 shares
 
Proposed Nasdaq National Market
symbol.............................    "EXAP"
 
Use of Proceeds....................    For general corporate purposes, including
                                       working capital, possible reduction of
                                       indebtedness and potential acquisitions.
---------------
(1) Excludes 2,085,408 shares of Common Stock issuable upon exercise of options
    outstanding at July 15, 1998 with exercise prices ranging from $0.65 to
    $14.50 per share and with a weighted average exercise price of $3.10 per
    share. See "Management -- 1996 Stock Incentive Plan" and Note 13 of Notes to
    Consolidated Financial Statements.
 
                                        2
<PAGE>   7
 
                   SUMMARY CONSOLIDATED FINANCIAL INFORMATION
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                                          SIX MONTHS ENDED
                                              YEAR ENDED DECEMBER 31,         JUNE 30,
                                            ---------------------------   -----------------
                                            1995(1)   1996(1)    1997      1997      1998
                                            -------   -------   -------   -------   -------
<S>                                         <C>       <C>       <C>       <C>       <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenues............................  $1,693    $ 6,034   $12,669   $ 4,822   $10,418
Gross profit..............................     681      1,939     5,735     1,662     6,987
Loss from operations......................    (507)    (1,411)   (2,624)   (1,450)   (1,108)
Net loss..................................    (554)    (1,606)   (2,599)   (1,460)   (1,079)
Net loss applicable to common
  stockholders............................    (554)    (1,606)   (3,283)   (2,025)   (1,199)
Pro forma basic and diluted net loss per
  share(2)(3).............................  $(0.19)   $ (0.55)  $ (0.48)  $ (0.31)  $ (0.15)
Pro forma basic and diluted weighted
  average common shares
  outstanding(2)(3).......................   2,925      2,930     5,391     4,683     7,377
</TABLE>
 
<TABLE>
<CAPTION>
                                                                  AS OF JUNE 30, 1998
                                                         --------------------------------------
                                                                                     PRO FORMA
                                                                        PRO         AS ADJUSTED
                                                         ACTUAL       FORMA(3)        (3)(4)
                                                         ------       --------      -----------
<S>                                                      <C>        <C>             <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents, and marketable securities......  $ 4,182      $ 4,182         $31,082
Working capital........................................    3,515        3,515          30,415
Total assets...........................................   12,134       12,134          39,034
Long-term debt, net of current portion.................      128          128             128
Redeemable preferred stock.............................    7,208           --              --
Stockholders' equity (deficit).........................   (1,836)       5,372          32,272
</TABLE>
 
---------------
(1) The Consolidated Statement of Operations Data for the years ended December
    31, 1995 and 1996 include the operations of the Company on a carve-out basis
    prior to November 15, 1996. During this period, the Company operated as a
    separate and substantially independent division of Grant & Partners, Inc.
    and Grant & Partners Limited Partnership, and focused on developing VALEX
    and providing integration and consulting services. See Note 1 of Notes to
    Consolidated Financial Statements.
 
(2) Computed on the basis described in Note 2(c) of the Notes to Consolidated
    Financial Statements.
 
(3) Reflects the reclassification of the Series A Preferred Stock to $3,209,000
    of additional paid-in capital, the conversion of all outstanding shares of
    the Series B Convertible Preferred Stock, at a redemption value of
    $3,999,000, into 2,555,556 shares of Common Stock and the conversion of all
    outstanding shares of Series C Convertible Preferred Stock, at $0.001 par
    value per share, to 1,223,954 shares of Common Stock upon the closing of
    this Offering.
 
(4) Adjusted to reflect the sale of 2,000,000 shares of Common Stock offered by
    the Company at an assumed initial public offering price of $15.00 per share,
    after deducting underwriting discounts and commissions and estimated
    offering expenses payable by the Company.
 
                                        3
<PAGE>   8
 
                                  RISK FACTORS
 
     In addition to the other information in this Prospectus, prospective
purchasers of the Common Stock offered hereby should carefully consider the
following factors in evaluating the Company and its business.
 
LIMITED OPERATING HISTORY; HISTORY OF LOSSES
 
     The Company began operations in 1994, was incorporated in 1996 and has
never achieved profitability. The Company began commercial shipment of its
initial VALEX product in July 1996 and, since such time, has transitioned its
primary business focus from providing services to selling software products. As
a result, the Company and its operations are subject to all of the risks
inherent in the establishment of a new business enterprise. The Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of development,
particularly in new and rapidly evolving markets. To address these risks, the
Company must, among other things, respond to competitive developments, continue
to upgrade its products and continue to attract, retain and motivate qualified
personnel. There can be no assurance that the Company will be successful in
addressing such risks, that the Company's revenues will continue to grow, that
the Company will achieve profitability or, if it does, that the Company will be
able to maintain such profitability on a quarterly or annual basis. See
"-- Dependence Upon Key Personnel", "-- Rapid Technological Change and New
Products" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
 
POTENTIAL FOR SIGNIFICANT FLUCTUATIONS IN QUARTERLY RESULTS
 
     The Company's quarterly revenues, expenses and operating results have
varied significantly in the past and are likely to vary significantly from
quarter to quarter in the future. Because purchase of the Company's products and
services generally involves a significant commitment of capital (ranging from
approximately $100,000 to $3,000,000 in 1997), the length of the sales cycle is
unpredictable and subject to a number of factors over which the Company has
little or no control, including customers' budgetary constraints, timing of
budget cycles and concerns about the introduction of new products by the Company
or its competitors. As a result of these and other factors, the timing of
significant orders may be delayed. A substantial portion of the Company's
revenues in any quarter are typically derived from a limited number of
non-recurring license sales and, like many software companies, the Company tends
to record a significant portion of its software license fee revenues in the last
month of a quarter. In addition, the amount of revenues associated with a
particular license can vary significantly based upon the size of the customer
databases and other factors, including the number of users of the software. The
Company may experience from time to time large, individual license sales which
can cause substantial variations in quarterly license revenues. Moreover, small
delays in customer orders can cause significant variability in the Company's
license revenues and results of operations for any particular period. The
Company establishes its expenditure levels for product development, sales and
marketing and other operating activities based, in large part, on its expected
future revenues. As a result, if revenues fall below expectations, operating
results are likely to be adversely and disproportionately affected because only
a small portion of the Company's expenses vary with its revenues.
 
     Quarterly fluctuations also result from factors such as increased
competition, the timing of new releases of the Company's software products and
market acceptance of such releases, changes in pricing policies of the Company
or its competitors, changes in operating expenses, foreign currency exchange
rate fluctuations and general economic factors. Based upon these and all of the
factors described above, the Company believes that its quarterly revenues,
expenses and operating results are likely to vary significantly in the future,
that period-to-period comparisons of its results of operations are not
necessarily meaningful and that, as a result, such comparisons should not be
relied upon as indications of future performance. Moreover, although the
Company's revenues have increased in recent periods, there can be no assurance
that revenues will continue to grow at past

                                        4
<PAGE>   9
 
rates, if at all, or that the Company will achieve and sustain profitability on
a quarterly or annual basis. As a result, the Company's operating results may
fall below market analysts' expectations in some future quarters, which would
have a material adverse effect on the market price of the Common Stock. See
"Selected Consolidated Financial Data" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
 
PRODUCT CONCENTRATION; DEPENDENCE ON EMERGING MARKET FOR CUSTOMER OPTIMIZATION
SOFTWARE AND SERVICES
 
     The Company currently derives all of its revenues from VALEX licenses and
services related to its Continuous Customer Management ("CCM") solution. The
Company expects that VALEX-related revenues, including CCM services and
maintenance contracts, will continue to account for substantially all of the
Company's revenues for the foreseeable future. As a result, the Company's future
operating results are dependent upon continued market acceptance of VALEX and
CCM and enhancements thereto. There can be no assurance that VALEX and CCM will
achieve continued market acceptance. A decline in demand or market acceptance as
a result of competition, technological change or other factors would have a
material adverse effect on the Company's business, operating results and
financial condition.
 
     Although demand for VALEX and similar products has grown in recent years,
the market for customer optimization software applications is still emerging and
there can be no assurance that it will continue to grow or that, even if the
market does grow, businesses will continue to adopt VALEX and CCM. The Company
has spent, and intends to continue to spend, considerable resources educating
potential customers about customer optimization software and services in general
and about the features and functions of VALEX and CCM in particular. However,
there can be no assurance that such expenditures will enable VALEX and CCM to
achieve any additional degree of market acceptance. If the market for VALEX and
CCM fails to grow or grows more slowly than the Company currently anticipates,
the Company's business, operating results and financial condition would be
materially adversely affected.
 
CUSTOMER CONCENTRATION; DEPENDENCE ON CERTAIN INDUSTRIES
 
     In fiscal 1997 and for the six months ended June 30, 1998, the Company's
top five customers accounted for 74.9% and 53.6% of total revenues,
respectively. There can be no assurance that these or other customers of the
Company will continue to purchase the Company's products or services. The
Company's failure to add new customers that make significant purchases of the
Company's products and services would have a material adverse effect on the
Company's business, financial condition and results of operations.
 
     A substantial portion of the Company's revenues have been derived from
sales to large financial institutions and telecommunications companies. There
can be no assurance that the Company will be successful in achieving significant
market acceptance or penetration in additional vertical markets targeted by the
Company. Failure to penetrate additional vertical markets could have a material
adverse effect on the Company's future growth, financial condition and results
of operations.
 
MANAGEMENT OF GROWTH
 
     The Company's business has grown rapidly, with total revenues increasing
from $1.7 million in 1995 to $6.0 million in 1996 and to $12.7 million in 1997.
The Company's recent expansion has resulted in substantial growth in the number
of its employees (from 47 at December 31, 1996 to 91 at December 31, 1997 and to
129 at June 30, 1998), the scope of its operating and financial systems and the
geographic distribution of its operations and customers. This recent rapid
growth has placed, and if sustained will continue to place, a significant strain
on the Company's management and operations. Accordingly, the Company's future
operating results will depend on the ability of its
 
                                        5
<PAGE>   10
 
officers and other key employees to continue to implement and improve its
operational, customer support and financial control systems, and to expand,
train and manage its employee base. There can be no assurance that the Company
will be able to manage any future expansion successfully, and any inability to
do so would have a material adverse effect on the Company's business, operating
results and financial condition.
 
DEPENDENCE UPON KEY PERSONNEL
 
     The Company's future operating results depend in significant part upon the
continued services of a relatively small number of key technical and senior
management personnel, including Andrew Frawley, its Chairman, President and
Chief Executive Officer, David McFarlane, its Executive Vice President,
Worldwide Sales and Services, and Michael McGonagle, its Vice President, Product
Development, none of whom is bound by an employment agreement. The Company's
future success also depends on its continuing ability to attract and retain
other highly qualified technical, sales and managerial personnel. Competition
for such personnel is intense, and the Company has at times in the past
experienced difficulty in recruiting qualified personnel. There can be no
assurance that the Company will retain its key technical, sales and managerial
employees or that it will be successful in attracting, assimilating and
retaining other highly qualified technical, sales and managerial personnel in
the future. The loss of any member of the Company's key technical, sales and
senior management personnel or the inability to attract and retain additional
qualified personnel could have a material adverse effect on the Company's
business, operating results and financial condition. See "Business -- Employees"
and "Management".
 
RAPID TECHNOLOGICAL CHANGE AND NEW PRODUCTS
 
     The market for the Company's software products is characterized by rapid
technological advances, evolving industry standards in computer hardware and
software technology, changes in customer requirements and frequent new product
introductions and enhancements. The Company's future success will depend upon
its ability to continue to enhance its current product line and to develop and
introduce new products that keep pace with technological developments, satisfy
increasingly sophisticated customer requirements and achieve market acceptance.
There can be no assurance that the Company will be successful in developing and
marketing, on a timely and cost-effective basis, fully functional product
enhancements or new products that respond to technological advances by others,
or that its new products will achieve market acceptance. Failure to successfully
develop and market product enhancements or new products could have a material
adverse effect on the Company's business, operating results and financial
condition.
 
     As a result of the complexities inherent in client/server computing
environments and the broad functionality and performance demanded by customers
for customer optimization software products, major new products and product
enhancements can require long development and testing periods. The Company has
on occasion experienced delays in the scheduled introduction of new and enhanced
products. In addition, software programs as complex as those offered by the
Company may contain undetected errors or "bugs" when first introduced or as new
versions are released that, despite testing by the Company, are discovered only
after a product has been installed and used by customers. To date the Company's
business has not been materially adversely affected by delays or the release of
products containing errors. There can be no assurance, however, that errors will
not be found in future releases of the Company's software, or that any such
errors will not impair the market acceptance of these products and adversely
affect the Company's business, operating results and financial condition.
 
     While the Company generally takes steps to avoid the interruptions of sales
often associated with the pending availability of new products, customers may
delay their purchasing decisions in anticipation of the general availability of
new or enhanced VALEX products, which could have a material adverse effect on
the Company's business and operating results. Moreover, significant delays in
the general availability of such new releases, significant problems in the
installation or
                                        6
<PAGE>   11
 
implementation of such new releases, or customer dissatisfaction with such new
releases, could have a material adverse effect on the Company's business,
operating results and financial condition. See "Business -- Products" and
"Product Development".
 
COMPETITION
 
     The market for customer optimization software and related services is
highly competitive. There can be no assurance that the Company will maintain its
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical and
other resources. Current and potential competitors fall into the following
categories: (i) database marketing vendors, such as Harte Hanks, Metromail (a
division of Great Universal Stores) and Harland, which provide a combination of
service bureau capabilities and software; (ii) small independent software
companies that are creating or are attempting to create offerings similar to the
VALEX product; (iii) enterprise resource planning ("ERP") and customer
interaction software ("CIS") vendors such as SAP, Baan, Oracle, Siebel and
Vantive, that may broaden their product lines to include applications with
competitive functionality; and (iv) internal corporate technology departments
that attempt to build their own systems. The Company believes that many of these
competitors are focusing significant resources on increasing the functionality
of their products and services. Ultimately, competitors may be able to offer
products and services with functionality comparable or superior to that of
VALEX. Many of the Company's competitors have longer operating histories,
significantly greater financial, technical, marketing and other resources,
greater name recognition, and larger customer bases than the Company. As a
result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements and to devote greater resources to the
promotion and sale of their products and services than the Company. If these
companies were to introduce products and services that effectively competed with
the Company's products and services, they could be in a position to
substantially lower the price of their customer optimization products and
services or to bundle such products and services with their other products and
services, which could give them competitive advantages over the Company. In
order to be successful in the future, the Company must continue to respond
promptly and effectively to the challenges of technological change and
competitors' innovations. There can be no assurance that the Company will be
able to compete successfully with existing or new competitors. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which would materially and adversely affect the Company's
business, operating results and financial condition. See
"Business -- Competition".
 
INCREASING RELIANCE ON INDIRECT DISTRIBUTION CHANNELS
 
     Although direct sales to date have accounted for a majority of the
Company's software revenues, the Company expects that it will increasingly
distribute its products to end users through various indirect distribution
channels, including re-seller agreements with IBM, NCR and others and
co-marketing arrangements with companies such as Compaq, Ernst & Young, KPMG
Peat Marwick, PricewaterhouseCoopers, SAS Institute and Sun Microsystems. The
Company's relationships with many of these organizations have been established
within the last twelve months, and the Company is unable to predict the extent
to which these channel partners will be successful in distributing the Company's
products. The Company is dependent on the marketing and sales efforts of these
organizations, many of whom also market and sell competitive products or are
able, under the terms of their agreements, to market and sell competitive
products. One of the Company's channel partners accounted for approximately 24%
of the Company's consolidated revenues for the six months ended June 30, 1998.
The loss of one or more of the Company's relationships with these organizations,
without replacement, either to competitive products offered by other companies
or products developed internally by these organizations, could have a material
adverse effect on the Company's business, operating results and financial
condition. The Company's future performance will also depend, in part, on its
ability to attract organizations that will be able to market and support the
Company's product effectively, especially in markets in which the Company has
not previously

                                        7
<PAGE>   12
 
distributed its products. None of the agreements governing the re-seller or
co-marketing relationships with these organizations includes any commitments on
the part of these organizations to effect any minimum number of sales of VALEX,
or otherwise to provide the Company with business. There can be no assurance
that revenues arising from the Company's relationships with these organizations
that accounted for significant revenues in past periods will continue, or if
continued will reach or exceed historical levels. See "Business -- Sales and
Marketing".
 
INTELLECTUAL PROPERTY RIGHTS; USE OF LICENSED TECHNOLOGY
 
     The Company relies primarily on a combination of copyright, trademark and
trade secret laws, confidentiality procedures and contractual provisions to
protect its proprietary rights. In addition, the Company generally licenses
VALEX to end users in object code (machine-readable) format, and the Company's
license agreements generally allow the use of VALEX solely by the customer for
internal purposes without the right to sublicense or transfer VALEX. The Company
believes that the foregoing measures afford only limited protection. Certain
customers have required the Company to maintain a source code escrow account
with a third-party software escrow agent, and a failure by the Company to
perform its obligations under any of the license and maintenance agreements, or
the insolvency of the Company, could conceivably cause the release of the
Company's source code to such customers. Despite the Company's efforts to
protect its proprietary rights, unauthorized parties may attempt to copy aspects
of the Company's products or to obtain and use information that the Company
regards as proprietary. Policing unauthorized use of the Company's products is
difficult, and while the Company is unable to determine the extent to which
piracy of its software products exists, software piracy can be expected to be a
problem. In addition, the laws of some foreign countries do not protect the
Company's proprietary rights to the same extent as the laws of the United
States. Furthermore, there can be no assurance that the Company's competitors
will not independently develop technology similar to that of the Company. The
Company may increasingly be subject to claims of intellectual property
infringement as the number of products and competitors in the Company's industry
segment grows and the functionality of products in different industry segments
overlaps. Although the Company is not aware that any of its products infringe
upon the proprietary rights of third parties, there can be no assurance that
third parties will not claim infringement by the Company with respect to current
or future products. Any such claims, with or without merit, could be
time-consuming to address, result in costly litigation, cause product shipment
delays or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, might not be available on
terms acceptable to the Company or at all, which could have a material adverse
effect upon the Company's business, operating results and financial condition.
 
     The Company has in the past and may in the future re-sell certain software
that it licenses from third parties. There can be no assurance that these third
party software licenses will continue to be available to the Company on
commercially reasonable terms. The loss of or inability to maintain or obtain
any of these software licenses could result in delays or reductions in product
shipments until equivalent software could be identified, licensed and
integrated, which could materially adversely affect the Company's business,
operating results and financial condition. See "Business -- Products" and
"-- Proprietary Rights and Licenses".
 
INTERNATIONAL OPERATIONS
 
     The Company derived approximately 22% of its total revenues from sales
outside the United States in the six months ended June 30, 1998. The Company
opened sales offices in the United Kingdom in July 1997 and in Australia in
January 1998, and believes that continued growth and profitability will require
expansion of its sales in international markets. In order to successfully expand
international sales, the Company must establish additional foreign operations
and hire additional personnel. To the extent that the Company is unable to do so
in a timely and effective manner, any growth in international sales will be
limited, and the Company's business, operating
 
                                        8
<PAGE>   13
 
results and financial condition could be materially adversely affected. In
addition, even if international operations are successfully expanded, there can
be no assurance that the Company will be able to maintain or increase
international market demand for its products.
 
     The Company's international operations are subject to the risks inherent in
any international business activities, including, in particular, management of
an organization spread over various countries, longer accounts receivable
payment cycles in certain countries, compliance with a variety of foreign laws
and regulations, unexpected changes in regulatory requirements, overlap of
different tax structures, foreign currency exchange rate fluctuations and
general economic conditions. Other risks associated with international
operations include import and export licensing requirements, trade restrictions
and changes in tariff rates. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business -- Sales and
Marketing".
 
CONTROL BY EXISTING STOCKHOLDERS
 
     Upon completion of the Offering, the current officers, directors and
principal stockholders will beneficially own approximately 69.1% of the
Company's outstanding Common Stock (64.5% if the Underwriters' over-allotment
option is exercised in full). Consequently, such persons, as a group, will be
able to control the outcome of all matters submitted for stockholder action,
including the election of members to the Company's Board of Directors and the
approval of significant change in control transactions, and will effectively
control the management and affairs of the Company, which may have the effect of
delaying or preventing a change in control of the Company. While the Company
intends to increase the size of its Board of Directors from four to six members,
representatives of the existing stockholders will nonetheless constitute three
of the six directors and will therefore have significant influence in directing
the actions of the Board of Directors. See "Management" and "Principal and
Selling Stockholders".
 
PRODUCT LIABILITY
 
     While the Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims, it is possible that such limitation of liability provisions
may not be effective under the laws of certain jurisdictions. Although the
Company has not experienced any product liability claims to date, there can be
no assurance that the Company will not be subject to such claims in the future.
A successful product liability claim brought against the Company could have a
material adverse effect on the Company's business, operating results and
financial condition. Moreover, defending such a suit, regardless of its merits,
could entail substantial expense and require the time and attention of key
management personnel, either of which could have a material adverse effect on
the Company's business, operating results and financial condition. See
"Business -- Products -- VALEX" and "-- Product Development".
 
YEAR 2000 COMPLIANCE
 
     Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and software used by many companies may need to be upgraded to comply
with such "Year 2000" requirements. Significant uncertainty exists in the
software industry concerning the potential effects associated with the failure
to comply with such requirements. Although all of the products currently offered
by the Company are designed to be Year 2000 compliant, there can be no assurance
that the Company's products contain all necessary date code changes, or that, in
the year 2000, the Company's products will be compatible with third-party
software that may be integrated or used in conjunction with the Company's
products. In addition, there can be no assurance that the Company's current and
potential customers or third-party distributors will not experience Year 2000
problems or that any such problems would not have a material adverse effect
 
                                        9
<PAGE>   14
 
on the Company's business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Impact of Year 2000 Issue".
 
NO PRIOR MARKET FOR THE COMMON STOCK; POSSIBLE VOLATILITY OF SHARE PRICE
 
     Prior to the Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will develop
upon completion of the Offering or, if it does develop, that such market will be
sustained. The initial public offering price of the Common Stock has been
determined by negotiation among the Company, the Selling Stockholders and the
representatives of the Underwriters, and may not be representative of the price
that will prevail in the open market. See "Underwriting" for a discussion of the
factors considered in determining the initial public offering price.
 
     The market price of the Common Stock after the Offering may be affected
significantly by factors such as quarterly variations in the Company's results
of operations, the announcement of new products or product enhancements by the
Company or its competitors, technological innovation by the Company or its
competitors and general market conditions or market conditions specific to
particular industries. In particular, the stock prices for many companies in the
technology and emerging growth sectors have experienced wide fluctuations which
have often been unrelated to the operating performance of such companies. Such
fluctuations may adversely affect the market price of the Common Stock.
 
ANTI-TAKEOVER PROVISIONS
 
     The Company's Amended and Restated Certificate of Incorporation (the
"Charter"), and Amended and Restated By-laws (the "By-laws"), contain certain
provisions that may have the effect of discouraging, delaying or preventing a
change in control of the Company or unsolicited acquisition proposals that a
stockholder might consider favorable. Such provisions include authorizing the
issuance of "blank check" preferred stock; providing for a Board of Directors
with staggered, three-year terms; requiring super-majority voting to effect
certain amendments to the Charter and By-laws; limiting the persons who may call
special meetings of stockholders; prohibiting stockholder action by written
consent; and establishing advance notice requirements for nominations for
election to the Board of Directors or for proposing matters that can be acted
upon at stockholders meetings. Certain provisions of Delaware law and the
Company's 1996 Stock Incentive Plan (the "1996 Plan") and 1998 Stock Incentive
Plan (the "1998 Plan") may also have the effect of discouraging, delaying or
preventing a change in control of the Company or unsolicited acquisition
proposals. See "Management -- Stock Incentive Plans" and "Description of Capital
Stock -- Certain Anti-Takeover, Limited Liability and Indemnification
Provisions".
 
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
 
     Sales of substantial amounts of Common Stock in the public market, or the
perception that such sales may occur, could adversely affect the prevailing
market price of the Common Stock or the ability of the Company to raise capital
through a public offering of its equity securities. Upon completion of the
Offering, the Company will have outstanding 9,716,740 shares of Common Stock
(not including shares issuable upon exercise of outstanding stock options).
Under agreements entered into between the representatives of the Underwriters
and each of the Company's officers, directors, principal stockholders and their
respective affiliates (the "Lock-Up Agreements") who beneficially hold, in the
aggregate,                shares of Common Stock (which includes
shares acquired in 1998 upon the exercise of stock options) prior to the
Offering, no shares held by such holders will be eligible for sale in the public
market for a period of 180 days following the date of this Prospectus. The
Company intends to file a registration statement under the Securities Act of
1933, as amended (the "Securities Act"), covering the sale of Common Stock
reserved for issuance under the 1996 Plan. As of July 15, 1998, there were
options outstanding under the 1996 Plan to purchase an aggregate of 2,085,408
shares and no other options

                                       10
<PAGE>   15
 
outstanding; all shares acquired upon exercise of the options within 180 days of
the Offering are or will be subject to Lock-Up Agreements as required under the
1996 Plan. Following the expiration of the 180-day term of the Lock-Up
Agreements, 5,651,892 shares, including the 3,000,000 shares offered hereby and
approximately 537,304 shares subject to options that will be exercisable on or
before the end of such term, will be eligible for sale in the public market
subject, in some cases, to the requirements of Rule 144 or Rule 701 under the
Securities Act. Goldman, Sachs & Co. in its sole discretion and at any time
without notice, may release all or any portion of the securities subject to the
Lock-Up Agreements. Any such decision to release securities would likely be
based upon individual stockholder circumstances, prevailing market conditions
and other relevant factors. Any such release could have a material adverse
effect upon the price of the Common Stock. See "Underwriting".
 
     After the Offering, holders of 6,025,310 shares of Common Stock are
currently entitled to certain demand and piggy-back registration rights with
respect to such shares. If the Company were required to register the shares held
by such holders pursuant to the exercise of their demand or piggy-back
registration rights, such sales could have an adverse effect upon the Company's
ability to raise needed capital. See "Shares Eligible for Future Sale".
 
IMMEDIATE SUBSTANTIAL DILUTION
 
     The initial public offering price is substantially higher than the book
value per share of the outstanding Common Stock. As a result, investors
purchasing Common Stock in the Offering will incur immediate substantial
dilution. In addition, the Company has issued options to acquire Common Stock at
prices significantly below the initial public offering price. To the extent such
outstanding options are exercised, there will be further dilution. See
"Dilution" and "Shares Eligible for Future Sale".
 
                                USE OF PROCEEDS
 
     Based on an assumed initial public offering price of $15.00 per share, the
Company will receive approximately $26,900,000 from the sale of shares of Common
Stock to be sold by the Company pursuant to the Offering after deducting the
underwriting discount and estimated offering expenses payable by the Company.
 
     The principal purposes of the Offering are to increase the Company's equity
capital, to create a public market for the Common Stock, to facilitate future
access by the Company to public equity markets, to provide liquidity for certain
of the Company's existing stockholders and to provide increased visibility of
the Company in a marketplace where many of its competitors are publicly held
companies.
 
     The Company currently intends to use the net proceeds of the Offering for
working capital and general corporate purposes, including financing accounts
receivable and capital expenditures made in the ordinary course of its business,
and the possible reduction of indebtedness. The Company may also apply a portion
of the net proceeds of the Offering to acquire businesses, products and
technologies that are complementary to those of the Company. Although the
Company has not identified any specific businesses, products or technologies
that it may acquire and as of the date of this Prospectus is not engaged in any
agreements or negotiations with respect to any such transactions, the Company
from time to time evaluates such opportunities. Pending such uses, the net
proceeds will be invested in government securities and other short-term,
investment-grade, interest-bearing instruments. The Company will not receive any
proceeds from the sale of Common Stock by the Selling Stockholders.
 
                                DIVIDEND POLICY
 
     The Company has never declared or paid any cash dividends on its capital
stock and does not intend to pay any cash dividends on its Common Stock in the
foreseeable future. Future dividends, if any, will be determined by the Board of
Directors.


 
                                       11
<PAGE>   16
 
                                 CAPITALIZATION
 
     The following table sets forth the capitalization of the Company at June
30, 1998, (i) on an actual basis, (ii) on a pro forma basis to reflect the
reclassification of Series A Preferred Stock to $3,209,000 of additional paid-in
capital, and the conversion of all outstanding shares of Series B Convertible
Preferred Stock and Series C Convertible Preferred Stock to a total of 3,779,510
shares of Common Stock upon the closing of this Offering and (iii) on a pro
forma as adjusted basis to give effect to the sale of 2,000,000 shares of Common
Stock offered by the Company at an assumed initial public offering price of
$15.00 per share after deducting the underwriting discount and estimated
offering expenses payable by the Company. This information should be read in
conjunction with the Company's Consolidated Financial Statements and the related
Notes thereto appearing elsewhere in this Prospectus.
 
<TABLE>
<CAPTION>
                                                                 AS OF JUNE 30, 1998
                                                      -----------------------------------------
                                                                                  PRO FORMA AS
                                                      ACTUAL     PRO FORMA(1)    ADJUSTED(1)(2)
                                                      ------     ------------    --------------
                                                                   (IN THOUSANDS)
<S>                                                   <C>        <C>             <C>
Long-term debt, net of current portion..............  $   128      $   128          $   128
                                                      -------      -------          -------
Redeemable Preferred Stock:
  Series A Preferred Stock..........................    3,209           --               --
  Series B Convertible Preferred Stock..............    3,999           --               --
                                                      -------      -------          -------
          Total Redeemable Preferred Stock..........    7,208           --               --
 
Stockholders' equity (deficit):
  Preferred Stock, $.001 par value; 10,000,000
     shares authorized..............................       --           --               --
  Series C Convertible Preferred Stock, $.001 par
     value; 1,223,954 shares designated, issued and
     outstanding, actual; 1,223,954 authorized, none
     issued, pro forma and pro forma as adjusted....        1           --               --
  Common Stock, $.001 par value, 30,000,000 shares
     authorized, pro forma and pro forma as adjusted
     4,298,305 shares issued, actual, 8,077,815
     shares issued, pro forma; 10,077,815 shares
     issued, pro forma as adjusted(3)...............        4            8               10
Additional paid-in capital..........................    4,878       12,083           38,981
Accumulated deficit.................................   (6,649)      (6,649)          (6,649)
Due from officer....................................     (125)        (125)            (125)
Cumulative translation adjustment...................       50           50               50
Unrealized gain on marketable securities............        5            5                5
Treasury stock, 361,075 shares at cost..............       --           --               --
                                                      -------      -------          -------
          Total stockholders' equity (deficit)......   (1,836)       5,372           32,272
                                                      -------      -------          -------
          Total capitalization......................  $ 5,500      $ 5,500          $32,400
                                                      =======      =======          =======
</TABLE>
 
---------------
(1) Gives effect to the reclassification of the Series A Preferred Stock to
    $3,209,000 of additional paid-in capital, the conversion of all outstanding
    shares of Series B Convertible Preferred Stock, at a redemption value of
    $3,999,000, into 2,555,556 shares of Common Stock, and the conversion of all
    outstanding shares of Series C Convertible Preferred Stock, at $.001 par
    value per share, into 1,223,954 shares of Common Stock upon the closing of
    the Offering.
 
(2) Gives effect to the sale of 2,000,000 shares of Common Stock offered by the
    Company and the application of the net proceeds therefrom.
 
(3) Excludes 2,085,408 shares of Common Stock issuable pursuant to stock options
    outstanding at July 15, 1998 (of which 324,232 options are exercisable as of
    July 15, 1998). See "Management -- Stock Plans" and Note 13 of Notes to
    Consolidated Financial Statements.
 
                                       12
<PAGE>   17
 
                                    DILUTION
 
     The pro forma net tangible book value of the Company as of June 30, 1998
was $5,372,000, or $0.70 per share of Common Stock, after giving effect to the
automatic conversion of all outstanding shares of Convertible Preferred Stock
and the reclassification of the value of Series A Preferred Stock to additional
paid-in capital. Pro forma net tangible book value per share is determined by
dividing the pro forma net tangible book value of the Company (total tangible
assets less total liabilities) by the total pro forma number of shares of Common
Stock outstanding, including shares of Common Stock resulting from the
conversion of the Convertible Preferred Stock. After giving effect to the sale
of the 2,000,000 shares of Common Stock offered by the Company hereby at an
assumed initial public offering price of $15.00 per share, and after deducting
estimated underwriting discounts and commissions and offering expenses payable
by the Company (resulting in estimated net proceeds of $26,900,000), the
adjusted pro forma net tangible book value of the Company as of June 30, 1998,
would have been $32,272,000, or $3.32 per share. This represents an immediate
increase in the pro forma net tangible book value of $2.62 per share to existing
stockholders and an immediate dilution of $11.68 per share to new investors. The
following table illustrates the per share dilution:
 
<TABLE>
<S>                                                           <C>      <C>
Assumed initial public offering price per share.............           $15.00
  Pro forma net tangible book value per share as of June 30,
     1998...................................................  $0.70
  Pro forma increase attributable to new investors..........   2.62
                                                              -----
Pro forma net tangible book value per share after the
  Offering..................................................             3.32
                                                                       ------
Pro forma dilution per share to new investors(1)............           $11.68
                                                                       ======
</TABLE>
 
     The following table summarizes, on a pro forma basis as of June 30, 1998,
the difference between the number of shares of Common Stock purchased from the
Company, the total consideration paid to the Company and the average price per
share paid by the existing stockholders and by the new investors (at an assumed
initial public offering price of $15.00 per share before deduction of estimated
underwriting discounts and commissions and offering expenses):
 
<TABLE>
<CAPTION>
                                  SHARES PURCHASED       TOTAL CONSIDERATION(1)
                                ---------------------    ----------------------    AVERAGE PRICE
                                  NUMBER      PERCENT      AMOUNT       PERCENT      PER SHARE
                                  ------      -------      ------       -------    -------------
<S>                             <C>           <C>        <C>            <C>        <C>
Existing stockholders(1)(2)...   7,716,740      79.4%    $11,334,000      27.4%       $ 1.47
New investors(1)..............   2,000,000      20.6      30,000,000      72.6         15.00
                                ----------     -----     -----------     -----        ------
          Total...............   9,716,740     100.0%    $41,334,000     100.0%
                                ==========     =====     ===========     =====
</TABLE>
 
---------------
(1) The foregoing table assumes no exercise of the Underwriters' over-allotment
    option and no exercise of stock options outstanding at June 30, 1998. As of
    July 15, 1998, the Company had 5,277,283 shares of Common Stock reserved for
    issuance under the Company's stock plans of which 2,085,408 shares were
    subject to outstanding stock options at a weighted average exercise price of
    $3.10 per share. To the extent any outstanding options are exercised, there
    will be further dilution to new investors. If all of the outstanding options
    were exercised in full, the dilution per share to new investors in this
    Offering would be increased by $0.04 per share to a total of $11.72 per
    share and the average price per share paid by the Company's existing
    shareholders would be $1.82. See "Capitalization", "Management -- Stock
    Option Plans" and Notes 12 and 13 of Notes to Consolidated Financial
    Statements.
 
(2) The net effect of sales by the Selling Stockholders in the Offering will be
    to reduce the number of shares held by existing stockholders to 6,716,740
    shares, or 69.1% of the total number of shares of Common Stock outstanding
    after the Offering, and to increase the number of shares held by new
    investors to 3,000,000 shares, or 30.9% of the total number of shares of
    Common Stock outstanding after the Offering.
 
                                       13
<PAGE>   18
 
                      SELECTED CONSOLIDATED FINANCIAL DATA
 
     The following historical selected consolidated financial data of the
Company is qualified by reference to and should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included elsewhere herein.
The selected consolidated financial data set forth below for each of the fiscal
years ended December 31, 1995, 1996 and 1997 are derived from consolidated
financial statements of the Company audited by Arthur Andersen LLP, independent
public accountants, which are included elsewhere in this Prospectus. The
selected consolidated financial data for the six months ended June 30, 1997 and
1998 are derived from the unaudited consolidated financial statements of the
Company, which are included elsewhere in this Prospectus. The selected
consolidated financial data for the period from inception (November 1, 1994)
through December 31, 1994 are derived from the unaudited consolidated financial
statements of the Company, which are not included in this Prospectus. The
unaudited consolidated financial statements include all adjustments (consisting
only of normal recurring adjustments) which the Company considers necessary for
a fair presentation. The results of operations for the six months ended June 30,
1998 are not necessarily indicative of results to be expected for any future
period. The data should be read in conjunction with the Consolidated Financial
Statements and the Notes thereto and with Management's Discussion and Analysis
of Financial Condition and Results of Operations appearing elsewhere in this
Prospectus.
 
<TABLE>
<CAPTION>
                                                  PERIOD FROM
                                                   INCEPTION
                                                 (NOVEMBER 1,            YEAR ENDED            SIX MONTHS ENDED
                                                 1994) THROUGH          DECEMBER 31,               JUNE 30,
                                                 DECEMBER 31,    ---------------------------   -----------------
                                                    1994(1)      1995(1)   1996(1)    1997      1997      1998
                                                 -------------   -------   -------   -------   -------   -------
                                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                              <C>             <C>       <C>       <C>       <C>       <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
  Software license fees........................     $   --       $   --    $ 1,500   $ 5,765   $ 1,793   $ 5,816
  Services and maintenance.....................         --        1,693      4,534     6,904     3,029     4,602
                                                    ------       ------    -------   -------   -------   -------
         Total revenues........................         --        1,693      6,034    12,669     4,822    10,418
Cost of revenues:
  Software license fees........................         --           --        890     1,707       863       129
  Services and maintenance.....................         --        1,012      3,205     5,227     2,297     3,302
                                                    ------       ------    -------   -------   -------   -------
         Total cost of revenues................         --        1,012      4,095     6,934     3,160     3,431
                                                    ------       ------    -------   -------   -------   -------
Gross profit...................................         --          681      1,939     5,735     1,662     6,987
Operating expenses:
  Sales and marketing..........................         --          128      1,007     3,602     1,268     4,163
  Research and development.....................         --          708      1,325     2,599     1,031     2,716
  General and administrative...................          7          352      1,018     2,158       813     1,216
                                                    ------       ------    -------   -------   -------   -------
         Total operating expenses..............          7        1,188      3,350     8,359     3,112     8,095
                                                    ------       ------    -------   -------   -------   -------
Loss from operations...........................         (7)        (507)    (1,411)   (2,624)   (1,450)   (1,108)
Interest income (expense), net.................         --          (47)      (195)       25       (10)       29
                                                    ------       ------    -------   -------   -------   -------
Net loss.......................................         (7)        (554)    (1,606)   (2,599)   (1,460)   (1,079)
Accretion of discount and dividends on
  preferred stock..............................         --           --         --      (684)     (565)     (120)
                                                    ------       ------    -------   -------   -------   -------
Net loss applicable to common stockholders.....     $   (7)      $ (554)   $(1,606)  $(3,283)  $(2,025)  $(1,199)
                                                    ======       ======    =======   =======   =======   =======
Basic and diluted net loss per share applicable
  to common stockholders.......................     $(0.01)      $(0.46)   $ (1.33)  $ (1.12)  $ (0.82)  $ (0.33)
                                                    ======       ======    =======   =======   =======   =======
Basic and diluted weighted average common
  shares outstanding...........................      1,200        1,200      1,205     2,920     2,478     3,598
                                                    ======       ======    =======   =======   =======   =======
Pro forma basic and diluted net loss per
  share(2) (3).................................     $   --       $(0.19)   $ (0.55)  $ (0.48)  $ (0.31)  $ (0.15)
                                                    ======       ======    =======   =======   =======   =======
Pro forma basic and diluted weighted average
  common shares outstanding(2) (3).............      2,925        2,925      2,930     5,391     4,683     7,377
                                                    ======       ======    =======   =======   =======   =======
</TABLE>
 
                                       14
<PAGE>   19
 
<TABLE>
<CAPTION>
                                                                                      AS OF JUNE 30, 1998
                                                      AS OF DECEMBER 31,             ----------------------
                                             -------------------------------------                  PRO
                                             1994(1)   1995(1)    1996      1997      ACTUAL     FORMA(2)
                                             -------   -------   -------   -------    ------     --------
                                                                     (IN THOUSANDS)
<S>                                          <C>       <C>       <C>       <C>       <C>        <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents, and marketable
  securities...............................   $  --    $   500   $   361   $ 5,475   $  4,182     $ 4,182
Working capital (deficit)..................    (120)    (1,224)     (853)    5,249      3,515       3,515
Total assets...............................     113      2,514     4,189    11,400     12,134      12,134
Long-term debt, net of current portion.....      --         38     2,368       237        128         128
Redeemable preferred stock.................      --         --        --     7,088      7,208          --
Stockholders' equity (deficit).............      (7)      (560)   (1,295)     (728)    (1,836)      5,372
</TABLE>
 
---------------
(1) The Consolidated Balance Sheet Data as of December 31, 1994 and 1995 and
    consolidated statement of operations data for the period from inception to
    December 31, 1994, and for the years ended December 31, 1995 and 1996
    include the operations of the Company on a carve-out basis prior to November
    15, 1996. During this period, the Company operated as a separate and
    substantially independent division of Grant & Partners, Inc. and Grant &
    Partners Limited Partnership, and focused on developing VALEX and providing
    integration and consulting services. See Note 1 of Notes to Consolidated
    Financial Statements.
 
(2) Gives effect to the reclassification of Series A Preferred Stock to
    $3,209,000 of additional paid-in capital, the conversion of all outstanding
    shares of the Series B Convertible Preferred Stock, at a redemption value of
    $3,999,000, into 2,555,556 shares of Common Stock, and the conversion of all
    outstanding shares of Series C Convertible Preferred Stock, at $.001 par
    value per share, into 1,223,954 shares of Common Stock upon the closing of
    the Offering.
 
(3) Computed on the basis described in Note 2(c) of Notes to Consolidated
    Financial Statements.
 
                                       15
<PAGE>   20
 
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
     The following discussion should be read in conjunction with the
Consolidated Financial Statements and related Notes thereto included elsewhere
in this Prospectus. This discussion contains forward-looking statements that
involve risks and uncertainties. The Company's actual results may differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including, but not limited to, those set forth under
"Risk Factors" and elsewhere in this Prospectus.
 
OVERVIEW
 
     The Company is a leading provider of customer optimization software and
solutions that enable businesses to maximize profitability and revenue growth
from new and existing customers through marketing automation and enterprise-wide
customer management. The Company's Continuous Customer Management ("CCM")
offering is principally comprised of VALEX, the Company's open enterprise
software application, and the Company's proprietary consulting and integration
services.
 
     The Company was incorporated in November 1996. Prior to incorporation, the
Company operated as a separate division of two entities, Grant & Partners, Inc.
("GPI") and Grant & Partners Limited Partnership ("GPLP"). See Note 1 to Notes
to Consolidated Financial Statements. The Company's activities during its early
stages of operation focused on the development of software solutions to provide
CCM support to businesses. In 1995, the Company began providing professional
services in the areas of marketing program design and execution and data
warehousing. In March 1997, the Company ceased providing marketing program
design services. The Company's development efforts culminated in the
introduction to the market in July 1996 of VALEX, the Company's marketing
automation software product. Since the introduction of VALEX, the Company has
continued to focus significant resources on the development of additional
functionality and features of the VALEX software. The Company also has continued
to expand its marketing activities, build the Exchange Applications identity,
develop the competencies of the professional services group, build international
sales and distribution channels and develop its general and administrative
infrastructure. The Company has shifted its primary business focus from
providing services to selling software products. However, the Company believes
that continuing to provide superior professional services will be critical to
maximizing its opportunities for future revenues.
 
     The financial results of the Company while it operated as a separate
division of GPI and GPLP for the period from inception (November 1, 1994) to
November 14, 1996 have been included on a carve-out basis in the Company's
Consolidated Financial Statements.
 
     The Company generates revenue from software licenses, professional service
arrangements and software maintenance agreements. The Company recognizes
software license fee revenues upon execution of a license agreement and delivery
of the software, provided that the fee is fixed or determinable and deemed
collectible by management. If acceptance of the software by the licensee is
required, revenues are only recognized upon satisfaction of the foregoing
conditions and acceptance of the software. Revenues from professional service
arrangements are recognized on either a time and materials or
percentage-of-completion basis as the services are performed, provided that
amounts due from customers are fixed or determinable and deemed collectible by
management. Revenues related to software maintenance agreements are recognized
ratably over the term of the maintenance period. Amounts collected or billed
prior to satisfying the above revenue recognition criteria are reflected as
deferred revenue or as customer deposits.
 
     Pricing for a VALEX software license is based on the number of customer
records included in a business' data warehouse and certain other factors,
including the number of users of the software. Professional services are
generally priced on a time and materials or fixed-fee basis. Annual maintenance,
which is typically purchased in conjunction with the licensing of VALEX, is a
separate component that is offered for a fee generally equal to 20% of the
license fee at the time of execution

                                       16
<PAGE>   21
 
of the maintenance contract and upon each renewal. Maintenance contracts
typically include telephone support and rights to unspecified product updates
and maintenance releases. The Company recommends that its customers enter into
and renew their maintenance contracts and, to date, all customers have done so.
As the Company continues to develop additional features and enhanced
functionality in unspecified future product updates, the Company believes that
most of its customers will continue to renew their maintenance contracts. As the
Company effects more sales of its software products through its re-seller
relationships, the Company plans to have the re-sellers provide certain of the
consulting and maintenance services associated with these sales. By using the
services resources of the re-sellers, the Company plans to allocate its own
professional services resources to direct-sale customers, to the projects that
require unique expertise or familiarity with the VALEX product and to other
profitable opportunities.
 
     Licenses originate principally from the Company's direct sales force. Sales
and marketing personnel from indirect sales channels, including re-sellers and
co-marketers, provide the Company with valuable introductions to potential
customers, work with the Company's sales force to complete sales and, in some
cases, effect sales of the Company's products virtually independently. The
Company expects that a significant portion of its revenues over the next several
quarters will be made with some participation from one or more of the Company's
re-sellers or co-marketers.
 
     Because the Company has only recently begun to sell its products,
period-to-period comparisons of its operating results are not meaningful.
Although the Company has experienced significant revenue growth recently, there
can be no assurance that such growth rates are sustainable and they should not
be relied upon as predictive of future performance. In addition, the timing of
license revenues is difficult to predict because of the length and variability
of the Company's sales cycle. The Company's prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by
companies in the early stage of development, particularly in new and rapidly
evolving markets. There can be no assurance that the Company will be successful
in addressing such risks and difficulties or that it will achieve profitability.
See "Risk Factors -- Limited Operating History; History of Losses".
 
RECENT ACCOUNTING PRONOUNCEMENT
 
     SOP 97-2, "Software Revenue Recognition", was issued in October 1997 and
supercedes the guidance of SOP 91-1 for recognizing revenue from software
arrangements. The Company adopted the provisions of SOP 97-2 for the year ended
December 31, 1997, and the Company believes its revenue recognition policies and
practices comply with the requirements of SOP 97-2. However, SOP 97-2 includes
restrictive provisions regarding specific terms of software arrangements which,
if present, require deferral of revenue recognition beyond the point of delivery
of the software. Future competitive conditions could necessitate changes in the
Company's business practices and the contract terms of its software
arrangements. Such changes might require deferral of revenue recognition, which
could materially adversely affect periodic operating results.
 
                                       17
<PAGE>   22
 
RESULTS OF OPERATIONS
 
     The following table sets forth, for the periods indicated, the percentage
of total revenues represented by certain items from the Company's Consolidated
Statements of Operations.
 
<TABLE>
<CAPTION>
                                                                             SIX MONTHS ENDED
                                                  YEAR ENDED DECEMBER 31,        JUNE 30,
                                                  -----------------------    ----------------
                                                  1995     1996     1997      1997      1998
                                                  -----    -----    -----    ------    ------
<S>                                               <C>      <C>      <C>      <C>       <C>
Revenues:
  Software license fees.........................     --%    24.9%    45.5%    37.2%     55.8%
  Services and maintenance......................  100.0     75.1     54.5     62.8      44.2
                                                  -----    -----    -----    -----     -----
          Total revenues........................  100.0    100.0    100.0    100.0     100.0
Cost of revenues:
  Software license fees.........................     --     14.8     13.4     17.9       1.2
  Services and maintenance......................   59.8     53.1     41.3     47.6      31.7
                                                  -----    -----    -----    -----     -----
          Total cost of revenues................   59.8     67.9     54.7     65.5      32.9
                                                  -----    -----    -----    -----     -----
Gross margin....................................   40.2     32.1     45.3     34.5      67.1
Operating expenses:
  Sales and marketing...........................    7.5     16.7     28.5     26.3      39.9
  Research and development......................   41.8     21.9     20.5     21.4      26.1
  General and administrative....................   20.8     16.9     17.0     16.9      11.7
                                                  -----    -----    -----    -----     -----
          Total operating expenses..............   70.1     55.5     66.0     64.6      77.7
                                                  -----    -----    -----    -----     -----
Loss from operations............................  (29.9)   (23.4)   (20.7)   (30.1)    (10.6)
Interest income (expense), net..................   (2.8)    (3.2)     0.2     (0.2)      0.2
                                                  -----    -----    -----    -----     -----
Net loss........................................  (32.7)%  (26.6)%  (20.5)%  (30.3)%   (10.4)%
                                                  =====    =====    =====    =====     =====
</TABLE>
 
SIX MONTHS ENDED JUNE 30, 1997 AND 1998
 
  REVENUES
 
     The Company's total revenues increased 116% from $4.8 million in the six
months ended June 30, 1997 to $10.4 million in the six months ended June 30,
1998. A number of factors contributed to the increase in total revenues,
including an increase in the Company's sales force, sales resulting from the
establishment of key strategic re-seller and co-marketing relationships in late
1997 and the first six months of 1998, increased international sales resulting
from the opening of a U.K. sales office during July 1997 and the growing
contribution of maintenance revenues from the larger installed base of the
Company's products.
 
     Software license fee revenues increased 224% from $1.8 million, or 37.2% of
total revenues, in the six months ended June 30, 1997 to $5.8 million, or 55.8%
of total revenues, in the six months ended June 30, 1998. The significant
increase in software license fee revenues was attributable primarily to the
growing market awareness and acceptance of the Company's products, particularly
in the telecommunications industry, the expansion of the Company's sales force,
and the establishment of key strategic re-seller and co-marketing relationships
in late 1997 and the first six months of 1998.
 
     Services and maintenance revenues increased 52% from $3.0 million, or 62.8%
of total revenues, in the six months ended June 30, 1997 to $4.6 million, or
44.2% of total revenues, in the six months ended June 30, 1998. The growth of
services and maintenance revenues resulted from professional services
engagements associated with the growing sales of the Company's software
products, increased maintenance revenues from the larger installed base of
software license customers and increased training revenues. The decrease in
services and maintenance revenues as a percentage of total revenues was
primarily attributable to market acceptance of VALEX and
 
                                       18
<PAGE>   23
 
increases in sales of VALEX by re-sellers and co-marketers that provided certain
of the related services.
 
     For the six months ended June 30, 1997, the Company's top five customers
accounted for 90.6% of total revenues, while the Company's three largest
customers accounted for 39.7%, 22.2% and 13.7%, respectively, of total revenues
during this same period. This compares to 53.6% for the Company's top five
customers and 24.1%, 9.9% and 7.3% for the Company's three largest customers,
respectively, for the six months ended June 30, 1998. In the six-month period
ended June 30, 1998, revenues from the largest customer were comprised of sales
through a single re-seller to multiple end-user businesses. The Company believes
that the loss of any one of these customers would not have a material adverse
effect upon the Company's business, operating results or financial condition.
 
     All of the Company's revenues for the six months ended June 30, 1997 were
from sales to customers in North America; however, international operations were
significantly expanded in late 1997 and 1998 and represent an increasing source
of the Company's revenues. Revenues from customers outside North America were
$1.6 million for the six months ended June 30, 1998, representing approximately
15.4% of total revenues.
 
  COST OF REVENUES
 
     Total cost of revenues consists of costs associated with software license
fees and costs associated with services and maintenance. Total cost of revenues
as a percentage of total revenues declined from 65.5% in the six months ended
June 30, 1997 to 32.9% in the six months ended June 30, 1998. The decrease in
cost of revenues as a percentage of total revenues in 1998 was primarily a
result of the fact that capitalized software development costs under Statement
of Financial Accounting Standards No. 86 ("SFAS 86") was fully amortized as of
December 1997. The results for the six months ended June 30, 1997 include
approximately $641,000 in SFAS 86 capitalized software amortization.
 
     Cost of software license fees as a percentage of total revenues decreased
from 17.9% to 1.2% for the six months ended June 30, 1997 and 1998,
respectively. Cost of software license fees as a percentage of software license
fee revenues decreased from 48.1% to 2.2% for the six months ended June 30, 1997
and 1998, respectively. Cost of software license fees for the six months ended
June 30, 1997 consisted primarily of amortization of software development
expenses capitalized under SFAS 86 and royalty payments made to a third party
for licensed intellectual property included in the Company's VALEX product. The
entire capitalized software balance was fully amortized as of December 31, 1997.
Cost of software license fees for the six months ended June 30, 1998 consisted
primarily of royalty payments for licensed software and costs associated with
software packaging and distribution. The Company's primary royalty obligation
for licensed intellectual property, which required the Company to pay royalties
to a third party on the first $10 million of revenues from VALEX sales, was
fully paid during the second quarter of 1998. No further royalties will be paid
to this third party and other current royalty obligations are not material to
the Company's financial position. If the effect of the SFAS 86 amortization and
royalties for licensed software were not included, gross margin on software
revenues would have been 96.5% for the six months ended June 30, 1997, versus
99.3% for the six months ended June 30, 1998. As the Company adds additional
components to its software products, the Company may choose to license software
from third parties. The cost of such licenses may increase the cost of software
license fees.
 
     Cost of services and maintenance consists primarily of personnel, facility
and system costs incurred in providing professional consulting services,
training, and customer support services. Cost of services and maintenance
revenues as a percentage of total revenues was 47.6% and 31.7% during the six
months ended June 30, 1997 and 1998, respectively. Cost of services and
maintenance as a percentage of services and maintenance revenues was 75.8% and
71.8% for the six months ended June 30, 1997 and June 30, 1998, respectively.
The decrease was attributable
 
                                       19
<PAGE>   24
 
primarily to the increased contribution of higher margin maintenance revenues
from the Company's increased installed base. As the Company effects more sales
of its software products through its re-seller relationships, the Company plans
to have the re-sellers provide certain of the consulting and maintenance
services associated with these sales. By using the services resources of the
re-sellers, the Company plans to allocate its own professional services
resources to direct-sale customers, to the projects that require unique
expertise or familiarity with the VALEX product and to other more profitable
opportunities.
 
     Overall gross margin increased from 34.5% for the six months ended June 30,
1997 to 67.1% for the six months ended June 30, 1998 due primarily to the
completion of SFAS 86 amortization, increased sales of VALEX and the expiration
of the Company's royalty obligations for licensed intellectual property. As
software license fee revenues continue to grow and maintenance revenues increase
as a percentage of total services and maintenance revenues, the Company expects
that overall gross margin will remain constant or increase slightly in future
periods.
 
  OPERATING EXPENSES
 
     Sales and Marketing.  Sales and marketing expenses consist primarily of
salaries for sales and marketing personnel, commissions, travel and promotional
expenses. Sales and marketing expenses increased from $1.3 million, or 26.3% of
total revenues, for the six months ended June 30, 1997, to $4.2 million, or
39.9% of total revenues, for the six months ended June 30, 1998. This increase
reflects the hiring of additional sales and marketing personnel, increased
promotional programs, and increased sales commissions associated with higher
revenues. While the Company expects sales and marketing expenses to continue to
grow in absolute dollars, the Company expects these expenses to remain
approximately the same as a percentage of total revenues due to increased
contribution from its indirect sales channels.
 
     Research and Development.  Research and development expenses consist
primarily of employee salary and benefits, consultant costs, and equipment and
purchased software depreciation costs associated with new product development,
enhancement of existing products and quality assurance activities. Research and
development expenses increased from $1.0 million, or 21.4% of total revenues, in
the six months ended June 30, 1997 to $2.7 million, or 26.1% of total revenues,
in the six months ended June 30, 1998. This increase reflects the hiring of
additional personnel and additional investments in the Company's VALEX product.
Software development costs were expensed as incurred in the six months ended
June 30, 1998, since software development costs were primarily related to
product enhancements and product maintenance. The Company anticipates that
research and development expenses will continue to increase in absolute dollars
but decrease on a percentage basis as the Company continues to commit
substantial resources to enhancing existing product functionality and to
developing new products.
 
     General and Administrative.  General and administrative expenses consist
primarily of salaries and related costs, outside professional fees, provision
for bad debts, and equipment and software depreciation costs associated with the
finance, legal, human resources, information systems, and administrative
functions of the Company. General and administrative expenses increased from
$813,000, or 16.9% of total revenues, for the six months ended June 30, 1997 to
$1.2 million, or 11.7% of total revenues, for the six months ended June 30,
1998. Expenses increased in absolute dollars as the Company added personnel to
its finance, information systems, and human resource departments and increased
its spending on outside legal services, but declined as a percentage of total
revenues, due primarily to economies of scale. The Company expects general and
administrative expenses to continue to grow in absolute dollars but to decrease
on a percentage basis as the Company implements additional management
information systems, continues its international expansion and incurs costs
incident to being a publicly held company.
 
                                       20
<PAGE>   25
 
  PROVISION FOR INCOME TAXES
 
     No provision for federal or state income taxes has been recorded as the
Company incurred net operating losses for all periods presented. The Company has
recorded a full valuation allowance against the deferred tax asset generated as
a result of these net operating loss carryforwards as the Company believes it is
more likely than not that these assets will not be realized.
 
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
 
  REVENUES
 
     The Company's total revenues increased 256% from $1.7 million in 1995 to
$6.0 million in 1996, reflecting significant software license fee revenues
related to the commercial introduction of the Company's VALEX product in July
1996. The Company's total revenues increased 110% to $12.7 million in 1997 as
the Company sold its products and services to a greater number of customers and
expanded its business internationally.
 
     Software license fee revenues increased from zero in 1995 to $1.5 million,
or 24.9% of total revenues, in 1996 and grew 284% to $5.8 million, or 45.5% of
total revenues, in 1997. The increase in software license fee revenues, both in
absolute dollars and as a percentage of total revenues, reflected increased
market awareness and acceptance of the Company's VALEX product, the continued
growth of indirect channel revenues, and expansion of international sales
resources.
 
     Services and maintenance revenues increased 168% from $1.7 million, or
100.0% of revenues, in 1995 to $4.5 million, or 75.1% of total revenues in 1996,
and grew 52% to $6.9 million, or 54.5% of total revenues, in 1997 primarily due
to growth in the providing of professional services associated with VALEX and,
to a lesser extent, to an increase in maintenance revenues. The Company expects
services and maintenance revenues to decline as a percentage of total revenues
as the parties with whom the Company has undertaken re-seller and co-marketing
relationships perform more of the professional services associated with the
Company's software licenses sold through these channels. However, the Company
expects services and maintenance revenues to increase in absolute dollars as the
installed base of the Company's products continues to increase.
 
     In 1997, the Company's top five customers accounted for 74.9% of total
revenues, while the Company's three largest customers accounted for 33.0%, 23.1%
and 7.6%, respectively, of the Company's total revenues during this same period.
In 1997, revenues from the largest customer were comprised of sales through a
single re-seller to multiple end-user businesses. During 1996, the Company's top
five customers accounted for 57.7% of total revenues, while the Company's three
largest customers accounted for 20.5%, 10.7% and 10.2%, respectively, of total
revenues. In 1995, the Company's top five customers accounted for 87.8% of total
revenues, while the Company's three largest customers accounted for 37.7%, 17.3%
and 13.0%, respectively, of the Company's total revenues during this same
period. The Company believes that the loss of any one of these customers would
not have a material adverse effect upon the Company's business, operating
results or financial condition. In 1995 and 1996, the Company's revenues
consisted primarily of the sale and delivery of the Company's professional
services in the area of customer optimization and data warehousing.
 
  COST OF REVENUES
 
     Total cost of revenues, as a percentage of total revenues, increased from
59.8% in 1995 to 67.9% in 1996, and then declined to 54.7% in 1997. The increase
in 1996 reflected six months of amortization of software development costs
previously capitalized in accordance with the guidelines of SFAS 86, which
amortization began in July 1996 upon general release of the Company's VALEX
product. The decline in the total cost of revenues as a percentage of total
revenues in 1997 reflected the increasing contribution of higher-margin software
license sales of VALEX, which was first shipped in July 1996.



 
                                       21
<PAGE>   26
 
     Cost of software license fees as a percentage of total revenues was 14.8%
in 1996 and 13.4% in 1997. There were no revenues derived from software license
fees prior to 1996. The cost of software license fees as a percentage of
software license fee revenues decreased from 59.3% in 1996 to 29.6% in 1997 due
primarily to increased software license sales volume in 1997. This increase
offset the additional six months of amortization of capitalized software
development costs in 1997 versus 1996, as well as royalties paid to a third
party for intellectual property included in VALEX. If the effect of SFAS 86
amortization and royalties for licensed intellectual property were not included,
gross margin on software license fee revenues would have been 95.7% and 99.3%
for 1996 and 1997, respectively. With the balance of capitalized software
development costs fully amortized at the end of 1997 and the primary royalty
obligations for licensed intellectual property fully paid as of the second
quarter of 1998, the cost of software license fee revenues consists principally
of the cost of the software media and other incidental costs.
 
     Cost of services and maintenance as a percentage of total revenues was
59.8%, 53.1% and 41.3% in 1995, 1996 and 1997, respectively. Cost of services
and maintenance as a percentage of services and maintenance revenues was 59.8%,
70.7% and 75.7% in 1995, 1996 and 1997, respectively. The increasing cost was
due to the costs of building a service organization infrastructure and the
increased use, at higher cost, of subcontracted labor on certain engagements.
The Company expects to continue to use subcontractors for the delivery of
professional services from time to time.
 
     Overall gross margin decreased from 40.2% in 1995 to 32.1% in 1996 as a
result of the Company's investments in its services infrastructure in
anticipation of increased VALEX sales and the inclusion of six months of SFAS 86
amortization. In 1997, gross margin increased to 45.3% of total revenues as the
Company's contribution of higher-margin software license fees increased from
24.9% of total revenues in 1996 to 45.5% in 1997. In addition, the Company began
to realize productive returns from the services infrastructure established in
1996.
 
  OPERATING EXPENSES
 
     Sales and Marketing.  Sales and marketing expenses were $128,000, $1.0
million, and $3.6 million, representing 7.5%, 16.7% and 28.5% of total revenues,
in 1995, 1996 and 1997, respectively. These increases were due primarily to the
increase in the Company's sales and marketing personnel and overall
infrastructure to support VALEX and expand internationally. The Company's
international expansion included the opening of its first international sales
office in the U.K. in July 1997. The Company expects to continue to expand its
direct sales force and marketing staff, increase its international presence, and
continue to develop its indirect sales channels and increase promotional
activity.
 
     Research and Development.  Research and development expenses were $708,000,
$1.3 million, and $2.6 million, representing 41.8%, 21.9%, and 20.5% of total
revenues, in 1995, 1996 and 1997, respectively. The increase in absolute dollars
was attributable primarily to the hiring of additional technical personnel
engaged in software development activities. The decline in research and
development expenses on a percentage basis was due primarily to the greater
growth in revenues.
 
     General and Administrative.  General and administrative expenses were
$352,000, $1.0 million and $2.2 million, representing 20.8%, 16.9% and 17.0% of
total revenues, in 1995, 1996 and 1997, respectively. General and administrative
expenses grew in absolute dollars as the Company added personnel to all
administrative areas, but declined on a percentage basis due primarily to
economies of scale.
 
  INTEREST INCOME (EXPENSE), NET
 
     Interest expense, net increased from $47,000 in 1995 to $195,000 in 1996 as
a result of interest charges on the Company's demand note payable to related
parties as well as finance charges




                                       22
<PAGE>   27
 
related to the Company's capital lease obligations. The Company reported net
interest income of $25,000 in 1997 as a result of the elimination of the related
party demand notes payable concurrent with the March 1997 venture capital
financing transaction, as well as the related interest income generated from the
proceeds of the March 1997 and December 1997 financing transactions.
 
  PROVISION FOR INCOME TAXES
 
     No provision for federal or state income taxes has been recorded as the
Company incurred net operating losses for all periods presented. The Company has
recorded a full valuation allowance against the deferred tax asset generated as
a result of these net operating loss carryforwards, as the Company currently
believes it is more likely than not that these assets will not be realized.




 
                                       23
<PAGE>   28
 
SELECTED QUARTERLY RESULTS OF OPERATIONS
 
     The following tables present unaudited quarterly consolidated statement of
operations data for each quarter in the six quarters ended June 30, 1998, as
well as such data expressed as a percentage of the Company's total revenues for
the periods indicated. This data has been derived from unaudited consolidated
financial statements that have been prepared on the same basis as the audited
consolidated financial statements and include all adjustments (consisting only
of normal recurring adjustments) that the Company considers necessary for a fair
presentation of such information. The Company believes quarter-to-quarter
comparisons of its financial results should not be relied upon as an indication
of future performance, and operating results may fluctuate from quarter to
quarter in the future.
 
<TABLE>
<CAPTION>
                                                                        QUARTER ENDED
                                              ------------------------------------------------------------------
                                              MARCH 31,   JUNE 30,   SEPT. 30,   DEC. 31,   MARCH 31,   JUNE 30,
                                                1997        1997       1997        1997       1998        1998
                                              ---------   --------   ---------   --------   ---------   --------
                                                                        (IN THOUSANDS)
<S>                                           <C>         <C>        <C>         <C>        <C>         <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
  Software license fees.....................   $  472      $1,321     $1,616      $2,356     $2,711      $3,105
  Services and maintenance..................    1,657       1,372      1,711       2,164      2,080       2,522
                                               ------      ------     ------      ------     ------      ------
        Total revenues......................    2,129       2,693      3,327       4,520      4,791       5,627
Cost of revenues:
  Software license fees.....................      430         433        449         395         84          45
  Services and maintenance..................    1,237       1,060      1,257       1,673      1,635       1,667
                                               ------      ------     ------      ------     ------      ------
        Total cost of revenues..............    1,667       1,493      1,706       2,068      1,719       1,712
                                               ------      ------     ------      ------     ------      ------
Gross profit................................      462       1,200      1,621       2,452      3,072       3,915
Operating expenses:
  Sales and marketing.......................      568         700        871       1,463      1,735       2,428
  Research and development..................      453         578        646         922      1,207       1,509
  General and administrative................      385         428        402         943        537         679
                                               ------      ------     ------      ------     ------      ------
        Total operating expenses............    1,406       1,706      1,919       3,328      3,479       4,616
                                               ------      ------     ------      ------     ------      ------
Loss from operations........................     (944)       (506)      (298)       (876)      (407)       (701)
Interest income (expense), net..............      (39)         29          7          28         23           6
                                               ------      ------     ------      ------     ------      ------
Net loss....................................   $ (983)     $ (477)    $ (291)     $ (848)    $ (384)     $ (695)
                                               ======      ======     ======      ======     ======      ======
</TABLE>
 
<TABLE>
<CAPTION>
                                                                        QUARTER ENDED
                                              ------------------------------------------------------------------
                                              MARCH 31,   JUNE 30,   SEPT. 30,   DEC. 31,   MARCH 31,   JUNE 30,
                                                1997        1997       1997        1997       1998        1998
                                              ---------   --------   ---------   --------   ---------   --------
<S>                                           <C>         <C>        <C>         <C>        <C>         <C>
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
  Software license fees.....................     22.2%       49.1%      48.6%       52.1%      56.6%       55.2%
  Services and maintenance..................     77.8        50.9       51.4        47.9       43.4        44.8
                                               ------      ------     ------      ------     ------      ------
        Total revenues......................    100.0       100.0      100.0       100.0      100.0       100.0
Cost of revenues:
  Software license fees.....................     20.2        16.1       13.5         8.7        1.8         0.8
  Services and maintenance..................     58.1        39.3       37.8        37.0       34.1        29.6
                                               ------      ------     ------      ------     ------      ------
        Total cost of revenues..............     78.3        55.4       51.3        45.7       35.9        30.4
                                               ------      ------     ------      ------     ------      ------
Gross margin................................     21.7        44.6       48.7        54.3       64.1        69.6
Operating expenses:
  Sales and marketing.......................     26.7        26.0       26.2        32.4       36.2        43.2
  Research and development..................     21.3        21.5       19.4        20.4       25.2        26.8
  General and administrative................     18.1        15.9       12.1        20.8       11.2        12.1
                                               ------      ------     ------      ------     ------      ------
        Total operating expenses............     66.1        63.4       57.7        73.6       72.6        82.1
                                               ------      ------     ------      ------     ------      ------
Loss from operations........................    (44.4)      (18.8)      (9.0)      (19.3)      (8.5)      (12.5)
Interest income (expense), net..............     (1.8)        1.1        0.2         0.6        0.5         0.1
                                               ------      ------     ------      ------     ------      ------
Net loss....................................    (46.2)%     (17.7)%     (8.8)%     (18.7)%     (8.0)%     (12.4)%
                                               ======      ======     ======      ======     ======      ======
</TABLE>
 
     The Company's revenues have increased in all quarters presented as a result
of increased market acceptance of the VALEX product, the continued growth of
indirect channel revenues, and expansion of international sales resources. Cost
of revenues on a percentage basis decreased throughout the quarters presented as
a result of an increase in software license fees in the
 
                                       24
<PAGE>   29
 
Company's revenue mix, the completion of the amortization of capitalized
software development costs in the fourth quarter of 1997 and the completion of
software royalty obligations in the second quarter of 1998. No assurances can be
given that the shift in revenue mix will continue. Gross profit for any quarter
will be affected by the revenue mix in that quarter.
 
     Operating expenses have increased in each of the quarters presented. Sales
and marketing expenses have increased as a result of increased sales and
marketing personnel and increased commissions associated with higher revenues.
Research and development expenses generally have increased as a result of
continued enhancements to the VALEX technology. General and administrative
expenses have increased primarily due to additional personnel, professional fees
and facilities and other infrastructure costs. General and administrative
expenses in the quarter ended December 31, 1997 included one-time charges
associated with the decision to relocate the Company's executive offices, as
well as noncash compensation expense associated with the Company's 1996 Stock
Incentive Plan.
 
     The Company's quarterly and annual operating results have varied
significantly in the past and are expected to do so in the future. Accordingly,
the Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
predictors of future performance. See "Risk Factors -- Potential for Significant
Fluctuations in Quarterly Results".
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Since its inception, the Company has financed its operations primarily
through the sale of equity securities in private placements and the issuance of
notes payable to related parties. In March 1997, the Company received $3,888,000
in net cash proceeds from the sale of its Series B Preferred Stock; and in
December 1997, the Company received $3,987,000 in net cash proceeds from the
sale of its Series C Preferred Stock. In addition, in December 1997, the Company
entered into a $2,000,000 revolving note agreement with Fleet National Bank. The
note bears interest at the bank's prime rate plus 0.75% per annum, payable
monthly in arrears, and expires on May 31, 1999.
 
     As of June 30, 1998, the Company had $4.2 million of cash, cash equivalents
and short-term investments. The Company believes that the net proceeds of this
Offering, along with its existing balance of cash, cash equivalents and
short-term investments, will be sufficient to meet the Company's working capital
and anticipated capital expenditure needs for at least the next 12 months.
Thereafter, the Company may require additional sources of funds to continue to
support its business. There can be no assurance that such capital, if needed,
will be available or will be available on terms acceptable to the Company.
 
     Cash provided by financing activities of $6.8 million in 1997 consisted
primarily of the proceeds from the issuance of Convertible Preferred Stock and
has been invested in short-term investments. Purchases of computer equipment
used in conducting the Company's business represented the primary component of
cash used in investing activities.
 
     Cash and cash equivalents for the six months ended June 30, 1998 decreased
$1.3 million from the December 31, 1997 ending balance. Net cash used for
operations of approximately $429,000 for the six months ended June 30, 1998
resulted primarily from a net operating loss before depreciation expense of
$851,000 less an approximately $422,000 decrease in working capital. The
decrease in working capital was primarily attributable to an increase in
accounts payable and deferred revenue, partially offset by an increase in
accounts receivable associated with increased license and services revenue in
the second quarter. Net cash used in investing activities for the six months
ended June 30, 1998 was a result of property and equipment purchases related to
the increase in headcount, the move to new operating facilities and the
acquisition of hardware and software for development and internal operating
systems. Net cash used in financing activities of $69,000 consisted of
approximately $110,000 for the repayment of capital lease obligations, offset by
cash inflow of $41,000 from the exercise of stock options under the 1996 Plan.

                                       25
<PAGE>   30
 
     The Company had net operating loss carryforwards of approximately $792,000
at December 31, 1997 to reduce future income taxes, if any. These carryforwards
expire through 2013 and are subject to review and possible adjustment by the
Internal Revenue Service. The Tax Reform Act of 1986 contains provisions that
may limit the amount of net operating loss and credit carryforwards that the
Company may utilize in any one year in the event of certain cumulative changes
in ownership over a three-year period in excess of 50% as defined. The Company
believes that it has experienced a change in ownership in excess of 50%. The
Company does not believe that this change will significantly impact the
Company's ability to utilize its net operating loss carryforwards.
 
     The Company currently intends to use the net proceeds of the Offering for
working capital and general corporate purposes, including financing accounts
receivable and capital expenditures made in the ordinary course of business, as
well as for possible reduction of indebtedness and for potential acquisitions of
businesses, products and technologies that are complementary to those of the
Company. Although the Company has not identified any specific businesses,
products or technologies that it may acquire, or entered into any current
agreements or negotiations with respect to any such transactions, the Company
from time to time evaluates such opportunities. Pending such uses, the net
proceeds will be invested in government securities and other short-term,
investment-grade, interest-bearing instruments.
 
IMPACT OF YEAR 2000 ISSUE
 
     The Year 2000 issue results from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
 
     The Company is in the process of conducting an assessment of its computer
information systems and is beginning to take the necessary steps to determine
the nature and extent of the work required to make its systems Year 2000
compliant, where necessary. These steps may require the Company to modify,
upgrade or replace some of its internal financial and operational systems. The
Company is currently in the process of upgrading its accounting and customer
care software with software warranted to be Year 2000 compliant. The Company
continues to evaluate the estimated cost of bringing all internal systems,
equipment and operations into Year 2000 compliance, but has not yet finished
determining the total cost of these compliance efforts. Although management does
not expect, based on currently available information, that Year 2000 issues will
have a material adverse effect on the Company's business, operating results or
financial condition, there can be no assurance that there will not be
interruptions of operations, other limitations of system or product
functionality or that the Company will not incur significant costs to avoid such
interruptions or limitations.
 
     The Company also intends to determine the extent to which it may be
vulnerable to any failures by its current and potential customers and
distributors to remedy their own Year 2000 issues, and is in the process of
initiating formal communications with these parties. At this time, the Company
is unable to estimate the nature or extent of any potential adverse impact
resulting from the failure of current and potential customers or third party
distributors to achieve Year 2000 compliance, although the Company does not
currently anticipate that it will experience any material sales delays from its
major distributors or current and potential customers due to Year 2000 issues.
However, there can be no assurance that these third parties will not experience
Year 2000 problems or that any problems would not have a material effect on the
Company's product distribution channels. Because the cost and timing of Year
2000 compliance by third parties such as customers and distributors is not
within the Company's control, no assurance can be given with respect to the cost
or timing of such efforts or any potential adverse effects on the Company of any
failure by these third parties to achieve Year 2000 compliance.



                                       26
<PAGE>   31
 
                                    BUSINESS
 
INTRODUCTION
 
     Exchange Applications, Inc. (the "Company") is a leading provider of
customer optimization software and solutions that enable businesses to maximize
profitability and revenue growth from new and existing customers through
marketing automation and enterprise-wide customer management. The Company's
Continuous Customer Management ("CCM") solution, including its VALEX software
and related consulting and integration services, enables businesses to
profitably retain and expand existing customer relationships and acquire new
customers by: (i) analyzing enterprise-wide databases of customer information to
identify profitable growth opportunities; (ii) planning and prioritizing
investments in high potential customers; (iii) creating targeted, real-time and
event-triggered marketing campaigns and other customer communications; (iv)
selecting the most effective channels for customer communications, such as
direct mail, call centers, sales forces and the Internet; and (v) continuously
evaluating the impact of these marketing campaigns and other communications on
profitability. CCM allows businesses to measure the value of marketing campaigns
and other customer communications against their associated costs and to use this
information to make investment decisions that maximize customer profitability.
 
     The principal components of the Company's CCM offering are VALEX, its open
enterprise software application, and the Company's proprietary consulting and
integration services. The Company has deployed CCM and VALEX across multiple
industries, with installations in over 40 businesses in North America and
Europe. Its customers include Federal Express, Fleet Bank, NatWest Bank (U.K.)
and US West. The Company's products and services are distributed through its
direct sales force, through re-seller relationships with IBM, NCR and others,
and through co-marketing arrangements with companies such as Compaq, Ernst &
Young, KPMG Peat Marwick, PricewaterhouseCoopers, SAS Institute and Sun
Microsystems.
 
BACKGROUND
 
     Today's increasingly competitive business environment has forced many
businesses to reduce costs in order to improve overall profitability. Enterprise
resource planning ("ERP") and supply chain management software and other
technologies have played a key role in helping businesses cut costs through the
automation of business and administrative functions such as accounting,
purchasing and inventory control, and human resources. While applications aimed
at cost reduction have generally been successful, businesses have realized that
these initiatives are only part of the solution to improve profitability and
have begun to invest in a new class of applications designed to increase
profitability through revenue growth. In the face of growing business
challenges, such as the high cost of attracting new customers, the proliferation
of customer purchasing options, increased customer sophistication and decreased
customer loyalty, revenue growth initiatives have become significantly more
difficult and more important to execute successfully.
 
     Many of these new applications are aimed at enabling businesses to grow
revenue by acquiring new customers and retaining and expanding relationships
with existing customers. These applications facilitate cross-selling and the
marketing of bundled products, new service offerings and differentiated service
relationships. To maximize the profitability of these efforts, businesses need
to allocate resources based not only on functional area and product
profitability, but also on current or potential customer profitability. To
enable this focus on customers, businesses need: (i) an investment allocation
methodology to identify profitable customer opportunities; (ii) the ability to
access and analyze large amounts of customer information; (iii) marketing
automation and campaign management applications to design and implement
effective marketing campaigns; (iv) technologies to manage interactions with
customers; and (v) the ability to evaluate the effectiveness of investments on
current and potential customer profitability.
 
                                       27
<PAGE>   32
 
     To this end, businesses have begun over the past several years to realign
existing marketing and customer management capabilities with new technologies
and processes that optimize customer relationships across the enterprise. This
evolution can be summarized in three phases, as follows:
 
     PHASE 1 -- TRADITIONAL APPROACH.  With traditional approaches, businesses
develop marketing campaigns that solicit broad customer segments with infrequent
and static offers. To manage these campaigns, businesses typically use
proprietary software provided by third-party commercial service bureaus to
access customer information maintained in large external databases. These
solutions have provided valuable information to businesses, but have had
significant limitations:
 
     - LIMITED ABILITY TO DEVELOP AND REFINE MARKETING CAMPAIGNS.  Traditional
       approaches are severely limited in the number and complexity of marketing
       campaigns that can be supported without manual intervention, increasing
       cycle time and cost and forcing businesses to run less targeted and less
       timely campaigns.
 
     - INABILITY TO ACCESS THE COMPLETE CUSTOMER RELATIONSHIP.  Traditional
       approaches use fixed data structures that store only a limited amount of
       information about each customer, forcing businesses to make decisions
       based on a limited portion of available customer information.
 
     - LIMITED ABILITY TO MEASURE PERFORMANCE.  Most traditional solutions use
       response rates and other basic metrics which do not provide the necessary
       information required to effectively measure campaign performance or to
       allocate marketing resources to those campaigns and other communications
       with the most positive impact on customer profitability.
 
     - POOR INTEGRATION WITH OTHER APPLICATIONS.  Many traditional solutions are
       limited by closed architectures and therefore require time-consuming,
       manual processes to be integrated with analytical tools, such as online
       analytical processing ("OLAP") and data mining tools, or customer
       touchpoint applications.
 
     PHASE 2 -- MARKETING AUTOMATION AND CAMPAIGN MANAGEMENT.  Recognizing the
competitive value of more active management of customer relationships,
businesses are transitioning from traditional approaches to more automated
marketing environments that enable businesses to target refined customer
segments, implement more customized offers on a timely basis, and measure the
effectiveness of offers with metrics such as return on investment. Central to
this approach are data warehouses which contain a more complete view of the
customer relationship, tools that predict customer behavior and software
applications that automate the design and execution of marketing campaigns.
Through marketing automation and campaign management, businesses benefit from
more timely access to, and robust analysis of, customer information, more
frequent and targeted campaigns, and more comprehensive measurement of the
effectiveness of investments. This results in increased return on investment,
reduced customer acquisition costs and reduced marketing cycle time.
 
     PHASE 3 -- ENTERPRISE-WIDE CUSTOMER MANAGEMENT.  Marketing automation and
campaign management solutions alone provide significant value. However, their
lack of integration with customer interaction software ("CIS") products, such as
sales force automation, call center, customer service, help desk and Internet
products, and other customer-related aspects of the business limits the ability
to plan and optimize customer relationships across the enterprise. In addition,
most CIS, marketing automation and campaign management solutions collectively
fail to provide a common customer management methodology. Enterprise-wide
customer management solutions integrate marketing automation and campaign
management software with data warehouses and CIS products in an environment in
which all aspects of the customer relationship are considered. This results in
more consistent messages to customers, greater penetration of potential
high-profit customers and the ability to employ lower cost communication
channels to optimize customer profitability.
 
                                       28
<PAGE>   33
 
THE CUSTOMER OPTIMIZATION OPPORTUNITY
 
     The Company believes that customer optimization software and solutions
represent a significant opportunity across many industries. Businesses are
adopting these technologies at different rates based on their access to customer
information, their level of database marketing sophistication, the marginal
economic impact of changes in the behavior of their customers and the degree of
competitiveness within their industry. The Company believes that the demand for
these technologies will grow rapidly as additional industries increasingly
recognize enterprise-wide customer management as a competitive requirement.
Significant opportunities exist for solutions that enable businesses to
transition from the traditional service bureau approach to marketing automation
and campaign management solutions and to enterprise-wide customer management
environments. These transitions require highly-automated marketing and campaign
management solutions that integrate people, processes and technology across the
enterprise to insure adherence to a common customer management methodology.
 
     According to an April 1997 Gartner Group report, overall spending on
service bureaus, marketing automation and campaign management, which Gartner
collectively refers to as database marketing, will be $1.3 billion in 1998,
growing at an annual rate of 35% over the next several years. Furthermore, as
evidence of the shift from traditional service bureau applications to marketing
automation and campaign management solutions, Gartner estimates that spending on
campaign management and marketing automation applications will be approximately
$220 million in 1998, increasing at an annual rate of approximately 100% to
nearly $900 million in 2000. Independent research analysts have reported that
marketing automation and campaign management efforts represent a major area of
focus for businesses today and note that many businesses are shifting to such
solutions. An earlier Gartner survey states that "database marketing appeared in
almost every industry as a high-payback, data-intensive application with
potentially significant returns".
 
     Other leading analysts believe that the transition to enterprise-wide
customer management represents an even greater opportunity than the earlier
shift to automated campaign management solutions. For example, Palo Alto
Management Group projects that the market for enterprise-wide customer
management software solutions will be $2.9 billion in 2002.
 
THE EXCHANGE APPLICATIONS SOLUTION
 
     The Company believes that its Continuous Customer Management solution,
implemented through its VALEX software and proprietary consulting and
integration services, represents a fundamentally new approach to customer
optimization that addresses the opportunities described above. CCM delivers
customer optimization solutions that allow a business to maximize the
profitability and revenue growth from new and existing customers through
marketing automation and campaign management that can evolve to enterprise-wide
customer management.
 
     VALEX enables businesses to optimize customer value by: (i) providing a
complete view of the relationship between a business and its customers; (ii)
leveraging a range of data mining, reporting and modeling products to identify
high-value customers; (iii) providing powerful marketing automation and campaign
management software that lets end-users define and execute targeted customer
communication streams; and (iv) integrating with CIS products and data
warehouses to perform enterprise-wide customer management. VALEX further
enhances the value of information stored in data warehouses by allowing
non-technical marketing professionals to design, execute and continuously
evaluate and refine targeted marketing campaigns.
 
     The Company's consulting and integration services include: (i) development
of processes that allow organizations to adopt the CCM solution across business
functions, including Value Exchange Optimization ("VEO"), a methodology for
allocating marketing investments based on expected return; (ii) Metrics
Repository, a custom software application that allows VALEX to track the success
or failure of marketing campaigns across business segments and across the
enterprise;
 
                                       29
<PAGE>   34
 
and (iii) VALEX Rapid Implementation, designed to quickly implement the core
VALEX modules, allowing access to data warehouse environments and campaign
execution in a matter of weeks.
 
     Through CCM and VALEX, businesses gain an understanding of the economics of
customer relationships, measure customer value and provide incentives through
campaigns that influence and optimize customer behavior. The Exchange
Applications solution offers the following key benefits:
 
     IMPROVED PROFITABILITY AND REVENUE GROWTH.  VALEX and CCM enable businesses
to retain and increase the value of existing customers and acquire new customers
by focusing investment resources on those customers with the greatest current
and potential value. Through the use of the Company's solution, businesses have
achieved increased retention rates, lower acquisition costs, more efficient
cross-selling and better customer satisfaction due to more relevant, less
intrusive communications.
 
     COMPREHENSIVE SOLUTION.  The Company's products and services provide a
complete solution for customer optimization. The Company believes that its
combined offering of software, proprietary methodologies and consulting services
help businesses implement marketing automation and campaign management software
and improve customer profitability quickly and with little risk.
 
     ENTERPRISE-WIDE CUSTOMER VIEW.  VALEX enables organizations to access and
use all types of information stored in data warehouses. Businesses are therefore
not restricted in the scope or type of information used to design customer
optimization strategies.
 
     INCREASED MARKETING VELOCITY.  VALEX creates continuous, fully-automated
marketing campaigns, allowing multiple end users to develop customized
communications triggered by customer characteristics (e.g., age, income, buying
behavior), specific events (e.g., changes in spending patterns, births of
children, changes in economic status) or dates (e.g., birth dates, contract
renewal dates). VALEX allows businesses to reduce dramatically the cycle time
from planning through design, execution and measurement of campaigns, to better
respond to competitive and market pressures and to quickly evaluate new
campaigns.
 
     OPEN, EXTENSIBLE ARCHITECTURE.  VALEX is designed to be open, easy-to-use
and scaleable across a wide variety of computing environments. The VALEX
architecture conforms to many current industry standards (OLE, COM, DCOM, CORBA,
ODBC) and can be integrated with existing hardware and software environments
allowing businesses to leverage their investments in CIS products and data
warehouse technologies.
 
STRATEGY
 
     The Company's objective is to be the leading provider of customer
optimization software and solutions globally. The Company's strategy for
achieving this objective includes:
 
     EXTEND VALEX.  The Company has developed unique technical solutions that
enable businesses to optimize customer relationships. The Company is currently
developing product extensions that will enhance the ability of its existing
products and services to directly integrate with data mining products and link
communications to customers with changes in their behavior. Further, the Company
is developing a local campaign management product to enable satellite offices
and remote users to design and execute independent campaigns while coordinating
with the central marketing function. The Company may also acquire businesses or
technologies that would provide the Company with extended product or service
offerings across the various aspects of a CCM implementation and/or specialized
knowledge or tailored software for selected vertical industries.
 
     DEVELOP ADDITIONAL CUSTOMER OPTIMIZATION SOLUTIONS.  The Company intends to
develop additional products to provide automation and business intelligence to
improve a business's ability to perform enterprise-wide customer management. The
Company's future products and services will be designed to optimize and control
communications across CIS environments and enhance business planning and
forecasting solutions based on customer and channel economics.
 
                                       30
<PAGE>   35
 
     EXPAND VERTICAL INDUSTRY FOCUS.  The Company currently targets the
telecommunications and financial services industries as well as other database
marketing intensive businesses that seek to develop customized marketing
campaigns. The Company intends to expand its focus to other industries as the
demand for its customer optimization solution grows. The Company's experience
has been that the rate of adoption of its solutions is driven by competitiveness
within a given industry, the level of database marketing sophistication, access
to customer information and the marginal economic impact of changes in customer
behavior. The Company is currently considering sales efforts focused on the
retail/catalog, energy/utility and insurance industries.
 
     BROADEN DISTRIBUTION CHANNELS AND BUILD ALLIANCES.  The Company will
continue to develop indirect distribution channels. The Company maintains global
re-seller agreements for VALEX with IBM, NCR and others to leverage these
partners' extensive marketing and distribution channels. The Company also has
co-marketing relationships with companies such as Compaq, Ernst & Young, KPMG
Peat Marwick, PricewaterhouseCoopers, SAS Institute and Sun Microsystems,
enabling it to utilize their extensive customer relationships and, in certain
cases, their products and services. The Company plans to leverage the
professional services resources of these re-seller and co-marketing
organizations to provide certain non-proprietary professional services required
in connection with the implementation of CCM and VALEX. This strategy will allow
the Company to provide and expand its professional services offerings to most
effectively complement its CCM methodology and software applications, and will
help increase the efficient implementation of CCM solutions in anticipation of
increased demands on the Company's services resources.
 
     INCREASE DIRECT SALES GLOBALLY.  The Company currently maintains and is
aggressively expanding its direct sales forces in North America, the U.K. and
Australia. In the future, the Company plans to expand further in Europe and the
Pacific Rim, with particular attention to territories or industries experiencing
trends advantageous to the adoption of the Company's solution, such as industry
deregulation.
 
PRODUCTS -- VALEX
 
     The Company's customer optimization software product, VALEX, allows end
users to select targeted customer segments, design time- and event-triggered
customized marketing campaigns and continuously execute and measure the
effectiveness of such marketing campaigns. VALEX may be implemented quickly with
a broad range of processes, databases and CIS environments.
 
     VALEX implementations range in size and complexity. A small implementation
may include data for 400,000 customers in a 50-100 gigabyte data warehouse, with
10 business users accessing the system. The price range for VALEX for this size
configuration is $200,000-$250,000. A large implementation may have 20,000,000
customers, a multi-terabyte data warehouse, and more than 100 users. The price
for VALEX in this configuration is typically more than $800,000.
 
                                       31
<PAGE>   36
 
     The principal VALEX components are listed and described in the following
table:
 
COMPONENT                                                         DESCRIPTION
---------                                                         -----------

Desktop..............  Allows users to define their core process steps for CCM
                       and then to organize VALEX components and associated
                       applications into those process steps.
                   
Segment..............  Allows users to segment the database into groups of
                       customers for a particular marketing campaign or
                       analysis.
                   
Profile..............  Allows users to analyze the characteristics of
                       individual customers within a segment.
                   
Campaign.............  Allows users to define and execute targeted campaigns
                       that run continuously and contain event triggers that
                       respond to customer behavior or inactivity.
                   
Schedule.............  Allows users to schedule VALEX components and to
                       automate campaign execution and tracking.
                   
Extract..............  Allows users to select information from the data
                       warehouse and export this information to other
                       applications and CIS technologies.
                   
Admin................  Allows users to interface VALEX with data warehouses and
                       provide configuration settings.
                   
Filter...............  Allows users to capture and analyze lists and
                       descriptions of customers and their characteristics in
                       the data warehouse.

 
     The figure below depicts VALEX and CCM as part of an enterprise-wide
solution.
 
 [A series of diagrams showing the VALEX architecture interfacing with customer
                      databases and customer touchpoints.]
 


                                       32
<PAGE>   37
 
     A VALEX USER CASE.  The following description and diagram illustrate how
VALEX is used to create, evaluate and refine marketing campaigns for
enterprise-wide customer management.
 
     - DESKTOP.  A user first selects a "work group", which directs a user to
       the database to be accessed and the process steps to be performed. A
       simplified marketing process may include identifying and planning
       opportunities, and then designing, executing and continuously evaluating
       and refining campaigns.
 
     - SEGMENT AND PROFILE.  During the opportunity identification stage, a user
       employs VALEX Segment to define desired groups of customers to be
       targeted in a particular campaign. The VALEX Profile component is then
       used to further analyze each segment by other attributes in the database
       (such as purchasing patterns, demographics, prior campaign history). In
       the example pictured below, three segments are defined. The "Targeted
       Prospects" segment comprises a group of prospective customers selected
       for a direct mail campaign. The "Cross Sell Opportunities" segment
       identifies a group of current customers whose purchase behavior indicates
       a likelihood of buying certain additional products. The "Likely to Leave"
       segment, derived using a statistical model, identifies customers with a
       high probability of attrition based on their behavioral and demographic
       characteristics.
 
             [A COMPUTER SCREEN DIAGRAM OF VALEX CAMPAIGN DECISION TREE.]
 
     - CAMPAIGN.  Once the user has decided on segments to be targeted for a
       particular campaign, he or she moves to the campaign design stage of the
       process. In this stage, a user employs VALEX Campaign to define the
       structure of the campaign. The user starts by specifying the campaign
       universe, and then defining all customers eligible to participate in the
       campaign. In this example, the user then creates three contact segments
       that branch off from the campaign universe. Groups are created by linking
       a query defined in VALEX Segment to


 
                                       33
<PAGE>   38
 
       the database of potential contacts and by specifying rules that determine
       whether each customer or prospect meets the campaign selection criteria.
       Rules are specified through database queries or data mining routines and
       can establish "triggers" that respond to customer behavior. Once a group
       of contacts is identified, it can be subdivided into smaller random
       groups that receive different communications. Subdivisions allow the user
       to test the relative effectiveness of various communication strategies,
       comparing different messages, offers and/or channels against a control
       group. In the example above, the user further divides the "Cross Sell
       Opportunities" contact group in order to test two different
       offers -- "Product Upgrade" and "Discounted Enrollment" -- against a
       control group which will not receive any offers. The behavior of all
       three "splits" of the "Cross Sell Opportunities" contact group will be
       evaluated to improve future campaigns.
 
     - EXTRACT AND SCHEDULE.  After a campaign has been created, the user links
       each element of the campaign to VALEX Extract. The physical destination
       of the targeted list of customers and the information content to be
       delivered to the customer touchpoint are defined as Extracts. In the
       pictured campaign, the "Mail House" extract is formatted for the
       generation of personalized direct mail. "Sales Agents", "Call Center" and
       "Service Center" extracts directly feed the appropriate system for each
       touchpoint. The "Promotional History" extract creates a record for each
       customer or prospect included in the campaign with information about that
       individual's contact group, offer and channel. This record, stored in a
       history table in the data warehouse, is used to measure campaign
       effectiveness and drive future communications. Through VALEX Schedule,
       campaign execution can be highly automated, reducing or eliminating human
       intervention. For instance, VALEX Schedule could automatically generate a
       nightly list of the best potential contacts for a cross-sell campaign or
       a weekly list of new customers to receive a welcome package through the
       mail.
 
     - METRICS REPOSITORY.  After executing a campaign, VALEX and Metrics
       Repository are used to analyze the campaign and refine it for the next
       cycle. Metrics Repository enables users to: (i) define campaign history
       tables, which update the data warehouse with information about customers
       or prospects selected in the campaign and capture information about each
       customer at the time they were contacted; (ii) establish test versus
       control groups to verify the incremental performance of a new message or
       segmentation technique; (iii) track each iteration of a campaign over
       time; (iv) define a "response" to a marketing action (e.g., a purchase of
       the offered product within two weeks of the start of the campaign); and
       (v) link responses to campaign promotions, providing the information
       foundation for measuring marketing effectiveness. Because the measurement
       needs of businesses vary widely, Metrics Repository is customized to meet
       the requirements of each individual business.
 
     VALEX ARCHITECTURE.  VALEX is an open enterprise software solution that can
operate on a variety of platforms in a multi-tiered environment, thereby
providing businesses maximum flexibility in the deployment of the software. For
some smaller installations, both the database and the application server can be
installed on one server with input from a separate client console. Larger
installations may require a three-tiered environment, with separate client,
data-warehouse and application servers. The software has been developed in
Visual C++ and Java and is object oriented. Parallel operation of VALEX enables
it to exploit database and hardware capabilities to operate in large database
environments. VALEX supports many of the common relational databases in use
today, and has been designed to generate structured query languages ("SQL") that
leverage the unique capabilities of the relational database systems ("RDBMS")
platforms. The following diagram represents an overview of VALEX and the
platforms it supports.


 
                                       34
<PAGE>   39
 
    [The graphic depicts a series of diagrams showing the VALEX architecture
  interfacing with customer databases and the platforms that VALEX supports.]
 
     Designed to be flexible and scaleable, VALEX uses industry standard
capabilities and interfaces, such as SQL, ODBC, COM, DCOM, MFC and CORBA, to
integrate closely with data warehouse and CIS environments. The Company is also
developing external interfaces to VALEX that will allow consultants, partners or
customers to quickly and easily add their own functional extensions to the
software while maintaining compatibility with future VALEX releases. The Company
believes that VALEX represents the most comprehensive combination of
functionality, scalability and openness in the marketplace today.

 
                                       35
<PAGE>   40
 
SERVICES
 
     The Company maintains its own integration services consulting group. The
group delivers capabilities to VALEX customers that include data warehouse
design and infrastructure development, business process design capabilities and
all aspects of the CCM implementation. Key service offerings include:
 
  CONSULTING
 
     PROCESS DESIGN.  A central part of the CCM solution is the design and
customization of processes for customer optimization. This includes process
templates in planning, campaign execution, measurement and continuous learning.
The Company's Value Exchange Optimization ("VEO") methodology describes a
process for businesses to allocate marketing investments based on the likely
return of a particular marketing campaign or customer communication. Through
VEO, businesses can make investments based on current and potential customer
profitability and allocate resources to customers with high profit potential
through more frequent and better targeted campaigns and differentiated service
offerings. VEO utilizes the data generated by VALEX to track overall campaign
performance as well as individual customer responses to campaigns. This allows a
business to discern more readily which customers are most likely to respond to
particular campaigns.
 
     VEO identifies gaps between the current and potential profitability of
customers. Companies can then employ VALEX to execute strategies to reduce those
gaps. Through VALEX and VEO, companies gain an understanding of the economics of
customer relationships, measure customer value and provide incentives through
campaigns that influence and optimize customer behavior.
 
     METRICS REPOSITORY.  The Company's Metrics Repository offering is a custom
application development project that enables a business to measure and visualize
the impact of its investments across customers and campaigns. Measurement is
accomplished through the CCM process steps, which require businesses to
establish a consistent measurement baseline and adopt a process-driven view for
managing and optimizing the value of its customer relationships. The Metrics
Repository is typically implemented through integration of OLAP tools with the
data warehouse and VALEX.
 
     VALEX RAPID IMPLEMENTATION.  With VALEX Rapid Implementation, the Company
implements the core VALEX components and integrates them with existing data
warehouse environments within a matter of weeks through a structured,
tightly-managed methodology. Rapid Implementation includes advising on campaign
structures and customer management strategies, training the first series of
users on VALEX and supporting and guiding users through the initial days of
operation.
 
  CUSTOMER SUPPORT AND SERVICE
 
     The Company believes that superior customer support and service are
critical to successful implementation of CCM and VALEX. The Company is committed
to providing high-quality customer support and to maintaining a qualified
customer support and service team. Ongoing customer support and service are
provided on a 24-hour-a-day, 7-day-a-week basis.
 
  TRAINING
 
     The Company offers complete training for its customers and partners. This
training includes end-user interaction with VALEX, administration of VALEX and
best practices in CCM.
 
  MAINTENANCE AND PRODUCT UPGRADES
 
     The Company provides ongoing product support services under its license and
maintenance agreements. Maintenance contracts are typically sold to customers
for one-year terms commencing on the date of the initial VALEX license and may
be renewed for additional periods. The Company also provides product updates to
VALEX free of charge for customers with a maintenance

                                       36
<PAGE>   41
 
agreement. Customers who do not purchase a maintenance agreement but would like
to receive product updates must purchase them from the Company.
 
PRODUCT DEVELOPMENT
 
     The Company originally introduced VALEX in July 1996 and has subsequently
made a number of product revisions and enhancements. The Company has adopted a
strategy of continuously reevaluating the needs of customers and marketplace
trends to develop new products. The Company's ongoing product development
efforts are focused on:
 
     - RELEASE 2.1-2.2 -- These releases of VALEX will include extensions to its
       existing functionality, a new component that links communications to
       changes in customer behavior and an improved interface with leading
       analytical applications.
 
     - RELEASE 3.0 -- This release will include open interfaces to the VALEX
       objects that will allow partners and customers to extend the software
       directly, further broadening the base functionality of VALEX.
 
     - ADAPTING VALEX FOR DIFFERENT LANGUAGES -- The Company is modifying VALEX
       to support multilingual databases and to permit translation into other
       languages.
 
     - DELIVERING A LOCAL CAMPAIGN MANAGEMENT CAPABILITIES -- This new module
       will enable satellite offices and remote users to design and execute
       independent campaigns while coordinating with the central marketing
       function.
 
     Each of these capabilities is expected to enter beta testing within the
next 12 months. Subsequent improvements and extensions will include a more
automated customer planning and forecasting capability and improved interfaces
to customer touchpoint applications. There can be no assurance that the Company
will not experience difficulties that could delay or prevent successful
development, introduction and sales of these products or that its new products
and enhancements will adequately meet the requirements of the marketplace and
achieve market acceptance. See "Risk Factors -- Rapid Technological Change and
New Products".
 
SALES AND MARKETING
 
     The Company markets its software and services through its direct sales
force of 11 quota-carrying sales representatives and indirectly through
re-sellers and co-marketers. As of June 30, 1998, the Company had sales offices
in Boston, Denver, London, England and Sydney, Australia. The Company's sales
force consists of teams made up of sales executives, managers and pre-sale
engineers organized by vertical industry. The Company currently has sales teams
focused on financial services and telecommunications and is currently evaluating
adding sales teams for other vertical industries, which may include
retail/catalog, utilities/energy and insurance.
 
     The Company currently has re-seller relationships with IBM, NCR and others,
which grants these companies the right to re-market VALEX and utilize the
Company's marketing materials. In addition, the Company has co-marketing
arrangements with companies such as Compaq, Ernst & Young, KPMG Peat Marwick,
PricewaterhouseCoopers, SAS Institute and Sun Microsystems to generate leads and
participate in sales efforts. None of the agreements governing the re-seller or
co-marketing relationships with these organizations includes any commitments on
the part of these organizations to effect any minimum number of sales of VALEX,
or to otherwise provide the Company with business. No assurances can be given
that any revenue will be realized by the Company from any of these
relationships.
 
CUSTOMERS
 
     The Company focuses on selling its CCM solution to leading businesses in
targeted vertical industries. The Company also has made significant sales to
other database-marketing intensive

 
                                       37
<PAGE>   42
 
businesses that seek to develop customized marketing campaigns. Following are
selected large customers in the financial services and telecommunications
vertical markets, as well as certain customers from other industries.
 
<TABLE>
<CAPTION>
FINANCIAL SERVICES   TELECOMMUNICATIONS           OTHER
------------------   ------------------           -----
<S>                  <C>                          <C>
First USA            BC TELECOM                   Aid Association for Lutherans
Fleet Bank           British SKY Broadcasting     Dutch Railways
INVESCO Funds Group  NEXTEL                       Federal Express Corporation
KeyCorp              Sprint                       Guidepost
Mellon Bank          US WEST                      New England Business Services
</TABLE>
 
  CUSTOMER CASE STUDIES:
 
     FEDERAL EXPRESS CORPORATION, MEMPHIS
 
     Federal Express over the last four years has re-engineered its database
marketing process -- from marketing and campaign planning to customer
segmentation, campaign execution, evaluation and refinement. VALEX has been
instrumental in Federal Express' efforts to automate and accelerate its database
marketing process.
 
     Federal Express reports the following accomplishments:
 
     - A dramatic time reduction in direct-marketing campaign cycles; and
 
     - A major improvement in "prospecting" campaigns.
 
     For its application of VALEX, Federal Express won both the 1997 "Best Data
Warehouse Application" award from the Data Warehouse Institute and the 1997
"Excellence Award" from the National Center for Database Marketing.
 
     KEYCORP, CLEVELAND
 
     In 1996, KeyCorp implemented a customer-centric data warehouse in an IBM
mainframe environment. KeyCorp began to develop sophisticated plans and concepts
around managing customer relationships over their financial services life cycle,
but found that the basic reporting and OLAP tools that were part of the data
warehouse did not have the capability to translate their strategic plans into
actual campaigns. As a result, KeyCorp's ability to execute campaigns was
constrained by the need for programmers to custom-develop each campaign, an
approach that is expensive, time-consuming and error-prone.
 
     The Company installed VALEX, enabling KeyCorp to access its data warehouse
directly and more quickly and effectively than before. In addition, the Company
provided CCM process optimization services to enable KeyCorp to implement a more
efficient and targeted methodology for planning, executing and measuring
campaigns.
 
     KeyCorp has reported increased campaign success rates due to automation of
customer segmenting and campaign testing and modeling. Profitability has also
increased due to better cross-selling and increased customer retention.


 
                                       38
<PAGE>   43
 
     BC TELECOM, VANCOUVER
 
     In 1997, BC TELECOM, Canada's second largest telecommunications company,
faced many challenges in marketing its services, including a need to shift its
focus from product marketing to customer-centric marketing, a lack of automation
in managing customer relationships across their lifecycles and limited
capabilities to allocate marketing dollars to customers presenting the greatest
potential value. Although BC TELECOM had made a major investment in a
multi-terabyte data warehouse, it believed that its business processes and
marketing systems were not sufficiently linked to the information available, and
that its large investment was therefore not generating optimal returns.
 
     To solve BC TELECOM's significant integration problems and its need for
quick action, Exchange Applications provided VALEX, Rapid Implementation and CCM
process optimization services in 1997. Within three months of implementation, BC
TELECOM had achieved significant results from highly targeted marketing
campaigns aimed at its 1.7 million residential customers.
 
COMPETITION
 
     The market for customer optimization software and related services is
highly competitive. There can be no assurance that the Company will maintain its
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical and
other resources. The Company's products and services are targeted at the
emerging market for customer optimization software solutions. The Company's
competitors are diverse in their orientation and history. The Company's current
and potential competitors fall into the following categories: (i) database
marketing vendors such as Harte Hanks, Metromail (a division of Great Universal
Stores) and Harland, which provide a combination of service bureau capabilities
and proprietary software; (ii) small independent software companies that have
created or are attempting to create offerings similar to the VALEX product;
(iii) ERP and CIS vendors such as SAP, Baan, Oracle, Siebel and Vantive, that
may have an interest in broadening their product lines to include applications
with competitive functionality; and (iv) internal information technology
departments that attempt to build their own systems.
 
     The principal competitive factors that favor the Company include: domain
expertise and intellectual property in customer optimization process management;
reputation of the Company and its employees and products; open and flexible
architecture; strong marketing automation and campaign management functionality;
and speed and ease of implementation and use. However, there can be no assurance
that the Company will be able to compete successfully with existing or new
competitors or that competition will not have a material adverse effect on the
Company's business, operating results and financial condition. See "Risk
Factors -- Competition".
 
PROPRIETARY RIGHTS AND LICENSES
 
     The Company relies primarily on a combination of copyright, trademark and
trade secret laws, confidentiality procedures and contractual provisions to
protect its proprietary rights. In addition, the Company generally licenses
VALEX to end users in object code (machine readable) format, and the Company's
license agreements generally allow the use of VALEX solely by the customer for
internal purposes without the right to sublicense or transfer VALEX. However,
certain customers have required the Company to maintain a source code escrow
account with a third-party software escrow agent, and a failure by the Company
to perform its obligations under the related license and maintenance agreements
or the insolvency of the Company could conceivably cause the release of the
Company's source code to such customers for certain limited purposes. The
Company believes that the foregoing measures afford only limited protection.
Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or to obtain and
use information that the Company regards as proprietary. Policing unauthorized
use of the Company's products is difficult, and while the Company is unable to
determine the extent to


 
                                       39
<PAGE>   44
 
which piracy of its software products exists, software piracy is a viable risk.
In addition, the laws of some foreign countries do not protect the Company's
proprietary rights to the same extent as the laws of the United States.
Furthermore, there can be no assurance that the Company's competitors will not
independently develop technology similar to that of the Company. The Company may
increasingly be subject to claims of intellectual property infringement as the
number of products and competitors in the Company's industry segment grows and
the functionality of products in different industry segments overlaps. Although
the Company is not aware that any of its products infringe upon the proprietary
rights of third parties, there can be no assurance that third parties will not
claim infringement by the Company with respect to current or future products.
Any such claims, with or without merit, could be time-consuming, result in
costly litigation, cause product shipment delays or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, might not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition. See "Risk Factors -- Intellectual
Property Rights; Use of Licensed Technology".
 
     The Company has in the past and may in the future resell certain software,
which it licenses from third parties. There can be no assurance that these third
party software licenses will continue to be available to the Company on
commercially reasonable terms. The loss of or inability to maintain or obtain
any of these software licenses could result in delays or reductions in product
shipments until equivalent software could be identified, licensed and
integrated, which could adversely affect the Company's business, operating
results and financial condition.
 
EMPLOYEES
 
     As of June 30, 1998, the Company had 129 full-time employees, including 33
primarily engaged in research and development and 40 in sales and marketing. The
Company's future success depends in significant part upon the continued service
of its key technical and senior management personnel and its continuing ability
to attract and retain highly qualified technical and managerial personnel.
Competition for such personnel is intense and there can be no assurance that the
Company can retain its key managerial and technical employees or that it can
attract, assimilate or retain other highly qualified technical and managerial
personnel in the future. None of the Company's employees is represented by
collective bargaining units and the Company, to date, has not experienced a work
stoppage. The Company believes that its employee relations are good.
 
FACILITIES
 
     The Company's primary offices are located in approximately 40,000 square
feet in Boston, Massachusetts pursuant to a lease expiring in June 1, 2003. The
Company also leases space for its sales offices in Denver, Colorado and London,
England.
 
                                       40
<PAGE>   45
 
                                   MANAGEMENT
 
DIRECTORS AND EXECUTIVE OFFICERS
 
     Set forth below is certain information concerning the directors and
executive officers of Company.
 
<TABLE>
<CAPTION>
NAME                                        AGE                   POSITION(S)
----                                        ---                   -----------
<S>                                         <C>    <C>
Andrew J. Frawley.........................  35     Chairman of the Board, President, Chief
                                                     Executive Officer and Director
John G. O'Brien...........................  47     Vice President, Chief Financial Officer,
                                                     Treasurer and Secretary
David G. McFarlane........................  35     Executive Vice President, Worldwide Sales
                                                     and Services
David L. Fitzgerald.......................  42     Vice President, North American Sales and
                                                     Alliances
Michael D. McGonagle......................  46     Vice President, Product Development
Patrick A. McHugh.........................  35     Vice President, Marketing and Business
                                                     Development
N. Wayne Townsend.........................  34     Vice President, Integration Services
Ramanan Raghavendran......................  29     Director
Jeffrey Horing............................  34     Director
Dean F. Goodermote........................  45     Director
</TABLE>
 
     Mr. Frawley founded the Company in November 1994 and has served as its
President and Chief Executive Officer since its incorporation in November 1996.
Mr. Frawley was elected Chairman of the Board of Directors of the Company in
January 1998. From July 1993 until founding the Company, Mr. Frawley served as a
principal of Grant & Partners Limited Partnership, a management consulting
company. From May 1989 to July 1993, Mr. Frawley held various positions at
MarketPulse, a subsidiary of Praxis International Inc. and developer and
provider of database marketing products, including serving as Vice President of
North American Operations. Mr. Frawley holds a B.S. in accounting from the
University of Maine and an M.B.A. from Babson College. Mr. Frawley has more than
10 years of experience in the high technology industry.
 
     Mr. O'Brien joined the Company in September 1997 as Vice President, Chief
Financial Officer and Secretary and was elected Treasurer of the Company in July
1998. From November 1996 to April 1997, Mr. O'Brien served as Vice President,
Finance and Chief Financial Officer of Advanced Modular Solutions, a computer
hardware manufacturing company. From August 1993 to November 1996, Mr. O'Brien
served as Corporate Controller of Avid Technology, Inc., a computerized film
editing system manufacturing company. From February 1991 to August 1993, Mr.
O'Brien served as Assistant Corporate Controller at Wang Laboratories, Inc., a
computer hardware and office automation system manufacturing company. Mr.
O'Brien is a C.P.A., holds a B.S. in accounting from Northeastern University,
and an M.B.A. from the Wharton School of the University of Pennsylvania. Mr.
O'Brien has more than 15 years of experience in the high technology industry. As
part of the settlement of Mr. O'Brien's recent divorce proceeding, Mr. O'Brien
voluntarily filed a bankruptcy petition under Chapter 13 of the federal
bankruptcy code. The Company does not believe that the filing of such petition
or the related circumstances reflects on Mr. O'Brien's ability or integrity as
an executive officer of the Company.
 
     Mr. McFarlane joined the Company in June 1997 as Executive Vice President,
Worldwide Sales and Services. From January 1988 until joining the Company, Mr.
McFarlane held various positions at Project Software & Development, Inc., a
publicly traded software company that develops and markets high value capital
asset software for processing plants and production equipment, most recently
serving as Vice President, International and Alliances. Mr. McFarlane holds a
B.Sc. in
 
                                       41
<PAGE>   46
 
electrical engineering and a Masters degree in electrical engineering from the
University of Bath in the U.K. Mr. McFarlane has more than 10 years of
experience in the high technology industry.
 
     Mr. Fitzgerald joined the Company in July 1998 as Vice President, North
American Sales and Alliances. From June 1996 until joining the Company, Mr.
Fitzgerald was the Group Vice President, Eastern Region of The Vantive
Corporation, an application software company. From April 1995 to April 1996, Mr.
Fitzgerald served as Vice President of Sales of Salesoft, Inc., a start-up
company specializing in sales force automation software. From March 1991 to
April 1995, Mr. Fitzgerald served as President of PowerCurve Corporation, a
company which he founded that specializes in systems integration and ERP
implementation services. Mr. Fitzgerald holds a B.S. in engineering from the
University of Massachusetts. Mr. Fitzgerald has more than 15 years of experience
in the high technology industry.
 
     Mr. McGonagle joined the Company upon its founding in November 1994 and has
served as Vice President, Product Development since its incorporation in
November 1996. From November 1993 until joining the Company, he was Vice
President, Research and Development at MarketPulse. From August 1991 to November
1993, he served as Director of Client-Server Development at Praxis International
Inc. Mr. McGonagle holds a B.A. in mathematics from the University of
Massachusetts (Lowell) and a Masters degree in mathematics from Brown
University. Mr. McGonagle has more than 20 years of experience in the high
technology industry.
 
     Mr. McHugh joined the Company in February 1996 and has served as Vice
President, Marketing and Business Development since March 1998. Mr. McHugh
served in various other capacities with the Company between February 1996 and
March 1998, including serving as Vice President, Sales and Vice President,
Marketing. From June 1995 until joining the Company, Mr. McHugh was the Eastern
Region Manager of Stanford Technology Group, a software development company.
From October 1994 to June 1995 he was Northeast Regional Manager of Siemens
Nixdorf, a computer systems manufacturing company, and from October 1993 to
October 1994 he was Northeast Regional Manager of Kendall Square Research, a
computer systems manufacturing company. Mr. McHugh holds a B.S. in marketing and
a B.S. in finance from Northeastern University. Mr. McHugh has more than 10
years of experience in the high technology industry.
 
     Mr. Townsend joined the Company in April 1996 as Vice President,
Integration Services. From April 1994 until joining the Company, Mr. Townsend
was a Project Director at Epsilon, a database marketing services company. From
May 1990 to April 1994, he was a consultant at Andersen Consulting, a management
consulting company. Mr. Townsend holds a B.S. in mechanical engineering from the
Massachusetts Institute of Technology and an M.S. in mechanical engineering from
the University of Dayton. Mr. Townsend has more than 10 years of experience in
the systems integration industry.
 
     Mr. Raghavendran has served as a Director of the Company since March 1997.
Mr. Raghavendran has served as a managing member of Insight Capital Partners, a
private equity investment firm, since January 1997. From 1992 to 1996, Mr.
Raghavendran was employed at General Atlantic Partners, an investment firm. Mr.
Raghavendran also serves on the boards of directors of several privately held
companies.
 
     Mr. Horing has served as a Director of the Company since March 1997. Mr.
Horing has served as a managing member of Insight Capital Partners, a private
equity investment firm, since January 1995. From 1990 to 1994, Mr. Horing was
employed at E.M. Warburg Pincus, an investment firm. Mr. Horing also serves on
the boards of directors of several privately held companies.
 
     Mr. Goodermote has been a Director of the Company since January 1998. Mr.
Goodermote has been the President and Chief Executive Officer of Process
Software Corporation, a software development company, since August 1996. From
August 1986 to August 1996, Mr. Goodermote held various positions at Project
Software and Development, Inc., including President and Chief Operating Officer
and most recently as Chairman of the Board of Directors. Mr. Goodermote also

 
                                       42
<PAGE>   47
 
serves on the boards of directors of several privately held companies. Mr.
Goodermote holds a B.A. in history from the University of Rochester and a M.A.
in Law and Diplomacy from the Fletcher School of Law and Diplomacy of Tufts
University. Mr. Goodermote has more than 15 years of experience in the high
technology industry.
 
BOARD OF DIRECTORS
 
     The Charter and By-laws provide that the size of the Board of Directors of
the Company (the "Board") shall be determined by resolution of the Board.
 
     The Charter provides for classification of the Board into three classes,
with the members of the respective classes serving for staggered three-year
terms. The first class will consist of Mr. Horing, the second of Mr. Goodermote
and the third of Mr. Frawley and Mr. Raghavendran, with the initial terms of the
directors comprising the classes expiring upon the election and qualification of
the directors at the annual meetings of the stockholders held following the
fiscal years of the Company ending December 31, 1998, 1999 and 2000,
respectively. At each annual meeting of stockholders, directors will be
re-elected or elected for full three-year terms. See "Description of Capital
Stock -- Certain Provisions of the Company's Amended and Restated Certificate of
Incorporation and By-laws".
 
     The Board has established a Compensation Committee and an Audit Committee.
The members of the Compensation Committee are Jeffrey Horing and Dean
Goodermote, and the members of the Audit Committee are Ramanan Raghavendran and
Dean Goodermote.
 
     The current and continuing directors of the Company were nominated and
elected in accordance with the Amended and Restated Stockholders Agreement,
dated as of December 4, 1997, which will terminate upon the closing of this
Offering.
 
     Executive officers of the Company are appointed by the Board and serve
until their successors have been duly elected and qualified. There are no family
relationships among any of the executive officers or directors of the Company.
 
     On January 30, 1998, the Company granted to Dean Goodermote an option to
purchase 20,000 shares of Common Stock at an exercise price of $1.35 per share,
vesting over a four-year period. Prior to the Offering, no other directors of
the Company have received compensation for their services in such capacity. The
Directors' Stock Option Plan provides for the grant of stock options to
non-employee directors. The Company anticipates that, following the Offering,
directors who are employees of the Company will not be paid any fees or
additional compensation for service as members of the Board or any committee
thereof and the Company will enter into customary arrangements with respect to
fees and other compensation (including expense reimbursement) for directors who
are not employees of the Company or any of its subsidiaries. The Company
maintains directors' and officers' liability insurance and its By-laws provide
for mandatory indemnification of directors and officers to the fullest extent
permitted by Delaware law. In addition, the Charter limits the liability of
directors of the Company to the Company or its stockholders for breaches of the
directors' fiduciary duties to the fullest extent permitted by Delaware law. See
"Description of Capital Stock -- Certain Anti-Takeover, Limited Liability and
Indemnification Provisions".
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     In March 1997, the Board established a compensation committee responsible
for determining compensation of officers of the Company. Prior to March 1997,
the Company had no compensation committee or other committee of the Board
performing similar functions. Andrew Frawley's salary during such year was
established by the Board and decisions concerning compensation of other
executive officers were made during such year by Mr. Frawley.
 
                                       43
<PAGE>   48
 
EMPLOYMENT CONTRACTS
 
     The officers serve at the discretion of the Board. The Company does not
presently have an employment contract in effect with any of its officers.
 
EXECUTIVE COMPENSATION
 
  SUMMARY COMPENSATION TABLE
 
     The following table sets forth certain information concerning the
compensation earned by the Company's Chief Executive Officer and the other
executive officers of the Company (collectively, "Named Officers") whose total
salary and bonus exceeded $100,000 for services rendered in capacities to the
Company and its subsidiaries during 1997. For disclosure regarding terms of the
stock options, see "Management -- Stock Option Plans".
 
<TABLE>
<CAPTION>
                                                                    LONG-TERM
                                                                   COMPENSATION
                                                                     OPTIONS
                                                               --------------------
                                               ANNUAL               (NUMBER OF
                                          COMPENSATION(1)           SECURITIES
                                        --------------------        UNDERLYING         ALL OTHER
    NAME AND PRINCIPAL POSITION(S)       SALARY      BONUS       OPTIONS GRANTED)     COMPENSATION
    ------------------------------       ------      -----       ----------------     ------------
<S>                                     <C>         <C>        <C>                    <C>
Andrew J. Frawley.....................  $200,000    $100,000         151,200              --
  Chairman of the Board, President and
  Chief Executive Officer
David G. McFarlane(2).................    78,757      47,500         300,000              --
  Executive Vice President, Worldwide
  Sales and Services
Michael D. McGonagle..................   131,000      30,000          58,000              --
  Vice President, Product Development
Patrick A. McHugh.....................   110,000     175,089          80,000              --
  Vice President, Marketing
N. Wayne Townsend.....................   125,000      85,000          74,000              --
  Vice President, Integration Services
</TABLE>
 
---------------
(1) Excludes certain perquisites and other benefits the amount of which did not
    exceed 10% of the employee's total salary and bonus.
 
(2) Mr. McFarlane joined the Company in June 1997 and his salary and bonus
    reflect compensation earned in the latter half of 1997.
 
                                       44
<PAGE>   49
 
      OPTION GRANTS IN LAST FISCAL YEAR
 
     The following table sets forth certain information concerning stock options
granted to each of the Named Officers during 1997. No stock appreciation rights
were granted to these individuals during such year.
 
<TABLE>
<CAPTION>
                                          NUMBER OF     % OF TOTAL
                                          SECURITIES     OPTIONS
                                          UNDERLYING    GRANTED TO    EXERCISE
                                           OPTIONS     EMPLOYEES IN     PRICE     EXPIRATION    GRANT DATE
NAME                                       GRANTED         1997       PER SHARE      DATE        VALUE(1)
----                                      ----------   ------------   ---------   ----------    ----------
<S>                                       <C>          <C>            <C>         <C>           <C>
Andrew J. Frawley.......................   151,200         10.4%        $0.72      7/31/02       $ 59,053
David G. McFarlane......................   250,000         17.3          0.65      7/31/07        100,861
David G. McFarlane......................    50,000          3.5          0.65      7/18/06         20,172
Michael D. McGonagle....................    18,000          1.2          0.65      7/31/07          7,262
Michael D. McGonagle....................    40,000          2.8          0.65      7/18/06         16,138
Patrick A. McHugh.......................    30,000          2.1          0.65      7/31/07         12,103
Patrick A. McHugh.......................    50,000          3.5          0.65      7/18/06         20,172
N. Wayne Townsend.......................    18,000          1.2          0.65      7/31/07          7,262
N. Wayne Townsend.......................    56,000          3.9          0.65      7/18/06         22,593
</TABLE>
 
---------------
(1) Represents the estimated fair value of the options as of the date of grant
    using the Black-Scholes option pricing model with the following assumptions:
    (i) expected volatility of 79%; (ii) expected life of four years; and (iii)
    risk-free interest rate of 5.96%. No dividends on common stock were assumed
    for purposes of this estimate.
 
  AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
 
     The following table sets forth certain information concerning option
exercises during 1997 and option holdings at December 31, 1997 with respect to
each of the Named Officers.
 
<TABLE>
<CAPTION>
                                                         NUMBER OF SECURITIES             VALUE OF UNEXERCISED
                                                        UNDERLYING UNEXERCISED            IN-THE-MONEY OPTIONS
                            SHARES                  OPTIONS AT DECEMBER 31, 1997(1)      AT DECEMBER 31, 1997(2)
                          ACQUIRED ON    VALUE     ---------------------------------   ---------------------------
NAME                       EXERCISE     REALIZED   EXERCISABLE(3)(4)   UNEXERCISABLE   EXERCISABLE   UNEXERCISABLE
----                      -----------   --------   -----------------   -------------   -----------   -------------
<S>                       <C>           <C>        <C>                 <C>             <C>           <C>
Andrew J. Frawley.......     --            --           151,200                --         $95,256     $       --
David G. McFarlane......     --            --            25,000           275,000          17,500        192,500
Michael D. McGonagle....     --            --             9,000            49,000           6,300         34,400
Patrick A. McHugh.......     --            --            15,000            65,000          10,500         45,500
N. Wayne Townsend.......     --            --             9,000            65,000           6,300         45,500
</TABLE>
 
---------------
(1) "Exercisable" refers to those options which were both exercisable and
    vested, while "Unexercisable" refers to those options which were unvested.
 
(2) Value is determined by subtracting the exercise price from the fair market
    value of the Common Stock at December 31, 1997 ($1.35 per share), as
    determined by the Company's Board of Directors, multiplied by the number of
    shares underlying the options.
 
(3) In March 1998, the Company granted stock options, none of which is currently
    exercisable, to the following Named Officers to purchase the corresponding
    number of shares of Common Stock at an option exercise price of $3.50 per
    share: (i) David G. McFarlane, 30,000 shares of Common Stock; (ii) Michael
    D. McGonagle, 9,000 shares of Common Stock; (iii) Patrick A. McHugh, 10,000
    shares of Common Stock; and (iv) N. Wayne Townsend, 11,500 shares of Common
    Stock. In addition, in March 1998, the Company granted Andrew J. Frawley
    options to purchase 105,000 shares of Common Stock at an exercise price of
    $3.85 per share.
 
                                       45
<PAGE>   50
 
(4) On June 12, 1998 (i) David G. McFarlane exercised options to purchase 25,000
    shares of Common Stock at an exercise price of $0.65 per share for an
    aggregate exercise price of $16,250, (ii) Patrick A. McHugh exercised
    options to purchase 15,000 shares of Common Stock at an exercise price of
    $0.65 per share for an aggregate purchase price of $9,750, and (iii) N.
    Wayne Townsend exercised options to purchase 9,000 shares of Common Stock at
    an exercise price of $0.65 per share for an aggregate purchase price of
    $5,850.
 
STOCK OPTION PLANS
 
     1998 Stock Incentive Plan.  The Company's 1998 Stock Incentive Plan (the
"1998 Plan") was approved by the Board on July 15, 1998 and was adopted by the
Company's stockholders on July 15, 1998. The aggregate number of shares of
Common Stock available for awards under the 1998 Plan is 2,700,000 shares. The
1998 Plan provides for the grant or award of stock options ("Stock Options") to
purchase shares of Common Stock of the Company. Stock Options granted under the
1998 Plan may be incentive stock options or non-statutory options. The purpose
of the 1998 Plan is to attract and retain outstanding employees through the
incentives of stock ownership. Any employee of the Company (including officers),
and any consultant to and any director of the Company, is eligible to receive
Stock Options under the 1998 Plan. As of July 15, 1998, none of the shares
reserved for issuance under the 1998 Plan was subject to outstanding Stock
Options.
 
     The 1998 Plan is administered by the Board. Subject to the provisions of
the 1998 Plan, the Board has the authority to designate participants and to
determine whether Stock Options granted are incentive stock options or not, the
number of shares to be covered by each Stock Option, the exercise price of the
Stock Option, the period of time over which Stock Options are exercisable or may
be settled, the method of payment and any other terms and conditions of the
awards. All Stock Options are evidenced by Stock Option Agreements between the
Company and the participant.
 
     While the Board determines the prices at which Stock Options may be
exercised under the 1998 Plan, the exercise price of an incentive Stock Option
under the 1998 Plan shall be at least 100% of the fair market value (as
determined under the terms of the 1998 Plan) (or 110% of the fair market value
if the grantee is deemed to own 10% or more of the outstanding voting stock of
the Company) of a share of Common Stock on the date of grant. Stock Options must
be exercised by the tenth anniversary of the date of grant, or if the grantee
owns 10% or more of the outstanding voting stock of the Company, by the fifth
anniversary of the date of the grant.
 
     1996 Stock Incentive Plan.  The Company's 1996 Stock Incentive Plan (the
"1996 Plan"), effective November 15, 1996, was approved by the Board of
Directors on November 15, 1996 and adopted by the Company's stockholders in
March 1997. The 1996 Plan provides for the grant or award of Stock Options,
which may be incentive stock options or non-statutory stock options, and for the
direct purchase of shares of Common Stock of the Company ("Restricted Common
Stock"). The purpose of the 1996 Plan is to attract and retain outstanding
employees through the incentives of stock ownership. Any employee of the Company
(including officers), and any consultant to and any director of the Company, is
eligible to receive Stock Options and to purchase Restricted Common Stock under
the 1996 Plan. As of July 15, 1998, the Company had 2,277,283 shares of Common
Stock reserved for issuance remaining under the 1996 Plan, of which 2,085,408
shares were subject to outstanding stock options at a weighted average exercise
price of $3.10 per share.
 
     The 1996 Plan is administered by the Board. Subject to the provisions of
the 1996 Plan, the Board has the authority to designate participants and to
determine whether Stock Options granted are incentive stock options or not, the
number of shares to be covered by each Stock Option, the price of the exercise
of the Stock Option and the purchase price of the Restricted Common Stock, the
time at which Stock Options are exercisable or may be settled, whether
restrictions such as repurchase options are to be imposed on shares subject to
the Stock Options and to the Restricted Common Stock, the method of payment and
any other terms and conditions of the awards. All Stock
 
                                       46
<PAGE>   51
 
Options and Restricted Common Stock are evidenced by Stock Option Agreements and
Restricted Stock Agreements, respectively, between the Company and the
participant.
 
     While the Board determines the prices at which Stock Options may be
exercised under the 1996 Plan, the exercise price of an incentive Stock Option
under the 1996 Plan shall be at least 100% of the fair market value (as
determined under the terms of the 1996 Plan) (or 110% of the fair market value
if the grantee is deemed to own 10% or more of the outstanding voting stock of
the Company) of a share of Common Stock on the date of grant. Stock Options must
be exercised by the tenth anniversary of the date of grant, or if the grantee
owns 10% or more of the outstanding voting stock of the Company, by the fifth
anniversary of the date of the grant.
 
     In the event that the Company is consolidated with or acquired by another
person or entity in a merger, sale of stock, sale of all or substantially all of
the Company's assets or otherwise (other than a merger or consolidation of the
Company with, or the sale of all or substantially all of the assets of the
Company to, any entity if 50% or more of the aggregate voting power of such
entity is held immediately after such transaction by persons who were
stockholders of the Company immediately prior to such transaction) (an
"Acquisition"), each outstanding Stock Option held by an executive officer of
the Company shall accelerate so as to be fully exercisable for all of the shares
subject to such Stock Option. The foregoing option acceleration provisions may
have the effect of discouraging, delaying or preventing a change in control of
the Company or unsolicited acquisition proposals that a stockholder might
consider favorable, and as a result, such provisions may have an adverse effect
upon the market price for the Common Stock. There are no option acceleration
provisions with respect to Stock Options held by any person other than executive
officers of the Company.
 
     Shares underlying Stock Options generally vest over a four-year period.
However, shares underlying certain Stock Options vest as of the ninth
anniversary of the date of the grant of such options, but vesting of up to 25%
of the original amount of such shares may accelerate and may become exercisable
at the end of each calendar year commencing with 1998 upon satisfaction of
certain performance criteria determined by the Board and the Chief Executive
Officer of the Company.
 
     Restricted Common Stock generally vests over a three-year period. However,
vesting may accelerate in the event of (i) the direct or indirect acquisition by
any person of 50% or more of the aggregate voting power of the Company, or (ii)
the sale of all or substantially all of the assets of the Company (other than a
merger or consolidation of the Company with, or the sale of all or substantially
all of the assets of the Company to, any entity if 50% or more of the aggregate
voting power of such entity is held immediately after such transaction by
persons who were stockholders of the Company immediately prior to such
transaction). Upon grant the recipient has full voting and dividend rights with
respect to all shares granted. The shares are subject to a purchase option of
the Company and are subject to restrictions on transfer.
 
401(k) SAVINGS PLAN
 
     The Company has established a tax-qualified cash or deferred profit sharing
plan (the "401(k) Savings Plan") covering all of the Company's eligible
full-time employees. The Company adopted the 401(k) Savings Plan effective June
1, 1998. Under the plan, participants may elect to contribute, through salary
reductions, up to 15.0% of their annual compensation subject to a statutory
maximum. The Company does not currently provide additional matching
contributions under the 401(k) Savings Plan, but may do so in the future. The
401(k) Savings Plan is designed to qualify under Section 401 of the Internal
Revenue Code of 1986, as amended, so that contributions by employees or by the
Company to the plan, and income earned on plan contributions, are not taxable to
employees until withdrawn from the 401(k) Savings Plan, and so that
contributions by the Company, if any, will be deductible by the Company when
made. The trustee under the plan, at the
 
                                       47
<PAGE>   52
 
direction of each plan participant, currently invests the assets of the 401(k)
Savings Plan in eight investment options.
 
     Director Stock Option Plan.  The Company's 1998 Director Stock Option Plan
(the "Directors' Plan") was approved by the Board on July 15, 1998. The
Directors' Plan will be administered by the Compensation Committee of the Board.
Under the Directors' Plan, on the business day immediately following each annual
meeting of the stockholders of the Company, commencing with the first annual
meeting of stockholders after December 31, 1998, each person who is then a
non-employee director of the Company will be eligible to receive an option to
purchase such number of shares of Common Stock as determined by the Compensation
Committee at an exercise price equal to the fair market value of the Common
Stock on the date the option is granted. A total of 100,000 shares of Common
Stock have been reserved for issuance under the Directors' Plan. The Directors'
Plan is intended to help the Company attract and retain non-employee directors
on the Company's Board.
 
     Employee Stock Purchase Plan.  The Company's 1998 Employee Stock Purchase
Plan (the "Stock Purchase Plan") was approved by the Board on July 15, 1996. The
Stock Purchase Plan will be administered by the Compensation Committee of the
Board. The Stock Purchase Plan is intended to qualify as an "employee stock
purchase plan" under Section 423 of the Internal Revenue Code of 1986, as
amended. The Compensation Committee may grant options to purchase shares of
Common Stock to employees eligible under the Stock Purchase Plan who may acquire
shares of the Company's Common Stock through payroll deductions. The purchase
price for the Company's Common Stock purchased under the Stock Purchase Plan is
85% of the lesser of the fair market value of the shares on the date the option
was granted or the date the option is exercised. A total of 200,000 shares of
Common Stock have been reserved for issuance under the Stock Purchase Plan. The
Stock Purchase Plan is intended to help the Company attract and retain
outstanding employees through the incentives of stock ownership.
 
                                       48
<PAGE>   53
 
                              CERTAIN TRANSACTIONS
 
PREFERRED STOCK ISSUANCE
 
     Pursuant to a Securities Purchase Agreement, dated as of December 4, 1997,
Insight Capital Partners II, L.P. and Wexford Insight LLC each purchased 611,977
shares of Series C Convertible Preferred Stock of the Company for an aggregate
purchase price, in each case, of $2,000,000, or $3.268 per share.
 
     Pursuant to a Stock Purchase and Waiver Agreement (the "Stock Purchase
Agreement"), dated as of December 4, 1997, GAP Coinvestment Partners, L.P.
("GAP") sold an aggregate of 246,006 shares of Series B Convertible Preferred
Stock of the Company to the following purchasers for an aggregate purchase price
of $803,947.58 or $3.268 per share: Andrew J. Frawley, David McFarlane, Daniel
Cox, Patrick McHugh, Michael McGonagle, Stewart Vassie, Steven Feldman, Patrick
D. Brady, Gregory P. Shlopak, David H. Brault, Ted L. Axelrod, Terry B.
Angstadt, James T. Brady, Dominic F. Mammola, James A. Dooley, Diane K. Green,
and Insight Venture Partners I, L.P.
 
     Pursuant to the Securities Purchase Agreement, dated as of March 18, 1997
(the "Securities Purchase Agreement") (i) Insight Venture Partners II, L.P.
purchased 1,154,775 shares of Series B Preferred Stock from the Company for an
aggregate purchase price of $1,807,222.88, or $1.565 per share; (ii) Wexford
Insight LLC purchased 1,154,775 shares of Series B Preferred Stock from the
Company for an aggregate purchase price of $1,807,222.88, or $1.565 per share;
(iii) GAP purchased 246,006 shares of Series B Preferred Stock from the Company
for an aggregate purchase price of $384,999.39, or $1.565 per share; (iv) GPLP
converted 2,300,000 shares of Series A Convertible Preferred Stock ("Old
Preferred Stock") to 1,725,000 shares of Common at a conversion price of
$3.01333; (v) GPLP purchased 377,408 shares of Series A Preferred Stock from the
Company in consideration of the cancellation of certain indebtedness owed by the
Company to GPLP; (vi) Cyrk purchased 2,522,592 shares of Series A Preferred
Stock from the Company in consideration of the cancellation of certain
indebtedness owed by the Company to Cyrk and (vii) the Company paid to Cyrk
$1,000,000 to discharge certain indebtedness.
 
REGISTRATION RIGHTS AGREEMENT
 
     Pursuant to an Amended and Restated Registration Rights Agreement, dated as
of December 4, 1997, the Company granted registration rights to certain
stockholders of the Company, including Insight Venture Partners I, L.P., Insight
Capital Partners II, L.P., Insight Capital Partners (Cayman) II, L.P., Wexford
Management LLC, Cyrk, Inc. ("Cyrk"), Grant & Partners Limited Partnership
("GPLP"), Andrew J. Frawley, Michael J. Feldman, Michael McGonagle, David
McFarlane, Daniel Cox, Patrick McHugh, Stewart Vassie, Steven Feldman, Patrick
D. Brady, Gregory P. Shlopak, David H. Brault, Ted L. Axelrod, Terry B.
Angstadt, James T. Brady, Dominic F. Mammola, James A. Dooley and Diane K.
Green. See "Shares Eligible for Future Sale -- Registration Rights".
 
CONTRACT WITH EXCHANGE MARKETING GROUP
 
     Pursuant to several Termination Agreements dated as of March 18, 1997, the
Company and each of Michael J. Feldman, a former director and employee of the
Company, and six other employees of the Company terminated their employment
arrangements with the Company. The Company repurchased an aggregate of 341,125
shares of Common Stock from the departing employees for an aggregate purchase
price of $341.13. Upon termination, Mr. Feldman formed Exchange Marketing Group,
LLC ("EMG"), a marketing consulting company. The Company engaged EMG to provide
consulting services to certain of the Company's customers pursuant to a
Consulting Agreement, dated as of March 18, 1997. As evidenced by a Promissory
Note (the "EMG Note"), dated as of March 18, 1997, the Company loaned to EMG
$350,000. On February 5, 1998, the entire principal and interest outstanding
under the EMG Note was repaid. In addition, in connection with the transactions
contemplated by the Consulting Agreement, EMG licensed from
 
                                       49
<PAGE>   54
 
the Company certain intellectual property to be used in its marketing consulting
business and the Company and EMG entered into mutual non-compete agreements.
 
FOUNDER'S LOANS
 
     As evidenced by a Promissory Note (the "Note"), dated as of December 4,
1997, in the original principal amount of $124,997.73, the Company loaned to Mr.
Frawley the total amount of the purchase price for the 38,249 shares of Series B
Convertible Preferred Stock purchased by Mr. Frawley under the Stock Purchase
Agreement. The Note bears interest at 8% per annum and is secured by 38,249
shares of Series B Convertible Preferred Stock owned by Mr. Frawley. As of June
30, 1998, the outstanding balance of the indebtedness under the Note was
$130,764.74.
 
SEPARATION FROM GPLP
 
     Pursuant to an Assignment and Assumption Agreement, dated as of November
15, 1996, the Company purchased certain assets, including, without limitation,
cash, accounts receivable, fixed assets and certain intangible property, from
GPLP, and the Company issued 2,300,000 shares of Series A Convertible Preferred
Stock to GPLP and assumed certain liabilities of GPLP, including, without
limitation, indebtedness owed to Cyrk, indebtedness under leasing arrangements,
indebtedness with respect to employee benefits and accounts payable. In
addition, in connection with the transactions contemplated by the Assignment and
Assumption Agreement, each of Andrew J. Frawley and Michael J. Feldman entered
into mutual releases of claims with Cyrk, GPLP, Alan Grant and GPI, and the
Company entered into a fully paid-up perpetual license with GPLP pursuant to
which the Company licensed from GPLP certain intellectual property.
 
LEGAL SERVICES
 
     The Company has, with respect to this Offering and from time to time,
retained the services of the law firm of Bingham Dana LLP. The Company
anticipates that legal fees to be paid to Bingham Dana LLP for 1998 will exceed
$300,000. Neil W. Townsend, a partner at Bingham Dana LLP, is the brother of N.
Wayne Townsend, Vice President, Integration Services of the Company.
 
FUTURE AFFILIATE TRANSACTIONS
 
     All future transactions, including loans, between the Company and its
officers, directors, principal stockholders and their affiliates, will be
approved by a majority of the Board, including a majority of the independent and
disinterested outside directors on the Board, and will be on terms no less
favorable to the Company than could be obtained from unaffiliated third parties.
 
                                       50
<PAGE>   55
 
                       PRINCIPAL AND SELLING STOCKHOLDERS
 
     The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of June 30, 1998, and as adjusted to
reflect the sale of shares offered hereby, by (i) each person who is known by
the Company to own beneficially more than five percent of the Company's Common
Stock; (ii) each of the Company's directors and Named Officers; (iii) all
current executive officers and directors as a group; and (iv) each of the
Selling Stockholders. Unless otherwise indicated, the address for the following
stockholders is 89 South Street, Boston, Massachusetts 02111.
 
<TABLE>
<CAPTION>
                                       SHARES BENEFICIALLY                   SHARES BENEFICIALLY
                                          OWNED BEFORE                           OWNED AFTER
                                           OFFERING(1)          NUMBER         OFFERING(1)(2)
                                     -----------------------   OF SHARES   -----------------------
BENEFICIAL OWNER                      NUMBER      PERCENTAGE    OFFERED      NUMBER     PERCENTAGE
----------------                      ------      ----------   ---------     ------     ----------
<S>                                  <C>          <C>          <C>         <C>          <C>
Entities affiliated with Insight
  Venture Associates, LLC(3).......  3,557,783       46.1%           --     3,557,783        36.6%
Cyrk, Inc.(4)......................  1,150,000       14.9       460,026       689,974         7.1
Grant & Partners Limited
  Partnership(5)...................    575,000        7.5       230,058       344,942         3.5
Michael J. Feldman(6)..............    530,250        6.9       212,104       318,146         3.3
Andrew J. Frawley(7)...............  1,038,249       13.2        57,162       981,087         9.9
David G. McFarlane(8)..............    126,009        1.6        17,800       108,209         1.1
David J. Fitzgerald................         --         --            --            --          --
John G. O'Brien(9).................     10,000          *            --        10,000           *
Michael D. McGonagle(10)...........    114,000        1.5         8,600       105,400           *
Patrick A. McHugh(11)..............     75,000          *         7,500        67,500           *
N. Wayne Townsend(12)..............     59,000          *         6,750        52,250           *
Ramanan Raghavendran(13)(14).......  3,557,783       46.1            --     3,557,783        36.6
Jeffrey Horing(15).................  3,557,783       46.1            --     3,557,783        36.6
Dean F. Goodermote(16).............         --         --            --            --          --
All directors and executive
  officers as a group (ten
  persons).........................  4,980,041       62.5        97,812     4,882,229        49.0
</TABLE>
 
---------------
  *  Indicates less than 1% of the outstanding shares of Common Stock.
 
 (1) Beneficial ownership is calculated in accordance with the rules of the
     Securities and Exchange Commission. In computing the number of shares
     beneficially owned by a person and the percentage ownership of that person,
     shares of Common Stock subject to options held by that person that are
     currently exercisable or become exercisable within 60 days following June
     30, 1998 are deemed outstanding. However, such shares are not deemed
     outstanding for the purpose of computing the percentage ownership of any
     other person. Unless otherwise indicated in the footnotes to this table,
     the persons and entities named in the table have sole voting and sole
     investment power with respect to all shares beneficially owned, subject to
     community property laws where applicable.
 
 (2) Assumes no exercise of the Underwriters' over-allotment option.
 
 (3) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
     shares held by Insight Capital Partners II, L.P. and 61,198 shares held by
     Insight Capital Partners (Cayman) II, L.P., each of which is under common
     control with Insight Venture Partners I, L.P. Also includes 1,766,752
     shares held by Wexford Insight LLC. Pursuant to a consulting agreement
     dated as of June 1, 1996 (the "Insight Consulting Agreement") between
     Insight Venture Management Inc. and Wexford Insight LLC, Insight Venture
     Partners I, L.P. may vote all of the shares held by Wexford Insight LLC for
     certain matters until six months after the completion of this Offering. As
     a result, Insight Venture Associates, LLC and its affiliates may be deemed
     to be the beneficial owners of all of the shares held by Wexford Insight
     LLC. The address of the Insight entities is 122 East 42nd Street, Ste 2300,
     New York, New York 10168, and the address of Wexford Insight LLC 411 West
     Putnam Avenue, Suite 125, Greenwich, Connecticut 06830.
 
                                       51
<PAGE>   56
 
 (4) Does not include 2,900,000 shares of Series A Preferred Stock which are
     eliminated upon consummation of the Offering. In addition to the number of
     shares shown as offered for sale in the table, Cyrk, Inc. intends to grant
     the Underwriters the right to purchase up to an additional 229,455 shares
     pursuant to the Underwriters' over-allotment option. The address of Cyrk,
     Inc. is 3 Pond Road, Gloucester, Massachusetts 01930.
 
 (5) In addition to the number of shares shown as offered for sale in the table,
     Grant & Partners Limited Partnership intends to grant the Underwriters the
     right to purchase up to an additional 114,750 shares pursuant to the
     Underwriters' over-allotment option. The address of Grant & Partners
     Limited Partnership is 150 Federal Street, Boston, Massachusetts 02110.
 
 (6) Includes 30,000 shares held by Smith Barney IRA f/b/o Michael Feldman. In
     addition to the number of shares shown as offered for sale in the table,
     Mr. Feldman intends to grant the Underwriters the right to purchase up to
     an additional 105,795 shares pursuant to the Underwriters' over-allotment
     option.
 
 (7) Includes 151,200 shares subject to options that currently are exercisable.
     Includes 848,800 shares of Restricted Common Stock, 141,495 shares of which
     are unvested and therefore subject to a repurchase option in favor of the
     Company.
 
 (8) Includes 75,000 shares subject to options that currently are exercisable.
 
 (9) Includes 10,000 shares subject to options that currently are exercisable.
 
(10) Includes 9,000 shares subject to options that currently are exercisable.
     Includes 100,000 shares of Restricted Common Stock which are subject to a
     repurchase option in favor of the Company.
 
(11) Includes 50,000 shares of Restricted Common Stock which are subject to a
     repurchase option in favor of the Company.
 
(12) Includes 50,000 shares of Restricted Common Stock which are subject to a
     repurchase option in favor of the Company.
 
(13) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
     shares held by Insight Capital Partners II, L.P., 61,198 shares held by
     Insight Capital Partners (Cayman) II, L.P. and 1,766,752 shares held by
     Wexford Insight LLC. Mr. Raghavendran is a managing member of Insight
     Capital Partners and as such he may be deemed to be a beneficial owner of
     all of the shares held by entities affiliated with Insight Capital
     Partners. In addition, Insight Venture Partners I, L.P., Insight Capital
     Partners II, L.P. and Insight Capital Partners (Cayman) II, L.P. may be
     deemed to be beneficial owners of all of the shares held by Wexford Insight
     LLC (see Notes 3, 4 and 5), and as a managing member of Insight Capital
     Partners, Mr. Raghavendran may be deemed to be a beneficial owner of all of
     the shares held by Wexford Insight LLC.
 
(14) The address of Mr. Raghavendran and Mr. Horing is c/o Insight Venture
     Associates, LLC, 122 East 42nd Street, Ste 2300, New York, New York 10168.
 
(15) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
     shares held by Insight Capital Partners II, L.P., 61,198 shares held by
     Insight Capital Partners (Cayman) II, L.P. and 1,766,752 shares held by
     Wexford Insight LLC. Mr. Horing is a managing member of Insight Capital
     Partners and as such he may be deemed to be a beneficial owner of all of
     the shares held by entities affiliated with Insight Capital Partners. In
     addition, Insight Venture Partners I, L.P., Insight Capital Partners II,
     L.P. and Insight Capital Partners (Cayman) II, L.P. may be deemed to be
     beneficial owners of all of the shares held by Wexford Insight LLC (see
     Notes 3, 4 and 5), and as a managing member of Insight Capital Partners,
     Mr. Horing may be deemed to be a beneficial owner of all of the shares held
     by Wexford Insight LLC.
 
(16) Does not include 20,000 shares subject to options that are not exercisable
     within 60 days of June 30, 1998.
 
                                       52
<PAGE>   57
 
                          DESCRIPTION OF CAPITAL STOCK
 
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
 
     The authorized capital stock of the Company consists of 30,000,000 shares
of Common Stock, par value $.001 per share, and 10,000,000 shares of preferred
stock, par value $.001 per share ("Preferred Stock"). Upon consummation of the
Offering, no shares of Preferred Stock and 9,716,740 shares of Common Stock
(10,166,740 shares if the Underwriters' over-allotment option is exercised in
full) will be outstanding. The following summary is qualified in its entirety by
reference to the Company's Charter and By-laws.
 
COMMON STOCK
 
     As of June 30, 1998, there were 7,716,740 shares of Common Stock
outstanding held of record by 68 stockholders, assuming the conversion of all
shares of Convertible Preferred Stock into an aggregate of 3,779,510 shares of
Common Stock upon closing of this Offering. The holders of Common Stock are
entitled to one vote per share on all matters to be voted upon by the
stockholders. Subject to preferences that may be applicable to any outstanding
Preferred Stock, the holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by the Board out of
funds legally available therefor. In the event of liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities, subject to prior
distribution rights of Preferred Stock, if any, then outstanding. The Common
Stock has no preemptive or conversion rights or other subscription rights. There
are no redemption or sinking fund provisions applicable to the Common Stock. All
outstanding shares of Common Stock are fully paid and nonassessable, and the
shares of Common Stock offered by the Company in the Offering will, when issued,
be fully paid and nonassessable.
 
PREFERRED STOCK
 
     The Board has the authority to issue the Preferred Stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, liquidation preferences and the number of shares
constituting any series or the designation of such series, without further vote
or action by the Company's stockholders. The issuance of Preferred Stock may
have the effect of delaying, deferring or preventing a change in control of the
Company and may adversely affect the voting and other rights of the holders of
Common Stock. At present, the Company has no plans to issue any shares of
Preferred Stock.
 
CERTAIN ANTI-TAKEOVER, LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
 
  DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS
 
     The Charter provides for the division of the Board into three classes as
nearly equal in size as practicable with staggered three-year terms, effective
upon consummation of this Offering. See "Management -- Board of Directors". A
director may be removed only for cause and then only by the vote of a majority
of the shares entitled to vote for the election of directors.
 
     The Charter empowers the Board of Directors, when considering a tender
offer or merger or acquisition proposal, to take into account factors in
addition to potential economic benefits to stockholders. Such factors may
include (i) comparison of the proposed consideration to be received by
stockholders in relation to the then current market price of the Company's
capital stock, the estimated current value of the Company in a freely negotiated
transaction or the estimated future value of the Company as an independent
entity and (ii) the impact of such a transaction on the employees, suppliers and
customers of the Company and its effect on the communities in which the Company
operates.
 
                                       53
<PAGE>   58
 
     The Charter and By-laws provide that, effective upon consummation of the
Offering, any action required or permitted to be taken by the stockholders of
the Company may be taken only at a duly called annual or special meeting of the
stockholders and that special meetings may be called only by the Chairman of the
Board, the President or a majority of the entire Board. These provisions could
have the effect of delaying until the next annual stockholders meeting
stockholder actions which are favored by the holders of a majority of the
outstanding voting securities of the Company, including actions to remove
directors. These provisions may also discourage another person or entity from
making a tender offer for the Company's Common Stock, because such person or
entity, even if it acquired all or a majority of the outstanding voting
securities of the Company, would be able to take action as a stockholder (such
as electing new directors or approving a merger) only at a duly called
stockholders meeting, and not by written consent.
 
     The Delaware General Corporation Law ("DGCL") provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless a corporation's certificate of incorporation or by-laws, as the case may
be, requires a greater percentage. The Charter requires the affirmative vote of
a majority of the entire Board and the holders of at least 66 2/3% of the
outstanding voting stock of the Company to amend or repeal any of the foregoing
Charter provisions or to reduce the number of authorized shares of Common Stock
and Preferred Stock. A 66 2/3% vote is also required to amend or repeal the
Company's By-laws. Such stockholder vote would in either case be in addition to
any separate class vote that might in the future be required pursuant to the
terms of any Preferred Stock that might be outstanding at the time any such
amendments are submitted to stockholders. The By-laws may also be amended or
repealed by a majority vote of the Board of Directors.
 
     The By-laws provide that for nominations for the Board or for other
business to be properly brought by a stockholder before an annual meeting of
stockholders, the stockholder must first have given timely notice thereof in
writing to the Secretary of the Company. To be timely, a stockholder's notice
generally must be delivered not later than 120 days in advance of the first
anniversary of the date that the Company's proxy statement to stockholders is
delivered in connection with the prior year's annual meeting of stockholders or
90 days prior to the date of the meeting if no such proxy statement was
delivered to the stockholders. The notice must contain, among other things,
certain information about the stockholder delivering the notice and, as
applicable, background information about each nominee or a description of the
proposed business to be brought before the meeting. Business transacted at a
special meeting is limited to the purposes for which the meeting is called.
 
     The foregoing provisions could have the effect of making it more difficult
for a third party to acquire, or of discouraging a third party from attempting
to acquire, control of the Company. See "Risk Factors -- Effect of Anti-takeover
Provisions".
 
     The Charter contains certain provisions permitted under the DGCL relating
to the liability of directors. These provisions eliminate a director's liability
for monetary damages for a breach of fiduciary duty, except in certain
circumstances involving certain wrongful acts, such as the breach of a
director's duty of loyalty or acts or omissions which involve intentional
misconduct or a knowing violation of law. The Charter and By-laws also contain
provisions indemnifying the directors and officers of the Company to the fullest
extend permitted by the DGCL. The Company expects to obtain, prior to the
consummation of the Offering, a directors and officers liability insurance
policy which provides for indemnification of its directors and officers against
certain liabilities incurred in their capacities as such, which may include
liabilities under the Securities Act of 1933, as amended (the "Securities Act").
The Company believes that these provisions will assist the Company in attracting
and retaining qualified individuals to serve as directors.
 
     The Company is subject to the provisions of Section 203 of the DGCL.
Subject to certain exceptions, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the interested stock-
 
                                       54
<PAGE>   59
 
holder attained such status with the approval of the Board or unless the
business combination is approved in a prescribed manner. A "business
combination" includes certain mergers, assets sales and other transactions
resulting in a financial benefit to the interested stockholder. Subject to
certain exceptions, an "interested stockholder" is a person who, together with
his or her affiliates and associates, owns, or owned within three years prior
15% or more of the corporation's voting stock.
 
TRANSFER AGENT AND REGISTRAR
 
     The Transfer Agent and Registrar for the Common Stock is BankBoston, N.A.
 
                        SHARES ELIGIBLE FOR FUTURE SALE
 
     Upon completion of this Offering, the Company will have 9,716,740 shares of
Common Stock outstanding (assuming no exercise of the Underwriters'
over-allotment option and no exercise of outstanding options under the Company's
1996 Plan or other options after June 30, 1998). Of such shares, the 3,000,000
shares sold in this Offering will be freely transferable without restriction or
further registration under the Securities Act, except for any shares held by an
existing "affiliate" of the Company, as that term is defined by the Securities
Act (an "Affiliate"), which shares will be subject to the resale limitations of
Rule 144 adopted under the Securities Act. As of the date of this Prospectus,
7,716,740 "restricted shares" as defined in Rule 144 will be outstanding. Of
such shares, and without consideration of the contractual restrictions described
below, no shares would be available for immediate sale in the public market
without restriction pursuant to Rule 144(k). Beginning 90 days after the date of
this Prospectus, and without consideration of the contractual restrictions
described below, 939,067 shares would be eligible for sale in reliance upon Rule
144 promulgated under the Securities Act and 1,330,595 shares would be eligible
for sale in reliance upon Rule 701 promulgated under the Securities Act.
 
     In general, under Rule 144 as currently in effect, beginning 90 days after
the Offering, a person (or persons whose shares are aggregated) who owns shares
that were purchased from the Company (or any Affiliate) at least one year
previously, including a person who may be deemed an Affiliate of the Company, is
entitled to sell within any three-month period a number of shares that does not
exceed the greater of (i) 1% of the then outstanding shares of the Common Stock
(approximately 97,167 shares immediately after the Offering) or (ii) the average
weekly trading volume of the Common Stock on the Nasdaq National Market during
the four calendar weeks preceding the date on which notice of the sale is filed
with the Securities and Exchange Commission (the "Commission"). Sales under Rule
144 are also subject to certain manner of sale provisions, notice requirements
and the availability of current public information about the Company. Any person
(or persons whose shares are aggregated) who is not deemed to have been an
Affiliate of the Company at any time during the 90 days preceding a sale, and
who owns shares within the definition of "restricted securities" under Rule 144
under the Securities Act that were purchased from the Company (or any Affiliate)
at least two years previously, would be entitled to sell such shares under Rule
144(k) without regard to the volume limitations, manner of sale provisions,
public information requirements or notice requirements.
 
     Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its employees,
directors, officers, consultants or advisers prior to the date the issuer
becomes subject to the reporting requirements of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), pursuant to written compensatory benefit
plans or written contracts relating to compensation of such persons. In
addition, the Commission has indicated that Rule 701 will apply to the typical
stock options granted by an issuer before it becomes subject to the reporting
requirements of the Exchange Act, along with the shares acquired upon exercise
of such options (including exercises after the date of this Prospectus).
Securities issued in reliance on Rule 701 are restricted securities and, subject
to the contractual restrictions described above,
 
                                       55
<PAGE>   60
 
beginning 90 days after the date of this Prospectus, may be sold (i) by persons
other than Affiliates, subject only to the manner of sale provisions of Rule
144, and (ii) by Affiliates under Rule 144 without compliance with its one-year
holding period requirement.
 
     All stockholders of the Company, including the officers, directors and
Selling Stockholders, have agreed not to sell any of their shares of Common
Stock for 180 days after the date of this Prospectus without the prior written
consent of the representatives of the Underwriters. As a result of these
contractual restrictions and subject to the provisions of Rules 144(k), 144 and
701, as applicable, 2,651,892 shares subject to restriction will be eligible for
sale upon expiration of the Lock-Up Agreements 180 days after the date of this
Prospectus. See "Underwriting".
 
     The Company has agreed not to offer, sell or otherwise dispose of any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock or any rights to acquire Common Stock for a period
of 180 days after the date of this prospectus, without the prior written consent
of the Representatives of the Underwriters, subject to certain limited
exceptions. See "Underwriting".
 
     After the Offering, the holders of 6,025,310 shares of Common Stock or
their respective transferees, would be entitled to certain rights with respect
to the registration of such shares under the Securities Act. Registration of
such shares under the Securities Act would result in such shares becoming freely
tradable without restriction under the Securities Act (except for shares
purchased by Affiliates) immediately upon the effectiveness of such
registration.
 
     The Company intends to file a registration statement under the Securities
Act covering all shares of Common Stock subject to outstanding stock options as
well as all shares of Common Stock reserved for issuance under the Company's
Stock Plans. Such registration statement is expected to be filed within 90 days
after the date of this Prospectus and will automatically become effective upon
filing. Following such filing, shares registered under such registration
statement will, subject to the Lock-Up Agreements, Rule 144 volume limitation
applicable to Affiliates and the lapsing of the Company's repurchase rights, be
available for sale in the open market upon the exercise of vested options 90
days after the effective date of this Prospectus. At July 15, 1998, options to
purchase 2,085,408 shares were issued and outstanding under the 1996 Plan and no
options were issued and outstanding outside of the 1996 Plan.
 
                                 LEGAL MATTERS
 
     The validity of the Common Stock offered hereby will be passed upon for the
Company by Bingham Dana LLP, Boston, Massachusetts. Certain legal matters in
connection with the Offering will be passed upon for the Underwriters by Ropes &
Gray, Boston, Massachusetts.
 
                                    EXPERTS
 
     The consolidated financial statements of Exchange Applications, Inc. as of
December 31, 1996 and 1997, and for each of the three years in the period ended
December 31, 1997 included in this Prospectus and Registration Statement have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto, and included herein in reliance
upon the authority of said firm as experts in giving said reports.
 
                             ADDITIONAL INFORMATION
 
     The Company has filed with the Securities and Exchange Commission (the
"Commission"), 450 Fifth Street, N.W., Washington, D.C. 20549, a Registration
Statement on Form S-1 (Reg. No. 333-01752) (the "Registration Statement") under
the Securities Act with respect to the Common Stock offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits to the Registration Statement. For further
information
                                       56
<PAGE>   61
 
with respect to the Company and the Common Stock offered hereby, reference is
made to the Registration Statement and the exhibits filed as part of the
Registration Statement. Statements contained in this Prospectus concerning the
contents of any contract or any other document are not necessarily complete;
reference is made in each instance to the copy of such contract or any other
document filed as an exhibit to the Registration Statement. Each such statement
is qualified in all respects by such reference to such exhibit. The Registration
Statement, including exhibits thereto, may be inspected without charge at the
Commission's principal office in Washington, D.C., and copies of all or any part
thereof may be obtained from such office after payment of fees prescribed by the
Commission.
 
                                       57
<PAGE>   62
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Report of Independent Public Accountants....................  F-2
Consolidated Balance Sheets.................................  F-3
Consolidated Statements of Operations.......................  F-4
Consolidated Statements of Stockholders' Equity (Deficit)...  F-5
Consolidated Statements of Cash Flows.......................  F-6
Notes to Consolidated Financial Statements..................  F-7
</TABLE>
 
                                       F-1
<PAGE>   63
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors of
Exchange Applications, Inc. and subsidiaries:
 
     We have audited the accompanying consolidated balance sheets of Exchange
Applications, Inc., a Delaware corporation, and subsidiaries as of December 31,
1996 and 1997, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of 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 Exchange Applications, Inc.
and subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
 
                                          ARTHUR ANDERSEN LLP
 
Boston, Massachusetts
June 16, 1998 (Except with
respect to the matters discussed
in Note 17, as to which the
date is July 15, 1998)
 
                                       F-2
<PAGE>   64
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                                      JUNE 30, 1998
                                                                 DECEMBER 31,      --------------------
                                                              ------------------              PRO FORMA
                                                               1996       1997      ACTUAL    (NOTE 3)
                                                              -------   --------   --------   ---------
                                                                                       (UNAUDITED)
<S>                                                           <C>       <C>        <C>        <C>
                                                ASSETS
Current assets:
  Cash and cash equivalents.................................  $   361   $  5,273   $  3,977   $  3,977
  Marketable securities.....................................       --        202        205        205
  Accounts receivable, less allowance for doubtful accounts
    of $43, $206 and $212 at December 31, 1996 and 1997 and
    June 30, 1998, respectively.............................    2,002      3,848      5,240      5,240
  Prepaid expenses and other current assets.................       --        729        727        727
                                                              -------   --------   --------   --------
         Total current assets...............................    2,363     10,052     10,149     10,149
Property and equipment, net.................................      606        913      1,627      1,627
Software development costs, net.............................    1,211         --         --         --
Other assets................................................        9        435        358        358
                                                              -------   --------   --------   --------
         Total assets.......................................  $ 4,189   $ 11,400   $ 12,134   $ 12,134
                                                              =======   ========   ========   ========
 
                            LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
  Current portion of obligations under capital leases.......  $    22   $    212   $    232   $    232
  Current portion of notes payable to related parties.......    1,000         --         --         --
  Accounts payable..........................................      535        422      1,234      1,234
  Accrued expenses..........................................    1,313      3,247      3,445      3,445
  Deferred revenue..........................................      346        922      1,723      1,723
                                                              -------   --------   --------   --------
         Total current liabilities..........................    3,216      4,803      6,634      6,634
Obligations under capital leases, net of current portion....       34        237        128        128
Notes payable to related parties, net of current portion....    2,234         --         --         --
Commitments (Note 9)
Redeemable Preferred Stock (Notes 10 and 11)................       --      7,088      7,208         --
Stockholders' equity (deficit):
  Preferred Stock; $.001 par value --
    10,000,000 shares authorized; 2,300,000 shares issued
    and outstanding at December 31, 1996....................        2         --         --         --
  Series C Preferred Stock, $.001 par value --
    1,223,954 shares designated, issued and outstanding at
    December 31, 1997 and June 30, 1998, actual.............       --          1          1         --
  Common Stock, $.001 par value --
    12,078,698 shares authorized; 2,484,375, 4,234,971,
    4,298,305 shares issued at December 31, 1996 and 1997
    and June 30, 1998, actual, respectively, and 8,077,815
    shares issued on a pro forma basis at June 30, 1998.....        2          4          4          8
  Additional paid-in capital................................      868      4,837      4,878     12,083
  Accumulated deficit.......................................   (2,167)    (5,450)    (6,649)    (6,649)
  Due from officer..........................................       --       (125)      (125)      (125)
  Cumulative translation adjustment.........................       --          2         50         50
  Unrealized gain on marketable securities..................       --          3          5          5
  Treasury stock, at cost; 354,825 shares at December 31,
    1997 and 361,075 shares at June 30, 1998, actual and pro
    forma...................................................       --         --         --         --
                                                              -------   --------   --------   --------
         Total stockholders' equity (deficit)...............   (1,295)      (728)    (1,836)     5,372
                                                              -------   --------   --------   --------
         Total liabilities and stockholders' equity
           (deficit)........................................  $ 4,189   $ 11,400   $ 12,134   $ 12,134
                                                              =======   ========   ========   ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       F-3
<PAGE>   65
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
               (IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                     YEARS ENDED                    SIX MONTHS ENDED
                                                     DECEMBER 31,                       JUNE 30,
                                        --------------------------------------   -----------------------
                                           1995          1996          1997         1997         1998
                                        ----------   ------------   ----------   ----------   ----------
                                         (NOTE 1)      (NOTE 1)                        (UNAUDITED)
<S>                                     <C>          <C>            <C>          <C>          <C>
Revenues:
  Software license fees...............  $       --    $    1,500    $    5,765   $    1,793   $    5,816
  Services and maintenance............       1,693         4,534         6,904        3,029        4,602
                                        ----------    ----------    ----------   ----------   ----------
         Total revenues...............       1,693         6,034        12,669        4,822       10,418
Cost of revenues:
  Software license fees...............          --           890         1,707          863          129
  Services and maintenance............       1,012         3,205         5,227        2,297        3,302
                                        ----------    ----------    ----------   ----------   ----------
         Total cost of revenues.......       1,012         4,095         6,934        3,160        3,431
                                        ----------    ----------    ----------   ----------   ----------
Gross profit..........................         681         1,939         5,735        1,662        6,987
Operating expenses:
  Sales and marketing.................         128         1,007         3,602        1,268        4,163
  Research and development............         708         1,325         2,599        1,031        2,716
  General and administrative..........         352         1,018         2,158          813        1,216
                                        ----------    ----------    ----------   ----------   ----------
         Total operating expenses.....       1,188         3,350         8,359        3,112        8,095
                                        ----------    ----------    ----------   ----------   ----------
Loss from operations..................        (507)       (1,411)       (2,624)      (1,450)      (1,108)
Interest income (expense):
  Interest income.....................          --             2            89           39           56
  Interest expense....................         (47)         (197)          (64)         (49)         (27)
                                        ----------    ----------    ----------   ----------   ----------
         Total interest income
           (expense)..................         (47)         (195)           25          (10)          29
                                        ----------    ----------    ----------   ----------   ----------
Net loss..............................        (554)       (1,606)       (2,599)      (1,460)      (1,079)
Accretion of discount and dividends on
  preferred stock.....................          --            --          (684)        (565)        (120)
                                        ----------    ----------    ----------   ----------   ----------
Net loss applicable to common
  stockholders........................  $     (554)   $   (1,606)   $   (3,283)  $   (2,025)  $   (1,199)
                                        ==========    ==========    ==========   ==========   ==========
Net loss per share (Note 2(c)):
  Basic and diluted net loss per share
    applicable to common
    stockholders......................  $    (0.46)   $    (1.33)   $    (1.12)  $    (0.82)  $    (0.33)
                                        ==========    ==========    ==========   ==========   ==========
  Basic and diluted weighted average
    common shares outstanding.........   1,200,016     1,205,041     2,919,775    2,477,683    3,597,711
                                        ==========    ==========    ==========   ==========   ==========
Pro forma net loss per share (Note
  2(c)):
  Pro forma basic and diluted net loss
    per share.........................  $    (0.19)   $    (0.55)   $    (0.48)  $    (0.31)  $    (0.15)
                                        ==========    ==========    ==========   ==========   ==========
  Pro forma basic and diluted
    weighted average common shares
    outstanding.......................   2,925,016     2,930,041     5,390,779    4,682,560    7,377,221
                                        ==========    ==========    ==========   ==========   ==========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       F-4
<PAGE>   66
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
                                                                                                       SERIES C
                                                                          PREFERRED STOCK          PREFERRED STOCK
                                                          NET PARENT   ----------------------   ----------------------
                                                           COMPANY     NUMBER OF      $.001     NUMBER OF      $.001
                                                          INVESTMENT     SHARES     PAR VALUE     SHARES     PAR VALUE
                                                          ----------   ---------    ---------   ---------    ---------
<S>                                                       <C>          <C>          <C>         <C>          <C>
Balance, January 1, 1995................................   $    (7)            --      $--              --      $--
 Net loss...............................................      (554)            --       --              --       --
 Comprehensive net loss for the year ended December 31,
   1995.................................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, December 31, 1995..............................      (561)            --       --              --       --
 Net loss prior to incorporation of the Company.........    (2,093)            --       --              --       --
 Capitalization of the Company..........................     2,654             --       --              --       --
 Issuance of Preferred Stock............................        --      2,300,000        2              --       --
 Issuance of common stock...............................        --             --       --              --       --
 Net income after incorporation of the Company..........        --             --       --              --       --
 Comprehensive net loss for the year ended December 31,
   1996.................................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, December 31, 1996..............................        --      2,300,000        2              --       --
 Issuance costs relating to the sale of Series B
   Preferred Stock......................................        --             --       --              --       --
 Conversion of Preferred Stock to common stock..........        --     (2,300,000)      (2)             --       --
 Compensation expense relating to stock options.........        --             --       --              --       --
 Sale of Series C Preferred Stock, net of issuance costs
   of $13...............................................        --             --       --       1,223,954        1
 Accretion of discount and dividends on Series A
   Preferred Stock......................................        --             --       --              --       --
 Loan to officer........................................        --             --       --              --       --
 Issuance of common stock...............................        --             --       --              --       --
 Exercise of common stock options.......................        --             --       --              --       --
 Cumulative translation adjustment......................        --             --       --              --       --
 Unrealized gain on marketable securities...............        --             --       --              --       --
 Net loss...............................................        --             --       --              --       --
 Comprehensive net loss for the year ended December 31,
   1997.................................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, December 31, 1997..............................        --             --       --       1,223,954        1
 Accretion of dividends on Series A Preferred Stock.....        --             --       --              --       --
 Exercise of common stock options.......................        --             --       --              --       --
 Cumulative translation adjustment......................        --             --       --              --       --
 Unrealized gain on marketable securities...............        --             --       --              --       --
 Net loss...............................................        --             --       --              --       --
 Comprehensive net loss for the six months ended June
   30, 1998.............................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, June 30, 1998 (unaudited)......................        --             --       --       1,223,954        1
 Cancellation of Series A Preferred Stock...............        --             --       --              --       --
 Conversion of Series B Preferred Stock to common
   stock................................................        --             --       --              --       --
 Conversion of Series C Preferred Stock to common
   stock................................................        --             --       --      (1,223,954)      (1)
                                                           -------     ----------      ---      ----------      ---
Pro Forma Balance, June 30, 1998 (unaudited) (Note 3)...   $    --             --      $--              --      $--
                                                           =======     ==========      ===      ==========      ===
 
<CAPTION>
 
                                                              COMMON STOCK
                                                          ---------------------   ADDITIONAL                            CUMULATIVE
                                                          NUMBER OF     $.001      PAID-IN     ACCUMULATED   DUE FROM   TRANSLATION
                                                           SHARES     PAR VALUE    CAPITAL       DEFICIT     OFFICER    ADJUSTMENT
                                                          ---------   ---------   ----------   -----------   --------   -----------
<S>                                                       <C>         <C>         <C>          <C>           <C>        <C>
Balance, January 1, 1995................................        --       $--       $    --       $    --      $  --        $--
 Net loss...............................................        --       --             --            --         --         --
 Comprehensive net loss for the year ended December 31,
   1995.................................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, December 31, 1995..............................        --       --             --            --         --         --
 Net loss prior to incorporation of the Company.........        --       --             --            --         --         --
 Capitalization of the Company..........................        --       --             --        (2,654)        --         --
 Issuance of Preferred Stock............................        --       --            868            --         --         --
 Issuance of common stock...............................  2,484,375       2             --            --         --         --
 Net income after incorporation of the Company..........        --       --             --           487         --         --
 Comprehensive net loss for the year ended December 31,
   1996.................................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, December 31, 1996..............................  2,484,375       2            868        (2,167)        --         --
 Issuance costs relating to the sale of Series B
   Preferred Stock......................................        --       --           (111)           --         --         --
 Conversion of Preferred Stock to common stock..........  1,725,000       2             --            --         --         --
 Compensation expense relating to stock options.........        --       --             77            --         --         --
 Sale of Series C Preferred Stock, net of issuance costs
   of $13...............................................        --       --          3,986            --         --         --
 Accretion of discount and dividends on Series A
   Preferred Stock......................................        --       --             --          (684)        --         --
 Loan to officer........................................        --       --             --            --       (125)        --
 Issuance of common stock...............................    15,500       --             10            --         --         --
 Exercise of common stock options.......................    10,096       --              7            --         --         --
 Cumulative translation adjustment......................        --       --             --            --         --          2
 Unrealized gain on marketable securities...............        --       --             --            --         --         --
 Net loss...............................................        --       --             --        (2,599)        --         --
 Comprehensive net loss for the year ended December 31,
   1997.................................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, December 31, 1997..............................  4,234,971       4          4,837       $(5,450)      (125)         2
 Accretion of dividends on Series A Preferred Stock.....        --       --             --          (120)        --         --
 Exercise of common stock options.......................    63,334       --             41            --         --         --
 Cumulative translation adjustment......................        --       --             --            --         --         48
 Unrealized gain on marketable securities...............        --       --             --            --         --         --
 Net loss...............................................        --       --             --        (1,079)        --         --
 Comprehensive net loss for the six months ended June
   30, 1998.............................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, June 30, 1998 (unaudited)......................  4,298,305       4          4,878        (6,649)      (125)        50
 Cancellation of Series A Preferred Stock...............        --       --          3,209            --         --         --
 Conversion of Series B Preferred Stock to common
   stock................................................  2,555,556       3          3,996            --         --         --
 Conversion of Series C Preferred Stock to common
   stock................................................  1,223,954       1             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Pro Forma Balance, June 30, 1998 (unaudited) (Note 3)...  8,077,815      $8        $12,083       $(6,649)     $(125)       $50
                                                          =========      ==        =======       =======      =====        ===
 
<CAPTION>
 
                                                          UNREALIZED
                                                           GAIN ON
                                                          MARKETABLE             COMPREHENSIVE
                                                          SECURITIES    TOTAL    INCOME (LOSS)
                                                          ----------   -------   -------------
<S>                                                       <C>          <C>       <C>
Balance, January 1, 1995................................      $--      $    (7)     $    --
 Net loss...............................................      --          (554)        (554)
                                                                                    -------
 Comprehensive net loss for the year ended December 31,
   1995.................................................      --            --      $  (554)
                                                              --       -------      =======
Balance, December 31, 1995..............................      --          (561)
 Net loss prior to incorporation of the Company.........      --        (2,093)     $(2,093)
 Capitalization of the Company..........................      --            --
 Issuance of Preferred Stock............................      --           870
 Issuance of common stock...............................      --             2
 Net income after incorporation of the Company..........      --           487          487
                                                                                    -------
 Comprehensive net loss for the year ended December 31,
   1996.................................................      --            --      $(1,606)
                                                              --       -------      =======
Balance, December 31, 1996..............................      --        (1,295)
 Issuance costs relating to the sale of Series B
   Preferred Stock......................................      --          (111)
 Conversion of Preferred Stock to common stock..........      --            --
 Compensation expense relating to stock options.........      --            77
 Sale of Series C Preferred Stock, net of issuance costs
   of $13...............................................      --         3,987
 Accretion of discount and dividends on Series A
   Preferred Stock......................................      --          (684)
 Loan to officer........................................      --          (125)
 Issuance of common stock...............................      --            10
 Exercise of common stock options.......................      --             7
 Cumulative translation adjustment......................      --             2      $     2
 Unrealized gain on marketable securities...............       3             3            3
 Net loss...............................................      --        (2,599)      (2,599)
                                                                                    -------
 Comprehensive net loss for the year ended December 31,
   1997.................................................      --            --      $(2,594)
                                                              --       -------      =======
Balance, December 31, 1997..............................       3          (728)
 Accretion of dividends on Series A Preferred Stock.....      --          (120)
 Exercise of common stock options.......................      --            41
 Cumulative translation adjustment......................      --            48      $    48
 Unrealized gain on marketable securities...............       2             2            2
 Net loss...............................................      --        (1,079)      (1,079)
                                                                                    -------
 Comprehensive net loss for the six months ended June
   30, 1998.............................................      --            --      $(1,029)
                                                              --       -------      =======
Balance, June 30, 1998 (unaudited)......................       5        (1,836)
 Cancellation of Series A Preferred Stock...............      --         3,209
 Conversion of Series B Preferred Stock to common
   stock................................................      --         3,999
 Conversion of Series C Preferred Stock to common
   stock................................................      --            --
                                                              --       -------
Pro Forma Balance, June 30, 1998 (unaudited) (Note 3)...      $5       $ 5,372
                                                              ==       =======
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-5
<PAGE>   67
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                                               SIX MONTHS
                                                                      YEARS ENDED                 ENDED
                                                                     DECEMBER 31,               JUNE 30,
                                                              ---------------------------   -----------------
                                                               1995      1996      1997      1997      1998
                                                              -------   -------   -------   -------   -------
                                                                                               (UNAUDITED)
<S>                                                           <C>       <C>       <C>       <C>       <C>
Cash flows from operating activities:
  Net loss..................................................  $  (554)  $(1,606)  $(2,599)  $(1,460)  $(1,079)
  Adjustments to reconcile net loss to net cash provided by
    (used in) operating activities --
  Amortization of software development costs................       --       712     1,211       641        --
  Depreciation and other amortization.......................       49       176       275        99       228
  Noncash compensation expense..............................       --        --        77        36        --
  Changes in operating assets and liabilities --
    Accounts receivable.....................................     (452)   (1,549)   (1,846)       (5)   (1,392)
    Prepaid expenses and other current assets...............       --        --      (476)     (232)        2
    Accounts payable........................................      150       385      (113)     (296)      812
    Accrued expenses........................................      525       872     2,105       181       198
    Deferred revenue........................................      418       (72)      576       (54)      802
                                                              -------   -------   -------   -------   -------
        Net cash provided by (used in) operating
          activities........................................      136    (1,082)     (790)   (1,090)     (429)
                                                              -------   -------   -------   -------   -------
Cash flows from investing activities:
  Purchase of marketable securities.........................       --        --      (200)       --        --
  Purchases of property and equipment.......................     (303)     (441)     (102)     (102)     (923)
  Increase in software development costs....................   (1,107)     (703)       --        --        --
  Increase (decrease) in other assets.......................       (6)       (3)     (679)     (599)       77
                                                              -------   -------   -------   -------   -------
        Net cash used in investing activities...............   (1,416)   (1,147)     (981)     (701)     (846)
                                                              -------   -------   -------   -------   -------
Cash flows from financing activities:
  Proceeds from notes payable to related parties............    1,800     2,100        --        --        --
  Payments of notes payable to related parties..............       --        --    (1,000)   (1,000)       --
  Repayments under capital leases...........................      (20)      (12)      (86)      (10)     (110)
  Due from officer..........................................       --        --      (125)       --        --
  Exercise of common stock options..........................       --        --         7        --        41
  Issuance of common stock..................................       --         2        10        --        --
  Issuance of Series B Preferred Stock, net of offering
    costs...................................................       --        --     3,888     3,888        --
  Issuance of Series C Preferred Stock, net of offering
    costs...................................................       --        --     3,987        --        --
                                                              -------   -------   -------   -------   -------
        Net cash provided by financing (used in)
          activities........................................    1,780     2,090     6,681     2,878       (69)
                                                              -------   -------   -------   -------   -------
Effect of exchange rate changes on cash and cash
  equivalents...............................................       --        --         2        --        48
                                                              -------   -------   -------   -------   -------
Net increase (decrease) in cash and cash equivalents........      500      (139)    4,912     1,087    (1,296)
                                                              -------   -------   -------   -------   -------
Cash and cash equivalents, beginning of period..............       --       500       361       361     5,273
                                                              -------   -------   -------   -------   -------
Cash and cash equivalents, end of period....................  $   500   $   361   $ 5,273   $ 1,448   $ 3,977
                                                              =======   =======   =======   =======   =======
Supplemental disclosure of cash flow information --
  Cash paid for interest....................................  $    35   $   155   $    19   $     4   $    13
                                                              =======   =======   =======   =======   =======
  Cash paid for income taxes................................  $    --   $    --   $   476   $   198   $    --
                                                              =======   =======   =======   =======   =======
Supplemental disclosure of noncash financing and investing
  activities:
  Equipment acquired under capital leases...................  $    81   $    35   $   479   $   186   $    20
                                                              =======   =======   =======   =======   =======
  Conversion of amounts due to a related party to Preferred
    Stock...................................................  $    --   $   870   $    --   $    --   $    --
                                                              =======   =======   =======   =======   =======
  Conversion of Preferred Stock to common stock.............  $    --   $    --   $     2   $     2   $    --
                                                              =======   =======   =======   =======   =======
  Conversion of notes payable to related parties to Series A
    Preferred Stock.........................................  $    --   $    --   $ 2,405   $ 2,405   $    --
                                                              =======   =======   =======   =======   =======
  Accretion of discount and dividends on preferred stock....  $    --   $    --   $   684   $   565   $   120
                                                              =======   =======   =======   =======   =======
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-6
<PAGE>   68
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(1)  BACKGROUND AND BASIS OF PRESENTATION
 
     Exchange Applications, Inc. and its subsidiaries (the "Company") is a
leading provider of customer optimization software and solutions that enable
businesses to maximize the economic value of their customers. The Company's
Continuous Customer Management ("CCM") solution, including its VALEX software
and related consulting and integration services, enables businesses to retain
and expand existing profitable customer relationships and to acquire new
customers by: (i) analyzing enterprise-wide databases of customer information;
(ii) identifying and prioritizing opportunities; (iii) creating customized
streams of targeted, real-time, event-triggered customer communications, such as
special offers, follow-up communications, special discounts, new products or
service offerings and other marketing campaigns; (iv) selecting the most
effective channels through which to communicate with customers, such as direct
mail, call centers, the Internet and sales forces; and (v) continuously
evaluating the impact of individual and collective customer communications on
marketing strategies and customer profitability.
 
     The Company was incorporated in Delaware on November 7, 1996. Prior to
incorporation, the Company operated as a division of two entities, Grant &
Partners, Inc. ("GPI") and Grant & Partners L.P. ("GPLP").
 
     GPI was incorporated in June 1993 and was primarily engaged in providing
management consulting services. In November 1994, the Company began operations
when it acquired the rights to certain intellectual property and hired employees
to commence the development of the VALEX software product.
 
     On March 28, 1995, GPI entered into a limited partnership agreement with
Cyrk, Inc. ("Cyrk") to form GPLP. GPI, as the general partner, contributed all
of its assets and liabilities to GPLP for a 50% limited partnership interest.
Cyrk purchased the remaining 50% limited partnership interest in GPLP. Upon
entering into the partnership agreement, GPI became a holding company, with no
substantial operations.
 
     GPLP was established to provide marketing and customer management services
for companies in a wide range of industries including retailing, transportation,
banking and manufacturing. GPLP operated as two separate divisions, Exchange
Applications ("EA") and Exchange Partners ("EP"). EA's focus was marketing
program design and execution and customer database and technology development.
EP's focus was providing a variety of management consulting services for
marketing organizations.
 
     On November 15, 1996, the Company and GPLP entered into an assignment and
assumption agreement whereby GPLP contributed EA to the Company in exchange for
2,300,000 shares of preferred stock ("Preferred Stock") of the Company. In
addition, the Company issued 2,484,375 shares of common stock to certain
employees. The Preferred Stock held by GPLP contained voting rights equal to two
votes for each share of common stock into which the Preferred Stock would
convert. As a result, GPLP held approximately 70% of the voting rights of the
Company, thereby retaining a controlling interest over the Company.
 
     In March 1997, the Company restructured its ownership interests through the
conversion of the 2,300,000 shares of Preferred Stock into 1,725,000 shares of
common stock, the conversion of notes payable to related parties (Cyrk and GPLP)
into 2,900,000 shares of Series A redeemable preferred stock ("Series A
Preferred Stock") (see Note 10), the payment of $1,000,000 to discharge certain
indebtedness to Cyrk, and the sale of 2,555,556 shares of Series B redeemable
convertible preferred stock ("Series B Preferred Stock") to venture capital
investors. As a result of the issuance of Series B Preferred Stock, GPLP and
Cyrk's ownership of the Company decreased


                                       F-7
<PAGE>   69
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
to approximately 11% and 38%, respectively, on an as-converted basis.
Accordingly, neither GPLP nor Cyrk retained a controlling interest in the
Company.
 
     The accompanying consolidated financial statements prior to the formation
of the Company represent the financial results of the EA division as included in
the consolidated financial statements of GPI from January 1, 1995 to March 27,
1995 and of GPLP from March 28, 1995 to November 14, 1996.
 
     General corporate overhead costs related to corporate headquarters and
shared administrative support were allocated by GPI and GPLP to EA based on a
number of factors, including, for example, personnel and space utilized.
Management believes these allocations were reasonable and the costs of the
services charged to the Company were not materially different from the costs
that would have been incurred if the Company had performed these functions as a
standalone entity.
 
(2)  SIGNIFICANT ACCOUNTING POLICIES
 
     The accompanying consolidated financial statements reflect the application
of certain significant accounting policies as described in this note and
elsewhere in the accompanying consolidated financial statements and notes.
 
  (a) PRINCIPLES OF CONSOLIDATION
 
          The accompanying consolidated financial statements include the
     accounts of the Company and its wholly owned subsidiaries. All significant
     intercompany balances have been eliminated in consolidation.
 
  (b) INTERIM FINANCIAL STATEMENTS
 
          The accompanying consolidated financial statements as of June 30, 1997
     and 1998 are unaudited but, in the opinion of management, include all
     adjustments, consisting only of normal recurring adjustments, necessary for
     a fair presentation of results of operations for the interim period.
     Certain financial information and footnote disclosures normally included in
     financial statements prepared in accordance with generally accepted
     accounting principles have been omitted with respect to the six-month
     periods, although the Company believes that the disclosures included are
     adequate to make the information presented not misleading. The results for
     the six months ended June 30, 1998 are not necessarily indicative of the
     results that may be expected for the entire year.
 
  (c) NET LOSS PER SHARE
 
          In accordance with Statement of Financial Accounting Standards
     ("SFAS") No. 128, Earnings per Share, basic and diluted net loss per common
     share is calculated by dividing the net loss applicable to common
     stockholders by the weighted average number of vested common shares
     outstanding (See Note 12(b)) for all periods presented. For the year ended
     December 31, 1995 and for the period from January 1, 1996 to November 14,
     1996 (representing the period prior to the Company's incorporation), the
     calculation of basic and diluted net loss per share applicable to common
     stockholders includes the number of shares of common stock that were vested
     upon issuance (November 15, 1996) as if those shares had been outstanding
     for the entire period. Pro forma basic and diluted net loss per share is
     calculated by dividing net loss by the weighted average number of vested
     shares of common stock and preferred stock, on an as-converted basis,
     outstanding during the period. For the years ended
 
                                       F-8
<PAGE>   70
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     December 31, 1995 and for the period from January 1, 1996 to November 14,
     1996 (representing the period prior to the Company's formation), the
     calculation of pro forma net loss per share includes 1,725,000 shares of
     common stock issued in March 1997 upon the conversion of the 2,300,000
     shares of Preferred Stock that were issued on November 15, 1996 (See Note
     10) as if those shares had been outstanding for the entire period.
 
          The Company has applied the provisions of SFAS No. 128 retroactively
     to all periods presented. In accordance with Securities and Exchange
     Commission ("SEC") Staff Accounting Bulletin ("SAB") No. 98, the Company
     has determined that there were no nominal issuances of potential common
     stock in the twelve months prior to the Company's planned initial public
     offering. The dilutive effect of potential common shares, consisting of
     outstanding stock options and convertible preferred stock, is determined
     using the treasury stock method and the as-converted method, respectively,
     in accordance with SFAS No. 128. The following table reconciles the
     weighted average common shares outstanding to the shares used in the
     computation of basic and diluted and pro forma basic and diluted weighted
     average common shares outstanding:
 
<TABLE>
<CAPTION>
                                                                     SIX MONTHS ENDED
                                   YEARS ENDED DECEMBER 31,              JUNE 30,
                               ---------------------------------   ---------------------
                                 1995        1996        1997        1997        1998
                               ---------   ---------   ---------   ---------   ---------
<S>                            <C>         <C>         <C>         <C>         <C>
Weighted average common
  shares outstanding.........  2,484,375   2,484,375   3,575,244   3,283,947   3,889,609
Less: Weighted average
  unvested common shares
  outstanding................  1,284,359   1,279,334     655,469     806,264     291,898
                               ---------   ---------   ---------   ---------   ---------
Basic and diluted weighted
  average common shares
  outstanding................  1,200,016   1,205,041   2,919,775   2,477,683   3,597,711
                               ---------   ---------   ---------   ---------   ---------
Add: Weighted average common
  shares issuable upon
  conversion of preferred
  stock......................  1,725,000   1,725,000   2,471,004   2,204,877   3,779,510
                               ---------   ---------   ---------   ---------   ---------
Pro forma basic and diluted
  weighted average common
  shares outstanding.........  2,925,016   2,930,041   5,390,779   4,682,560   7,377,221
                               =========   =========   =========   =========   =========
</TABLE>
 
          Diluted weighted average shares outstanding for all periods presented
     exclude the potential common shares from stock options, unvested common
     stock and convertible preferred stock, because to include such shares would
     have been antidilutive. As of December 31, 1996 and 1997, and June 30,
     1998, 3,004,334, 5,598,003 and 5,886,927 potential common shares were
     outstanding, respectively.
 
  (d) CASH EQUIVALENTS AND MARKETABLE SECURITIES
 
          The Company accounts for cash equivalents and marketable securities in
     accordance with SFAS No. 115, Accounting for Certain Investments in Debt
     and Equity Securities. Cash equivalents are short-term, highly liquid
     investments with original maturity dates of three months or less. Cash
     equivalents are carried at cost, which approximates fair market value. The
     Company's marketable securities are classified as available-for-sale and
     are recorded at fair value with any unrealized gain or loss recorded as an
     element of stockholders' equity (deficit).
 

                                       F-9
<PAGE>   71
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     As of December 31, 1997 and June 30, 1998, the Company's marketable
     securities consisted of investment-grade corporate bonds. As of December
     31, 1997 and June 30, 1998, the Company had recorded unrealized gains of
     approximately $3,000 and $5,000, respectively.
 
  (e) LONG-LIVED ASSETS
 
          In accordance with the provisions of SFAS No. 121, Accounting for
     Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed
     Of, the Company evaluates the realizability of its long-lived assets at
     each reporting period based on projected future cash flows. As of December
     31, 1996 and 1997 and June 30, 1998, the Company has determined that no
     material adjustment was required to the carrying value of its long-lived
     assets.
 
  (f) SOFTWARE DEVELOPMENT COSTS
 
          The Company's VALEX software is highly technical and required a
     significant engineering and development effort. In accordance with SFAS No.
     86, Accounting for the Costs of Computer Software To Be Sold, Leased or
     Otherwise Marketed, during 1994, 1995 and 1996, the Company capitalized
     certain software development costs relating to VALEX incurred from the date
     technological feasibility of the software development project had been
     established through June 1996. These costs were amortized over an estimated
     useful life of 18 months commencing with the general availability of the
     product in July 1996. For the years ended December 31, 1995, 1996 and 1997
     and the six months ended June 30, 1997, the Company charged approximately
     $0, $712,000, $1,211,000 and $641,000, respectively, to cost of software
     license fee revenues for the amortization of these costs. As of December
     31, 1997, capitalized software development costs were fully amortized.
 
          The software development costs incurred subsequent to the commercial
     release of VALEX were primarily related to product enhancements and product
     maintenance. Consequently, software development costs that would otherwise
     be capitalized were not material and, therefore, were expensed as incurred.
 
  (g) INCOME TAXES
 
          The Company accounts for income taxes in accordance with the
     provisions of SFAS No. 109, Accounting for Income Taxes. This statement
     requires the Company to recognize a current tax liability or asset for
     current taxes payable or refundable and to record a deferred tax asset or
     liability for the estimated future tax effects of temporary differences and
     carryforwards to the extent they are realizable. A deferred tax provision
     or benefit results from the net change in deferred tax assets and
     liabilities during the year. A deferred tax valuation allowance is required
     if it is "more likely than not" that all or a portion of recorded deferred
     tax assets will not be realized.
 
  (h) FINANCIAL INSTRUMENTS
 
          SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
     requires disclosures about the fair value of financial instruments.
     Financial instruments consist principally of cash equivalents, marketable
     securities, accounts receivable, accounts payable, notes payable to related
     parties and redeemable preferred stock. The estimated fair value of these
     financial instruments approximates their carrying value.
 
                                      F-10
<PAGE>   72
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
  (i) CONCENTRATION OF CREDIT RISK
 
          SFAS No. 105, Disclosure of Information About Financial Instruments
     with Off-Balance-Sheet Risk and Financial Instruments with Concentrations
     of Credit Risk, requires disclosure of any significant off-balance-sheet
     and credit risk concentrations. The Company has no significant
     off-balance-sheet concentration of credit risk such as foreign exchange
     contracts, option contracts or other foreign hedging arrangements.
     Financial instruments that potentially subject the Company to
     concentrations of credit risk are principally cash equivalents, marketable
     securities and accounts receivable. Concentration of credit risk with
     respect to accounts receivable is limited to certain customers to whom the
     Company makes substantial sales. The Company performs periodic credit
     evaluations of its customers and has recorded allowances for estimated
     losses.
 
          The following table summarizes the number of customers that
     individually comprise greater than 10% of total revenue and/or total
     accounts receivable and their aggregate percentage of the Company's total
     revenues and accounts receivable.
 
<TABLE>
<CAPTION>
                                                       REVENUE              ACCOUNTS RECEIVABLE
                                               -----------------------    ------------------------
                                                            PERCENT OF                 PERCENT OF
                                               NUMBER OF      TOTAL       NUMBER OF    TOTAL TRADE
                                               CUSTOMERS     REVENUE      CUSTOMERS    RECEIVABLES
                                               ---------    ----------    ---------    -----------
    <S>                                        <C>          <C>           <C>          <C>
    Year Ended --
      December 31, 1995......................      4            78%           3            48%
      December 31, 1996......................      3            41            4            74
      December 31, 1997......................      2            56            2            66
    Six Months Ended --
      June 30, 1997..........................      3            76            3            86
      June 30, 1998..........................      3            41            2            28
</TABLE>
 
  (j) FOREIGN CURRENCY
 
          The functional currencies of the Company's wholly owned subsidiaries
     in the United Kingdom and Australia are the local currencies. The financial
     statements of the subsidiaries are translated to United States dollars
     using period-end exchange rates for assets and liabilities and average
     exchange rates during the corresponding period for revenues, cost of
     revenues and expenses. Translation gains and losses are deferred and
     accumulated as a component of stockholders' equity (deficit). Net gains and
     losses resulting from foreign exchange transactions are included in the
     consolidated statements of operations and were not significant during the
     periods presented.
 
  (k) REVENUE RECOGNITION
 
          The Company generates revenue from licensing the rights to use its
     software to end users and certain re-sellers. The Company also generates
     service and maintenance revenues from integrating its software with its
     customers' operating environments, the sale of maintenance services and the
     sale of certain other consulting and development services.
 
          The Company has recognized revenue in accordance with the provisions
     of Statement of Position ("SOP") No. 91-1, Software Revenue Recognition. In
     October 1997, the American Institute of Certified Public Accountants
     ("AICPA") issued SOP 97-2, Software Revenue Recognition, which supercedes
     SOP 91-1 and is effective for transactions entered into for fiscal
 
                                      F-11
<PAGE>   73
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     years beginning after December 15, 1997. The Company adopted the provisions
     of SOP 97-2 for the year ended December 31, 1997. The adoption of this
     statement did not have a material impact on the Company's results of
     operations or financial position.
 
          Revenues from software license fee agreements are recognized upon
     execution of a license agreement and delivery of the software, provided
     that the fee is fixed or determinable and deemed collectible by management.
     If conditions for acceptance are required subsequent to delivery, revenues
     are recognized upon customer acceptance. Revenues from software maintenance
     agreements are recognized ratably over the term of the maintenance period,
     which is typically one year. Revenues from professional service
     arrangements are recognized on either a time and materials or
     percentage-of-completion basis as the services are performed, provided that
     amounts due from customers are fixed or determinable and deemed collectible
     by management. Amounts collected or billed prior to satisfying the above
     revenue recognition criteria are reflected as deferred revenue or as
     customer deposits.
 
          Cost of software license fee revenues consists of costs to distribute
     the product, including the cost of the media on which it is delivered and
     royalty payments to third party vendors, as well as the amortization of
     software development costs. Cost of service and maintenance revenues
     consists primarily of consulting and support personnel salaries and related
     costs.
 
  (l) ACCOUNTING FOR STOCK-BASED COMPENSATION
 
          In 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based
     Compensation. As permitted by SFAS No. 123, the Company has continued to
     account for employee stock options in accordance with Accounting Principles
     Board Opinion No. 25, Accounting for Stock Issued to Employees, and has
     included the pro forma disclosures required by SFAS No. 123 for all periods
     presented.
 
  (m) NEW ACCOUNTING STANDARDS
 
          In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of
     Start-Up Activities, which requires that all nongovernmental entities
     expense the costs of start-up activities, including organizational costs,
     as those costs are incurred. The Company has historically recorded all such
     costs as expense, in the period incurred.
 
          In June 1997, the Financial Accounting Standards Board ("FASB") issued
     SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires
     disclosure of all components of comprehensive income on an annual and
     interim basis. Comprehensive income is defined as the change in
     stockholders' equity (deficit) of a business enterprise during a period
     from transactions and other events and circumstances from nonowner sources.
     The Company adopted SFAS No. 130, effective January 1, 1998, and has
     disclosed comprehensive income (loss) for all periods presented in the
     accompanying consolidated statements of stockholders' equity (deficit).
 
          In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments
     of an Enterprise and Related Information. SFAS No. 131 requires certain
     financial and supplementary information to be disclosed on an annual and
     interim basis for each reportable segment of an enterprise. SFAS No. 131 is
     effective for fiscal years beginning after December 15, 1997. Unless
     impracticable, companies would be required to restate prior period
     information upon adoption. The Company does not believe the adoption of
     this accounting pronouncement will have a significant impact on the
     Company's financial statements.
 
                                      F-12
<PAGE>   74
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
  (n) POSTRETIREMENT BENEFITS
 
          The Company has no obligations for postretirement benefits.
 
  (o) 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, the
     disclosure of contingent assets and liabilities at the date of the
     financial statements, and the reported amounts of revenues and expenses
     during the reporting periods. Actual results could differ from those
     estimates.
 
(3)  PRO FORMA CONVERSION AND RETIREMENT OF PREFERRED STOCK
 
     On July 15, 1998, the Board of Directors of the Company authorized
management to pursue an initial public offering ("IPO") of the Company's common
stock. Upon closing of the Company's proposed IPO, all of the Company's Series B
and C Preferred Stock will automatically convert into 3,779,510 shares of common
stock. In addition, based on the terms of the redemption preference of the
Series A Preferred Stock, Series A Preferred Stock will be cancelled and the
Company will not be required to pay the redemption preference of $3,209,000. As
a result, such amount will be reclassified to additional paid-in capital (see
Note 10). The pro forma effect of the conversion and cancellation of the
preferred stock on stockholders' equity (deficit) has been presented separately
in the Company's accompanying consolidated balance sheets and consolidated
statements of stockholders' equity (deficit) and Note 11, assuming the
conversion and cancellation had occurred as of June 30, 1998.
 
(4)  PROPERTY AND EQUIPMENT
 
     Property and equipment are stated at cost, net of accumulated depreciation
and amortization. The Company provides for depreciation and amortization using
the straight-line method to allocate the cost of property and equipment over
their estimated useful lives. Property and equipment, at cost, and their
estimated useful lives are as follows:
 
<TABLE>
<CAPTION>
                                                                     DECEMBER 31,
                                                   ESTIMATED        ---------------    JUNE 30,
                                                  USEFUL LIFE       1996      1997       1998
                                                  -----------       ----      ----     --------
                                                                          (IN THOUSANDS)
<S>                                            <C>                  <C>      <C>       <C>
Computers and equipment......................       4 years         $ 621    $  912     $1,322
Furniture and fixtures.......................      10 years           156       307        557
Purchased software...........................       3 years            45        60        292
Leasehold improvements.......................  Life of the lease        8        39         89
                                                                    -----    ------     ------
                                                                      830     1,318      2,260
Less -- Accumulated depreciation and
  amortization...............................                         224       405        633
                                                                    -----    ------     ------
                                                                    $ 606    $  913     $1,627
                                                                    =====    ======     ======
</TABLE>
 
     Depreciation and amortization expense for the years ended December 31,
1995, 1996 and 1997 and the six months ended June 30, 1997 and 1998 was
approximately $49,000, $176,000, $275,000, $99,000 and $228,000, respectively.
 
                                      F-13
<PAGE>   75
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(5)  ACCRUED EXPENSES
 
     Accrued expenses at December 31, 1996 and 1997 and June 30, 1998 consisted
of the following:
 
<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                         ----------------    JUNE 30,
                                                          1996      1997       1998
                                                         ------    ------    --------
                                                                (IN THOUSANDS)
<S>                                                      <C>       <C>       <C>
Payroll and related costs..............................  $  859    $1,508     $1,474
Royalties..............................................     153       283         --
Other..................................................     301     1,456      1,971
                                                         ------    ------     ------
                                                         $1,313    $3,247     $3,445
                                                         ======    ======     ======
</TABLE>
 
(6)  INCOME TAXES
 
     No provision for federal or state income taxes has been recorded, as the
Company incurred net operating losses for all periods presented. The Company had
net operating loss carryforwards of approximately $792,000 at December 31, 1997
to reduce future income taxes, if any. These carryforwards expire through 2013
and are subject to review and possible adjustment by the Internal Revenue
Service ("IRS").
 
     The Tax Reform Act of 1986 contains provisions that may limit the amount of
net operating loss and credit carryforwards that the Company may utilize in any
one year in the event of certain cumulative changes in ownership over a
three-year period in excess of 50%, as defined. The Company believes it has
experienced a change in ownership in excess of 50%. The Company does not believe
that this change in ownership will significantly impact the Company's ability to
utilize its net operating loss carryforwards.
 
     The approximate tax effects of temporary differences that give rise to
significant portions of the Company's deferred tax assets are as follows:
 
<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                            --------------
                                                            1996     1997
                                                            ----     ----
                                                            (IN THOUSANDS)
<S>                                                         <C>      <C>
Nondeductible expenses and reserves.......................  $ 365    $ 465
Net operating loss carryforwards..........................     --      318
                                                            -----    -----
                                                              365      783
                                                            -----    -----
Less -- Valuation allowance...............................   (365)    (783)
                                                            -----    -----
          Net deferred tax asset..........................  $  --    $  --
                                                            =====    =====
</TABLE>
 
     It is the Company's objective to become a profitable enterprise and to
realize the benefits of its deferred tax assets. However, in evaluating the
realizability of these deferred tax assets, management has considered the
Company's short operating history, the volatility of the market in which it
competes, the operating losses incurred to date, and believes that given the
significance of this evidence, a full valuation reserve against its deferred tax
assets is required as of December 31, 1996 and 1997. The increase in the
valuation allowance during these periods relates primarily to the Company's
operating results.
 
                                      F-14
<PAGE>   76
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(7)  REVOLVING NOTE AGREEMENT
 
     In December 1997, the Company entered into a $2,000,000 revolving note
agreement (the "Note") with a bank. Borrowings and the face amount of
outstanding letters of credit are limited to 75% of qualified receivables. As of
December 31, 1997 and June 30, 1998, letters of credit totaling $945,000 and
$971,000, respectively, were outstanding. Borrowings under the Note bear
interest at the bank's prime rate (8.5% at June 30, 1998) plus .75% per annum,
payable monthly in arrears. The Note, which expires May 31, 1999, is secured by
substantially all assets of the Company. As of December 31, 1997 and June 30,
1998, no borrowings were outstanding under the Note.
 
     Under the Note agreement as amended, the Company must comply with certain
restrictive financial covenants. As of December 31, 1997 and June 30, 1998, the
Company had received waivers from the bank for all events of default.
 
(8)  RELATED PARTY TRANSACTIONS
 
  (a) NOTES PAYABLE
 
          As of December 31, 1996, the Company had outstanding demand notes
     payable totaling $2,960,000 to Cyrk and $274,000 to GPLP. These notes bore
     interest at the prime rate payable monthly in arrears. Interest expense on
     the demand notes payable amounted to approximately $41,000, $193,000 and
     $43,000 for the years ended December 31, 1995 and 1996 and the six months
     ended June 30, 1997, respectively. On March 18, 1997, $1,000,000 of
     principal and accrued interest was repaid and the remaining principal
     balance on the Notes was converted into 2,900,000 shares of Series A
     Preferred Stock (see Note 11).
 
  (b) TRANSACTIONS WITH GPLP
 
          As discussed in Note 1, on November 15, 1996, the Company and GPLP
     entered into an assignment and assumption agreement whereby the Company
     received the EA business from GPLP in exchange for 2,300,000 shares of the
     Company's convertible preferred stock. At the date of transfer, the total
     liabilities of the EA business exceeded its total assets by approximately
     $1,700,000. GPLP contributed $870,000 of its advances to EA to the capital
     of the Company.
 
  (c) EXCHANGE MARKETING GROUP
 
          In March 1997, the Company entered into an employment termination
     agreement with an officer of the Company. Upon termination, the officer
     established Exchange Marketing Group ("EMG"). The Company repurchased
     341,125 shares of common stock from the officer and six other employees who
     also terminated their employment with the Company.
 
          In March 1997, the Company loaned EMG $350,000, as evidenced by a note
     receivable. This note accrued interest at 9% per annum with quarterly
     interest payments due commencing June 30, 1997. This note and all accrued
     interest were repaid in February 1998.
 
(9)  COMMITMENTS
 
  (a) LEASE OBLIGATIONS
 
          The Company leases certain equipment under agreements that are
     accounted for as capital leases and expire at various dates through year
     2000. Interest rates on these leases range from 12.0% to 14.5%.
 
                                      F-15
<PAGE>   77
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
          The Company has certain noncancellable operating leases for facilities
     and equipment. The operating leases expire at various dates through the
     year 2003. The Company has letters of credit outstanding with a bank (see
     Note 7) for $971,000 as collateral on its leased facilities and certain
     equipment. Total rent expense under these agreements was approximately
     $17,000, $239,000, $399,000, $155,000 and $254,000 for the years ended
     December 31, 1995, 1996 and 1997 and the six months ended June 30, 1997 and
     1998, respectively.
 
          At December 31, 1997, the minimum lease commitments for all leased
     facilities and equipment with an initial or remaining term in excess of one
     year are as follows:
 
<TABLE>
<CAPTION>
                                                           CAPITAL    OPERATING
                                                           LEASES      LEASES
                                                           -------    ---------
                                                              (IN THOUSANDS)
<S>                                                        <C>        <C>
1998.....................................................   $ 258      $1,409
1999.....................................................     196       1,412
2000.....................................................      62       1,407
2001.....................................................      --       1,293
2002.....................................................      --       1,080
Thereafter...............................................      --         450
                                                            -----      ------
          Total minimum payments.........................     516      $7,051
                                                                       ======
Less -- Amount representing interest.....................      67
                                                            -----
          Principal obligation...........................     449
Less -- Current portion..................................     212
                                                            -----
                                                            $ 237
                                                            =====
</TABLE>
 
     As of December 31, 1997, the Company had entered into two sublease
agreements that will reduce rent expense by approximately $275,000, $550,000,
$355,000 and $236,000 for the years ended December 31, 1998, 1999, 2000, and
2001, respectively.
 
  (b) ROYALTY
 
          The Company licensed certain intellectual property from a third party,
     which has been integrated with VALEX, under a royalty-bearing agreement.
     Under the terms of the license agreement, the Company is required to pay
     royalties to the licensor totaling approximately $656,000 on the first
     $10,000,000 of cumulative VALEX license fees. For the years ended December
     31, 1995, 1996 and 1997 and the six months ended June 30, 1997 and 1998,
     the Company charged royalties of approximately $0, $114,000, $456,000
     $160,000 and $86,000, respectively, to the cost of software license fees
     relating to this agreement. As of June 30, 1998, the aggregate sales of
     VALEX had exceeded the $10,000,000 limit. Accordingly, the Company has no
     further royalty obligation under this agreement.
 
(10)  PREFERRED STOCK
 
     At incorporation on November 7, 1996, the Company authorized 10,000,000
shares of $.001 par value Preferred Stock for future issuance in one or more
series. On November 15, 1996, the Company issued 2,300,000 shares of Preferred
Stock to GPLP in consideration for a capital contribution of $870,000, as
discussed in Note 1 and Note 8(b).
 
                                      F-16
<PAGE>   78
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     On March 18, 1997, the Company converted all of its previously outstanding
shares of Preferred Stock into 1,725,000 shares of common stock. The Company
then amended its certificate of incorporation to reduce the number of authorized
shares of its $.001 par value preferred stock to 5,455,556 shares, of which
2,900,000 shares were designated as Series A Preferred Stock and 2,555,556
shares were designated Series B Preferred Stock. The 2,900,000 shares of Series
A Preferred Stock were issued upon the conversion of $2,405,000 of notes payable
to the related parties, as discussed in Note 8(a). The 2,555,556 shares of
Series B Preferred Stock were sold to venture capital investors at a price of
$1.565 per share, with net proceeds to the Company of $3,888,000.
 
     On December 4, 1997, the Company authorized an additional 1,223,954 shares
of $.001 par value Preferred Stock and designated these shares as Series C
Convertible Preferred Stock (Series C Preferred Stock). The 1,223,954 shares of
the Series C Preferred Stock were sold to venture capital investors at a price
of $3.268 per share, with net proceeds to the Company of $3,987,000.
 
     The Company loaned $125,000 to an officer for the purchase of approximately
38,000 shares of Series B Preferred Stock from another stockholder. The loan is
evidenced by a note that bears interest at the prime rate and is secured by the
38,000 shares of Series B Preferred Stock the officer purchased. The Company has
accounted for this loan as a stock subscription receivable classified as Due
from Officer in the accompanying consolidated statements of stockholders' equity
(deficit) as of December 31, 1997 and June 30, 1998.
 
     The rights and preferences of the Company's preferred stock are as follows:
 
  DIVIDENDS
 
          Each outstanding share of Series A Preferred Stock accrues a
     cumulative annual dividend of 8.25%. Holders of Series B Preferred Stock
     and Series C Preferred Stock are entitled to a proportionate share of any
     cash or noncash common stock dividend as though they were holders of the
     number of shares of common stock into which their shares were convertible
     as of the date declared. To date, no dividends have been declared. The
     Company has provided for Series A Preferred Stock cumulative dividends by
     accreting charges against the accumulated deficit with corresponding
     increases to the carrying value of the Series A Preferred Stock. Such
     increases aggregated approximately $189,000, $70,000 and $120,000 for the
     year ended December 31, 1997 and the six months ended June 30, 1997 and
     1998, respectively.
 
  LIQUIDATION PREFERENCE
 
          Upon liquidation, the holders of Series C Preferred Stock are entitled
     to receive $3.268 per share, plus all accrued or declared but unpaid
     dividends, prior to any distribution to any holder of any share of any
     other class or series of capital stock. If available assets are sufficient
     to permit payment of the full preferential amounts on the Series C
     Preferred Stock, then holders of Series B Preferred Stock are entitled to
     receive out of any additional assets up to $1.565 per share, plus all
     accrued or declared but unpaid dividends, and then holders of Series A
     Preferred Stock are entitled to receive out of any additional assets up to
     $1.00 per share, plus all accrued or declared but unpaid dividends. If the
     assets available for distribution with respect to any such series of
     capital stock are insufficient to permit the payment of the full
     preferential amount on such series, as described above, then the holders of
     such series shall share ratably on the distribution of assets within that
     series of stock. If the remaining assets of the Company permit a
     distribution to common stockholders, then holders of Series B Preferred
     Stock are entitled to


                                      F-17
<PAGE>   79
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     share ratably in such distribution with the holders of common stock as if
     their shares had been converted to common stock.
 
  REDEMPTION
 
          The Company may at any time redeem all or any portion of the shares of
     Series A Preferred Stock then outstanding at $1.00 per share, plus all
     accrued or declared but unpaid dividends. The number of shares to be
     redeemed by each holder shall be equal to each specific holder's pro rata
     share of the total amount outstanding.
 
          If upon any redemption of Series A Preferred Stock the assets
     available for redemption are insufficient to pay to the holders of Series A
     Preferred Stock the full redemption value, the holders of a majority of
     Series A Preferred Stock may elect (i) that no redemption be made (in which
     event all rights in respect of the shares to be redeemed shall continue in
     full force and effect) or (ii) that the holders shall share ratably in the
     redemption according to the respective amounts which would have been
     payable to them.
 
          Upon an IPO with gross proceeds of at least $20,000,000 at an offering
     price per common share such that the amount obtained by multiplying such
     offering price by the number of common stock equivalents, as defined,
     outstanding immediately after such offering would be at least $130,000,000
     (a "Qualified Offering"), all shares of Series A Preferred Stock shall be
     automatically canceled and the shares outstanding prior to such closing
     shall no longer be deemed to be outstanding.
 
          In the event that the Company completes an IPO that is not a Qualified
     Offering, holders of Series A Preferred Stock have the option to redeem all
     shares held for $1.00 per share. All shares surrendered under such
     redemption shall be canceled. Subsequent to redemption, all rights in
     respect of the Series A Preferred Stock, except the right to receive the
     liquidation preference, shall cease and terminate, and such shares shall no
     longer be deemed to be outstanding.
 
          Upon an IPO, all shares of Series B Preferred Stock will automatically
     convert into shares of common stock. In the event that the Company
     completes an IPO that is not a Qualified Offering, the Company, in addition
     to converting such Series B Preferred Stock to Common Stock, shall pay to
     each holder of Series B Preferred Stock being thereby converted, $1.565 per
     share, prior and in preference to any distribution to any holder of any
     class or series of capital stock of the Company.
 
          Upon the closing of a qualified sale of the Company, as defined,
     holders of Series B Preferred Stock not selling shares as part of the sale
     of the Company may redeem their Series B Preferred Stock at the liquidation
     preference or convert all or any part of such shares into shares of common
     stock. Subsequent to redemption, all rights in respect of the Series B
     Preferred Stock, except the right to receive the liquidation preference,
     shall cease and terminate, and such shares shall no longer be deemed to be
     outstanding.
 
          In connection with the proposed IPO, the Company expects to satisfy
     the conditions of a Qualified Offering. Accordingly, upon the closing of
     the IPO, Series A Preferred Stock will be reclassified to $3,209,000 of
     additional paid-in capital and the Series B Preferred Stock, at a
     redemption value of $3,999,000, will be converted into 2,555,556 shares of
     Common Stock without any cash payment required to be made to the holders of
     Series B Preferred Stock.
 
                                      F-18
<PAGE>   80
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
          The Company has presented the Series A and Series B Preferred Stock
     outside of stockholders' equity (deficit) due to the existence of
     redemption rights beyond the control of the Company. A summary of the
     activity of Series A and Series B Preferred Stock is provided in Note 11.
 
  VOTING
 
          Holders of Series A Preferred Stock do not have voting rights. Each
     share of Series B and Series C Preferred Stock votes ratably with the
     common stockholders as if their shares had been converted to common stock.
 
  CONVERSION
 
          Holders of Series B and Series C Preferred Stock have the option to
     convert any such shares into common shares at any time. Upon a conversion
     of each share of Series B and Series C Preferred Stock the number of common
     shares to be issued is an amount equal to (i) their respective liquidation
     preferences divided by (ii) the product of the number of shares being
     converted and the conversion price at that time, as defined.
 
          The conversion price shall initially be the respective per share
     liquidation preference for each series of preferred stock and is subject to
     adjustment in the event that common stock or common stock equivalents are
     issued for less per share than the conversion price, subject to certain
     exceptions.
 
          Upon closing of any IPO, all outstanding shares of preferred stock
     shall be automatically converted into that number of shares of common stock
     as would have been the case in the event of an optional conversion. All
     rights with respect to the preferred stock shall be deemed automatically
     waived upon such conversion.
 
          In connection with the proposed IPO, the Company expects to satisfy
     the conditions of a Qualified Offering. Accordingly, upon the closing of
     the IPO, all 2,555,556 outstanding shares of Series B Preferred Stock will
     be converted into 2,555,556 shares of common stock, and all 1,223,954
     outstanding shares of Series C Preferred Stock will be converted into
     1,223,954 shares of common stock.
 
                                      F-19
<PAGE>   81
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(11)  REDEEMABLE PREFERRED STOCK
 
     The following is a summary of the activity for the Series A and Series B
Preferred Stock:
 
<TABLE>
<CAPTION>
                                           SERIES A                  SERIES B
                                          REDEEMABLE          CONVERTIBLE REDEEMABLE
                                        PREFERRED STOCK           PREFERRED STOCK
                                    -----------------------   -----------------------     TOTAL
                                    NUMBER OF    REDEMPTION   NUMBER OF    REDEMPTION   REDEMPTION
                                      SHARES       VALUE        SHARES       VALUE        VALUE
                                    ---------    ----------   ---------    ----------   ----------
                                            (IN THOUSANDS, EXCEPT SHARE DATA)
<S>                                 <C>          <C>          <C>          <C>          <C>
BALANCE, DECEMBER 31, 1996........          --    $    --             --    $    --      $    --
  Conversion of notes payable to
     related parties into Series A
     Preferred Stock..............   2,900,000      2,405             --         --        2,405
  Issuance of Series B Preferred
     Stock........................          --         --      2,555,556      3,999        3,999
  Accretion of discount and
     dividends on Series A
     Preferred Stock..............          --        684             --         --          684
                                    ----------    -------     ----------    -------      -------
BALANCE, DECEMBER 31, 1997........   2,900,000      3,089      2,555,556      3,999        7,088
  Accretion of dividends on Series
     A Preferred Stock............          --        120             --         --          120
                                    ----------    -------     ----------    -------      -------
BALANCE, JUNE 30, 1998
  (UNAUDITED).....................   2,900,000      3,209      2,555,556      3,999        7,208
Pro forma effect of proposed IPO:
  Retirement of Series A Preferred
     Stock........................  (2,900,000)    (3,209)            --         --       (3,209)
  Conversion of Series B Preferred
     Stock to common stock........          --         --     (2,555,556)    (3,999)      (3,999)
                                    ----------    -------     ----------    -------      -------
PRO FORMA BALANCE, JUNE 30, 1998
  (UNAUDITED) (Note 3)............          --    $    --             --    $    --      $    --
                                    ==========    =======     ==========    =======      =======
</TABLE>
 
     During 1997, the Company issued Series A Preferred Stock at a discount of
$495,000 from its redemption value. The Company accreted this discount to the
Series A Preferred Stock through a charge to accumulated deficit upon issuance.
 
(12)  STOCKHOLDERS' EQUITY (DEFICIT)
 
  (a) COMMON STOCK
 
          At incorporation, the Company authorized 10,000,000 shares of $.001
     par value common stock. In March 1997 and December 1997, the Company
     amended its certificate of incorporation to increase the number of
     authorized shares of $.001 par value common stock to a total of 12,078,698
     shares.
 
          The Company has reserved 3,779,510 shares of common stock for the
     potential conversion of Series B and Series C Preferred Stock into common
     stock. The Company also has reserved 3,124,963 shares of common stock for
     the issuance of stock options under the 1996 Stock Incentive Plan.
     Subsequent to June 30, 1998, the Company reserved additional shares of
     common stock in connection with the adoption of the 1998 Stock Incentive
     Plan, an Employee Stock Purchase Plan and a Directors' Stock Option Plan.
     (See Note 17).
 
    
                                      F-20
<PAGE>   82
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
  (b) RESTRICTED COMMON STOCK
 
          At incorporation, the Company issued 2,484,375 shares of common stock
     to the Company's founders and employees at $.001 per share, the fair market
     value as determined by the Board of Directors at the time of issuance.
 
          In connection with the issuance of common stock, the Company and two
     of its founders signed a Founder Restricted Stock Agreement (the Founder
     Agreement). These shares vested 50% immediately with the balance vesting
     ratably on an annual basis through January 1, 1999.
 
          As provided in the Founder Agreement, if the employment of the
     founders is terminated, the Company has the option (the Company Option) to
     purchase their unvested stock. This Company Option shall be exercisable by
     the Company at a price equal to the lesser of the issue price or the fair
     market value of the stock as determined by the Board of Directors. In March
     1997, one of the founders terminated employment, resulting in the Company's
     repurchase of unvested common shares (see Note 8(c)).
 
          In addition, on November 15, 1996, the Company and all of its
     employees holding common stock, excluding the two founders, signed
     restricted stock agreements (the Restricted Stock Agreements) providing for
     shares issued from the 1996 Stock Incentive Plan to vest retroactively, 25%
     on the respective employee's date of hire with an additional 25% on each
     anniversary thereafter.
 
          According to the Restricted Stock Agreements, if an employee ceases to
     provide services to the Company either as a consultant or employee prior to
     the third anniversary of the date of hire, the Company has the right to
     repurchase the unvested stock from the employee at the price paid by the
     employee.
 
          In the event of a change of control, as defined, all remaining
     unvested stock held by the founders and employees issued under the Founder
     Agreement and Restricted Stock Agreements shall be deemed vested and the
     Company's options to repurchase unvested shares of restricted common stock
     shall immediately terminate.
 
          During 1997, the Company repurchased 341,125 shares of unvested common
     stock at $.001 per share from an officer and six employees who terminated
     their employment with the Company. (See Note 8(c)). The Company also
     repurchased 13,700 shares and 6,250 shares of unvested common stock at
     $.001 per share in July 1997 and June 1998, respectively, from other
     terminated employees.
 
(13)  STOCK OPTIONS
 
     In November 1996, the Company adopted the 1996 Stock Incentive Plan (the
1996 Plan), which provides for the grant of incentive stock options,
nonqualified stock options and restricted common stock to officers, employees
and directors who are also employees of the Company. Nonemployee directors and
outside consultants to the Company are eligible to receive nonqualified options
and restricted common stock only.
 
     The 1996 Plan is administered by the Board of Directors, which determines
the fair market value and the purchase price for such options. Options generally
vest over a four-year period and expire 10 years from the date of grant.
Restricted common stock awards entitle recipients to purchase shares of the
Company's common stock subject to restrictions concerning the sale, transfer and
other disposition of the shares issued until such shares are vested. The shares
subject to options
 
                                      F-21
<PAGE>   83
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
that expire or are not exercised for other reasons, or any restricted common
stock that is repurchased by the Company will be available for future grant
under the 1996 Plan.
 
     In addition, the 1996 Plan provides for the granting of time accelerated
incentive stock options. During 1997 and 1998, approximately 590,000 time
accelerated incentive stock options were granted to certain employees. These
options vest and become exercisable 25% annually upon the achievement of certain
performance criteria (the Criteria) as approved by the Company on an annual
basis, or after nine years from the date of grant. The Criteria, which are set
each year by the Board of Directors, allows for vesting upon the achievement of
the Criteria as of December 31 for that year.
 
     Stock option activity from the 1996 Plan's inception through June 30, 1998
is as follows:
 
<TABLE>
<CAPTION>
                                              NUMBER OF       RANGE OF        WEIGHTED AVERAGE
                                               SHARES      EXERCISE PRICES     EXERCISE PRICE
                                              ---------    ---------------    ----------------
<S>                                           <C>          <C>                <C>
Outstanding, December 31, 1995..............     --        $     --                $   --
  Granted...................................    968,575         0.001               0.001
  Exercised.................................   (968,575)        0.001               0.001
                                              ---------    ---------------         ------
Outstanding, December 31, 1996..............     --              --                    --
  Granted...................................  1,449,475      0.65 -   1.35           0.74
  Exercised.................................    (10,096)        0.65                 0.65
  Canceled..................................    (40,154)     0.65 -   0.85           0.66
                                              ---------    ---------------         ------
Outstanding, December 31, 1997..............  1,399,225      0.65 -   1.35           0.74
  Granted...................................    572,000      1.35 -  14.50           4.51
  Exercised.................................    (63,334)     0.65 -   0.85           0.65
  Canceled..................................    (23,333)     0.65 -   3.50           1.31
                                              ---------    ---------------         ------
Outstanding, June 30, 1998 (unaudited)......  1,884,558    $ 0.65 - $14.50         $ 1.88
                                              =========    ===============         ======
Exercisable, June 30, 1998 (unaudited)......    324,232    $ 0.65 - $ 1.35         $ 0.72
                                              =========    ===============         ======
</TABLE>
 
     Subsequent to June 30, 1998, the Company granted options to purchase
200,850 shares of common stock at $14.50 per share.
 
     The Company has computed the pro forma disclosures required under SFAS No.
123 for options granted during 1996 and 1997 using the Black-Scholes option
pricing model prescribed by SFAS No. 123. The weighted average assumptions used
were as follows:
 
<TABLE>
<CAPTION>
                                                                1996         1997
                                                                ----         ----
<S>                                                           <C>          <C>
Risk-free interest rate.....................................    6.3%         5.96%
Expected dividend yield.....................................     --           --
Expected lives..............................................   4 years      4 years
Expected volatility.........................................     76%          79%
Weighted average grant date fair value......................    $.002        $.46
Weighted average remaining contractual life of options
  outstanding...............................................  9.9 years    9.1 years
</TABLE>
 
                                      F-22
<PAGE>   84
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     Had compensation expense for the Company's stock option plans been
determined consistent with SFAS No. 123, net loss and net loss per share would
have been approximately as follows:
 
<TABLE>
<CAPTION>
                                                                1996         1997
                                                              ---------    ---------
                                                              (IN THOUSANDS, EXCEPT
                                                                 PER SHARE DATA)
<S>                                                           <C>          <C>
As reported --
  Net loss applicable to common stockholders................   $(1,606)     $(3,283)
                                                               =======      =======
  Basic and diluted net loss per share......................   $ (1.33)     $ (1.12)
                                                               =======      =======
Pro forma --
  Net loss applicable to common stockholders................   $(1,607)     $(3,455)
                                                               =======      =======
  Basic and diluted net loss per share......................   $ (1.33)     $ (1.18)
                                                               =======      =======
</TABLE>
 
(14)  EMPLOYEE BENEFIT PLAN
 
     The Company has a qualified 401(k) savings plan (the 401(k) Plan) covering
all of the Company's eligible full-time employees. Under this plan, participants
may elect to defer a portion of their compensation, subject to certain IRS
limitations. The Company does not currently provide employer matching
contributions under the 401(k) Plan.
 
(15)  GEOGRAPHIC INFORMATION
 
     Revenues by geographic destination as a percentage of total revenues are as
follows:
 
<TABLE>
<CAPTION>
                                                                           SIX MONTHS
                                                      YEARS ENDED            ENDED
                                                      DECEMBER 31,          JUNE 30,
                                                  --------------------    ------------
                                                  1995    1996    1997    1997    1998
                                                  ----    ----    ----    ----    ----
<S>                                               <C>     <C>     <C>     <C>     <C>
United States...................................   81%     96%     86%    100%     78%
United Kingdom..................................   --      --       5      --      14
Canada..........................................   19       4       8      --       7
Other...........................................   --      --       1      --       1
                                                  ---     ---     ---     ----    ---
                                                  100%    100%    100%    100%    100%
                                                  ===     ===     ===     ====    ===
</TABLE>
 
(16)  ALLOWANCE FOR DOUBTFUL ACCOUNTS
 
     A summary of the allowance for doubtful accounts is as follows:
 
<TABLE>
<CAPTION>
                                                       DECEMBER 31,
                                                   ---------------------    JUNE 30,
                                                   1995    1996     1997      1998
                                                   ----    ----     ----    --------
                                                            (IN THOUSANDS)
<S>                                                <C>     <C>      <C>     <C>
Balance, beginning of period.....................  $ --    $  75    $ 43      $206
  Provision for doubtful accounts................   121       99     180        55
  Write-offs.....................................   (46)    (131)    (17)      (49)
                                                   ----    -----    ----      ----
Balance, end of period...........................  $ 75    $  43    $206      $212
                                                   ====    =====    ====      ====
</TABLE>
 
                                      F-23
<PAGE>   85
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(17)  STOCK PLANS AND AMENDMENT TO CERTIFICATE OF INCORPORATION
 
     On July 15, 1998, the Board of Directors and stockholders approved (i) the
adoption of the 1998 Stock Incentive Plan pursuant to which 2,700,000 additional
shares of the Company's common stock have been reserved for future issuance,
(ii) the adoption of an Employee Stock Purchase Plan pursuant to which 200,000
shares of the Company's common stock have been reserved for future issuance,
(iii) the adoption of a Directors' Stock Option Plan pursuant to which 100,000
shares of the Company's common stock have been reserved for future issuance,
(iv) an increase in the number of authorized shares of common stock to
30,000,000 shares and (v) the authorization of 10,000,000 shares of $.001 par
value preferred stock, of which the Board of Directors has full authority to
issue and fix the voting powers, preferences, rights, qualifications,
limitations or restrictions thereof, including dividend rights, conversion
rights, redemption privileges and liquidation preferences and the number of
shares constituting any series or designation of such series.
 
                                      F-24
<PAGE>   86
 
                                  UNDERWRITING
 
     Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
Underwriters named below, and each of such Underwriters, for whom Goldman, Sachs
& Co., BT Alex. Brown Incorporated and Hambrecht & Quist LLC are acting as
representatives, has severally agreed to purchase from the Company and the
Selling Stockholders, the respective number of shares of Common Stock set forth
opposite its name below:
 
<TABLE>
<CAPTION>
                                                               NUMBER OF
                                                               SHARES OF
                        UNDERWRITER                           COMMON STOCK
                        -----------                           ------------
<S>                                                           <C>
Goldman, Sachs & Co. .......................................
BT Alex. Brown Incorporated.................................
Hambrecht & Quist LLC.......................................
 
                                                                --------
          Total.............................................
                                                                ========
</TABLE>
 
     Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.
 
     The Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus, and in part to certain securities dealers at such
price less a concession of $     per share. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $     per share to certain
brokers and dealers. After the shares of Common Stock are released for sale to
the public, the offering price and other selling terms may from time to time be
varied by the representatives.
 
     Certain of the Selling Stockholders have granted the Underwriters an option
exercisable for 30 days after the date of this Prospectus to purchase up to an
aggregate of 450,000 additional shares of Common Stock solely to cover
over-allotments, if any. If the Underwriters exercise their over-allotment
option, the Underwriters have severally agreed, subject to certain conditions,
to purchase approximately the same percentage thereof that the number of shares
to be purchased by each of them, as shown in the foregoing table, bears to the
3,000,000 shares of Common Stock offered.
 
     The Company, the Selling Stockholders and certain other stockholders have
agreed that, during the period beginning from the date of this Prospectus and
continuing to and including the date 180 days after the date of this Prospectus,
they will not offer, sell, contract to sell or otherwise dispose of any
securities of the Company (other than pursuant to employee stock option plans
existing, or on the conversion or exchange of convertible or exchangeable
securities outstanding, on the date of this Prospectus) which are substantially
similar to the shares of Common Stock or which are convertible or exchangeable
into securities which are substantially similar to the shares of Common Stock
without the prior written consent of the representatives except for the shares
of Common Stock offered in connection with the Offering and shares of Common
Stock acquired in the public market after the date of this Prospectus. The
representatives have informed the Company that the Underwriters have no current
intention to release shares from the Lock-Up Agreements prior to expiration of
the [180] -day term of such agreements. Any request for release would be
evaluated by the representatives, and the decision whether or not to permit
early release of shares would be made dependent upon the facts and circumstances
existing at the time of the request.
 
                                       U-1
<PAGE>   87
 
     The representatives of the Underwriters have informed the Company that they
do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed five percent of the total number of shares of
Common Stock offered by them.
 
     Prior to the Offering, there has been no public market for the shares of
Common Stock. The initial public offering price was negotiated among the
Company, the Selling Stockholders and the representatives. Among the factors
considered in determining the initial public offering price of the Common Stock,
in addition to prevailing market conditions, were the Company's historical
performance, estimates of the business potential and earnings prospects of the
Company, an assessment of the Company's management and the consideration of the
above factors in relation to market valuation of companies in related
businesses.
 
     The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "EXAP," subject to official notice of issuance.
 
     The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act.
 
                                       U-2
<PAGE>   88
BUILDING A CAMPAIGN WITH VALEX

1.   VALEX Desktop allows users to define the core CCM process steps needed to
     to run a campaign. Users quickly structure and schedule campaigns with the
     time and event triggers by selecting "Campaign Management" to bring up the
     applications associated with designing customer communication streams.

[Back page Graphic]

2.   In this example, users drag and drop icons to design a three-branch 
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     existing customers ripe for cross-selling; the third branch attempts to
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     appropriate touch point for delivery of the customer communication stream.
     Promotion history is captured for all three branches in order to measure
     campaign effectiveness.


[Back page Graphic]

3.   Users can easily schedule dates and times to run campaigns. In this
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[Back page Graphic]

 
                                   [ART WORK]

          [A graphic depicting a recreation of screens from a desktop
                 PC showing the VALEX Campaign decision tree.]
<PAGE>   89
 
==========================================================

  NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.

                             ----------------------
 
                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                           PAGE
                                           ----
<S>                                        <C>
Prospectus Summary.......................    1
Risk Factors.............................    4
The Company..............................
Use of Proceeds..........................   11
Dividend Policy..........................   11
Capitalization...........................   12
Dilution.................................   13
Selected Consolidated Financial Data.....   14
Management's Discussion and Analysis of
  Financial Condition and Results of
  Operations.............................   16
Business.................................   27
Management...............................   41
Certain Transactions.....................   49
Principal and Selling Stockholders.......   51
Description of Capital Stock.............   53
Shares Eligible for Future Sale..........   55
Legal Matters............................   56
Experts..................................   56
Additional Information...................   56
Index to Consolidated Financial
  Statements.............................  F-1
Underwriting.............................  U-1
</TABLE>
 
                             ----------------------
 
  THROUGH AND INCLUDING             , 1998 (THE 25TH DAY AFTER THE DATE OF THIS
PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.

==========================================================

                                3,000,000 SHARES
 
                                    EXCHANGE
                               APPLICATIONS, INC.
 
                                  COMMON STOCK
                          (PAR VALUE $.001 PER SHARE)

                             ----------------------
 
                          [EXCHANGE APPLICATION LOGO]

                             ----------------------
 
                              GOLDMAN, SACHS & CO.
                                 BT ALEX. BROWN
                               HAMBRECHT & QUIST
                      REPRESENTATIVES OF THE UNDERWRITERS

==========================================================
<PAGE>   90
 
                                    PART II
 
                     INFORMATION NOT REQUIRED IN PROSPECTUS
 
ITEM 13.  Other Expenses of Issuance and Distribution
 
     Expenses of the Registrant in connection with the issuance and distribution
of the securities being registered, other than the underwriting discount, are
estimated as follows:
 
<TABLE>
<CAPTION>
                                                                TOTAL
                                                                -----
<S>                                                           <C>
SEC Registration Fee........................................  $16,284.00
NASD Fees...................................................  $ 6,020.00
NASDAQ Listing Fees.........................................  $22,250.00
Printing and Engraving Expenses.............................  $        *
Legal Fees and Expenses.....................................  $        *
Accountants' Fees and Expenses..............................  $        *
Expenses of Qualification Under State Securities Laws,
  Including Attorneys' Fees.................................  $        *
Transfer Agent and Registrar's Fees.........................  $        *
Miscellaneous Costs.........................................  $        *
                                                              ----------
          Total.............................................  $        *
                                                              ==========
</TABLE>
 
---------------
* To be provided by amendment.
 
ITEM 14.  Indemnification of Directors, Officers and Employees
 
     Section 145 of the Delaware General Corporation law empowers a Delaware
corporation to indemnify its officers and directors and certain other persons to
the extent and under the circumstances set forth therein.
 
     The Amended and Restated Certificate of Incorporation of the Company and
the Amended and Restated By-laws of the Company, copies of which are filed as
Exhibits 3.1 and 3.2, provide for indemnification of officers and directors of
the Company and certain other persons against liabilities and expenses incurred
by any of them in certain stated proceedings and under certain stated
conditions.
 
ITEM 15.  Recent Sales of Unregistered Securities
 
     On November 15, 1996, in connection with the organization of the
Registrant, the Registrant entered into Restricted Stock Agreements dated as of
such date (Restricted Stock Agreements) with certain key employees of the
Registrant. Pursuant to the Restricted Stock Agreements, the Registrant issued
968,575 shares of restricted Common Stock under the Registrant's 1996 Stock
Incentive Plan to such employees for an aggregate consideration of $968.58 at a
purchase price of $.001 per share.
 
     On November 15, 1996, in addition to the shares of restricted Common Stock
issued pursuant to the Registrant's 1996 Stock Incentive Plan, (i) the
Registrant issued 848,800 shares of restricted Common Stock to Andrew J. Frawley
for an aggregate consideration of $848.80 pursuant to a Restricted Stock
Agreement entered into between the Registrant and Andrew J. Frawley, and (ii)
the Registrant issued 667,000 shares of restricted Common Stock to Michael J.
Feldman for an aggregate consideration of $667.00 pursuant to a Restricted Stock
Agreement entered into between the Registrant and Michael J. Feldman.
 
     The Registrant has, from time to time, repurchased an aggregate of 361,075
shares of Common Stock from its employees for an aggregate consideration of
$361.08.
 
                                      II-1
<PAGE>   91
 
     On November 15, 1996, in connection with the organization of the
Registrant, the Registrant entered into an Assignment and Assumption Agreement
dated as of such date (Assignment Agreement) with Grant & Partners Limited
Partnership (GPLP) pursuant to which the Registrant issued 2,300,000 shares of
Series A Convertible Preferred Stock to GPLP and assumed certain liabilities of
GPLP in exchange for certain assets of GPLP.
 
     On March 18, 1997, the Registrant entered into a Securities Purchase
Agreement dated as of such date (Securities Purchase Agreement) with certain of
its existing stockholders and certain new investors. Pursuant to the Securities
Purchase Agreement, (i) the Registrant issued 1,154,775 shares of Series B
Preferred Stock to Insight Venture Partners II, L.P. for an aggregate
consideration of $1,807,222.88, (ii) the Registrant issued 1,154,775 shares of
Series B Preferred Stock to Wexford Insight LLC for an aggregate consideration
of $1,807,222.88, (iii) the Registrant issued 246,006 shares of Series B
Convertible Preferred Stock to GAP Coinvestment Partners, L.P. for an aggregate
consideration of $384,999.39, (iv) the Registrant converted 2,300,000 shares of
Series A Convertible Preferred Stock held by GPLP to 1,725,000 shares of Common
Stock, (v) the Registrant issued 377,408 shares of a newly designated Series A
Preferred Stock to GPLP in consideration of the cancellation of certain
indebtedness owed by the Registrant to GPLP, and (vi) the Registrant issued
2,522,592 shares of Series A Preferred Stock to Cyrk, Inc. (Cyrk) in
consideration of the cancellation of certain indebtedness owed by the Registrant
to Cyrk.
 
     On October 3, 1997, the Registrant entered into a Subscription Agreement
dated as of such date with Michael Caccavale pursuant to which the Registrant
issued 15,500 shares of Common Stock to Michael Caccavale for an aggregate
consideration of $13,175.
 
     On December 4, 1997, the Registrant entered into a Securities Purchase
Agreement dated as of such date with Insight Capital Partners II, L.P. and
Wexford Insight LLC pursuant to which (i) the Registrant issued 611,977 shares
of Series C Convertible Preferred Stock to Insight Capital Partners II, L.P. for
an aggregate consideration of $2,000,000, and (ii) the Registrant issued 611,977
shares of Series C Convertible Preferred Stock to Wexford Insight LLC for an
aggregate consideration of $2,000,000.
 
     The Registrant has, from time to time, issued an aggregate of 73,430 shares
of restricted Common Stock to various employees upon the exercise of options
granted pursuant to the Registrant's 1996 Stock Incentive Plan for an aggregate
consideration of $47,979.50 at an average exercise price of $0.65 per share.
 
     No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relating to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of certain restricted shares, options to purchase
Common Stock and shares issuable upon the exercise of such options, Rule 701 of
the Act. All of the foregoing securities are deemed restricted securities for
purposes of the Act.
 
                                      II-2
<PAGE>   92
 
ITEM 16.  Exhibits and Financial Statement Schedules
 
     (a) The following is a list of exhibits filed as a part of this
registration statement:
 
<TABLE>
<CAPTION>
EXHIBITS
--------
<C>        <S>
  1.1      Form of Underwriting Agreement.
  3.1      Form of Amended and Restated Certificate of Incorporation of
           the Registrant.
  3.2      Form of Amended and Restated By-laws of the Registrant.
  4.1*     Specimen Certificate for Shares of the Registrant's Common
           Stock, $0.001 par value.
  5.1*     Opinion of Bingham Dana LLP with respect to the legality of
           the shares being registered.
 10.1*     Form of 1998 Stock Incentive Plan, with related forms of
           stock option agreements.
 10.2      1996 Stock Incentive Plan, as amended, with related forms of
           stock option agreements and form of restricted stock
           agreement.
 10.3      Form of 1998 Director Stock Option Plan, with related form
           of stock option agreement.
 10.4      Form of 1998 Employee Stock Purchase Plan.
 10.5      401(k) Plan.
 10.6      Employment Agreement, dated November 15, 1996, between the
           Registrant and Andrew J. Frawley.
 10.7      Restricted Stock Agreement, dated November 8, 1996, between
           the Registrant and Andrew J. Frawley.
 10.8      Consulting Agreement, dated March 18, 1997, between the
           Registrant and Exchange Marketing Group, LLC.
 10.9      Securities Purchase Agreement, dated March 18, 1997.
 10.10     Securities Purchase Agreement, dated December 4, 1997.
 10.11     Stock Purchase and Waiver Agreement, dated December 4, 1997.
 10.12     Promissory Note, dated December 4, 1997, by Andrew J.
           Frawley payable to the Registrant.
 10.13     Amended and Restated Stockholders Agreement dated
           December 4, 1997.
 10.14     Amended and Restated Registration Rights Agreement dated
           December 4, 1997.
 10.15     Letter Agreement, dated December 22, 1997, between the
           Registrant and Fleet National Bank, as amended, and the
           related Promissory Note.
 10.16     Stock Purchase Agreement, dated June 25, 1998, and the
           related Waiver Agreement to the Amended and Restated
           Stockholders Agreement, dated June 25, 1998.
 10.17     Office lease for 89 South Street, Boston, Massachusetts.
 21.1      Subsidiaries of Registrant.
 23.1      Consent of Arthur Andersen LLP.
 23.2*     Consent of Bingham Dana LLP, counsel to Registrant (included
           in Exhibit 5.1).
 24.1      Power of Attorney (included in signature page to
           Registration Statement).
 27.1      Financial Data Schedule (6 months ended June 30, 1998)
 27.2      Financial Data Schedule (12 months ended December 31, 1997)
 27.3      Financial Data Schedule (12 months ended December 31, 1996)
</TABLE>
 
---------------
* To be filed by amendment
 
     (b) Financial Statement Schedules
 
                                      II-3
<PAGE>   93
 
  SCHEDULES
 
     All schedules have been omitted because either they are not required, are
not applicable or the information is otherwise set forth in the Consolidated
Financial Statements and notes thereto.
 
ITEM 17.  Undertakings
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described in Item 14 hereof, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
 
     The undersigned Registrant hereby undertakes:
 
          (1) To provide the Underwriter at the closing specified in the
     Underwriting Agreement certificates in such denominations and registered in
     such names as required by the Underwriter to permit prompt delivery to each
     purchaser.
 
          (2) That for purposes of determining any liability under the
     Securities Act of 1933, the information omitted from the form of prospectus
     filed as part of this registration statement in reliance upon Rule 430A and
     contained in a form of prospectus filed by the Registrant pursuant to Rule
     424(b)(1) or (4), or 497(h) under the Securities Act shall be deemed to be
     part of this registration statement as of the time it was declared
     effective.
 
          (3) That for the purpose of determining any liability under the
     Securities Act of 1933, each post-effective amendment that contains a form
     of prospectus shall be deemed to be a new registration statement relating
     to the securities offered therein, and the Offering of such securities at
     that time shall be deemed to be the initial bona fide offering thereof.
 
                                      II-4
<PAGE>   94
 
                                   SIGNATURES
 
     Pursuant to the requirements of the Securities Act of 1933, the registrant,
Exchange Applications, Inc., certifies that it has reasonable grounds to believe
that it meets all of the requirements for filing on Form S-1 and has duly caused
this registration statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Boston, Commonwealth of Massachusetts,
on this 22nd day of July, 1998.
 
                                          EXCHANGE APPLICATIONS, INC.
 
                                          By: /s/  ANDREW J. FRAWLEY
                                            ------------------------------------
                                                     Andrew J. Frawley
                                              Chairman of the Board, President
                                                and Chief Executive Officer
 
                               POWER OF ATTORNEY
 
     Each person whose signature appears below hereby appoints Andrew J. Frawley
and John G. O'Brien, each of them severally, acting alone and without the other,
his/her true and lawful attorney-in-fact with the authority to execute in the
name of each such person, and to file with the Securities and Exchange
Commission, together with any exhibits thereto and other documents therewith,
any and all amendments (including without limitation post-effective amendments)
to this Registration Statement necessary or advisable to enable the Registrant
to comply with the Securities Act of 1933, as amended (the "Act"), and any
rules, regulations and requirements of the Securities and Exchange Commission in
respect thereof, and to sign any registration statement for the same offering
covered by this Registration Statement that is to be effective upon filing
pursuant to Rule 462(b) promulgated under the Act, which amendments may make
such other changes in the Registration Statement as the aforesaid
attorney-in-fact executing the same deems appropriate.
 
     Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated:
 
<TABLE>
<CAPTION>
                     SIGNATURE                                      TITLE                     DATE
                     ---------                                      -----                     ----
<C>                                                  <S>                                  <C>
 
               /s/ ANDREW J. FRAWLEY                 Chairman of the Board, President,    July 22, 1998
---------------------------------------------------  Chief Executive Officer and
                 Andrew J. Frawley                   Director (Principal Executive
                                                     Officer)
 
              /s/ DEAN F. GOODERMOTE                 Director                             July 22, 1998
---------------------------------------------------
                Dean F. Goodermote
 
                /s/ JEFFREY HORING                   Director                             July 22, 1998
---------------------------------------------------
                  Jeffrey Horing
 
             /s/ RAMANAN RAGHAVENDRAN                Director                             July 22, 1998
---------------------------------------------------
               Ramanan Raghavendran
 
                /s/ JOHN G. O'BRIEN                  Vice President, Chief Financial      July 22, 1998
---------------------------------------------------  Officer, Treasurer and Secretary
                  John G. O'Brien                    (Principal Financial and Accounting
                                                     Officer)
</TABLE>
 
                                      II-5
<PAGE>   95
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                              DESCRIPTION
--------                           -----------
<C>        <S>
  1.1      Form of Underwriting Agreement.
  3.1      Form of Amended and Restated Certificate of Incorporation of
           the Registrant.
  3.2      Form of Amended and Restated By-laws of the Registrant.
  4.1*     Specimen Certificate for Shares of the Registrant's Common
           Stock, $0.001 par value.
  5.1*     Opinion of Bingham Dana LLP with respect to the legality of
           the shares being registered.
 10.1*     Form of 1998 Stock Incentive Plan, with related forms of
           stock option agreements.
 10.2      1996 Stock Incentive Plan, as amended, with related forms of
           stock option agreements and form of restricted stock
           agreement.
 10.3      Form of 1998 Director Stock Option Plan, with related form
           of stock option agreement.
 10.4      Form of 1998 Employee Stock Purchase Plan.
 10.5      401(k) Plan.
 10.6      Employment Agreement, dated November 15, 1996, between the
           Registrant and Andrew J. Frawley.
 10.7      Restricted Stock Agreement, dated November 8, 1996, between
           the Registrant and Andrew J. Frawley.
 10.8      Consulting Agreement, dated March 18, 1997, between the
           Registrant and Exchange Marketing Group, LLC.
 10.9      Securities Purchase Agreement, dated March 18, 1997.
 10.10     Securities Purchase Agreement, dated December 4, 1997.
 10.11     Stock Purchase and Waiver Agreement, dated December 4, 1997.
 10.12     Promissory Note, dated December 4, 1997, by Andrew J.
           Frawley payable to the Registrant.
 10.13     Amended and Restated Stockholders Agreement dated December
           4, 1997.
 10.14     Amended and Restated Registration Rights Agreement dated
           December 4, 1997.
 10.15     Letter Agreement, dated December 22, 1997, between the
           Registrant and Fleet National Bank, as amended, and the
           related Promissory Note.
 10.16     Stock Purchase Agreement, dated June 25, 1998, and the
           related Waiver Agreement to the Amended and Restated
           Stockholders Agreement, dated June 25, 1998.
 10.17     Office lease for 89 South Street, Boston, Massachusetts.
 21.1      Subsidiaries of Registrant.
 23.1      Consent of Arthur Andersen LLP.
 23.2*     Consent of Bingham Dana LLP, counsel to Registrant (included
           in Exhibit 5.1).
 24.1      Power of Attorney (included in signature page to
           Registration Statement).
 27.1      Financial Data Schedule (6 months ended June 30, 1998)
 27.2      Financial Data Schedule (12 months ended December 31, 1997)
 27.3      Financial Data Schedule (12 months ended December 31, 1996)
</TABLE>
 
---------------
* To be filed by amendment
[{"type": "S-1", "sequence": "1", "description": "EXCHANGE APPLICATIONS, INC.", "secsgml_size_bytes": 378362}]
{"company-data": {"conformed-name": "EXCHANGE APPLICATIONS INC", "cik": "0001065857", "assigned-sic": "", "irs-number": "043338916", "state-of-incorporation": "DE", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "S-1", "act": "33", "file-number": "333-59613", "film-number": "98669890"}, "business-address": {"street1": "89 SOUTH STREET", "city": "BOSTON", "state": "MA", "zip": "02111", "phone": "6177372244"}, "mail-address": {"street1": "89 SOUTH STREET", "city": "BOSYON", "state": "MA", "zip": "02111"}}
1
 
     AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 22, 1998
 
                                                 REGISTRATION NO. 333-
================================================================================
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------
 
                                    FORM S-1
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933

                            ------------------------
 
                          EXCHANGE APPLICATIONS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE                                 7373                                04-3338916
   (STATE OR OTHER JURISDICTION OF          (PRIMARY STANDARD INDUSTRIAL                 (I.R.S. EMPLOYER
    INCORPORATION OR ORGANIZATION)          CLASSIFICATION CODE NUMBERS)               IDENTIFICATION NO.)
89 SOUTH STREET
                          BOSTON, MASSACHUSETTS 02111
                                 (617) 737-2244
  (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
                   REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

                            ------------------------
 
                               ANDREW J. FRAWLEY
                        CHAIRMAN OF THE BOARD, PRESIDENT
                          AND CHIEF EXECUTIVE OFFICER
                          EXCHANGE APPLICATIONS, INC.
                                89 SOUTH STREET
                          BOSTON, MASSACHUSETTS 02111
                                 (617) 737-2244
 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
                             OF AGENT FOR SERVICE)
                            ------------------------
 
                                with copies to:
NEIL W. TOWNSEND, ESQ.                                   DAVID C. CHAPIN, ESQ.
                    BINGHAM DANA LLP                                           ROPES & GRAY
                   150 FEDERAL STREET                                    ONE INTERNATIONAL PLACE
              BOSTON, MASSACHUSETTS 02110                              BOSTON, MASSACHUSETTS 02110
                     (617) 951-8000                                           (617) 951-7000
              FACSIMILE NO. (617) 951-8736                             FACSIMILE NO. (617) 951-7050
------------------------
 
    APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:  As soon as
practicable after the effective date of this Registration Statement.
    If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box.  [ ]
    If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering.  [ ]
    If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the same
offering.  [ ]
    If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box.  [ ]

                            ------------------------
 
                        CALCULATION OF REGISTRATION FEE
=================================================================================================================================
                                           AMOUNT             PROPOSED MAXIMUM        PROPOSED MAXIMUM
     TITLE OF EACH CLASS OF                TO BE               OFFERING PRICE        AGGREGATE OFFERING          AMOUNT OF
   SECURITIES TO BE REGISTERED         REGISTERED(1)            PER SHARE(2)              PRICE(2)            REGISTRATION FEE
---------------------------------------------------------------------------------------------------------------------------------
Common Stock, $0.001 par value
  per share......................        3,450,000                 $16.00               $55,200,000               $16,284
=================================================================================================================================
(1) Includes 450,000 shares subject to the Underwriters' over-allotment option.
    See "Underwriting."
 
(2) Estimated solely for the purpose of calculating the registration fee in
    accordance with Rule 457 under the Securities Act of 1933, as amended.

                            ------------------------
 
    THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
================================================================================
2
 
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
 
                   SUBJECT TO COMPLETION, DATED JULY 22, 1998
 
                                3,000,000 SHARES
 
                          [EXCHANGE APPLICATION LOGO]

                                  COMMON STOCK
                          (PAR VALUE $.001 PER SHARE)

                             ----------------------
 
     Of the 3,000,000 shares of Common Stock offered hereby, 2,000,000 shares
are being sold by the Company and 1,000,000 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders". The Company will not
receive any of the proceeds from the sale of the shares being sold by the
Selling Stockholders.
 
     Prior to this Offering, there has been no public market for the Common
Stock of the Company. It is currently estimated that the initial public offering
price per share will be between $14.00 and $16.00. For factors considered in
determining the initial public offering price, see "Underwriting".
 
     SEE "RISK FACTORS" COMMENCING ON PAGE 4 FOR CERTAIN CONSIDERATIONS RELEVANT
TO AN INVESTMENT IN THE COMMON STOCK.
 
     The Company intends to apply for quotation and trading of the Common Stock
on the Nasdaq National Market under the symbol "EXAP".

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

    THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
       AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
               UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
           ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

                             ----------------------
INITIAL PUBLIC       UNDERWRITING         PROCEEDS TO      PROCEEDS TO SELLING
                                 OFFERING PRICE        DISCOUNT(1)         COMPANY(2)           STOCKHOLDERS
                                 --------------       ------------         -----------      -------------------
Per Share....................           $                   $                   $                    $
Total(3).....................         $                   $                   $                    $
---------------
(1) The Company and the Selling Stockholders have agreed to indemnify the
    Underwriters against certain liabilities, including liabilities under the
    Securities Act of 1933.
(2) Before deducting estimated expenses of $1,000,000 payable by the Company.
(3) The Company has granted the Underwriters an option for 30 days to purchase
    up to an additional 450,000 shares at the initial public offering price per
    share, less the underwriting discount, solely to cover over-allotments. If
    such option is exercised in full, the total initial public offering price,
    underwriting discount and proceeds to Company will be $          ,
    $          and $          , respectively. See "Underwriting".

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

     The shares offered hereby are offered severally by the Underwriters, as
specified herein, subject to receipt and acceptance by them and subject to their
right to reject any order in whole or in part. It is expected that certificates
for the shares will be ready for delivery in New York, New York on or about
               , 1998, against payment therefor in immediately available funds.

GOLDMAN, SACHS & CO.
                                     BT ALEX. BROWN
                                                               HAMBRECHT & QUIST

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

               The date of this Prospectus is             , 1998.
3
 
                         CONTINUOUS CUSTOMER MANAGEMENT
                   OPTIMIZING CUSTOMER VALUE THROUGH PROCESS,
                           APPLICATIONS & TECHNOLOGY
 
                                   [ART WORK]
 
[This graphic is a series of diagrams showing the VALEX architecture interfacing
with customer databases and customer touchpoints surrounded by figures depicting
the functional benefits of VALEX.]
 
Continuous Customer Management (CCM) is Exchange Applications' enterprise-wide
offering for customer optimization. The CCM solution, including the Company's
VALEX software and related consulting and integration services, enables
businesses to:
 
 - analyze enterprise-wide databases of customer information
 
 - conduct customer planning to prioritize for opportunity identification
   investment
 
 - execute targeted, real-time and event-triggered customer communication
 
 - select the most effective methods of customer interaction
 
 - perform measurement and analysis to continuously evaluate and refine
   marketing campaigns and their impact on customer profitability

 
Exchange Applications, VALEX, Continuous Customer Management, CCM, Value
Exchange Optimization, Metrics Repository and the Exchange Applications logo are
trademarks of the Company. All other trademarks or tradenames referred to in
this Prospectus are the property of their respective owners.
 
The Company intends to furnish to its stockholders annual reports containing
audited financial statements examined by its independent auditors.
 
     CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE OFFERING.
FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".
4
OPTIMIZING CUSTOMER VALUE        MANAGING CUSTOMER RELATIONSHIPS OVER TIME
 THROUGH CONTINUOUS CUSTOMER
      MANAGEMENT                      Exchange Applications' Continuous Customer
                                 Management solution enables businesses to
                                 maximize the profitability of their customer 
                                 relationships. Full potential is achieved by 
                                 allocating marketing investments to most 
                                 effectively aquire new customers, expand the 
         [ART WORK]              profitability of existing customers and retain
[This graphic is a               customers longer.
representation of the three
aspects of the Company's
Continuous Customer Management                      [ART WORK]
offering. The graphic is a
dramatization of the use of
VALEX to acquire new customers,
expand purchasing of existing
customers and retain customers        Businesses use VALEX to run campaigns that
longer thereby optimizing        maximize profitability by focusing on key
customer value.]                 elements of a customer relationship. In
                                 the "ACQUIRE" cycle, a prospect is contacted
                                 via direct mail, resulting in the acquisition 
                                 of a new customer. In the "EXPAND" cycle, 
                                 VALEX identifies high potential cross-
                                 selling opportunities to expand customer
                                 relationships with additional product sales.
                                 In the "RETAIN" cycle, VALEX automatically
                                 executes a statistical model, notifying a
                                 customer-care organization that the
                                 customer is at risk of leaving, and enabling 
                                 that customer to be contacted and encouraged
                                 to stay. Customer optimization is achieved by 
                                 simultaneously executing hundreds of these 
                                 campaigns and continuously monitoring customers
                                 to maximize their profitability across the
                                 enterprise.
5
 
                               PROSPECTUS SUMMARY
 
     The following summary should be read in conjunction with, and is qualified
in its entirety by, the more detailed information and the Consolidated Financial
Statements and Notes thereto appearing elsewhere in this Prospectus. Except as
otherwise noted, all information in this Prospectus, including share and per
share information, assumes: (i) the mandatory conversion into Common Stock of
all outstanding shares of Series B Redeemable Convertible Preferred Stock and
Series C Convertible Preferred Stock (the "Convertible Preferred Stock") upon
the consummation of the Offering; (ii) the cancellation of all outstanding
shares of Series A Redeemable Preferred Stock (the "Series A Preferred Stock")
upon consummation of the Offering; (iii) no exercise of stock options after June
30, 1998; (iv) no exercise of the Underwriters' over-allotment option; and (v)
the amendment and restatement of the Company's Certificate of Incorporation and
By-laws immediately prior to the consummation of the Offering. See "Description
of Capital Stock" and "Underwriting".
 
                                  THE COMPANY
 
     Exchange Applications, Inc. (the "Company") is a leading provider of
customer optimization software and solutions that enable businesses to maximize
profitability and revenue growth from new and existing customers through
marketing automation and enterprise-wide customer management. The Company's
Continuous Customer Management ("CCM") solution, including its VALEX software
and related consulting and integration services, enables businesses to
profitably retain and expand existing customer relationships and acquire new
customers by: (i) analyzing enterprise-wide databases of customer information to
identify profitable growth opportunities; (ii) planning and prioritizing
investments in high potential customers; (iii) creating targeted, real-time and
event-triggered marketing campaigns and other customer communications; (iv)
selecting the most effective channels for customer communications, such as
direct mail, call centers, sales forces and the Internet; and (v) continuously
evaluating the impact of these marketing campaigns and other communications on
profitability. CCM allows businesses to measure the value of these campaigns
against their associated costs, and to use this information to make investment
decisions that maximize customer profitability. The Company has deployed CCM and
VALEX across multiple industries, with installations in over 40 businesses in
North America and Europe. Its customers include Federal Express, Fleet Bank,
NatWest Bank (U.K.) and US West. The Company's products and services are
distributed through its direct sales force, through re-seller relationships with
IBM, NCR and others, and through co-marketing arrangements with companies such
as Compaq, Ernst & Young, KPMG Peat Marwick, PricewaterhouseCoopers, SAS
Institute and Sun Microsystems.
 
     While enterprise resource planning ("ERP"), supply chain management and
other software applications aimed at reducing costs have generally been
successful, businesses have begun to invest in a new class of applications
designed to increase profitability through revenue growth. Many of these new
applications are aimed at enabling businesses to increase revenue by acquiring
new customers and retaining and expanding relationships with existing customers.
These applications facilitate cross-selling and the marketing of bundled
products, new service offerings and differentiated service relationships. The
success of these efforts depends on the ability of businesses to allocate
resources based not only on functional area and product profitability, but also
on current and potential customer profitability. The Company believes there are
significant opportunities in many industries for solutions that realign
businesses' existing marketing and customer management capabilities with new
technologies and processes that utilize complete economic profiles of customers
to optimize customer relationships across the enterprise.
 
     The Company believes that CCM and VALEX represent a fundamentally new
approach to customer optimization. VALEX enables businesses to maximize
profitability by: (i) providing a complete view of the relationship between a
business and its customers; (ii) leveraging a range of data mining, reporting
and modeling products to identify high-value customers; (iii) providing powerful
marketing automation and campaign management software that lets end users define
and
 
                                        1
6
 
execute targeted customer communication streams; and (iv) integrating with
customer interaction software ("CIS") and data warehouses to perform
enterprise-wide customer management. Through its consulting and integration
services, the Company provides assistance in adopting the CCM solution across
business functions and in rapidly implementing the core VALEX modules. The
Company also provides Metrics Repository, a custom software application that
leverages VALEX to track the success or failure of marketing campaigns across
customer segments and across the enterprise.
 
     The Company's objective is to be the leading provider of customer
optimization software and solutions globally. Key elements of the Company's
strategy include extending VALEX, developing additional customer optimization
solutions, expanding vertical industry focus, broadening distribution channels
and building alliances, and increasing direct sales globally.
 
     The Company commenced operations in November 1994 and was incorporated in
Delaware in November 1996. Unless the context otherwise requires, references in
this Prospectus to the Company refer to Exchange Applications, Inc. and its
subsidiaries. The Company's principal executive offices are located at 89 South
Street, Boston, Massachusetts 02111, and its telephone number is (617) 737-2244.
 
                                  THE OFFERING
 
Common Stock offered by the
Company............................    2,000,000 shares
 
Common Stock offered by the Selling
  Stockholders.....................    1,000,000 shares
 
Common Stock outstanding after the
  Offering(1)......................    9,716,740 shares
 
Proposed Nasdaq National Market
symbol.............................    "EXAP"
 
Use of Proceeds....................    For general corporate purposes, including
                                       working capital, possible reduction of
                                       indebtedness and potential acquisitions.
---------------
(1) Excludes 2,085,408 shares of Common Stock issuable upon exercise of options
    outstanding at July 15, 1998 with exercise prices ranging from $0.65 to
    $14.50 per share and with a weighted average exercise price of $3.10 per
    share. See "Management -- 1996 Stock Incentive Plan" and Note 13 of Notes to
    Consolidated Financial Statements.
 
                                        2
7
 
                   SUMMARY CONSOLIDATED FINANCIAL INFORMATION
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED
                                              YEAR ENDED DECEMBER 31,         JUNE 30,
                                            ---------------------------   -----------------
                                            1995(1)   1996(1)    1997      1997      1998
                                            -------   -------   -------   -------   -------
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenues............................  $1,693    $ 6,034   $12,669   $ 4,822   $10,418
Gross profit..............................     681      1,939     5,735     1,662     6,987
Loss from operations......................    (507)    (1,411)   (2,624)   (1,450)   (1,108)
Net loss..................................    (554)    (1,606)   (2,599)   (1,460)   (1,079)
Net loss applicable to common
  stockholders............................    (554)    (1,606)   (3,283)   (2,025)   (1,199)
Pro forma basic and diluted net loss per
  share(2)(3).............................  $(0.19)   $ (0.55)  $ (0.48)  $ (0.31)  $ (0.15)
Pro forma basic and diluted weighted
  average common shares
  outstanding(2)(3).......................   2,925      2,930     5,391     4,683     7,377
AS OF JUNE 30, 1998
                                                         --------------------------------------
                                                                                     PRO FORMA
                                                                        PRO         AS ADJUSTED
                                                         ACTUAL       FORMA(3)        (3)(4)
                                                         ------       --------      -----------
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents, and marketable securities......  $ 4,182      $ 4,182         $31,082
Working capital........................................    3,515        3,515          30,415
Total assets...........................................   12,134       12,134          39,034
Long-term debt, net of current portion.................      128          128             128
Redeemable preferred stock.............................    7,208           --              --
Stockholders' equity (deficit).........................   (1,836)       5,372          32,272
---------------
(1) The Consolidated Statement of Operations Data for the years ended December
    31, 1995 and 1996 include the operations of the Company on a carve-out basis
    prior to November 15, 1996. During this period, the Company operated as a
    separate and substantially independent division of Grant & Partners, Inc.
    and Grant & Partners Limited Partnership, and focused on developing VALEX
    and providing integration and consulting services. See Note 1 of Notes to
    Consolidated Financial Statements.
 
(2) Computed on the basis described in Note 2(c) of the Notes to Consolidated
    Financial Statements.
 
(3) Reflects the reclassification of the Series A Preferred Stock to $3,209,000
    of additional paid-in capital, the conversion of all outstanding shares of
    the Series B Convertible Preferred Stock, at a redemption value of
    $3,999,000, into 2,555,556 shares of Common Stock and the conversion of all
    outstanding shares of Series C Convertible Preferred Stock, at $0.001 par
    value per share, to 1,223,954 shares of Common Stock upon the closing of
    this Offering.
 
(4) Adjusted to reflect the sale of 2,000,000 shares of Common Stock offered by
    the Company at an assumed initial public offering price of $15.00 per share,
    after deducting underwriting discounts and commissions and estimated
    offering expenses payable by the Company.
 
                                        3
8
 
                                  RISK FACTORS
 
     In addition to the other information in this Prospectus, prospective
purchasers of the Common Stock offered hereby should carefully consider the
following factors in evaluating the Company and its business.
 
LIMITED OPERATING HISTORY; HISTORY OF LOSSES
 
     The Company began operations in 1994, was incorporated in 1996 and has
never achieved profitability. The Company began commercial shipment of its
initial VALEX product in July 1996 and, since such time, has transitioned its
primary business focus from providing services to selling software products. As
a result, the Company and its operations are subject to all of the risks
inherent in the establishment of a new business enterprise. The Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of development,
particularly in new and rapidly evolving markets. To address these risks, the
Company must, among other things, respond to competitive developments, continue
to upgrade its products and continue to attract, retain and motivate qualified
personnel. There can be no assurance that the Company will be successful in
addressing such risks, that the Company's revenues will continue to grow, that
the Company will achieve profitability or, if it does, that the Company will be
able to maintain such profitability on a quarterly or annual basis. See
"-- Dependence Upon Key Personnel", "-- Rapid Technological Change and New
Products" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
 
POTENTIAL FOR SIGNIFICANT FLUCTUATIONS IN QUARTERLY RESULTS
 
     The Company's quarterly revenues, expenses and operating results have
varied significantly in the past and are likely to vary significantly from
quarter to quarter in the future. Because purchase of the Company's products and
services generally involves a significant commitment of capital (ranging from
approximately $100,000 to $3,000,000 in 1997), the length of the sales cycle is
unpredictable and subject to a number of factors over which the Company has
little or no control, including customers' budgetary constraints, timing of
budget cycles and concerns about the introduction of new products by the Company
or its competitors. As a result of these and other factors, the timing of
significant orders may be delayed. A substantial portion of the Company's
revenues in any quarter are typically derived from a limited number of
non-recurring license sales and, like many software companies, the Company tends
to record a significant portion of its software license fee revenues in the last
month of a quarter. In addition, the amount of revenues associated with a
particular license can vary significantly based upon the size of the customer
databases and other factors, including the number of users of the software. The
Company may experience from time to time large, individual license sales which
can cause substantial variations in quarterly license revenues. Moreover, small
delays in customer orders can cause significant variability in the Company's
license revenues and results of operations for any particular period. The
Company establishes its expenditure levels for product development, sales and
marketing and other operating activities based, in large part, on its expected
future revenues. As a result, if revenues fall below expectations, operating
results are likely to be adversely and disproportionately affected because only
a small portion of the Company's expenses vary with its revenues.
 
     Quarterly fluctuations also result from factors such as increased
competition, the timing of new releases of the Company's software products and
market acceptance of such releases, changes in pricing policies of the Company
or its competitors, changes in operating expenses, foreign currency exchange
rate fluctuations and general economic factors. Based upon these and all of the
factors described above, the Company believes that its quarterly revenues,
expenses and operating results are likely to vary significantly in the future,
that period-to-period comparisons of its results of operations are not
necessarily meaningful and that, as a result, such comparisons should not be
relied upon as indications of future performance. Moreover, although the
Company's revenues have increased in recent periods, there can be no assurance
that revenues will continue to grow at past

                                        4
9
 
rates, if at all, or that the Company will achieve and sustain profitability on
a quarterly or annual basis. As a result, the Company's operating results may
fall below market analysts' expectations in some future quarters, which would
have a material adverse effect on the market price of the Common Stock. See
"Selected Consolidated Financial Data" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
 
PRODUCT CONCENTRATION; DEPENDENCE ON EMERGING MARKET FOR CUSTOMER OPTIMIZATION
SOFTWARE AND SERVICES
 
     The Company currently derives all of its revenues from VALEX licenses and
services related to its Continuous Customer Management ("CCM") solution. The
Company expects that VALEX-related revenues, including CCM services and
maintenance contracts, will continue to account for substantially all of the
Company's revenues for the foreseeable future. As a result, the Company's future
operating results are dependent upon continued market acceptance of VALEX and
CCM and enhancements thereto. There can be no assurance that VALEX and CCM will
achieve continued market acceptance. A decline in demand or market acceptance as
a result of competition, technological change or other factors would have a
material adverse effect on the Company's business, operating results and
financial condition.
 
     Although demand for VALEX and similar products has grown in recent years,
the market for customer optimization software applications is still emerging and
there can be no assurance that it will continue to grow or that, even if the
market does grow, businesses will continue to adopt VALEX and CCM. The Company
has spent, and intends to continue to spend, considerable resources educating
potential customers about customer optimization software and services in general
and about the features and functions of VALEX and CCM in particular. However,
there can be no assurance that such expenditures will enable VALEX and CCM to
achieve any additional degree of market acceptance. If the market for VALEX and
CCM fails to grow or grows more slowly than the Company currently anticipates,
the Company's business, operating results and financial condition would be
materially adversely affected.
 
CUSTOMER CONCENTRATION; DEPENDENCE ON CERTAIN INDUSTRIES
 
     In fiscal 1997 and for the six months ended June 30, 1998, the Company's
top five customers accounted for 74.9% and 53.6% of total revenues,
respectively. There can be no assurance that these or other customers of the
Company will continue to purchase the Company's products or services. The
Company's failure to add new customers that make significant purchases of the
Company's products and services would have a material adverse effect on the
Company's business, financial condition and results of operations.
 
     A substantial portion of the Company's revenues have been derived from
sales to large financial institutions and telecommunications companies. There
can be no assurance that the Company will be successful in achieving significant
market acceptance or penetration in additional vertical markets targeted by the
Company. Failure to penetrate additional vertical markets could have a material
adverse effect on the Company's future growth, financial condition and results
of operations.
 
MANAGEMENT OF GROWTH
 
     The Company's business has grown rapidly, with total revenues increasing
from $1.7 million in 1995 to $6.0 million in 1996 and to $12.7 million in 1997.
The Company's recent expansion has resulted in substantial growth in the number
of its employees (from 47 at December 31, 1996 to 91 at December 31, 1997 and to
129 at June 30, 1998), the scope of its operating and financial systems and the
geographic distribution of its operations and customers. This recent rapid
growth has placed, and if sustained will continue to place, a significant strain
on the Company's management and operations. Accordingly, the Company's future
operating results will depend on the ability of its
 
                                        5
10
 
officers and other key employees to continue to implement and improve its
operational, customer support and financial control systems, and to expand,
train and manage its employee base. There can be no assurance that the Company
will be able to manage any future expansion successfully, and any inability to
do so would have a material adverse effect on the Company's business, operating
results and financial condition.
 
DEPENDENCE UPON KEY PERSONNEL
 
     The Company's future operating results depend in significant part upon the
continued services of a relatively small number of key technical and senior
management personnel, including Andrew Frawley, its Chairman, President and
Chief Executive Officer, David McFarlane, its Executive Vice President,
Worldwide Sales and Services, and Michael McGonagle, its Vice President, Product
Development, none of whom is bound by an employment agreement. The Company's
future success also depends on its continuing ability to attract and retain
other highly qualified technical, sales and managerial personnel. Competition
for such personnel is intense, and the Company has at times in the past
experienced difficulty in recruiting qualified personnel. There can be no
assurance that the Company will retain its key technical, sales and managerial
employees or that it will be successful in attracting, assimilating and
retaining other highly qualified technical, sales and managerial personnel in
the future. The loss of any member of the Company's key technical, sales and
senior management personnel or the inability to attract and retain additional
qualified personnel could have a material adverse effect on the Company's
business, operating results and financial condition. See "Business -- Employees"
and "Management".
 
RAPID TECHNOLOGICAL CHANGE AND NEW PRODUCTS
 
     The market for the Company's software products is characterized by rapid
technological advances, evolving industry standards in computer hardware and
software technology, changes in customer requirements and frequent new product
introductions and enhancements. The Company's future success will depend upon
its ability to continue to enhance its current product line and to develop and
introduce new products that keep pace with technological developments, satisfy
increasingly sophisticated customer requirements and achieve market acceptance.
There can be no assurance that the Company will be successful in developing and
marketing, on a timely and cost-effective basis, fully functional product
enhancements or new products that respond to technological advances by others,
or that its new products will achieve market acceptance. Failure to successfully
develop and market product enhancements or new products could have a material
adverse effect on the Company's business, operating results and financial
condition.
 
     As a result of the complexities inherent in client/server computing
environments and the broad functionality and performance demanded by customers
for customer optimization software products, major new products and product
enhancements can require long development and testing periods. The Company has
on occasion experienced delays in the scheduled introduction of new and enhanced
products. In addition, software programs as complex as those offered by the
Company may contain undetected errors or "bugs" when first introduced or as new
versions are released that, despite testing by the Company, are discovered only
after a product has been installed and used by customers. To date the Company's
business has not been materially adversely affected by delays or the release of
products containing errors. There can be no assurance, however, that errors will
not be found in future releases of the Company's software, or that any such
errors will not impair the market acceptance of these products and adversely
affect the Company's business, operating results and financial condition.
 
     While the Company generally takes steps to avoid the interruptions of sales
often associated with the pending availability of new products, customers may
delay their purchasing decisions in anticipation of the general availability of
new or enhanced VALEX products, which could have a material adverse effect on
the Company's business and operating results. Moreover, significant delays in
the general availability of such new releases, significant problems in the
installation or
                                        6
11
 
implementation of such new releases, or customer dissatisfaction with such new
releases, could have a material adverse effect on the Company's business,
operating results and financial condition. See "Business -- Products" and
"Product Development".
 
COMPETITION
 
     The market for customer optimization software and related services is
highly competitive. There can be no assurance that the Company will maintain its
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical and
other resources. Current and potential competitors fall into the following
categories: (i) database marketing vendors, such as Harte Hanks, Metromail (a
division of Great Universal Stores) and Harland, which provide a combination of
service bureau capabilities and software; (ii) small independent software
companies that are creating or are attempting to create offerings similar to the
VALEX product; (iii) enterprise resource planning ("ERP") and customer
interaction software ("CIS") vendors such as SAP, Baan, Oracle, Siebel and
Vantive, that may broaden their product lines to include applications with
competitive functionality; and (iv) internal corporate technology departments
that attempt to build their own systems. The Company believes that many of these
competitors are focusing significant resources on increasing the functionality
of their products and services. Ultimately, competitors may be able to offer
products and services with functionality comparable or superior to that of
VALEX. Many of the Company's competitors have longer operating histories,
significantly greater financial, technical, marketing and other resources,
greater name recognition, and larger customer bases than the Company. As a
result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements and to devote greater resources to the
promotion and sale of their products and services than the Company. If these
companies were to introduce products and services that effectively competed with
the Company's products and services, they could be in a position to
substantially lower the price of their customer optimization products and
services or to bundle such products and services with their other products and
services, which could give them competitive advantages over the Company. In
order to be successful in the future, the Company must continue to respond
promptly and effectively to the challenges of technological change and
competitors' innovations. There can be no assurance that the Company will be
able to compete successfully with existing or new competitors. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which would materially and adversely affect the Company's
business, operating results and financial condition. See
"Business -- Competition".
 
INCREASING RELIANCE ON INDIRECT DISTRIBUTION CHANNELS
 
     Although direct sales to date have accounted for a majority of the
Company's software revenues, the Company expects that it will increasingly
distribute its products to end users through various indirect distribution
channels, including re-seller agreements with IBM, NCR and others and
co-marketing arrangements with companies such as Compaq, Ernst & Young, KPMG
Peat Marwick, PricewaterhouseCoopers, SAS Institute and Sun Microsystems. The
Company's relationships with many of these organizations have been established
within the last twelve months, and the Company is unable to predict the extent
to which these channel partners will be successful in distributing the Company's
products. The Company is dependent on the marketing and sales efforts of these
organizations, many of whom also market and sell competitive products or are
able, under the terms of their agreements, to market and sell competitive
products. One of the Company's channel partners accounted for approximately 24%
of the Company's consolidated revenues for the six months ended June 30, 1998.
The loss of one or more of the Company's relationships with these organizations,
without replacement, either to competitive products offered by other companies
or products developed internally by these organizations, could have a material
adverse effect on the Company's business, operating results and financial
condition. The Company's future performance will also depend, in part, on its
ability to attract organizations that will be able to market and support the
Company's product effectively, especially in markets in which the Company has
not previously

                                        7
12
 
distributed its products. None of the agreements governing the re-seller or
co-marketing relationships with these organizations includes any commitments on
the part of these organizations to effect any minimum number of sales of VALEX,
or otherwise to provide the Company with business. There can be no assurance
that revenues arising from the Company's relationships with these organizations
that accounted for significant revenues in past periods will continue, or if
continued will reach or exceed historical levels. See "Business -- Sales and
Marketing".
 
INTELLECTUAL PROPERTY RIGHTS; USE OF LICENSED TECHNOLOGY
 
     The Company relies primarily on a combination of copyright, trademark and
trade secret laws, confidentiality procedures and contractual provisions to
protect its proprietary rights. In addition, the Company generally licenses
VALEX to end users in object code (machine-readable) format, and the Company's
license agreements generally allow the use of VALEX solely by the customer for
internal purposes without the right to sublicense or transfer VALEX. The Company
believes that the foregoing measures afford only limited protection. Certain
customers have required the Company to maintain a source code escrow account
with a third-party software escrow agent, and a failure by the Company to
perform its obligations under any of the license and maintenance agreements, or
the insolvency of the Company, could conceivably cause the release of the
Company's source code to such customers. Despite the Company's efforts to
protect its proprietary rights, unauthorized parties may attempt to copy aspects
of the Company's products or to obtain and use information that the Company
regards as proprietary. Policing unauthorized use of the Company's products is
difficult, and while the Company is unable to determine the extent to which
piracy of its software products exists, software piracy can be expected to be a
problem. In addition, the laws of some foreign countries do not protect the
Company's proprietary rights to the same extent as the laws of the United
States. Furthermore, there can be no assurance that the Company's competitors
will not independently develop technology similar to that of the Company. The
Company may increasingly be subject to claims of intellectual property
infringement as the number of products and competitors in the Company's industry
segment grows and the functionality of products in different industry segments
overlaps. Although the Company is not aware that any of its products infringe
upon the proprietary rights of third parties, there can be no assurance that
third parties will not claim infringement by the Company with respect to current
or future products. Any such claims, with or without merit, could be
time-consuming to address, result in costly litigation, cause product shipment
delays or require the Company to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, might not be available on
terms acceptable to the Company or at all, which could have a material adverse
effect upon the Company's business, operating results and financial condition.
 
     The Company has in the past and may in the future re-sell certain software
that it licenses from third parties. There can be no assurance that these third
party software licenses will continue to be available to the Company on
commercially reasonable terms. The loss of or inability to maintain or obtain
any of these software licenses could result in delays or reductions in product
shipments until equivalent software could be identified, licensed and
integrated, which could materially adversely affect the Company's business,
operating results and financial condition. See "Business -- Products" and
"-- Proprietary Rights and Licenses".
 
INTERNATIONAL OPERATIONS
 
     The Company derived approximately 22% of its total revenues from sales
outside the United States in the six months ended June 30, 1998. The Company
opened sales offices in the United Kingdom in July 1997 and in Australia in
January 1998, and believes that continued growth and profitability will require
expansion of its sales in international markets. In order to successfully expand
international sales, the Company must establish additional foreign operations
and hire additional personnel. To the extent that the Company is unable to do so
in a timely and effective manner, any growth in international sales will be
limited, and the Company's business, operating
 
                                        8
13
 
results and financial condition could be materially adversely affected. In
addition, even if international operations are successfully expanded, there can
be no assurance that the Company will be able to maintain or increase
international market demand for its products.
 
     The Company's international operations are subject to the risks inherent in
any international business activities, including, in particular, management of
an organization spread over various countries, longer accounts receivable
payment cycles in certain countries, compliance with a variety of foreign laws
and regulations, unexpected changes in regulatory requirements, overlap of
different tax structures, foreign currency exchange rate fluctuations and
general economic conditions. Other risks associated with international
operations include import and export licensing requirements, trade restrictions
and changes in tariff rates. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business -- Sales and
Marketing".
 
CONTROL BY EXISTING STOCKHOLDERS
 
     Upon completion of the Offering, the current officers, directors and
principal stockholders will beneficially own approximately 69.1% of the
Company's outstanding Common Stock (64.5% if the Underwriters' over-allotment
option is exercised in full). Consequently, such persons, as a group, will be
able to control the outcome of all matters submitted for stockholder action,
including the election of members to the Company's Board of Directors and the
approval of significant change in control transactions, and will effectively
control the management and affairs of the Company, which may have the effect of
delaying or preventing a change in control of the Company. While the Company
intends to increase the size of its Board of Directors from four to six members,
representatives of the existing stockholders will nonetheless constitute three
of the six directors and will therefore have significant influence in directing
the actions of the Board of Directors. See "Management" and "Principal and
Selling Stockholders".
 
PRODUCT LIABILITY
 
     While the Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims, it is possible that such limitation of liability provisions
may not be effective under the laws of certain jurisdictions. Although the
Company has not experienced any product liability claims to date, there can be
no assurance that the Company will not be subject to such claims in the future.
A successful product liability claim brought against the Company could have a
material adverse effect on the Company's business, operating results and
financial condition. Moreover, defending such a suit, regardless of its merits,
could entail substantial expense and require the time and attention of key
management personnel, either of which could have a material adverse effect on
the Company's business, operating results and financial condition. See
"Business -- Products -- VALEX" and "-- Product Development".
 
YEAR 2000 COMPLIANCE
 
     Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and software used by many companies may need to be upgraded to comply
with such "Year 2000" requirements. Significant uncertainty exists in the
software industry concerning the potential effects associated with the failure
to comply with such requirements. Although all of the products currently offered
by the Company are designed to be Year 2000 compliant, there can be no assurance
that the Company's products contain all necessary date code changes, or that, in
the year 2000, the Company's products will be compatible with third-party
software that may be integrated or used in conjunction with the Company's
products. In addition, there can be no assurance that the Company's current and
potential customers or third-party distributors will not experience Year 2000
problems or that any such problems would not have a material adverse effect
 
                                        9
14
 
on the Company's business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Impact of Year 2000 Issue".
 
NO PRIOR MARKET FOR THE COMMON STOCK; POSSIBLE VOLATILITY OF SHARE PRICE
 
     Prior to the Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will develop
upon completion of the Offering or, if it does develop, that such market will be
sustained. The initial public offering price of the Common Stock has been
determined by negotiation among the Company, the Selling Stockholders and the
representatives of the Underwriters, and may not be representative of the price
that will prevail in the open market. See "Underwriting" for a discussion of the
factors considered in determining the initial public offering price.
 
     The market price of the Common Stock after the Offering may be affected
significantly by factors such as quarterly variations in the Company's results
of operations, the announcement of new products or product enhancements by the
Company or its competitors, technological innovation by the Company or its
competitors and general market conditions or market conditions specific to
particular industries. In particular, the stock prices for many companies in the
technology and emerging growth sectors have experienced wide fluctuations which
have often been unrelated to the operating performance of such companies. Such
fluctuations may adversely affect the market price of the Common Stock.
 
ANTI-TAKEOVER PROVISIONS
 
     The Company's Amended and Restated Certificate of Incorporation (the
"Charter"), and Amended and Restated By-laws (the "By-laws"), contain certain
provisions that may have the effect of discouraging, delaying or preventing a
change in control of the Company or unsolicited acquisition proposals that a
stockholder might consider favorable. Such provisions include authorizing the
issuance of "blank check" preferred stock; providing for a Board of Directors
with staggered, three-year terms; requiring super-majority voting to effect
certain amendments to the Charter and By-laws; limiting the persons who may call
special meetings of stockholders; prohibiting stockholder action by written
consent; and establishing advance notice requirements for nominations for
election to the Board of Directors or for proposing matters that can be acted
upon at stockholders meetings. Certain provisions of Delaware law and the
Company's 1996 Stock Incentive Plan (the "1996 Plan") and 1998 Stock Incentive
Plan (the "1998 Plan") may also have the effect of discouraging, delaying or
preventing a change in control of the Company or unsolicited acquisition
proposals. See "Management -- Stock Incentive Plans" and "Description of Capital
Stock -- Certain Anti-Takeover, Limited Liability and Indemnification
Provisions".
 
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
 
     Sales of substantial amounts of Common Stock in the public market, or the
perception that such sales may occur, could adversely affect the prevailing
market price of the Common Stock or the ability of the Company to raise capital
through a public offering of its equity securities. Upon completion of the
Offering, the Company will have outstanding 9,716,740 shares of Common Stock
(not including shares issuable upon exercise of outstanding stock options).
Under agreements entered into between the representatives of the Underwriters
and each of the Company's officers, directors, principal stockholders and their
respective affiliates (the "Lock-Up Agreements") who beneficially hold, in the
aggregate,                shares of Common Stock (which includes
shares acquired in 1998 upon the exercise of stock options) prior to the
Offering, no shares held by such holders will be eligible for sale in the public
market for a period of 180 days following the date of this Prospectus. The
Company intends to file a registration statement under the Securities Act of
1933, as amended (the "Securities Act"), covering the sale of Common Stock
reserved for issuance under the 1996 Plan. As of July 15, 1998, there were
options outstanding under the 1996 Plan to purchase an aggregate of 2,085,408
shares and no other options

                                       10
15
 
outstanding; all shares acquired upon exercise of the options within 180 days of
the Offering are or will be subject to Lock-Up Agreements as required under the
1996 Plan. Following the expiration of the 180-day term of the Lock-Up
Agreements, 5,651,892 shares, including the 3,000,000 shares offered hereby and
approximately 537,304 shares subject to options that will be exercisable on or
before the end of such term, will be eligible for sale in the public market
subject, in some cases, to the requirements of Rule 144 or Rule 701 under the
Securities Act. Goldman, Sachs & Co. in its sole discretion and at any time
without notice, may release all or any portion of the securities subject to the
Lock-Up Agreements. Any such decision to release securities would likely be
based upon individual stockholder circumstances, prevailing market conditions
and other relevant factors. Any such release could have a material adverse
effect upon the price of the Common Stock. See "Underwriting".
 
     After the Offering, holders of 6,025,310 shares of Common Stock are
currently entitled to certain demand and piggy-back registration rights with
respect to such shares. If the Company were required to register the shares held
by such holders pursuant to the exercise of their demand or piggy-back
registration rights, such sales could have an adverse effect upon the Company's
ability to raise needed capital. See "Shares Eligible for Future Sale".
 
IMMEDIATE SUBSTANTIAL DILUTION
 
     The initial public offering price is substantially higher than the book
value per share of the outstanding Common Stock. As a result, investors
purchasing Common Stock in the Offering will incur immediate substantial
dilution. In addition, the Company has issued options to acquire Common Stock at
prices significantly below the initial public offering price. To the extent such
outstanding options are exercised, there will be further dilution. See
"Dilution" and "Shares Eligible for Future Sale".
 
                                USE OF PROCEEDS
 
     Based on an assumed initial public offering price of $15.00 per share, the
Company will receive approximately $26,900,000 from the sale of shares of Common
Stock to be sold by the Company pursuant to the Offering after deducting the
underwriting discount and estimated offering expenses payable by the Company.
 
     The principal purposes of the Offering are to increase the Company's equity
capital, to create a public market for the Common Stock, to facilitate future
access by the Company to public equity markets, to provide liquidity for certain
of the Company's existing stockholders and to provide increased visibility of
the Company in a marketplace where many of its competitors are publicly held
companies.
 
     The Company currently intends to use the net proceeds of the Offering for
working capital and general corporate purposes, including financing accounts
receivable and capital expenditures made in the ordinary course of its business,
and the possible reduction of indebtedness. The Company may also apply a portion
of the net proceeds of the Offering to acquire businesses, products and
technologies that are complementary to those of the Company. Although the
Company has not identified any specific businesses, products or technologies
that it may acquire and as of the date of this Prospectus is not engaged in any
agreements or negotiations with respect to any such transactions, the Company
from time to time evaluates such opportunities. Pending such uses, the net
proceeds will be invested in government securities and other short-term,
investment-grade, interest-bearing instruments. The Company will not receive any
proceeds from the sale of Common Stock by the Selling Stockholders.
 
                                DIVIDEND POLICY
 
     The Company has never declared or paid any cash dividends on its capital
stock and does not intend to pay any cash dividends on its Common Stock in the
foreseeable future. Future dividends, if any, will be determined by the Board of
Directors.

 
                                       11
16
 
                                 CAPITALIZATION
 
     The following table sets forth the capitalization of the Company at June
30, 1998, (i) on an actual basis, (ii) on a pro forma basis to reflect the
reclassification of Series A Preferred Stock to $3,209,000 of additional paid-in
capital, and the conversion of all outstanding shares of Series B Convertible
Preferred Stock and Series C Convertible Preferred Stock to a total of 3,779,510
shares of Common Stock upon the closing of this Offering and (iii) on a pro
forma as adjusted basis to give effect to the sale of 2,000,000 shares of Common
Stock offered by the Company at an assumed initial public offering price of
$15.00 per share after deducting the underwriting discount and estimated
offering expenses payable by the Company. This information should be read in
conjunction with the Company's Consolidated Financial Statements and the related
Notes thereto appearing elsewhere in this Prospectus.
AS OF JUNE 30, 1998
                                                      -----------------------------------------
                                                                                  PRO FORMA AS
                                                      ACTUAL     PRO FORMA(1)    ADJUSTED(1)(2)
                                                      ------     ------------    --------------
                                                                   (IN THOUSANDS)
Long-term debt, net of current portion..............  $   128      $   128          $   128
                                                      -------      -------          -------
Redeemable Preferred Stock:
  Series A Preferred Stock..........................    3,209           --               --
  Series B Convertible Preferred Stock..............    3,999           --               --
                                                      -------      -------          -------
          Total Redeemable Preferred Stock..........    7,208           --               --
 
Stockholders' equity (deficit):
  Preferred Stock, $.001 par value; 10,000,000
     shares authorized..............................       --           --               --
  Series C Convertible Preferred Stock, $.001 par
     value; 1,223,954 shares designated, issued and
     outstanding, actual; 1,223,954 authorized, none
     issued, pro forma and pro forma as adjusted....        1           --               --
  Common Stock, $.001 par value, 30,000,000 shares
     authorized, pro forma and pro forma as adjusted
     4,298,305 shares issued, actual, 8,077,815
     shares issued, pro forma; 10,077,815 shares
     issued, pro forma as adjusted(3)...............        4            8               10
Additional paid-in capital..........................    4,878       12,083           38,981
Accumulated deficit.................................   (6,649)      (6,649)          (6,649)
Due from officer....................................     (125)        (125)            (125)
Cumulative translation adjustment...................       50           50               50
Unrealized gain on marketable securities............        5            5                5
Treasury stock, 361,075 shares at cost..............       --           --               --
                                                      -------      -------          -------
          Total stockholders' equity (deficit)......   (1,836)       5,372           32,272
                                                      -------      -------          -------
          Total capitalization......................  $ 5,500      $ 5,500          $32,400
                                                      =======      =======          =======
---------------
(1) Gives effect to the reclassification of the Series A Preferred Stock to
    $3,209,000 of additional paid-in capital, the conversion of all outstanding
    shares of Series B Convertible Preferred Stock, at a redemption value of
    $3,999,000, into 2,555,556 shares of Common Stock, and the conversion of all
    outstanding shares of Series C Convertible Preferred Stock, at $.001 par
    value per share, into 1,223,954 shares of Common Stock upon the closing of
    the Offering.
 
(2) Gives effect to the sale of 2,000,000 shares of Common Stock offered by the
    Company and the application of the net proceeds therefrom.
 
(3) Excludes 2,085,408 shares of Common Stock issuable pursuant to stock options
    outstanding at July 15, 1998 (of which 324,232 options are exercisable as of
    July 15, 1998). See "Management -- Stock Plans" and Note 13 of Notes to
    Consolidated Financial Statements.
 
                                       12
17
 
                                    DILUTION
 
     The pro forma net tangible book value of the Company as of June 30, 1998
was $5,372,000, or $0.70 per share of Common Stock, after giving effect to the
automatic conversion of all outstanding shares of Convertible Preferred Stock
and the reclassification of the value of Series A Preferred Stock to additional
paid-in capital. Pro forma net tangible book value per share is determined by
dividing the pro forma net tangible book value of the Company (total tangible
assets less total liabilities) by the total pro forma number of shares of Common
Stock outstanding, including shares of Common Stock resulting from the
conversion of the Convertible Preferred Stock. After giving effect to the sale
of the 2,000,000 shares of Common Stock offered by the Company hereby at an
assumed initial public offering price of $15.00 per share, and after deducting
estimated underwriting discounts and commissions and offering expenses payable
by the Company (resulting in estimated net proceeds of $26,900,000), the
adjusted pro forma net tangible book value of the Company as of June 30, 1998,
would have been $32,272,000, or $3.32 per share. This represents an immediate
increase in the pro forma net tangible book value of $2.62 per share to existing
stockholders and an immediate dilution of $11.68 per share to new investors. The
following table illustrates the per share dilution:
Assumed initial public offering price per share.............           $15.00
  Pro forma net tangible book value per share as of June 30,
     1998...................................................  $0.70
  Pro forma increase attributable to new investors..........   2.62
                                                              -----
Pro forma net tangible book value per share after the
  Offering..................................................             3.32
                                                                       ------
Pro forma dilution per share to new investors(1)............           $11.68
                                                                       ======
The following table summarizes, on a pro forma basis as of June 30, 1998,
the difference between the number of shares of Common Stock purchased from the
Company, the total consideration paid to the Company and the average price per
share paid by the existing stockholders and by the new investors (at an assumed
initial public offering price of $15.00 per share before deduction of estimated
underwriting discounts and commissions and offering expenses):
SHARES PURCHASED       TOTAL CONSIDERATION(1)
                                ---------------------    ----------------------    AVERAGE PRICE
                                  NUMBER      PERCENT      AMOUNT       PERCENT      PER SHARE
                                  ------      -------      ------       -------    -------------
Existing stockholders(1)(2)...   7,716,740      79.4%    $11,334,000      27.4%       $ 1.47
New investors(1)..............   2,000,000      20.6      30,000,000      72.6         15.00
                                ----------     -----     -----------     -----        ------
          Total...............   9,716,740     100.0%    $41,334,000     100.0%
                                ==========     =====     ===========     =====
---------------
(1) The foregoing table assumes no exercise of the Underwriters' over-allotment
    option and no exercise of stock options outstanding at June 30, 1998. As of
    July 15, 1998, the Company had 5,277,283 shares of Common Stock reserved for
    issuance under the Company's stock plans of which 2,085,408 shares were
    subject to outstanding stock options at a weighted average exercise price of
    $3.10 per share. To the extent any outstanding options are exercised, there
    will be further dilution to new investors. If all of the outstanding options
    were exercised in full, the dilution per share to new investors in this
    Offering would be increased by $0.04 per share to a total of $11.72 per
    share and the average price per share paid by the Company's existing
    shareholders would be $1.82. See "Capitalization", "Management -- Stock
    Option Plans" and Notes 12 and 13 of Notes to Consolidated Financial
    Statements.
 
(2) The net effect of sales by the Selling Stockholders in the Offering will be
    to reduce the number of shares held by existing stockholders to 6,716,740
    shares, or 69.1% of the total number of shares of Common Stock outstanding
    after the Offering, and to increase the number of shares held by new
    investors to 3,000,000 shares, or 30.9% of the total number of shares of
    Common Stock outstanding after the Offering.
 
                                       13
18
 
                      SELECTED CONSOLIDATED FINANCIAL DATA
 
     The following historical selected consolidated financial data of the
Company is qualified by reference to and should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included elsewhere herein.
The selected consolidated financial data set forth below for each of the fiscal
years ended December 31, 1995, 1996 and 1997 are derived from consolidated
financial statements of the Company audited by Arthur Andersen LLP, independent
public accountants, which are included elsewhere in this Prospectus. The
selected consolidated financial data for the six months ended June 30, 1997 and
1998 are derived from the unaudited consolidated financial statements of the
Company, which are included elsewhere in this Prospectus. The selected
consolidated financial data for the period from inception (November 1, 1994)
through December 31, 1994 are derived from the unaudited consolidated financial
statements of the Company, which are not included in this Prospectus. The
unaudited consolidated financial statements include all adjustments (consisting
only of normal recurring adjustments) which the Company considers necessary for
a fair presentation. The results of operations for the six months ended June 30,
1998 are not necessarily indicative of results to be expected for any future
period. The data should be read in conjunction with the Consolidated Financial
Statements and the Notes thereto and with Management's Discussion and Analysis
of Financial Condition and Results of Operations appearing elsewhere in this
Prospectus.
PERIOD FROM
                                                   INCEPTION
                                                 (NOVEMBER 1,            YEAR ENDED            SIX MONTHS ENDED
                                                 1994) THROUGH          DECEMBER 31,               JUNE 30,
                                                 DECEMBER 31,    ---------------------------   -----------------
                                                    1994(1)      1995(1)   1996(1)    1997      1997      1998
                                                 -------------   -------   -------   -------   -------   -------
                                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
  Software license fees........................     $   --       $   --    $ 1,500   $ 5,765   $ 1,793   $ 5,816
  Services and maintenance.....................         --        1,693      4,534     6,904     3,029     4,602
                                                    ------       ------    -------   -------   -------   -------
         Total revenues........................         --        1,693      6,034    12,669     4,822    10,418
Cost of revenues:
  Software license fees........................         --           --        890     1,707       863       129
  Services and maintenance.....................         --        1,012      3,205     5,227     2,297     3,302
                                                    ------       ------    -------   -------   -------   -------
         Total cost of revenues................         --        1,012      4,095     6,934     3,160     3,431
                                                    ------       ------    -------   -------   -------   -------
Gross profit...................................         --          681      1,939     5,735     1,662     6,987
Operating expenses:
  Sales and marketing..........................         --          128      1,007     3,602     1,268     4,163
  Research and development.....................         --          708      1,325     2,599     1,031     2,716
  General and administrative...................          7          352      1,018     2,158       813     1,216
                                                    ------       ------    -------   -------   -------   -------
         Total operating expenses..............          7        1,188      3,350     8,359     3,112     8,095
                                                    ------       ------    -------   -------   -------   -------
Loss from operations...........................         (7)        (507)    (1,411)   (2,624)   (1,450)   (1,108)
Interest income (expense), net.................         --          (47)      (195)       25       (10)       29
                                                    ------       ------    -------   -------   -------   -------
Net loss.......................................         (7)        (554)    (1,606)   (2,599)   (1,460)   (1,079)
Accretion of discount and dividends on
  preferred stock..............................         --           --         --      (684)     (565)     (120)
                                                    ------       ------    -------   -------   -------   -------
Net loss applicable to common stockholders.....     $   (7)      $ (554)   $(1,606)  $(3,283)  $(2,025)  $(1,199)
                                                    ======       ======    =======   =======   =======   =======
Basic and diluted net loss per share applicable
  to common stockholders.......................     $(0.01)      $(0.46)   $ (1.33)  $ (1.12)  $ (0.82)  $ (0.33)
                                                    ======       ======    =======   =======   =======   =======
Basic and diluted weighted average common
  shares outstanding...........................      1,200        1,200      1,205     2,920     2,478     3,598
                                                    ======       ======    =======   =======   =======   =======
Pro forma basic and diluted net loss per
  share(2) (3).................................     $   --       $(0.19)   $ (0.55)  $ (0.48)  $ (0.31)  $ (0.15)
                                                    ======       ======    =======   =======   =======   =======
Pro forma basic and diluted weighted average
  common shares outstanding(2) (3).............      2,925        2,925      2,930     5,391     4,683     7,377
                                                    ======       ======    =======   =======   =======   =======
14
19
AS OF JUNE 30, 1998
                                                      AS OF DECEMBER 31,             ----------------------
                                             -------------------------------------                  PRO
                                             1994(1)   1995(1)    1996      1997      ACTUAL     FORMA(2)
                                             -------   -------   -------   -------    ------     --------
                                                                     (IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents, and marketable
  securities...............................   $  --    $   500   $   361   $ 5,475   $  4,182     $ 4,182
Working capital (deficit)..................    (120)    (1,224)     (853)    5,249      3,515       3,515
Total assets...............................     113      2,514     4,189    11,400     12,134      12,134
Long-term debt, net of current portion.....      --         38     2,368       237        128         128
Redeemable preferred stock.................      --         --        --     7,088      7,208          --
Stockholders' equity (deficit).............      (7)      (560)   (1,295)     (728)    (1,836)      5,372
---------------
(1) The Consolidated Balance Sheet Data as of December 31, 1994 and 1995 and
    consolidated statement of operations data for the period from inception to
    December 31, 1994, and for the years ended December 31, 1995 and 1996
    include the operations of the Company on a carve-out basis prior to November
    15, 1996. During this period, the Company operated as a separate and
    substantially independent division of Grant & Partners, Inc. and Grant &
    Partners Limited Partnership, and focused on developing VALEX and providing
    integration and consulting services. See Note 1 of Notes to Consolidated
    Financial Statements.
 
(2) Gives effect to the reclassification of Series A Preferred Stock to
    $3,209,000 of additional paid-in capital, the conversion of all outstanding
    shares of the Series B Convertible Preferred Stock, at a redemption value of
    $3,999,000, into 2,555,556 shares of Common Stock, and the conversion of all
    outstanding shares of Series C Convertible Preferred Stock, at $.001 par
    value per share, into 1,223,954 shares of Common Stock upon the closing of
    the Offering.
 
(3) Computed on the basis described in Note 2(c) of Notes to Consolidated
    Financial Statements.
 
                                       15
20
 
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
     The following discussion should be read in conjunction with the
Consolidated Financial Statements and related Notes thereto included elsewhere
in this Prospectus. This discussion contains forward-looking statements that
involve risks and uncertainties. The Company's actual results may differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including, but not limited to, those set forth under
"Risk Factors" and elsewhere in this Prospectus.
 
OVERVIEW
 
     The Company is a leading provider of customer optimization software and
solutions that enable businesses to maximize profitability and revenue growth
from new and existing customers through marketing automation and enterprise-wide
customer management. The Company's Continuous Customer Management ("CCM")
offering is principally comprised of VALEX, the Company's open enterprise
software application, and the Company's proprietary consulting and integration
services.
 
     The Company was incorporated in November 1996. Prior to incorporation, the
Company operated as a separate division of two entities, Grant & Partners, Inc.
("GPI") and Grant & Partners Limited Partnership ("GPLP"). See Note 1 to Notes
to Consolidated Financial Statements. The Company's activities during its early
stages of operation focused on the development of software solutions to provide
CCM support to businesses. In 1995, the Company began providing professional
services in the areas of marketing program design and execution and data
warehousing. In March 1997, the Company ceased providing marketing program
design services. The Company's development efforts culminated in the
introduction to the market in July 1996 of VALEX, the Company's marketing
automation software product. Since the introduction of VALEX, the Company has
continued to focus significant resources on the development of additional
functionality and features of the VALEX software. The Company also has continued
to expand its marketing activities, build the Exchange Applications identity,
develop the competencies of the professional services group, build international
sales and distribution channels and develop its general and administrative
infrastructure. The Company has shifted its primary business focus from
providing services to selling software products. However, the Company believes
that continuing to provide superior professional services will be critical to
maximizing its opportunities for future revenues.
 
     The financial results of the Company while it operated as a separate
division of GPI and GPLP for the period from inception (November 1, 1994) to
November 14, 1996 have been included on a carve-out basis in the Company's
Consolidated Financial Statements.
 
     The Company generates revenue from software licenses, professional service
arrangements and software maintenance agreements. The Company recognizes
software license fee revenues upon execution of a license agreement and delivery
of the software, provided that the fee is fixed or determinable and deemed
collectible by management. If acceptance of the software by the licensee is
required, revenues are only recognized upon satisfaction of the foregoing
conditions and acceptance of the software. Revenues from professional service
arrangements are recognized on either a time and materials or
percentage-of-completion basis as the services are performed, provided that
amounts due from customers are fixed or determinable and deemed collectible by
management. Revenues related to software maintenance agreements are recognized
ratably over the term of the maintenance period. Amounts collected or billed
prior to satisfying the above revenue recognition criteria are reflected as
deferred revenue or as customer deposits.
 
     Pricing for a VALEX software license is based on the number of customer
records included in a business' data warehouse and certain other factors,
including the number of users of the software. Professional services are
generally priced on a time and materials or fixed-fee basis. Annual maintenance,
which is typically purchased in conjunction with the licensing of VALEX, is a
separate component that is offered for a fee generally equal to 20% of the
license fee at the time of execution

                                       16
21
 
of the maintenance contract and upon each renewal. Maintenance contracts
typically include telephone support and rights to unspecified product updates
and maintenance releases. The Company recommends that its customers enter into
and renew their maintenance contracts and, to date, all customers have done so.
As the Company continues to develop additional features and enhanced
functionality in unspecified future product updates, the Company believes that
most of its customers will continue to renew their maintenance contracts. As the
Company effects more sales of its software products through its re-seller
relationships, the Company plans to have the re-sellers provide certain of the
consulting and maintenance services associated with these sales. By using the
services resources of the re-sellers, the Company plans to allocate its own
professional services resources to direct-sale customers, to the projects that
require unique expertise or familiarity with the VALEX product and to other
profitable opportunities.
 
     Licenses originate principally from the Company's direct sales force. Sales
and marketing personnel from indirect sales channels, including re-sellers and
co-marketers, provide the Company with valuable introductions to potential
customers, work with the Company's sales force to complete sales and, in some
cases, effect sales of the Company's products virtually independently. The
Company expects that a significant portion of its revenues over the next several
quarters will be made with some participation from one or more of the Company's
re-sellers or co-marketers.
 
     Because the Company has only recently begun to sell its products,
period-to-period comparisons of its operating results are not meaningful.
Although the Company has experienced significant revenue growth recently, there
can be no assurance that such growth rates are sustainable and they should not
be relied upon as predictive of future performance. In addition, the timing of
license revenues is difficult to predict because of the length and variability
of the Company's sales cycle. The Company's prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by
companies in the early stage of development, particularly in new and rapidly
evolving markets. There can be no assurance that the Company will be successful
in addressing such risks and difficulties or that it will achieve profitability.
See "Risk Factors -- Limited Operating History; History of Losses".
 
RECENT ACCOUNTING PRONOUNCEMENT
 
     SOP 97-2, "Software Revenue Recognition", was issued in October 1997 and
supercedes the guidance of SOP 91-1 for recognizing revenue from software
arrangements. The Company adopted the provisions of SOP 97-2 for the year ended
December 31, 1997, and the Company believes its revenue recognition policies and
practices comply with the requirements of SOP 97-2. However, SOP 97-2 includes
restrictive provisions regarding specific terms of software arrangements which,
if present, require deferral of revenue recognition beyond the point of delivery
of the software. Future competitive conditions could necessitate changes in the
Company's business practices and the contract terms of its software
arrangements. Such changes might require deferral of revenue recognition, which
could materially adversely affect periodic operating results.
 
                                       17
22
 
RESULTS OF OPERATIONS
 
     The following table sets forth, for the periods indicated, the percentage
of total revenues represented by certain items from the Company's Consolidated
Statements of Operations.
SIX MONTHS ENDED
                                                  YEAR ENDED DECEMBER 31,        JUNE 30,
                                                  -----------------------    ----------------
                                                  1995     1996     1997      1997      1998
                                                  -----    -----    -----    ------    ------
Revenues:
  Software license fees.........................     --%    24.9%    45.5%    37.2%     55.8%
  Services and maintenance......................  100.0     75.1     54.5     62.8      44.2
                                                  -----    -----    -----    -----     -----
          Total revenues........................  100.0    100.0    100.0    100.0     100.0
Cost of revenues:
  Software license fees.........................     --     14.8     13.4     17.9       1.2
  Services and maintenance......................   59.8     53.1     41.3     47.6      31.7
                                                  -----    -----    -----    -----     -----
          Total cost of revenues................   59.8     67.9     54.7     65.5      32.9
                                                  -----    -----    -----    -----     -----
Gross margin....................................   40.2     32.1     45.3     34.5      67.1
Operating expenses:
  Sales and marketing...........................    7.5     16.7     28.5     26.3      39.9
  Research and development......................   41.8     21.9     20.5     21.4      26.1
  General and administrative....................   20.8     16.9     17.0     16.9      11.7
                                                  -----    -----    -----    -----     -----
          Total operating expenses..............   70.1     55.5     66.0     64.6      77.7
                                                  -----    -----    -----    -----     -----
Loss from operations............................  (29.9)   (23.4)   (20.7)   (30.1)    (10.6)
Interest income (expense), net..................   (2.8)    (3.2)     0.2     (0.2)      0.2
                                                  -----    -----    -----    -----     -----
Net loss........................................  (32.7)%  (26.6)%  (20.5)%  (30.3)%   (10.4)%
                                                  =====    =====    =====    =====     =====
SIX MONTHS ENDED JUNE 30, 1997 AND 1998
 
  REVENUES
 
     The Company's total revenues increased 116% from $4.8 million in the six
months ended June 30, 1997 to $10.4 million in the six months ended June 30,
1998. A number of factors contributed to the increase in total revenues,
including an increase in the Company's sales force, sales resulting from the
establishment of key strategic re-seller and co-marketing relationships in late
1997 and the first six months of 1998, increased international sales resulting
from the opening of a U.K. sales office during July 1997 and the growing
contribution of maintenance revenues from the larger installed base of the
Company's products.
 
     Software license fee revenues increased 224% from $1.8 million, or 37.2% of
total revenues, in the six months ended June 30, 1997 to $5.8 million, or 55.8%
of total revenues, in the six months ended June 30, 1998. The significant
increase in software license fee revenues was attributable primarily to the
growing market awareness and acceptance of the Company's products, particularly
in the telecommunications industry, the expansion of the Company's sales force,
and the establishment of key strategic re-seller and co-marketing relationships
in late 1997 and the first six months of 1998.
 
     Services and maintenance revenues increased 52% from $3.0 million, or 62.8%
of total revenues, in the six months ended June 30, 1997 to $4.6 million, or
44.2% of total revenues, in the six months ended June 30, 1998. The growth of
services and maintenance revenues resulted from professional services
engagements associated with the growing sales of the Company's software
products, increased maintenance revenues from the larger installed base of
software license customers and increased training revenues. The decrease in
services and maintenance revenues as a percentage of total revenues was
primarily attributable to market acceptance of VALEX and
 
                                       18
23
 
increases in sales of VALEX by re-sellers and co-marketers that provided certain
of the related services.
 
     For the six months ended June 30, 1997, the Company's top five customers
accounted for 90.6% of total revenues, while the Company's three largest
customers accounted for 39.7%, 22.2% and 13.7%, respectively, of total revenues
during this same period. This compares to 53.6% for the Company's top five
customers and 24.1%, 9.9% and 7.3% for the Company's three largest customers,
respectively, for the six months ended June 30, 1998. In the six-month period
ended June 30, 1998, revenues from the largest customer were comprised of sales
through a single re-seller to multiple end-user businesses. The Company believes
that the loss of any one of these customers would not have a material adverse
effect upon the Company's business, operating results or financial condition.
 
     All of the Company's revenues for the six months ended June 30, 1997 were
from sales to customers in North America; however, international operations were
significantly expanded in late 1997 and 1998 and represent an increasing source
of the Company's revenues. Revenues from customers outside North America were
$1.6 million for the six months ended June 30, 1998, representing approximately
15.4% of total revenues.
 
  COST OF REVENUES
 
     Total cost of revenues consists of costs associated with software license
fees and costs associated with services and maintenance. Total cost of revenues
as a percentage of total revenues declined from 65.5% in the six months ended
June 30, 1997 to 32.9% in the six months ended June 30, 1998. The decrease in
cost of revenues as a percentage of total revenues in 1998 was primarily a
result of the fact that capitalized software development costs under Statement
of Financial Accounting Standards No. 86 ("SFAS 86") was fully amortized as of
December 1997. The results for the six months ended June 30, 1997 include
approximately $641,000 in SFAS 86 capitalized software amortization.
 
     Cost of software license fees as a percentage of total revenues decreased
from 17.9% to 1.2% for the six months ended June 30, 1997 and 1998,
respectively. Cost of software license fees as a percentage of software license
fee revenues decreased from 48.1% to 2.2% for the six months ended June 30, 1997
and 1998, respectively. Cost of software license fees for the six months ended
June 30, 1997 consisted primarily of amortization of software development
expenses capitalized under SFAS 86 and royalty payments made to a third party
for licensed intellectual property included in the Company's VALEX product. The
entire capitalized software balance was fully amortized as of December 31, 1997.
Cost of software license fees for the six months ended June 30, 1998 consisted
primarily of royalty payments for licensed software and costs associated with
software packaging and distribution. The Company's primary royalty obligation
for licensed intellectual property, which required the Company to pay royalties
to a third party on the first $10 million of revenues from VALEX sales, was
fully paid during the second quarter of 1998. No further royalties will be paid
to this third party and other current royalty obligations are not material to
the Company's financial position. If the effect of the SFAS 86 amortization and
royalties for licensed software were not included, gross margin on software
revenues would have been 96.5% for the six months ended June 30, 1997, versus
99.3% for the six months ended June 30, 1998. As the Company adds additional
components to its software products, the Company may choose to license software
from third parties. The cost of such licenses may increase the cost of software
license fees.
 
     Cost of services and maintenance consists primarily of personnel, facility
and system costs incurred in providing professional consulting services,
training, and customer support services. Cost of services and maintenance
revenues as a percentage of total revenues was 47.6% and 31.7% during the six
months ended June 30, 1997 and 1998, respectively. Cost of services and
maintenance as a percentage of services and maintenance revenues was 75.8% and
71.8% for the six months ended June 30, 1997 and June 30, 1998, respectively.
The decrease was attributable
 
                                       19
24
 
primarily to the increased contribution of higher margin maintenance revenues
from the Company's increased installed base. As the Company effects more sales
of its software products through its re-seller relationships, the Company plans
to have the re-sellers provide certain of the consulting and maintenance
services associated with these sales. By using the services resources of the
re-sellers, the Company plans to allocate its own professional services
resources to direct-sale customers, to the projects that require unique
expertise or familiarity with the VALEX product and to other more profitable
opportunities.
 
     Overall gross margin increased from 34.5% for the six months ended June 30,
1997 to 67.1% for the six months ended June 30, 1998 due primarily to the
completion of SFAS 86 amortization, increased sales of VALEX and the expiration
of the Company's royalty obligations for licensed intellectual property. As
software license fee revenues continue to grow and maintenance revenues increase
as a percentage of total services and maintenance revenues, the Company expects
that overall gross margin will remain constant or increase slightly in future
periods.
 
  OPERATING EXPENSES
 
     Sales and Marketing.  Sales and marketing expenses consist primarily of
salaries for sales and marketing personnel, commissions, travel and promotional
expenses. Sales and marketing expenses increased from $1.3 million, or 26.3% of
total revenues, for the six months ended June 30, 1997, to $4.2 million, or
39.9% of total revenues, for the six months ended June 30, 1998. This increase
reflects the hiring of additional sales and marketing personnel, increased
promotional programs, and increased sales commissions associated with higher
revenues. While the Company expects sales and marketing expenses to continue to
grow in absolute dollars, the Company expects these expenses to remain
approximately the same as a percentage of total revenues due to increased
contribution from its indirect sales channels.
 
     Research and Development.  Research and development expenses consist
primarily of employee salary and benefits, consultant costs, and equipment and
purchased software depreciation costs associated with new product development,
enhancement of existing products and quality assurance activities. Research and
development expenses increased from $1.0 million, or 21.4% of total revenues, in
the six months ended June 30, 1997 to $2.7 million, or 26.1% of total revenues,
in the six months ended June 30, 1998. This increase reflects the hiring of
additional personnel and additional investments in the Company's VALEX product.
Software development costs were expensed as incurred in the six months ended
June 30, 1998, since software development costs were primarily related to
product enhancements and product maintenance. The Company anticipates that
research and development expenses will continue to increase in absolute dollars
but decrease on a percentage basis as the Company continues to commit
substantial resources to enhancing existing product functionality and to
developing new products.
 
     General and Administrative.  General and administrative expenses consist
primarily of salaries and related costs, outside professional fees, provision
for bad debts, and equipment and software depreciation costs associated with the
finance, legal, human resources, information systems, and administrative
functions of the Company. General and administrative expenses increased from
$813,000, or 16.9% of total revenues, for the six months ended June 30, 1997 to
$1.2 million, or 11.7% of total revenues, for the six months ended June 30,
1998. Expenses increased in absolute dollars as the Company added personnel to
its finance, information systems, and human resource departments and increased
its spending on outside legal services, but declined as a percentage of total
revenues, due primarily to economies of scale. The Company expects general and
administrative expenses to continue to grow in absolute dollars but to decrease
on a percentage basis as the Company implements additional management
information systems, continues its international expansion and incurs costs
incident to being a publicly held company.
 
                                       20
25
 
  PROVISION FOR INCOME TAXES
 
     No provision for federal or state income taxes has been recorded as the
Company incurred net operating losses for all periods presented. The Company has
recorded a full valuation allowance against the deferred tax asset generated as
a result of these net operating loss carryforwards as the Company believes it is
more likely than not that these assets will not be realized.
 
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
 
  REVENUES
 
     The Company's total revenues increased 256% from $1.7 million in 1995 to
$6.0 million in 1996, reflecting significant software license fee revenues
related to the commercial introduction of the Company's VALEX product in July
1996. The Company's total revenues increased 110% to $12.7 million in 1997 as
the Company sold its products and services to a greater number of customers and
expanded its business internationally.
 
     Software license fee revenues increased from zero in 1995 to $1.5 million,
or 24.9% of total revenues, in 1996 and grew 284% to $5.8 million, or 45.5% of
total revenues, in 1997. The increase in software license fee revenues, both in
absolute dollars and as a percentage of total revenues, reflected increased
market awareness and acceptance of the Company's VALEX product, the continued
growth of indirect channel revenues, and expansion of international sales
resources.
 
     Services and maintenance revenues increased 168% from $1.7 million, or
100.0% of revenues, in 1995 to $4.5 million, or 75.1% of total revenues in 1996,
and grew 52% to $6.9 million, or 54.5% of total revenues, in 1997 primarily due
to growth in the providing of professional services associated with VALEX and,
to a lesser extent, to an increase in maintenance revenues. The Company expects
services and maintenance revenues to decline as a percentage of total revenues
as the parties with whom the Company has undertaken re-seller and co-marketing
relationships perform more of the professional services associated with the
Company's software licenses sold through these channels. However, the Company
expects services and maintenance revenues to increase in absolute dollars as the
installed base of the Company's products continues to increase.
 
     In 1997, the Company's top five customers accounted for 74.9% of total
revenues, while the Company's three largest customers accounted for 33.0%, 23.1%
and 7.6%, respectively, of the Company's total revenues during this same period.
In 1997, revenues from the largest customer were comprised of sales through a
single re-seller to multiple end-user businesses. During 1996, the Company's top
five customers accounted for 57.7% of total revenues, while the Company's three
largest customers accounted for 20.5%, 10.7% and 10.2%, respectively, of total
revenues. In 1995, the Company's top five customers accounted for 87.8% of total
revenues, while the Company's three largest customers accounted for 37.7%, 17.3%
and 13.0%, respectively, of the Company's total revenues during this same
period. The Company believes that the loss of any one of these customers would
not have a material adverse effect upon the Company's business, operating
results or financial condition. In 1995 and 1996, the Company's revenues
consisted primarily of the sale and delivery of the Company's professional
services in the area of customer optimization and data warehousing.
 
  COST OF REVENUES
 
     Total cost of revenues, as a percentage of total revenues, increased from
59.8% in 1995 to 67.9% in 1996, and then declined to 54.7% in 1997. The increase
in 1996 reflected six months of amortization of software development costs
previously capitalized in accordance with the guidelines of SFAS 86, which
amortization began in July 1996 upon general release of the Company's VALEX
product. The decline in the total cost of revenues as a percentage of total
revenues in 1997 reflected the increasing contribution of higher-margin software
license sales of VALEX, which was first shipped in July 1996.

 
                                       21
26
 
     Cost of software license fees as a percentage of total revenues was 14.8%
in 1996 and 13.4% in 1997. There were no revenues derived from software license
fees prior to 1996. The cost of software license fees as a percentage of
software license fee revenues decreased from 59.3% in 1996 to 29.6% in 1997 due
primarily to increased software license sales volume in 1997. This increase
offset the additional six months of amortization of capitalized software
development costs in 1997 versus 1996, as well as royalties paid to a third
party for intellectual property included in VALEX. If the effect of SFAS 86
amortization and royalties for licensed intellectual property were not included,
gross margin on software license fee revenues would have been 95.7% and 99.3%
for 1996 and 1997, respectively. With the balance of capitalized software
development costs fully amortized at the end of 1997 and the primary royalty
obligations for licensed intellectual property fully paid as of the second
quarter of 1998, the cost of software license fee revenues consists principally
of the cost of the software media and other incidental costs.
 
     Cost of services and maintenance as a percentage of total revenues was
59.8%, 53.1% and 41.3% in 1995, 1996 and 1997, respectively. Cost of services
and maintenance as a percentage of services and maintenance revenues was 59.8%,
70.7% and 75.7% in 1995, 1996 and 1997, respectively. The increasing cost was
due to the costs of building a service organization infrastructure and the
increased use, at higher cost, of subcontracted labor on certain engagements.
The Company expects to continue to use subcontractors for the delivery of
professional services from time to time.
 
     Overall gross margin decreased from 40.2% in 1995 to 32.1% in 1996 as a
result of the Company's investments in its services infrastructure in
anticipation of increased VALEX sales and the inclusion of six months of SFAS 86
amortization. In 1997, gross margin increased to 45.3% of total revenues as the
Company's contribution of higher-margin software license fees increased from
24.9% of total revenues in 1996 to 45.5% in 1997. In addition, the Company began
to realize productive returns from the services infrastructure established in
1996.
 
  OPERATING EXPENSES
 
     Sales and Marketing.  Sales and marketing expenses were $128,000, $1.0
million, and $3.6 million, representing 7.5%, 16.7% and 28.5% of total revenues,
in 1995, 1996 and 1997, respectively. These increases were due primarily to the
increase in the Company's sales and marketing personnel and overall
infrastructure to support VALEX and expand internationally. The Company's
international expansion included the opening of its first international sales
office in the U.K. in July 1997. The Company expects to continue to expand its
direct sales force and marketing staff, increase its international presence, and
continue to develop its indirect sales channels and increase promotional
activity.
 
     Research and Development.  Research and development expenses were $708,000,
$1.3 million, and $2.6 million, representing 41.8%, 21.9%, and 20.5% of total
revenues, in 1995, 1996 and 1997, respectively. The increase in absolute dollars
was attributable primarily to the hiring of additional technical personnel
engaged in software development activities. The decline in research and
development expenses on a percentage basis was due primarily to the greater
growth in revenues.
 
     General and Administrative.  General and administrative expenses were
$352,000, $1.0 million and $2.2 million, representing 20.8%, 16.9% and 17.0% of
total revenues, in 1995, 1996 and 1997, respectively. General and administrative
expenses grew in absolute dollars as the Company added personnel to all
administrative areas, but declined on a percentage basis due primarily to
economies of scale.
 
  INTEREST INCOME (EXPENSE), NET
 
     Interest expense, net increased from $47,000 in 1995 to $195,000 in 1996 as
a result of interest charges on the Company's demand note payable to related
parties as well as finance charges

                                       22
27
 
related to the Company's capital lease obligations. The Company reported net
interest income of $25,000 in 1997 as a result of the elimination of the related
party demand notes payable concurrent with the March 1997 venture capital
financing transaction, as well as the related interest income generated from the
proceeds of the March 1997 and December 1997 financing transactions.
 
  PROVISION FOR INCOME TAXES
 
     No provision for federal or state income taxes has been recorded as the
Company incurred net operating losses for all periods presented. The Company has
recorded a full valuation allowance against the deferred tax asset generated as
a result of these net operating loss carryforwards, as the Company currently
believes it is more likely than not that these assets will not be realized.

 
                                       23
28
 
SELECTED QUARTERLY RESULTS OF OPERATIONS
 
     The following tables present unaudited quarterly consolidated statement of
operations data for each quarter in the six quarters ended June 30, 1998, as
well as such data expressed as a percentage of the Company's total revenues for
the periods indicated. This data has been derived from unaudited consolidated
financial statements that have been prepared on the same basis as the audited
consolidated financial statements and include all adjustments (consisting only
of normal recurring adjustments) that the Company considers necessary for a fair
presentation of such information. The Company believes quarter-to-quarter
comparisons of its financial results should not be relied upon as an indication
of future performance, and operating results may fluctuate from quarter to
quarter in the future.
QUARTER ENDED
                                              ------------------------------------------------------------------
                                              MARCH 31,   JUNE 30,   SEPT. 30,   DEC. 31,   MARCH 31,   JUNE 30,
                                                1997        1997       1997        1997       1998        1998
                                              ---------   --------   ---------   --------   ---------   --------
                                                                        (IN THOUSANDS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
  Software license fees.....................   $  472      $1,321     $1,616      $2,356     $2,711      $3,105
  Services and maintenance..................    1,657       1,372      1,711       2,164      2,080       2,522
                                               ------      ------     ------      ------     ------      ------
        Total revenues......................    2,129       2,693      3,327       4,520      4,791       5,627
Cost of revenues:
  Software license fees.....................      430         433        449         395         84          45
  Services and maintenance..................    1,237       1,060      1,257       1,673      1,635       1,667
                                               ------      ------     ------      ------     ------      ------
        Total cost of revenues..............    1,667       1,493      1,706       2,068      1,719       1,712
                                               ------      ------     ------      ------     ------      ------
Gross profit................................      462       1,200      1,621       2,452      3,072       3,915
Operating expenses:
  Sales and marketing.......................      568         700        871       1,463      1,735       2,428
  Research and development..................      453         578        646         922      1,207       1,509
  General and administrative................      385         428        402         943        537         679
                                               ------      ------     ------      ------     ------      ------
        Total operating expenses............    1,406       1,706      1,919       3,328      3,479       4,616
                                               ------      ------     ------      ------     ------      ------
Loss from operations........................     (944)       (506)      (298)       (876)      (407)       (701)
Interest income (expense), net..............      (39)         29          7          28         23           6
                                               ------      ------     ------      ------     ------      ------
Net loss....................................   $ (983)     $ (477)    $ (291)     $ (848)    $ (384)     $ (695)
                                               ======      ======     ======      ======     ======      ======
QUARTER ENDED
                                              ------------------------------------------------------------------
                                              MARCH 31,   JUNE 30,   SEPT. 30,   DEC. 31,   MARCH 31,   JUNE 30,
                                                1997        1997       1997        1997       1998        1998
                                              ---------   --------   ---------   --------   ---------   --------
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
  Software license fees.....................     22.2%       49.1%      48.6%       52.1%      56.6%       55.2%
  Services and maintenance..................     77.8        50.9       51.4        47.9       43.4        44.8
                                               ------      ------     ------      ------     ------      ------
        Total revenues......................    100.0       100.0      100.0       100.0      100.0       100.0
Cost of revenues:
  Software license fees.....................     20.2        16.1       13.5         8.7        1.8         0.8
  Services and maintenance..................     58.1        39.3       37.8        37.0       34.1        29.6
                                               ------      ------     ------      ------     ------      ------
        Total cost of revenues..............     78.3        55.4       51.3        45.7       35.9        30.4
                                               ------      ------     ------      ------     ------      ------
Gross margin................................     21.7        44.6       48.7        54.3       64.1        69.6
Operating expenses:
  Sales and marketing.......................     26.7        26.0       26.2        32.4       36.2        43.2
  Research and development..................     21.3        21.5       19.4        20.4       25.2        26.8
  General and administrative................     18.1        15.9       12.1        20.8       11.2        12.1
                                               ------      ------     ------      ------     ------      ------
        Total operating expenses............     66.1        63.4       57.7        73.6       72.6        82.1
                                               ------      ------     ------      ------     ------      ------
Loss from operations........................    (44.4)      (18.8)      (9.0)      (19.3)      (8.5)      (12.5)
Interest income (expense), net..............     (1.8)        1.1        0.2         0.6        0.5         0.1
                                               ------      ------     ------      ------     ------      ------
Net loss....................................    (46.2)%     (17.7)%     (8.8)%     (18.7)%     (8.0)%     (12.4)%
                                               ======      ======     ======      ======     ======      ======
The Company's revenues have increased in all quarters presented as a result
of increased market acceptance of the VALEX product, the continued growth of
indirect channel revenues, and expansion of international sales resources. Cost
of revenues on a percentage basis decreased throughout the quarters presented as
a result of an increase in software license fees in the
 
                                       24
29
 
Company's revenue mix, the completion of the amortization of capitalized
software development costs in the fourth quarter of 1997 and the completion of
software royalty obligations in the second quarter of 1998. No assurances can be
given that the shift in revenue mix will continue. Gross profit for any quarter
will be affected by the revenue mix in that quarter.
 
     Operating expenses have increased in each of the quarters presented. Sales
and marketing expenses have increased as a result of increased sales and
marketing personnel and increased commissions associated with higher revenues.
Research and development expenses generally have increased as a result of
continued enhancements to the VALEX technology. General and administrative
expenses have increased primarily due to additional personnel, professional fees
and facilities and other infrastructure costs. General and administrative
expenses in the quarter ended December 31, 1997 included one-time charges
associated with the decision to relocate the Company's executive offices, as
well as noncash compensation expense associated with the Company's 1996 Stock
Incentive Plan.
 
     The Company's quarterly and annual operating results have varied
significantly in the past and are expected to do so in the future. Accordingly,
the Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
predictors of future performance. See "Risk Factors -- Potential for Significant
Fluctuations in Quarterly Results".
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Since its inception, the Company has financed its operations primarily
through the sale of equity securities in private placements and the issuance of
notes payable to related parties. In March 1997, the Company received $3,888,000
in net cash proceeds from the sale of its Series B Preferred Stock; and in
December 1997, the Company received $3,987,000 in net cash proceeds from the
sale of its Series C Preferred Stock. In addition, in December 1997, the Company
entered into a $2,000,000 revolving note agreement with Fleet National Bank. The
note bears interest at the bank's prime rate plus 0.75% per annum, payable
monthly in arrears, and expires on May 31, 1999.
 
     As of June 30, 1998, the Company had $4.2 million of cash, cash equivalents
and short-term investments. The Company believes that the net proceeds of this
Offering, along with its existing balance of cash, cash equivalents and
short-term investments, will be sufficient to meet the Company's working capital
and anticipated capital expenditure needs for at least the next 12 months.
Thereafter, the Company may require additional sources of funds to continue to
support its business. There can be no assurance that such capital, if needed,
will be available or will be available on terms acceptable to the Company.
 
     Cash provided by financing activities of $6.8 million in 1997 consisted
primarily of the proceeds from the issuance of Convertible Preferred Stock and
has been invested in short-term investments. Purchases of computer equipment
used in conducting the Company's business represented the primary component of
cash used in investing activities.
 
     Cash and cash equivalents for the six months ended June 30, 1998 decreased
$1.3 million from the December 31, 1997 ending balance. Net cash used for
operations of approximately $429,000 for the six months ended June 30, 1998
resulted primarily from a net operating loss before depreciation expense of
$851,000 less an approximately $422,000 decrease in working capital. The
decrease in working capital was primarily attributable to an increase in
accounts payable and deferred revenue, partially offset by an increase in
accounts receivable associated with increased license and services revenue in
the second quarter. Net cash used in investing activities for the six months
ended June 30, 1998 was a result of property and equipment purchases related to
the increase in headcount, the move to new operating facilities and the
acquisition of hardware and software for development and internal operating
systems. Net cash used in financing activities of $69,000 consisted of
approximately $110,000 for the repayment of capital lease obligations, offset by
cash inflow of $41,000 from the exercise of stock options under the 1996 Plan.

                                       25
30
 
     The Company had net operating loss carryforwards of approximately $792,000
at December 31, 1997 to reduce future income taxes, if any. These carryforwards
expire through 2013 and are subject to review and possible adjustment by the
Internal Revenue Service. The Tax Reform Act of 1986 contains provisions that
may limit the amount of net operating loss and credit carryforwards that the
Company may utilize in any one year in the event of certain cumulative changes
in ownership over a three-year period in excess of 50% as defined. The Company
believes that it has experienced a change in ownership in excess of 50%. The
Company does not believe that this change will significantly impact the
Company's ability to utilize its net operating loss carryforwards.
 
     The Company currently intends to use the net proceeds of the Offering for
working capital and general corporate purposes, including financing accounts
receivable and capital expenditures made in the ordinary course of business, as
well as for possible reduction of indebtedness and for potential acquisitions of
businesses, products and technologies that are complementary to those of the
Company. Although the Company has not identified any specific businesses,
products or technologies that it may acquire, or entered into any current
agreements or negotiations with respect to any such transactions, the Company
from time to time evaluates such opportunities. Pending such uses, the net
proceeds will be invested in government securities and other short-term,
investment-grade, interest-bearing instruments.
 
IMPACT OF YEAR 2000 ISSUE
 
     The Year 2000 issue results from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
 
     The Company is in the process of conducting an assessment of its computer
information systems and is beginning to take the necessary steps to determine
the nature and extent of the work required to make its systems Year 2000
compliant, where necessary. These steps may require the Company to modify,
upgrade or replace some of its internal financial and operational systems. The
Company is currently in the process of upgrading its accounting and customer
care software with software warranted to be Year 2000 compliant. The Company
continues to evaluate the estimated cost of bringing all internal systems,
equipment and operations into Year 2000 compliance, but has not yet finished
determining the total cost of these compliance efforts. Although management does
not expect, based on currently available information, that Year 2000 issues will
have a material adverse effect on the Company's business, operating results or
financial condition, there can be no assurance that there will not be
interruptions of operations, other limitations of system or product
functionality or that the Company will not incur significant costs to avoid such
interruptions or limitations.
 
     The Company also intends to determine the extent to which it may be
vulnerable to any failures by its current and potential customers and
distributors to remedy their own Year 2000 issues, and is in the process of
initiating formal communications with these parties. At this time, the Company
is unable to estimate the nature or extent of any potential adverse impact
resulting from the failure of current and potential customers or third party
distributors to achieve Year 2000 compliance, although the Company does not
currently anticipate that it will experience any material sales delays from its
major distributors or current and potential customers due to Year 2000 issues.
However, there can be no assurance that these third parties will not experience
Year 2000 problems or that any problems would not have a material effect on the
Company's product distribution channels. Because the cost and timing of Year
2000 compliance by third parties such as customers and distributors is not
within the Company's control, no assurance can be given with respect to the cost
or timing of such efforts or any potential adverse effects on the Company of any
failure by these third parties to achieve Year 2000 compliance.

                                       26
31
 
                                    BUSINESS
 
INTRODUCTION
 
     Exchange Applications, Inc. (the "Company") is a leading provider of
customer optimization software and solutions that enable businesses to maximize
profitability and revenue growth from new and existing customers through
marketing automation and enterprise-wide customer management. The Company's
Continuous Customer Management ("CCM") solution, including its VALEX software
and related consulting and integration services, enables businesses to
profitably retain and expand existing customer relationships and acquire new
customers by: (i) analyzing enterprise-wide databases of customer information to
identify profitable growth opportunities; (ii) planning and prioritizing
investments in high potential customers; (iii) creating targeted, real-time and
event-triggered marketing campaigns and other customer communications; (iv)
selecting the most effective channels for customer communications, such as
direct mail, call centers, sales forces and the Internet; and (v) continuously
evaluating the impact of these marketing campaigns and other communications on
profitability. CCM allows businesses to measure the value of marketing campaigns
and other customer communications against their associated costs and to use this
information to make investment decisions that maximize customer profitability.
 
     The principal components of the Company's CCM offering are VALEX, its open
enterprise software application, and the Company's proprietary consulting and
integration services. The Company has deployed CCM and VALEX across multiple
industries, with installations in over 40 businesses in North America and
Europe. Its customers include Federal Express, Fleet Bank, NatWest Bank (U.K.)
and US West. The Company's products and services are distributed through its
direct sales force, through re-seller relationships with IBM, NCR and others,
and through co-marketing arrangements with companies such as Compaq, Ernst &
Young, KPMG Peat Marwick, PricewaterhouseCoopers, SAS Institute and Sun
Microsystems.
 
BACKGROUND
 
     Today's increasingly competitive business environment has forced many
businesses to reduce costs in order to improve overall profitability. Enterprise
resource planning ("ERP") and supply chain management software and other
technologies have played a key role in helping businesses cut costs through the
automation of business and administrative functions such as accounting,
purchasing and inventory control, and human resources. While applications aimed
at cost reduction have generally been successful, businesses have realized that
these initiatives are only part of the solution to improve profitability and
have begun to invest in a new class of applications designed to increase
profitability through revenue growth. In the face of growing business
challenges, such as the high cost of attracting new customers, the proliferation
of customer purchasing options, increased customer sophistication and decreased
customer loyalty, revenue growth initiatives have become significantly more
difficult and more important to execute successfully.
 
     Many of these new applications are aimed at enabling businesses to grow
revenue by acquiring new customers and retaining and expanding relationships
with existing customers. These applications facilitate cross-selling and the
marketing of bundled products, new service offerings and differentiated service
relationships. To maximize the profitability of these efforts, businesses need
to allocate resources based not only on functional area and product
profitability, but also on current or potential customer profitability. To
enable this focus on customers, businesses need: (i) an investment allocation
methodology to identify profitable customer opportunities; (ii) the ability to
access and analyze large amounts of customer information; (iii) marketing
automation and campaign management applications to design and implement
effective marketing campaigns; (iv) technologies to manage interactions with
customers; and (v) the ability to evaluate the effectiveness of investments on
current and potential customer profitability.
 
                                       27
32
 
     To this end, businesses have begun over the past several years to realign
existing marketing and customer management capabilities with new technologies
and processes that optimize customer relationships across the enterprise. This
evolution can be summarized in three phases, as follows:
 
     PHASE 1 -- TRADITIONAL APPROACH.  With traditional approaches, businesses
develop marketing campaigns that solicit broad customer segments with infrequent
and static offers. To manage these campaigns, businesses typically use
proprietary software provided by third-party commercial service bureaus to
access customer information maintained in large external databases. These
solutions have provided valuable information to businesses, but have had
significant limitations:
 
     - LIMITED ABILITY TO DEVELOP AND REFINE MARKETING CAMPAIGNS.  Traditional
       approaches are severely limited in the number and complexity of marketing
       campaigns that can be supported without manual intervention, increasing
       cycle time and cost and forcing businesses to run less targeted and less
       timely campaigns.
 
     - INABILITY TO ACCESS THE COMPLETE CUSTOMER RELATIONSHIP.  Traditional
       approaches use fixed data structures that store only a limited amount of
       information about each customer, forcing businesses to make decisions
       based on a limited portion of available customer information.
 
     - LIMITED ABILITY TO MEASURE PERFORMANCE.  Most traditional solutions use
       response rates and other basic metrics which do not provide the necessary
       information required to effectively measure campaign performance or to
       allocate marketing resources to those campaigns and other communications
       with the most positive impact on customer profitability.
 
     - POOR INTEGRATION WITH OTHER APPLICATIONS.  Many traditional solutions are
       limited by closed architectures and therefore require time-consuming,
       manual processes to be integrated with analytical tools, such as online
       analytical processing ("OLAP") and data mining tools, or customer
       touchpoint applications.
 
     PHASE 2 -- MARKETING AUTOMATION AND CAMPAIGN MANAGEMENT.  Recognizing the
competitive value of more active management of customer relationships,
businesses are transitioning from traditional approaches to more automated
marketing environments that enable businesses to target refined customer
segments, implement more customized offers on a timely basis, and measure the
effectiveness of offers with metrics such as return on investment. Central to
this approach are data warehouses which contain a more complete view of the
customer relationship, tools that predict customer behavior and software
applications that automate the design and execution of marketing campaigns.
Through marketing automation and campaign management, businesses benefit from
more timely access to, and robust analysis of, customer information, more
frequent and targeted campaigns, and more comprehensive measurement of the
effectiveness of investments. This results in increased return on investment,
reduced customer acquisition costs and reduced marketing cycle time.
 
     PHASE 3 -- ENTERPRISE-WIDE CUSTOMER MANAGEMENT.  Marketing automation and
campaign management solutions alone provide significant value. However, their
lack of integration with customer interaction software ("CIS") products, such as
sales force automation, call center, customer service, help desk and Internet
products, and other customer-related aspects of the business limits the ability
to plan and optimize customer relationships across the enterprise. In addition,
most CIS, marketing automation and campaign management solutions collectively
fail to provide a common customer management methodology. Enterprise-wide
customer management solutions integrate marketing automation and campaign
management software with data warehouses and CIS products in an environment in
which all aspects of the customer relationship are considered. This results in
more consistent messages to customers, greater penetration of potential
high-profit customers and the ability to employ lower cost communication
channels to optimize customer profitability.
 
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33
 
THE CUSTOMER OPTIMIZATION OPPORTUNITY
 
     The Company believes that customer optimization software and solutions
represent a significant opportunity across many industries. Businesses are
adopting these technologies at different rates based on their access to customer
information, their level of database marketing sophistication, the marginal
economic impact of changes in the behavior of their customers and the degree of
competitiveness within their industry. The Company believes that the demand for
these technologies will grow rapidly as additional industries increasingly
recognize enterprise-wide customer management as a competitive requirement.
Significant opportunities exist for solutions that enable businesses to
transition from the traditional service bureau approach to marketing automation
and campaign management solutions and to enterprise-wide customer management
environments. These transitions require highly-automated marketing and campaign
management solutions that integrate people, processes and technology across the
enterprise to insure adherence to a common customer management methodology.
 
     According to an April 1997 Gartner Group report, overall spending on
service bureaus, marketing automation and campaign management, which Gartner
collectively refers to as database marketing, will be $1.3 billion in 1998,
growing at an annual rate of 35% over the next several years. Furthermore, as
evidence of the shift from traditional service bureau applications to marketing
automation and campaign management solutions, Gartner estimates that spending on
campaign management and marketing automation applications will be approximately
$220 million in 1998, increasing at an annual rate of approximately 100% to
nearly $900 million in 2000. Independent research analysts have reported that
marketing automation and campaign management efforts represent a major area of
focus for businesses today and note that many businesses are shifting to such
solutions. An earlier Gartner survey states that "database marketing appeared in
almost every industry as a high-payback, data-intensive application with
potentially significant returns".
 
     Other leading analysts believe that the transition to enterprise-wide
customer management represents an even greater opportunity than the earlier
shift to automated campaign management solutions. For example, Palo Alto
Management Group projects that the market for enterprise-wide customer
management software solutions will be $2.9 billion in 2002.
 
THE EXCHANGE APPLICATIONS SOLUTION
 
     The Company believes that its Continuous Customer Management solution,
implemented through its VALEX software and proprietary consulting and
integration services, represents a fundamentally new approach to customer
optimization that addresses the opportunities described above. CCM delivers
customer optimization solutions that allow a business to maximize the
profitability and revenue growth from new and existing customers through
marketing automation and campaign management that can evolve to enterprise-wide
customer management.
 
     VALEX enables businesses to optimize customer value by: (i) providing a
complete view of the relationship between a business and its customers; (ii)
leveraging a range of data mining, reporting and modeling products to identify
high-value customers; (iii) providing powerful marketing automation and campaign
management software that lets end-users define and execute targeted customer
communication streams; and (iv) integrating with CIS products and data
warehouses to perform enterprise-wide customer management. VALEX further
enhances the value of information stored in data warehouses by allowing
non-technical marketing professionals to design, execute and continuously
evaluate and refine targeted marketing campaigns.
 
     The Company's consulting and integration services include: (i) development
of processes that allow organizations to adopt the CCM solution across business
functions, including Value Exchange Optimization ("VEO"), a methodology for
allocating marketing investments based on expected return; (ii) Metrics
Repository, a custom software application that allows VALEX to track the success
or failure of marketing campaigns across business segments and across the
enterprise;
 
                                       29
34
 
and (iii) VALEX Rapid Implementation, designed to quickly implement the core
VALEX modules, allowing access to data warehouse environments and campaign
execution in a matter of weeks.
 
     Through CCM and VALEX, businesses gain an understanding of the economics of
customer relationships, measure customer value and provide incentives through
campaigns that influence and optimize customer behavior. The Exchange
Applications solution offers the following key benefits:
 
     IMPROVED PROFITABILITY AND REVENUE GROWTH.  VALEX and CCM enable businesses
to retain and increase the value of existing customers and acquire new customers
by focusing investment resources on those customers with the greatest current
and potential value. Through the use of the Company's solution, businesses have
achieved increased retention rates, lower acquisition costs, more efficient
cross-selling and better customer satisfaction due to more relevant, less
intrusive communications.
 
     COMPREHENSIVE SOLUTION.  The Company's products and services provide a
complete solution for customer optimization. The Company believes that its
combined offering of software, proprietary methodologies and consulting services
help businesses implement marketing automation and campaign management software
and improve customer profitability quickly and with little risk.
 
     ENTERPRISE-WIDE CUSTOMER VIEW.  VALEX enables organizations to access and
use all types of information stored in data warehouses. Businesses are therefore
not restricted in the scope or type of information used to design customer
optimization strategies.
 
     INCREASED MARKETING VELOCITY.  VALEX creates continuous, fully-automated
marketing campaigns, allowing multiple end users to develop customized
communications triggered by customer characteristics (e.g., age, income, buying
behavior), specific events (e.g., changes in spending patterns, births of
children, changes in economic status) or dates (e.g., birth dates, contract
renewal dates). VALEX allows businesses to reduce dramatically the cycle time
from planning through design, execution and measurement of campaigns, to better
respond to competitive and market pressures and to quickly evaluate new
campaigns.
 
     OPEN, EXTENSIBLE ARCHITECTURE.  VALEX is designed to be open, easy-to-use
and scaleable across a wide variety of computing environments. The VALEX
architecture conforms to many current industry standards (OLE, COM, DCOM, CORBA,
ODBC) and can be integrated with existing hardware and software environments
allowing businesses to leverage their investments in CIS products and data
warehouse technologies.
 
STRATEGY
 
     The Company's objective is to be the leading provider of customer
optimization software and solutions globally. The Company's strategy for
achieving this objective includes:
 
     EXTEND VALEX.  The Company has developed unique technical solutions that
enable businesses to optimize customer relationships. The Company is currently
developing product extensions that will enhance the ability of its existing
products and services to directly integrate with data mining products and link
communications to customers with changes in their behavior. Further, the Company
is developing a local campaign management product to enable satellite offices
and remote users to design and execute independent campaigns while coordinating
with the central marketing function. The Company may also acquire businesses or
technologies that would provide the Company with extended product or service
offerings across the various aspects of a CCM implementation and/or specialized
knowledge or tailored software for selected vertical industries.
 
     DEVELOP ADDITIONAL CUSTOMER OPTIMIZATION SOLUTIONS.  The Company intends to
develop additional products to provide automation and business intelligence to
improve a business's ability to perform enterprise-wide customer management. The
Company's future products and services will be designed to optimize and control
communications across CIS environments and enhance business planning and
forecasting solutions based on customer and channel economics.
 
                                       30
35
 
     EXPAND VERTICAL INDUSTRY FOCUS.  The Company currently targets the
telecommunications and financial services industries as well as other database
marketing intensive businesses that seek to develop customized marketing
campaigns. The Company intends to expand its focus to other industries as the
demand for its customer optimization solution grows. The Company's experience
has been that the rate of adoption of its solutions is driven by competitiveness
within a given industry, the level of database marketing sophistication, access
to customer information and the marginal economic impact of changes in customer
behavior. The Company is currently considering sales efforts focused on the
retail/catalog, energy/utility and insurance industries.
 
     BROADEN DISTRIBUTION CHANNELS AND BUILD ALLIANCES.  The Company will
continue to develop indirect distribution channels. The Company maintains global
re-seller agreements for VALEX with IBM, NCR and others to leverage these
partners' extensive marketing and distribution channels. The Company also has
co-marketing relationships with companies such as Compaq, Ernst & Young, KPMG
Peat Marwick, PricewaterhouseCoopers, SAS Institute and Sun Microsystems,
enabling it to utilize their extensive customer relationships and, in certain
cases, their products and services. The Company plans to leverage the
professional services resources of these re-seller and co-marketing
organizations to provide certain non-proprietary professional services required
in connection with the implementation of CCM and VALEX. This strategy will allow
the Company to provide and expand its professional services offerings to most
effectively complement its CCM methodology and software applications, and will
help increase the efficient implementation of CCM solutions in anticipation of
increased demands on the Company's services resources.
 
     INCREASE DIRECT SALES GLOBALLY.  The Company currently maintains and is
aggressively expanding its direct sales forces in North America, the U.K. and
Australia. In the future, the Company plans to expand further in Europe and the
Pacific Rim, with particular attention to territories or industries experiencing
trends advantageous to the adoption of the Company's solution, such as industry
deregulation.
 
PRODUCTS -- VALEX
 
     The Company's customer optimization software product, VALEX, allows end
users to select targeted customer segments, design time- and event-triggered
customized marketing campaigns and continuously execute and measure the
effectiveness of such marketing campaigns. VALEX may be implemented quickly with
a broad range of processes, databases and CIS environments.
 
     VALEX implementations range in size and complexity. A small implementation
may include data for 400,000 customers in a 50-100 gigabyte data warehouse, with
10 business users accessing the system. The price range for VALEX for this size
configuration is $200,000-$250,000. A large implementation may have 20,000,000
customers, a multi-terabyte data warehouse, and more than 100 users. The price
for VALEX in this configuration is typically more than $800,000.
 
                                       31
36
 
     The principal VALEX components are listed and described in the following
table:
 
COMPONENT                                                         DESCRIPTION
---------                                                         -----------

Desktop..............  Allows users to define their core process steps for CCM
                       and then to organize VALEX components and associated
                       applications into those process steps.
                   
Segment..............  Allows users to segment the database into groups of
                       customers for a particular marketing campaign or
                       analysis.
                   
Profile..............  Allows users to analyze the characteristics of
                       individual customers within a segment.
                   
Campaign.............  Allows users to define and execute targeted campaigns
                       that run continuously and contain event triggers that
                       respond to customer behavior or inactivity.
                   
Schedule.............  Allows users to schedule VALEX components and to
                       automate campaign execution and tracking.
                   
Extract..............  Allows users to select information from the data
                       warehouse and export this information to other
                       applications and CIS technologies.
                   
Admin................  Allows users to interface VALEX with data warehouses and
                       provide configuration settings.
                   
Filter...............  Allows users to capture and analyze lists and
                       descriptions of customers and their characteristics in
                       the data warehouse.

 
     The figure below depicts VALEX and CCM as part of an enterprise-wide
solution.
 
 [A series of diagrams showing the VALEX architecture interfacing with customer
                      databases and customer touchpoints.]
 

                                       32
37
 
     A VALEX USER CASE.  The following description and diagram illustrate how
VALEX is used to create, evaluate and refine marketing campaigns for
enterprise-wide customer management.
 
     - DESKTOP.  A user first selects a "work group", which directs a user to
       the database to be accessed and the process steps to be performed. A
       simplified marketing process may include identifying and planning
       opportunities, and then designing, executing and continuously evaluating
       and refining campaigns.
 
     - SEGMENT AND PROFILE.  During the opportunity identification stage, a user
       employs VALEX Segment to define desired groups of customers to be
       targeted in a particular campaign. The VALEX Profile component is then
       used to further analyze each segment by other attributes in the database
       (such as purchasing patterns, demographics, prior campaign history). In
       the example pictured below, three segments are defined. The "Targeted
       Prospects" segment comprises a group of prospective customers selected
       for a direct mail campaign. The "Cross Sell Opportunities" segment
       identifies a group of current customers whose purchase behavior indicates
       a likelihood of buying certain additional products. The "Likely to Leave"
       segment, derived using a statistical model, identifies customers with a
       high probability of attrition based on their behavioral and demographic
       characteristics.
 
             [A COMPUTER SCREEN DIAGRAM OF VALEX CAMPAIGN DECISION TREE.]
 
     - CAMPAIGN.  Once the user has decided on segments to be targeted for a
       particular campaign, he or she moves to the campaign design stage of the
       process. In this stage, a user employs VALEX Campaign to define the
       structure of the campaign. The user starts by specifying the campaign
       universe, and then defining all customers eligible to participate in the
       campaign. In this example, the user then creates three contact segments
       that branch off from the campaign universe. Groups are created by linking
       a query defined in VALEX Segment to

 
                                       33
38
 
       the database of potential contacts and by specifying rules that determine
       whether each customer or prospect meets the campaign selection criteria.
       Rules are specified through database queries or data mining routines and
       can establish "triggers" that respond to customer behavior. Once a group
       of contacts is identified, it can be subdivided into smaller random
       groups that receive different communications. Subdivisions allow the user
       to test the relative effectiveness of various communication strategies,
       comparing different messages, offers and/or channels against a control
       group. In the example above, the user further divides the "Cross Sell
       Opportunities" contact group in order to test two different
       offers -- "Product Upgrade" and "Discounted Enrollment" -- against a
       control group which will not receive any offers. The behavior of all
       three "splits" of the "Cross Sell Opportunities" contact group will be
       evaluated to improve future campaigns.
 
     - EXTRACT AND SCHEDULE.  After a campaign has been created, the user links
       each element of the campaign to VALEX Extract. The physical destination
       of the targeted list of customers and the information content to be
       delivered to the customer touchpoint are defined as Extracts. In the
       pictured campaign, the "Mail House" extract is formatted for the
       generation of personalized direct mail. "Sales Agents", "Call Center" and
       "Service Center" extracts directly feed the appropriate system for each
       touchpoint. The "Promotional History" extract creates a record for each
       customer or prospect included in the campaign with information about that
       individual's contact group, offer and channel. This record, stored in a
       history table in the data warehouse, is used to measure campaign
       effectiveness and drive future communications. Through VALEX Schedule,
       campaign execution can be highly automated, reducing or eliminating human
       intervention. For instance, VALEX Schedule could automatically generate a
       nightly list of the best potential contacts for a cross-sell campaign or
       a weekly list of new customers to receive a welcome package through the
       mail.
 
     - METRICS REPOSITORY.  After executing a campaign, VALEX and Metrics
       Repository are used to analyze the campaign and refine it for the next
       cycle. Metrics Repository enables users to: (i) define campaign history
       tables, which update the data warehouse with information about customers
       or prospects selected in the campaign and capture information about each
       customer at the time they were contacted; (ii) establish test versus
       control groups to verify the incremental performance of a new message or
       segmentation technique; (iii) track each iteration of a campaign over
       time; (iv) define a "response" to a marketing action (e.g., a purchase of
       the offered product within two weeks of the start of the campaign); and
       (v) link responses to campaign promotions, providing the information
       foundation for measuring marketing effectiveness. Because the measurement
       needs of businesses vary widely, Metrics Repository is customized to meet
       the requirements of each individual business.
 
     VALEX ARCHITECTURE.  VALEX is an open enterprise software solution that can
operate on a variety of platforms in a multi-tiered environment, thereby
providing businesses maximum flexibility in the deployment of the software. For
some smaller installations, both the database and the application server can be
installed on one server with input from a separate client console. Larger
installations may require a three-tiered environment, with separate client,
data-warehouse and application servers. The software has been developed in
Visual C++ and Java and is object oriented. Parallel operation of VALEX enables
it to exploit database and hardware capabilities to operate in large database
environments. VALEX supports many of the common relational databases in use
today, and has been designed to generate structured query languages ("SQL") that
leverage the unique capabilities of the relational database systems ("RDBMS")
platforms. The following diagram represents an overview of VALEX and the
platforms it supports.

 
                                       34
39
 
    [The graphic depicts a series of diagrams showing the VALEX architecture
  interfacing with customer databases and the platforms that VALEX supports.]
 
     Designed to be flexible and scaleable, VALEX uses industry standard
capabilities and interfaces, such as SQL, ODBC, COM, DCOM, MFC and CORBA, to
integrate closely with data warehouse and CIS environments. The Company is also
developing external interfaces to VALEX that will allow consultants, partners or
customers to quickly and easily add their own functional extensions to the
software while maintaining compatibility with future VALEX releases. The Company
believes that VALEX represents the most comprehensive combination of
functionality, scalability and openness in the marketplace today.

 
                                       35
40
 
SERVICES
 
     The Company maintains its own integration services consulting group. The
group delivers capabilities to VALEX customers that include data warehouse
design and infrastructure development, business process design capabilities and
all aspects of the CCM implementation. Key service offerings include:
 
  CONSULTING
 
     PROCESS DESIGN.  A central part of the CCM solution is the design and
customization of processes for customer optimization. This includes process
templates in planning, campaign execution, measurement and continuous learning.
The Company's Value Exchange Optimization ("VEO") methodology describes a
process for businesses to allocate marketing investments based on the likely
return of a particular marketing campaign or customer communication. Through
VEO, businesses can make investments based on current and potential customer
profitability and allocate resources to customers with high profit potential
through more frequent and better targeted campaigns and differentiated service
offerings. VEO utilizes the data generated by VALEX to track overall campaign
performance as well as individual customer responses to campaigns. This allows a
business to discern more readily which customers are most likely to respond to
particular campaigns.
 
     VEO identifies gaps between the current and potential profitability of
customers. Companies can then employ VALEX to execute strategies to reduce those
gaps. Through VALEX and VEO, companies gain an understanding of the economics of
customer relationships, measure customer value and provide incentives through
campaigns that influence and optimize customer behavior.
 
     METRICS REPOSITORY.  The Company's Metrics Repository offering is a custom
application development project that enables a business to measure and visualize
the impact of its investments across customers and campaigns. Measurement is
accomplished through the CCM process steps, which require businesses to
establish a consistent measurement baseline and adopt a process-driven view for
managing and optimizing the value of its customer relationships. The Metrics
Repository is typically implemented through integration of OLAP tools with the
data warehouse and VALEX.
 
     VALEX RAPID IMPLEMENTATION.  With VALEX Rapid Implementation, the Company
implements the core VALEX components and integrates them with existing data
warehouse environments within a matter of weeks through a structured,
tightly-managed methodology. Rapid Implementation includes advising on campaign
structures and customer management strategies, training the first series of
users on VALEX and supporting and guiding users through the initial days of
operation.
 
  CUSTOMER SUPPORT AND SERVICE
 
     The Company believes that superior customer support and service are
critical to successful implementation of CCM and VALEX. The Company is committed
to providing high-quality customer support and to maintaining a qualified
customer support and service team. Ongoing customer support and service are
provided on a 24-hour-a-day, 7-day-a-week basis.
 
  TRAINING
 
     The Company offers complete training for its customers and partners. This
training includes end-user interaction with VALEX, administration of VALEX and
best practices in CCM.
 
  MAINTENANCE AND PRODUCT UPGRADES
 
     The Company provides ongoing product support services under its license and
maintenance agreements. Maintenance contracts are typically sold to customers
for one-year terms commencing on the date of the initial VALEX license and may
be renewed for additional periods. The Company also provides product updates to
VALEX free of charge for customers with a maintenance

                                       36
41
 
agreement. Customers who do not purchase a maintenance agreement but would like
to receive product updates must purchase them from the Company.
 
PRODUCT DEVELOPMENT
 
     The Company originally introduced VALEX in July 1996 and has subsequently
made a number of product revisions and enhancements. The Company has adopted a
strategy of continuously reevaluating the needs of customers and marketplace
trends to develop new products. The Company's ongoing product development
efforts are focused on:
 
     - RELEASE 2.1-2.2 -- These releases of VALEX will include extensions to its
       existing functionality, a new component that links communications to
       changes in customer behavior and an improved interface with leading
       analytical applications.
 
     - RELEASE 3.0 -- This release will include open interfaces to the VALEX
       objects that will allow partners and customers to extend the software
       directly, further broadening the base functionality of VALEX.
 
     - ADAPTING VALEX FOR DIFFERENT LANGUAGES -- The Company is modifying VALEX
       to support multilingual databases and to permit translation into other
       languages.
 
     - DELIVERING A LOCAL CAMPAIGN MANAGEMENT CAPABILITIES -- This new module
       will enable satellite offices and remote users to design and execute
       independent campaigns while coordinating with the central marketing
       function.
 
     Each of these capabilities is expected to enter beta testing within the
next 12 months. Subsequent improvements and extensions will include a more
automated customer planning and forecasting capability and improved interfaces
to customer touchpoint applications. There can be no assurance that the Company
will not experience difficulties that could delay or prevent successful
development, introduction and sales of these products or that its new products
and enhancements will adequately meet the requirements of the marketplace and
achieve market acceptance. See "Risk Factors -- Rapid Technological Change and
New Products".
 
SALES AND MARKETING
 
     The Company markets its software and services through its direct sales
force of 11 quota-carrying sales representatives and indirectly through
re-sellers and co-marketers. As of June 30, 1998, the Company had sales offices
in Boston, Denver, London, England and Sydney, Australia. The Company's sales
force consists of teams made up of sales executives, managers and pre-sale
engineers organized by vertical industry. The Company currently has sales teams
focused on financial services and telecommunications and is currently evaluating
adding sales teams for other vertical industries, which may include
retail/catalog, utilities/energy and insurance.
 
     The Company currently has re-seller relationships with IBM, NCR and others,
which grants these companies the right to re-market VALEX and utilize the
Company's marketing materials. In addition, the Company has co-marketing
arrangements with companies such as Compaq, Ernst & Young, KPMG Peat Marwick,
PricewaterhouseCoopers, SAS Institute and Sun Microsystems to generate leads and
participate in sales efforts. None of the agreements governing the re-seller or
co-marketing relationships with these organizations includes any commitments on
the part of these organizations to effect any minimum number of sales of VALEX,
or to otherwise provide the Company with business. No assurances can be given
that any revenue will be realized by the Company from any of these
relationships.
 
CUSTOMERS
 
     The Company focuses on selling its CCM solution to leading businesses in
targeted vertical industries. The Company also has made significant sales to
other database-marketing intensive

 
                                       37
42
 
businesses that seek to develop customized marketing campaigns. Following are
selected large customers in the financial services and telecommunications
vertical markets, as well as certain customers from other industries.
FINANCIAL SERVICES   TELECOMMUNICATIONS           OTHER
------------------   ------------------           -----
First USA            BC TELECOM                   Aid Association for Lutherans
Fleet Bank           British SKY Broadcasting     Dutch Railways
INVESCO Funds Group  NEXTEL                       Federal Express Corporation
KeyCorp              Sprint                       Guidepost
Mellon Bank          US WEST                      New England Business Services
CUSTOMER CASE STUDIES:
 
     FEDERAL EXPRESS CORPORATION, MEMPHIS
 
     Federal Express over the last four years has re-engineered its database
marketing process -- from marketing and campaign planning to customer
segmentation, campaign execution, evaluation and refinement. VALEX has been
instrumental in Federal Express' efforts to automate and accelerate its database
marketing process.
 
     Federal Express reports the following accomplishments:
 
     - A dramatic time reduction in direct-marketing campaign cycles; and
 
     - A major improvement in "prospecting" campaigns.
 
     For its application of VALEX, Federal Express won both the 1997 "Best Data
Warehouse Application" award from the Data Warehouse Institute and the 1997
"Excellence Award" from the National Center for Database Marketing.
 
     KEYCORP, CLEVELAND
 
     In 1996, KeyCorp implemented a customer-centric data warehouse in an IBM
mainframe environment. KeyCorp began to develop sophisticated plans and concepts
around managing customer relationships over their financial services life cycle,
but found that the basic reporting and OLAP tools that were part of the data
warehouse did not have the capability to translate their strategic plans into
actual campaigns. As a result, KeyCorp's ability to execute campaigns was
constrained by the need for programmers to custom-develop each campaign, an
approach that is expensive, time-consuming and error-prone.
 
     The Company installed VALEX, enabling KeyCorp to access its data warehouse
directly and more quickly and effectively than before. In addition, the Company
provided CCM process optimization services to enable KeyCorp to implement a more
efficient and targeted methodology for planning, executing and measuring
campaigns.
 
     KeyCorp has reported increased campaign success rates due to automation of
customer segmenting and campaign testing and modeling. Profitability has also
increased due to better cross-selling and increased customer retention.

 
                                       38
43
 
     BC TELECOM, VANCOUVER
 
     In 1997, BC TELECOM, Canada's second largest telecommunications company,
faced many challenges in marketing its services, including a need to shift its
focus from product marketing to customer-centric marketing, a lack of automation
in managing customer relationships across their lifecycles and limited
capabilities to allocate marketing dollars to customers presenting the greatest
potential value. Although BC TELECOM had made a major investment in a
multi-terabyte data warehouse, it believed that its business processes and
marketing systems were not sufficiently linked to the information available, and
that its large investment was therefore not generating optimal returns.
 
     To solve BC TELECOM's significant integration problems and its need for
quick action, Exchange Applications provided VALEX, Rapid Implementation and CCM
process optimization services in 1997. Within three months of implementation, BC
TELECOM had achieved significant results from highly targeted marketing
campaigns aimed at its 1.7 million residential customers.
 
COMPETITION
 
     The market for customer optimization software and related services is
highly competitive. There can be no assurance that the Company will maintain its
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical and
other resources. The Company's products and services are targeted at the
emerging market for customer optimization software solutions. The Company's
competitors are diverse in their orientation and history. The Company's current
and potential competitors fall into the following categories: (i) database
marketing vendors such as Harte Hanks, Metromail (a division of Great Universal
Stores) and Harland, which provide a combination of service bureau capabilities
and proprietary software; (ii) small independent software companies that have
created or are attempting to create offerings similar to the VALEX product;
(iii) ERP and CIS vendors such as SAP, Baan, Oracle, Siebel and Vantive, that
may have an interest in broadening their product lines to include applications
with competitive functionality; and (iv) internal information technology
departments that attempt to build their own systems.
 
     The principal competitive factors that favor the Company include: domain
expertise and intellectual property in customer optimization process management;
reputation of the Company and its employees and products; open and flexible
architecture; strong marketing automation and campaign management functionality;
and speed and ease of implementation and use. However, there can be no assurance
that the Company will be able to compete successfully with existing or new
competitors or that competition will not have a material adverse effect on the
Company's business, operating results and financial condition. See "Risk
Factors -- Competition".
 
PROPRIETARY RIGHTS AND LICENSES
 
     The Company relies primarily on a combination of copyright, trademark and
trade secret laws, confidentiality procedures and contractual provisions to
protect its proprietary rights. In addition, the Company generally licenses
VALEX to end users in object code (machine readable) format, and the Company's
license agreements generally allow the use of VALEX solely by the customer for
internal purposes without the right to sublicense or transfer VALEX. However,
certain customers have required the Company to maintain a source code escrow
account with a third-party software escrow agent, and a failure by the Company
to perform its obligations under the related license and maintenance agreements
or the insolvency of the Company could conceivably cause the release of the
Company's source code to such customers for certain limited purposes. The
Company believes that the foregoing measures afford only limited protection.
Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or to obtain and
use information that the Company regards as proprietary. Policing unauthorized
use of the Company's products is difficult, and while the Company is unable to
determine the extent to

 
                                       39
44
 
which piracy of its software products exists, software piracy is a viable risk.
In addition, the laws of some foreign countries do not protect the Company's
proprietary rights to the same extent as the laws of the United States.
Furthermore, there can be no assurance that the Company's competitors will not
independently develop technology similar to that of the Company. The Company may
increasingly be subject to claims of intellectual property infringement as the
number of products and competitors in the Company's industry segment grows and
the functionality of products in different industry segments overlaps. Although
the Company is not aware that any of its products infringe upon the proprietary
rights of third parties, there can be no assurance that third parties will not
claim infringement by the Company with respect to current or future products.
Any such claims, with or without merit, could be time-consuming, result in
costly litigation, cause product shipment delays or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, might not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition. See "Risk Factors -- Intellectual
Property Rights; Use of Licensed Technology".
 
     The Company has in the past and may in the future resell certain software,
which it licenses from third parties. There can be no assurance that these third
party software licenses will continue to be available to the Company on
commercially reasonable terms. The loss of or inability to maintain or obtain
any of these software licenses could result in delays or reductions in product
shipments until equivalent software could be identified, licensed and
integrated, which could adversely affect the Company's business, operating
results and financial condition.
 
EMPLOYEES
 
     As of June 30, 1998, the Company had 129 full-time employees, including 33
primarily engaged in research and development and 40 in sales and marketing. The
Company's future success depends in significant part upon the continued service
of its key technical and senior management personnel and its continuing ability
to attract and retain highly qualified technical and managerial personnel.
Competition for such personnel is intense and there can be no assurance that the
Company can retain its key managerial and technical employees or that it can
attract, assimilate or retain other highly qualified technical and managerial
personnel in the future. None of the Company's employees is represented by
collective bargaining units and the Company, to date, has not experienced a work
stoppage. The Company believes that its employee relations are good.
 
FACILITIES
 
     The Company's primary offices are located in approximately 40,000 square
feet in Boston, Massachusetts pursuant to a lease expiring in June 1, 2003. The
Company also leases space for its sales offices in Denver, Colorado and London,
England.
 
                                       40
45
 
                                   MANAGEMENT
 
DIRECTORS AND EXECUTIVE OFFICERS
 
     Set forth below is certain information concerning the directors and
executive officers of Company.
NAME                                        AGE                   POSITION(S)
----                                        ---                   -----------
Andrew J. Frawley.........................  35     Chairman of the Board, President, Chief
                                                     Executive Officer and Director
John G. O'Brien...........................  47     Vice President, Chief Financial Officer,
                                                     Treasurer and Secretary
David G. McFarlane........................  35     Executive Vice President, Worldwide Sales
                                                     and Services
David L. Fitzgerald.......................  42     Vice President, North American Sales and
                                                     Alliances
Michael D. McGonagle......................  46     Vice President, Product Development
Patrick A. McHugh.........................  35     Vice President, Marketing and Business
                                                     Development
N. Wayne Townsend.........................  34     Vice President, Integration Services
Ramanan Raghavendran......................  29     Director
Jeffrey Horing............................  34     Director
Dean F. Goodermote........................  45     Director
Mr. Frawley founded the Company in November 1994 and has served as its
President and Chief Executive Officer since its incorporation in November 1996.
Mr. Frawley was elected Chairman of the Board of Directors of the Company in
January 1998. From July 1993 until founding the Company, Mr. Frawley served as a
principal of Grant & Partners Limited Partnership, a management consulting
company. From May 1989 to July 1993, Mr. Frawley held various positions at
MarketPulse, a subsidiary of Praxis International Inc. and developer and
provider of database marketing products, including serving as Vice President of
North American Operations. Mr. Frawley holds a B.S. in accounting from the
University of Maine and an M.B.A. from Babson College. Mr. Frawley has more than
10 years of experience in the high technology industry.
 
     Mr. O'Brien joined the Company in September 1997 as Vice President, Chief
Financial Officer and Secretary and was elected Treasurer of the Company in July
1998. From November 1996 to April 1997, Mr. O'Brien served as Vice President,
Finance and Chief Financial Officer of Advanced Modular Solutions, a computer
hardware manufacturing company. From August 1993 to November 1996, Mr. O'Brien
served as Corporate Controller of Avid Technology, Inc., a computerized film
editing system manufacturing company. From February 1991 to August 1993, Mr.
O'Brien served as Assistant Corporate Controller at Wang Laboratories, Inc., a
computer hardware and office automation system manufacturing company. Mr.
O'Brien is a C.P.A., holds a B.S. in accounting from Northeastern University,
and an M.B.A. from the Wharton School of the University of Pennsylvania. Mr.
O'Brien has more than 15 years of experience in the high technology industry. As
part of the settlement of Mr. O'Brien's recent divorce proceeding, Mr. O'Brien
voluntarily filed a bankruptcy petition under Chapter 13 of the federal
bankruptcy code. The Company does not believe that the filing of such petition
or the related circumstances reflects on Mr. O'Brien's ability or integrity as
an executive officer of the Company.
 
     Mr. McFarlane joined the Company in June 1997 as Executive Vice President,
Worldwide Sales and Services. From January 1988 until joining the Company, Mr.
McFarlane held various positions at Project Software & Development, Inc., a
publicly traded software company that develops and markets high value capital
asset software for processing plants and production equipment, most recently
serving as Vice President, International and Alliances. Mr. McFarlane holds a
B.Sc. in
 
                                       41
46
 
electrical engineering and a Masters degree in electrical engineering from the
University of Bath in the U.K. Mr. McFarlane has more than 10 years of
experience in the high technology industry.
 
     Mr. Fitzgerald joined the Company in July 1998 as Vice President, North
American Sales and Alliances. From June 1996 until joining the Company, Mr.
Fitzgerald was the Group Vice President, Eastern Region of The Vantive
Corporation, an application software company. From April 1995 to April 1996, Mr.
Fitzgerald served as Vice President of Sales of Salesoft, Inc., a start-up
company specializing in sales force automation software. From March 1991 to
April 1995, Mr. Fitzgerald served as President of PowerCurve Corporation, a
company which he founded that specializes in systems integration and ERP
implementation services. Mr. Fitzgerald holds a B.S. in engineering from the
University of Massachusetts. Mr. Fitzgerald has more than 15 years of experience
in the high technology industry.
 
     Mr. McGonagle joined the Company upon its founding in November 1994 and has
served as Vice President, Product Development since its incorporation in
November 1996. From November 1993 until joining the Company, he was Vice
President, Research and Development at MarketPulse. From August 1991 to November
1993, he served as Director of Client-Server Development at Praxis International
Inc. Mr. McGonagle holds a B.A. in mathematics from the University of
Massachusetts (Lowell) and a Masters degree in mathematics from Brown
University. Mr. McGonagle has more than 20 years of experience in the high
technology industry.
 
     Mr. McHugh joined the Company in February 1996 and has served as Vice
President, Marketing and Business Development since March 1998. Mr. McHugh
served in various other capacities with the Company between February 1996 and
March 1998, including serving as Vice President, Sales and Vice President,
Marketing. From June 1995 until joining the Company, Mr. McHugh was the Eastern
Region Manager of Stanford Technology Group, a software development company.
From October 1994 to June 1995 he was Northeast Regional Manager of Siemens
Nixdorf, a computer systems manufacturing company, and from October 1993 to
October 1994 he was Northeast Regional Manager of Kendall Square Research, a
computer systems manufacturing company. Mr. McHugh holds a B.S. in marketing and
a B.S. in finance from Northeastern University. Mr. McHugh has more than 10
years of experience in the high technology industry.
 
     Mr. Townsend joined the Company in April 1996 as Vice President,
Integration Services. From April 1994 until joining the Company, Mr. Townsend
was a Project Director at Epsilon, a database marketing services company. From
May 1990 to April 1994, he was a consultant at Andersen Consulting, a management
consulting company. Mr. Townsend holds a B.S. in mechanical engineering from the
Massachusetts Institute of Technology and an M.S. in mechanical engineering from
the University of Dayton. Mr. Townsend has more than 10 years of experience in
the systems integration industry.
 
     Mr. Raghavendran has served as a Director of the Company since March 1997.
Mr. Raghavendran has served as a managing member of Insight Capital Partners, a
private equity investment firm, since January 1997. From 1992 to 1996, Mr.
Raghavendran was employed at General Atlantic Partners, an investment firm. Mr.
Raghavendran also serves on the boards of directors of several privately held
companies.
 
     Mr. Horing has served as a Director of the Company since March 1997. Mr.
Horing has served as a managing member of Insight Capital Partners, a private
equity investment firm, since January 1995. From 1990 to 1994, Mr. Horing was
employed at E.M. Warburg Pincus, an investment firm. Mr. Horing also serves on
the boards of directors of several privately held companies.
 
     Mr. Goodermote has been a Director of the Company since January 1998. Mr.
Goodermote has been the President and Chief Executive Officer of Process
Software Corporation, a software development company, since August 1996. From
August 1986 to August 1996, Mr. Goodermote held various positions at Project
Software and Development, Inc., including President and Chief Operating Officer
and most recently as Chairman of the Board of Directors. Mr. Goodermote also

 
                                       42
47
 
serves on the boards of directors of several privately held companies. Mr.
Goodermote holds a B.A. in history from the University of Rochester and a M.A.
in Law and Diplomacy from the Fletcher School of Law and Diplomacy of Tufts
University. Mr. Goodermote has more than 15 years of experience in the high
technology industry.
 
BOARD OF DIRECTORS
 
     The Charter and By-laws provide that the size of the Board of Directors of
the Company (the "Board") shall be determined by resolution of the Board.
 
     The Charter provides for classification of the Board into three classes,
with the members of the respective classes serving for staggered three-year
terms. The first class will consist of Mr. Horing, the second of Mr. Goodermote
and the third of Mr. Frawley and Mr. Raghavendran, with the initial terms of the
directors comprising the classes expiring upon the election and qualification of
the directors at the annual meetings of the stockholders held following the
fiscal years of the Company ending December 31, 1998, 1999 and 2000,
respectively. At each annual meeting of stockholders, directors will be
re-elected or elected for full three-year terms. See "Description of Capital
Stock -- Certain Provisions of the Company's Amended and Restated Certificate of
Incorporation and By-laws".
 
     The Board has established a Compensation Committee and an Audit Committee.
The members of the Compensation Committee are Jeffrey Horing and Dean
Goodermote, and the members of the Audit Committee are Ramanan Raghavendran and
Dean Goodermote.
 
     The current and continuing directors of the Company were nominated and
elected in accordance with the Amended and Restated Stockholders Agreement,
dated as of December 4, 1997, which will terminate upon the closing of this
Offering.
 
     Executive officers of the Company are appointed by the Board and serve
until their successors have been duly elected and qualified. There are no family
relationships among any of the executive officers or directors of the Company.
 
     On January 30, 1998, the Company granted to Dean Goodermote an option to
purchase 20,000 shares of Common Stock at an exercise price of $1.35 per share,
vesting over a four-year period. Prior to the Offering, no other directors of
the Company have received compensation for their services in such capacity. The
Directors' Stock Option Plan provides for the grant of stock options to
non-employee directors. The Company anticipates that, following the Offering,
directors who are employees of the Company will not be paid any fees or
additional compensation for service as members of the Board or any committee
thereof and the Company will enter into customary arrangements with respect to
fees and other compensation (including expense reimbursement) for directors who
are not employees of the Company or any of its subsidiaries. The Company
maintains directors' and officers' liability insurance and its By-laws provide
for mandatory indemnification of directors and officers to the fullest extent
permitted by Delaware law. In addition, the Charter limits the liability of
directors of the Company to the Company or its stockholders for breaches of the
directors' fiduciary duties to the fullest extent permitted by Delaware law. See
"Description of Capital Stock -- Certain Anti-Takeover, Limited Liability and
Indemnification Provisions".
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     In March 1997, the Board established a compensation committee responsible
for determining compensation of officers of the Company. Prior to March 1997,
the Company had no compensation committee or other committee of the Board
performing similar functions. Andrew Frawley's salary during such year was
established by the Board and decisions concerning compensation of other
executive officers were made during such year by Mr. Frawley.
 
                                       43
48
 
EMPLOYMENT CONTRACTS
 
     The officers serve at the discretion of the Board. The Company does not
presently have an employment contract in effect with any of its officers.
 
EXECUTIVE COMPENSATION
 
  SUMMARY COMPENSATION TABLE
 
     The following table sets forth certain information concerning the
compensation earned by the Company's Chief Executive Officer and the other
executive officers of the Company (collectively, "Named Officers") whose total
salary and bonus exceeded $100,000 for services rendered in capacities to the
Company and its subsidiaries during 1997. For disclosure regarding terms of the
stock options, see "Management -- Stock Option Plans".
LONG-TERM
                                                                   COMPENSATION
                                                                     OPTIONS
                                                               --------------------
                                               ANNUAL               (NUMBER OF
                                          COMPENSATION(1)           SECURITIES
                                        --------------------        UNDERLYING         ALL OTHER
    NAME AND PRINCIPAL POSITION(S)       SALARY      BONUS       OPTIONS GRANTED)     COMPENSATION
    ------------------------------       ------      -----       ----------------     ------------
Andrew J. Frawley.....................  $200,000    $100,000         151,200              --
  Chairman of the Board, President and
  Chief Executive Officer
David G. McFarlane(2).................    78,757      47,500         300,000              --
  Executive Vice President, Worldwide
  Sales and Services
Michael D. McGonagle..................   131,000      30,000          58,000              --
  Vice President, Product Development
Patrick A. McHugh.....................   110,000     175,089          80,000              --
  Vice President, Marketing
N. Wayne Townsend.....................   125,000      85,000          74,000              --
  Vice President, Integration Services
---------------
(1) Excludes certain perquisites and other benefits the amount of which did not
    exceed 10% of the employee's total salary and bonus.
 
(2) Mr. McFarlane joined the Company in June 1997 and his salary and bonus
    reflect compensation earned in the latter half of 1997.
 
                                       44
49
 
      OPTION GRANTS IN LAST FISCAL YEAR
 
     The following table sets forth certain information concerning stock options
granted to each of the Named Officers during 1997. No stock appreciation rights
were granted to these individuals during such year.
NUMBER OF     % OF TOTAL
                                          SECURITIES     OPTIONS
                                          UNDERLYING    GRANTED TO    EXERCISE
                                           OPTIONS     EMPLOYEES IN     PRICE     EXPIRATION    GRANT DATE
NAME                                       GRANTED         1997       PER SHARE      DATE        VALUE(1)
----                                      ----------   ------------   ---------   ----------    ----------
Andrew J. Frawley.......................   151,200         10.4%        $0.72      7/31/02       $ 59,053
David G. McFarlane......................   250,000         17.3          0.65      7/31/07        100,861
David G. McFarlane......................    50,000          3.5          0.65      7/18/06         20,172
Michael D. McGonagle....................    18,000          1.2          0.65      7/31/07          7,262
Michael D. McGonagle....................    40,000          2.8          0.65      7/18/06         16,138
Patrick A. McHugh.......................    30,000          2.1          0.65      7/31/07         12,103
Patrick A. McHugh.......................    50,000          3.5          0.65      7/18/06         20,172
N. Wayne Townsend.......................    18,000          1.2          0.65      7/31/07          7,262
N. Wayne Townsend.......................    56,000          3.9          0.65      7/18/06         22,593
---------------
(1) Represents the estimated fair value of the options as of the date of grant
    using the Black-Scholes option pricing model with the following assumptions:
    (i) expected volatility of 79%; (ii) expected life of four years; and (iii)
    risk-free interest rate of 5.96%. No dividends on common stock were assumed
    for purposes of this estimate.
 
  AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
 
     The following table sets forth certain information concerning option
exercises during 1997 and option holdings at December 31, 1997 with respect to
each of the Named Officers.
NUMBER OF SECURITIES             VALUE OF UNEXERCISED
                                                        UNDERLYING UNEXERCISED            IN-THE-MONEY OPTIONS
                            SHARES                  OPTIONS AT DECEMBER 31, 1997(1)      AT DECEMBER 31, 1997(2)
                          ACQUIRED ON    VALUE     ---------------------------------   ---------------------------
NAME                       EXERCISE     REALIZED   EXERCISABLE(3)(4)   UNEXERCISABLE   EXERCISABLE   UNEXERCISABLE
----                      -----------   --------   -----------------   -------------   -----------   -------------
Andrew J. Frawley.......     --            --           151,200                --         $95,256     $       --
David G. McFarlane......     --            --            25,000           275,000          17,500        192,500
Michael D. McGonagle....     --            --             9,000            49,000           6,300         34,400
Patrick A. McHugh.......     --            --            15,000            65,000          10,500         45,500
N. Wayne Townsend.......     --            --             9,000            65,000           6,300         45,500
---------------
(1) "Exercisable" refers to those options which were both exercisable and
    vested, while "Unexercisable" refers to those options which were unvested.
 
(2) Value is determined by subtracting the exercise price from the fair market
    value of the Common Stock at December 31, 1997 ($1.35 per share), as
    determined by the Company's Board of Directors, multiplied by the number of
    shares underlying the options.
 
(3) In March 1998, the Company granted stock options, none of which is currently
    exercisable, to the following Named Officers to purchase the corresponding
    number of shares of Common Stock at an option exercise price of $3.50 per
    share: (i) David G. McFarlane, 30,000 shares of Common Stock; (ii) Michael
    D. McGonagle, 9,000 shares of Common Stock; (iii) Patrick A. McHugh, 10,000
    shares of Common Stock; and (iv) N. Wayne Townsend, 11,500 shares of Common
    Stock. In addition, in March 1998, the Company granted Andrew J. Frawley
    options to purchase 105,000 shares of Common Stock at an exercise price of
    $3.85 per share.
 
                                       45
50
 
(4) On June 12, 1998 (i) David G. McFarlane exercised options to purchase 25,000
    shares of Common Stock at an exercise price of $0.65 per share for an
    aggregate exercise price of $16,250, (ii) Patrick A. McHugh exercised
    options to purchase 15,000 shares of Common Stock at an exercise price of
    $0.65 per share for an aggregate purchase price of $9,750, and (iii) N.
    Wayne Townsend exercised options to purchase 9,000 shares of Common Stock at
    an exercise price of $0.65 per share for an aggregate purchase price of
    $5,850.
 
STOCK OPTION PLANS
 
     1998 Stock Incentive Plan.  The Company's 1998 Stock Incentive Plan (the
"1998 Plan") was approved by the Board on July 15, 1998 and was adopted by the
Company's stockholders on July 15, 1998. The aggregate number of shares of
Common Stock available for awards under the 1998 Plan is 2,700,000 shares. The
1998 Plan provides for the grant or award of stock options ("Stock Options") to
purchase shares of Common Stock of the Company. Stock Options granted under the
1998 Plan may be incentive stock options or non-statutory options. The purpose
of the 1998 Plan is to attract and retain outstanding employees through the
incentives of stock ownership. Any employee of the Company (including officers),
and any consultant to and any director of the Company, is eligible to receive
Stock Options under the 1998 Plan. As of July 15, 1998, none of the shares
reserved for issuance under the 1998 Plan was subject to outstanding Stock
Options.
 
     The 1998 Plan is administered by the Board. Subject to the provisions of
the 1998 Plan, the Board has the authority to designate participants and to
determine whether Stock Options granted are incentive stock options or not, the
number of shares to be covered by each Stock Option, the exercise price of the
Stock Option, the period of time over which Stock Options are exercisable or may
be settled, the method of payment and any other terms and conditions of the
awards. All Stock Options are evidenced by Stock Option Agreements between the
Company and the participant.
 
     While the Board determines the prices at which Stock Options may be
exercised under the 1998 Plan, the exercise price of an incentive Stock Option
under the 1998 Plan shall be at least 100% of the fair market value (as
determined under the terms of the 1998 Plan) (or 110% of the fair market value
if the grantee is deemed to own 10% or more of the outstanding voting stock of
the Company) of a share of Common Stock on the date of grant. Stock Options must
be exercised by the tenth anniversary of the date of grant, or if the grantee
owns 10% or more of the outstanding voting stock of the Company, by the fifth
anniversary of the date of the grant.
 
     1996 Stock Incentive Plan.  The Company's 1996 Stock Incentive Plan (the
"1996 Plan"), effective November 15, 1996, was approved by the Board of
Directors on November 15, 1996 and adopted by the Company's stockholders in
March 1997. The 1996 Plan provides for the grant or award of Stock Options,
which may be incentive stock options or non-statutory stock options, and for the
direct purchase of shares of Common Stock of the Company ("Restricted Common
Stock"). The purpose of the 1996 Plan is to attract and retain outstanding
employees through the incentives of stock ownership. Any employee of the Company
(including officers), and any consultant to and any director of the Company, is
eligible to receive Stock Options and to purchase Restricted Common Stock under
the 1996 Plan. As of July 15, 1998, the Company had 2,277,283 shares of Common
Stock reserved for issuance remaining under the 1996 Plan, of which 2,085,408
shares were subject to outstanding stock options at a weighted average exercise
price of $3.10 per share.
 
     The 1996 Plan is administered by the Board. Subject to the provisions of
the 1996 Plan, the Board has the authority to designate participants and to
determine whether Stock Options granted are incentive stock options or not, the
number of shares to be covered by each Stock Option, the price of the exercise
of the Stock Option and the purchase price of the Restricted Common Stock, the
time at which Stock Options are exercisable or may be settled, whether
restrictions such as repurchase options are to be imposed on shares subject to
the Stock Options and to the Restricted Common Stock, the method of payment and
any other terms and conditions of the awards. All Stock
 
                                       46
51
 
Options and Restricted Common Stock are evidenced by Stock Option Agreements and
Restricted Stock Agreements, respectively, between the Company and the
participant.
 
     While the Board determines the prices at which Stock Options may be
exercised under the 1996 Plan, the exercise price of an incentive Stock Option
under the 1996 Plan shall be at least 100% of the fair market value (as
determined under the terms of the 1996 Plan) (or 110% of the fair market value
if the grantee is deemed to own 10% or more of the outstanding voting stock of
the Company) of a share of Common Stock on the date of grant. Stock Options must
be exercised by the tenth anniversary of the date of grant, or if the grantee
owns 10% or more of the outstanding voting stock of the Company, by the fifth
anniversary of the date of the grant.
 
     In the event that the Company is consolidated with or acquired by another
person or entity in a merger, sale of stock, sale of all or substantially all of
the Company's assets or otherwise (other than a merger or consolidation of the
Company with, or the sale of all or substantially all of the assets of the
Company to, any entity if 50% or more of the aggregate voting power of such
entity is held immediately after such transaction by persons who were
stockholders of the Company immediately prior to such transaction) (an
"Acquisition"), each outstanding Stock Option held by an executive officer of
the Company shall accelerate so as to be fully exercisable for all of the shares
subject to such Stock Option. The foregoing option acceleration provisions may
have the effect of discouraging, delaying or preventing a change in control of
the Company or unsolicited acquisition proposals that a stockholder might
consider favorable, and as a result, such provisions may have an adverse effect
upon the market price for the Common Stock. There are no option acceleration
provisions with respect to Stock Options held by any person other than executive
officers of the Company.
 
     Shares underlying Stock Options generally vest over a four-year period.
However, shares underlying certain Stock Options vest as of the ninth
anniversary of the date of the grant of such options, but vesting of up to 25%
of the original amount of such shares may accelerate and may become exercisable
at the end of each calendar year commencing with 1998 upon satisfaction of
certain performance criteria determined by the Board and the Chief Executive
Officer of the Company.
 
     Restricted Common Stock generally vests over a three-year period. However,
vesting may accelerate in the event of (i) the direct or indirect acquisition by
any person of 50% or more of the aggregate voting power of the Company, or (ii)
the sale of all or substantially all of the assets of the Company (other than a
merger or consolidation of the Company with, or the sale of all or substantially
all of the assets of the Company to, any entity if 50% or more of the aggregate
voting power of such entity is held immediately after such transaction by
persons who were stockholders of the Company immediately prior to such
transaction). Upon grant the recipient has full voting and dividend rights with
respect to all shares granted. The shares are subject to a purchase option of
the Company and are subject to restrictions on transfer.
 
401(k) SAVINGS PLAN
 
     The Company has established a tax-qualified cash or deferred profit sharing
plan (the "401(k) Savings Plan") covering all of the Company's eligible
full-time employees. The Company adopted the 401(k) Savings Plan effective June
1, 1998. Under the plan, participants may elect to contribute, through salary
reductions, up to 15.0% of their annual compensation subject to a statutory
maximum. The Company does not currently provide additional matching
contributions under the 401(k) Savings Plan, but may do so in the future. The
401(k) Savings Plan is designed to qualify under Section 401 of the Internal
Revenue Code of 1986, as amended, so that contributions by employees or by the
Company to the plan, and income earned on plan contributions, are not taxable to
employees until withdrawn from the 401(k) Savings Plan, and so that
contributions by the Company, if any, will be deductible by the Company when
made. The trustee under the plan, at the
 
                                       47
52
 
direction of each plan participant, currently invests the assets of the 401(k)
Savings Plan in eight investment options.
 
     Director Stock Option Plan.  The Company's 1998 Director Stock Option Plan
(the "Directors' Plan") was approved by the Board on July 15, 1998. The
Directors' Plan will be administered by the Compensation Committee of the Board.
Under the Directors' Plan, on the business day immediately following each annual
meeting of the stockholders of the Company, commencing with the first annual
meeting of stockholders after December 31, 1998, each person who is then a
non-employee director of the Company will be eligible to receive an option to
purchase such number of shares of Common Stock as determined by the Compensation
Committee at an exercise price equal to the fair market value of the Common
Stock on the date the option is granted. A total of 100,000 shares of Common
Stock have been reserved for issuance under the Directors' Plan. The Directors'
Plan is intended to help the Company attract and retain non-employee directors
on the Company's Board.
 
     Employee Stock Purchase Plan.  The Company's 1998 Employee Stock Purchase
Plan (the "Stock Purchase Plan") was approved by the Board on July 15, 1996. The
Stock Purchase Plan will be administered by the Compensation Committee of the
Board. The Stock Purchase Plan is intended to qualify as an "employee stock
purchase plan" under Section 423 of the Internal Revenue Code of 1986, as
amended. The Compensation Committee may grant options to purchase shares of
Common Stock to employees eligible under the Stock Purchase Plan who may acquire
shares of the Company's Common Stock through payroll deductions. The purchase
price for the Company's Common Stock purchased under the Stock Purchase Plan is
85% of the lesser of the fair market value of the shares on the date the option
was granted or the date the option is exercised. A total of 200,000 shares of
Common Stock have been reserved for issuance under the Stock Purchase Plan. The
Stock Purchase Plan is intended to help the Company attract and retain
outstanding employees through the incentives of stock ownership.
 
                                       48
53
 
                              CERTAIN TRANSACTIONS
 
PREFERRED STOCK ISSUANCE
 
     Pursuant to a Securities Purchase Agreement, dated as of December 4, 1997,
Insight Capital Partners II, L.P. and Wexford Insight LLC each purchased 611,977
shares of Series C Convertible Preferred Stock of the Company for an aggregate
purchase price, in each case, of $2,000,000, or $3.268 per share.
 
     Pursuant to a Stock Purchase and Waiver Agreement (the "Stock Purchase
Agreement"), dated as of December 4, 1997, GAP Coinvestment Partners, L.P.
("GAP") sold an aggregate of 246,006 shares of Series B Convertible Preferred
Stock of the Company to the following purchasers for an aggregate purchase price
of $803,947.58 or $3.268 per share: Andrew J. Frawley, David McFarlane, Daniel
Cox, Patrick McHugh, Michael McGonagle, Stewart Vassie, Steven Feldman, Patrick
D. Brady, Gregory P. Shlopak, David H. Brault, Ted L. Axelrod, Terry B.
Angstadt, James T. Brady, Dominic F. Mammola, James A. Dooley, Diane K. Green,
and Insight Venture Partners I, L.P.
 
     Pursuant to the Securities Purchase Agreement, dated as of March 18, 1997
(the "Securities Purchase Agreement") (i) Insight Venture Partners II, L.P.
purchased 1,154,775 shares of Series B Preferred Stock from the Company for an
aggregate purchase price of $1,807,222.88, or $1.565 per share; (ii) Wexford
Insight LLC purchased 1,154,775 shares of Series B Preferred Stock from the
Company for an aggregate purchase price of $1,807,222.88, or $1.565 per share;
(iii) GAP purchased 246,006 shares of Series B Preferred Stock from the Company
for an aggregate purchase price of $384,999.39, or $1.565 per share; (iv) GPLP
converted 2,300,000 shares of Series A Convertible Preferred Stock ("Old
Preferred Stock") to 1,725,000 shares of Common at a conversion price of
$3.01333; (v) GPLP purchased 377,408 shares of Series A Preferred Stock from the
Company in consideration of the cancellation of certain indebtedness owed by the
Company to GPLP; (vi) Cyrk purchased 2,522,592 shares of Series A Preferred
Stock from the Company in consideration of the cancellation of certain
indebtedness owed by the Company to Cyrk and (vii) the Company paid to Cyrk
$1,000,000 to discharge certain indebtedness.
 
REGISTRATION RIGHTS AGREEMENT
 
     Pursuant to an Amended and Restated Registration Rights Agreement, dated as
of December 4, 1997, the Company granted registration rights to certain
stockholders of the Company, including Insight Venture Partners I, L.P., Insight
Capital Partners II, L.P., Insight Capital Partners (Cayman) II, L.P., Wexford
Management LLC, Cyrk, Inc. ("Cyrk"), Grant & Partners Limited Partnership
("GPLP"), Andrew J. Frawley, Michael J. Feldman, Michael McGonagle, David
McFarlane, Daniel Cox, Patrick McHugh, Stewart Vassie, Steven Feldman, Patrick
D. Brady, Gregory P. Shlopak, David H. Brault, Ted L. Axelrod, Terry B.
Angstadt, James T. Brady, Dominic F. Mammola, James A. Dooley and Diane K.
Green. See "Shares Eligible for Future Sale -- Registration Rights".
 
CONTRACT WITH EXCHANGE MARKETING GROUP
 
     Pursuant to several Termination Agreements dated as of March 18, 1997, the
Company and each of Michael J. Feldman, a former director and employee of the
Company, and six other employees of the Company terminated their employment
arrangements with the Company. The Company repurchased an aggregate of 341,125
shares of Common Stock from the departing employees for an aggregate purchase
price of $341.13. Upon termination, Mr. Feldman formed Exchange Marketing Group,
LLC ("EMG"), a marketing consulting company. The Company engaged EMG to provide
consulting services to certain of the Company's customers pursuant to a
Consulting Agreement, dated as of March 18, 1997. As evidenced by a Promissory
Note (the "EMG Note"), dated as of March 18, 1997, the Company loaned to EMG
$350,000. On February 5, 1998, the entire principal and interest outstanding
under the EMG Note was repaid. In addition, in connection with the transactions
contemplated by the Consulting Agreement, EMG licensed from
 
                                       49
54
 
the Company certain intellectual property to be used in its marketing consulting
business and the Company and EMG entered into mutual non-compete agreements.
 
FOUNDER'S LOANS
 
     As evidenced by a Promissory Note (the "Note"), dated as of December 4,
1997, in the original principal amount of $124,997.73, the Company loaned to Mr.
Frawley the total amount of the purchase price for the 38,249 shares of Series B
Convertible Preferred Stock purchased by Mr. Frawley under the Stock Purchase
Agreement. The Note bears interest at 8% per annum and is secured by 38,249
shares of Series B Convertible Preferred Stock owned by Mr. Frawley. As of June
30, 1998, the outstanding balance of the indebtedness under the Note was
$130,764.74.
 
SEPARATION FROM GPLP
 
     Pursuant to an Assignment and Assumption Agreement, dated as of November
15, 1996, the Company purchased certain assets, including, without limitation,
cash, accounts receivable, fixed assets and certain intangible property, from
GPLP, and the Company issued 2,300,000 shares of Series A Convertible Preferred
Stock to GPLP and assumed certain liabilities of GPLP, including, without
limitation, indebtedness owed to Cyrk, indebtedness under leasing arrangements,
indebtedness with respect to employee benefits and accounts payable. In
addition, in connection with the transactions contemplated by the Assignment and
Assumption Agreement, each of Andrew J. Frawley and Michael J. Feldman entered
into mutual releases of claims with Cyrk, GPLP, Alan Grant and GPI, and the
Company entered into a fully paid-up perpetual license with GPLP pursuant to
which the Company licensed from GPLP certain intellectual property.
 
LEGAL SERVICES
 
     The Company has, with respect to this Offering and from time to time,
retained the services of the law firm of Bingham Dana LLP. The Company
anticipates that legal fees to be paid to Bingham Dana LLP for 1998 will exceed
$300,000. Neil W. Townsend, a partner at Bingham Dana LLP, is the brother of N.
Wayne Townsend, Vice President, Integration Services of the Company.
 
FUTURE AFFILIATE TRANSACTIONS
 
     All future transactions, including loans, between the Company and its
officers, directors, principal stockholders and their affiliates, will be
approved by a majority of the Board, including a majority of the independent and
disinterested outside directors on the Board, and will be on terms no less
favorable to the Company than could be obtained from unaffiliated third parties.
 
                                       50
55
 
                       PRINCIPAL AND SELLING STOCKHOLDERS
 
     The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of June 30, 1998, and as adjusted to
reflect the sale of shares offered hereby, by (i) each person who is known by
the Company to own beneficially more than five percent of the Company's Common
Stock; (ii) each of the Company's directors and Named Officers; (iii) all
current executive officers and directors as a group; and (iv) each of the
Selling Stockholders. Unless otherwise indicated, the address for the following
stockholders is 89 South Street, Boston, Massachusetts 02111.
SHARES BENEFICIALLY                   SHARES BENEFICIALLY
                                          OWNED BEFORE                           OWNED AFTER
                                           OFFERING(1)          NUMBER         OFFERING(1)(2)
                                     -----------------------   OF SHARES   -----------------------
BENEFICIAL OWNER                      NUMBER      PERCENTAGE    OFFERED      NUMBER     PERCENTAGE
----------------                      ------      ----------   ---------     ------     ----------
Entities affiliated with Insight
  Venture Associates, LLC(3).......  3,557,783       46.1%           --     3,557,783        36.6%
Cyrk, Inc.(4)......................  1,150,000       14.9       460,026       689,974         7.1
Grant & Partners Limited
  Partnership(5)...................    575,000        7.5       230,058       344,942         3.5
Michael J. Feldman(6)..............    530,250        6.9       212,104       318,146         3.3
Andrew J. Frawley(7)...............  1,038,249       13.2        57,162       981,087         9.9
David G. McFarlane(8)..............    126,009        1.6        17,800       108,209         1.1
David J. Fitzgerald................         --         --            --            --          --
John G. O'Brien(9).................     10,000          *            --        10,000           *
Michael D. McGonagle(10)...........    114,000        1.5         8,600       105,400           *
Patrick A. McHugh(11)..............     75,000          *         7,500        67,500           *
N. Wayne Townsend(12)..............     59,000          *         6,750        52,250           *
Ramanan Raghavendran(13)(14).......  3,557,783       46.1            --     3,557,783        36.6
Jeffrey Horing(15).................  3,557,783       46.1            --     3,557,783        36.6
Dean F. Goodermote(16).............         --         --            --            --          --
All directors and executive
  officers as a group (ten
  persons).........................  4,980,041       62.5        97,812     4,882,229        49.0
---------------
  *  Indicates less than 1% of the outstanding shares of Common Stock.
 
 (1) Beneficial ownership is calculated in accordance with the rules of the
     Securities and Exchange Commission. In computing the number of shares
     beneficially owned by a person and the percentage ownership of that person,
     shares of Common Stock subject to options held by that person that are
     currently exercisable or become exercisable within 60 days following June
     30, 1998 are deemed outstanding. However, such shares are not deemed
     outstanding for the purpose of computing the percentage ownership of any
     other person. Unless otherwise indicated in the footnotes to this table,
     the persons and entities named in the table have sole voting and sole
     investment power with respect to all shares beneficially owned, subject to
     community property laws where applicable.
 
 (2) Assumes no exercise of the Underwriters' over-allotment option.
 
 (3) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
     shares held by Insight Capital Partners II, L.P. and 61,198 shares held by
     Insight Capital Partners (Cayman) II, L.P., each of which is under common
     control with Insight Venture Partners I, L.P. Also includes 1,766,752
     shares held by Wexford Insight LLC. Pursuant to a consulting agreement
     dated as of June 1, 1996 (the "Insight Consulting Agreement") between
     Insight Venture Management Inc. and Wexford Insight LLC, Insight Venture
     Partners I, L.P. may vote all of the shares held by Wexford Insight LLC for
     certain matters until six months after the completion of this Offering. As
     a result, Insight Venture Associates, LLC and its affiliates may be deemed
     to be the beneficial owners of all of the shares held by Wexford Insight
     LLC. The address of the Insight entities is 122 East 42nd Street, Ste 2300,
     New York, New York 10168, and the address of Wexford Insight LLC 411 West
     Putnam Avenue, Suite 125, Greenwich, Connecticut 06830.
 
                                       51
56
 
 (4) Does not include 2,900,000 shares of Series A Preferred Stock which are
     eliminated upon consummation of the Offering. In addition to the number of
     shares shown as offered for sale in the table, Cyrk, Inc. intends to grant
     the Underwriters the right to purchase up to an additional 229,455 shares
     pursuant to the Underwriters' over-allotment option. The address of Cyrk,
     Inc. is 3 Pond Road, Gloucester, Massachusetts 01930.
 
 (5) In addition to the number of shares shown as offered for sale in the table,
     Grant & Partners Limited Partnership intends to grant the Underwriters the
     right to purchase up to an additional 114,750 shares pursuant to the
     Underwriters' over-allotment option. The address of Grant & Partners
     Limited Partnership is 150 Federal Street, Boston, Massachusetts 02110.
 
 (6) Includes 30,000 shares held by Smith Barney IRA f/b/o Michael Feldman. In
     addition to the number of shares shown as offered for sale in the table,
     Mr. Feldman intends to grant the Underwriters the right to purchase up to
     an additional 105,795 shares pursuant to the Underwriters' over-allotment
     option.
 
 (7) Includes 151,200 shares subject to options that currently are exercisable.
     Includes 848,800 shares of Restricted Common Stock, 141,495 shares of which
     are unvested and therefore subject to a repurchase option in favor of the
     Company.
 
 (8) Includes 75,000 shares subject to options that currently are exercisable.
 
 (9) Includes 10,000 shares subject to options that currently are exercisable.
 
(10) Includes 9,000 shares subject to options that currently are exercisable.
     Includes 100,000 shares of Restricted Common Stock which are subject to a
     repurchase option in favor of the Company.
 
(11) Includes 50,000 shares of Restricted Common Stock which are subject to a
     repurchase option in favor of the Company.
 
(12) Includes 50,000 shares of Restricted Common Stock which are subject to a
     repurchase option in favor of the Company.
 
(13) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
     shares held by Insight Capital Partners II, L.P., 61,198 shares held by
     Insight Capital Partners (Cayman) II, L.P. and 1,766,752 shares held by
     Wexford Insight LLC. Mr. Raghavendran is a managing member of Insight
     Capital Partners and as such he may be deemed to be a beneficial owner of
     all of the shares held by entities affiliated with Insight Capital
     Partners. In addition, Insight Venture Partners I, L.P., Insight Capital
     Partners II, L.P. and Insight Capital Partners (Cayman) II, L.P. may be
     deemed to be beneficial owners of all of the shares held by Wexford Insight
     LLC (see Notes 3, 4 and 5), and as a managing member of Insight Capital
     Partners, Mr. Raghavendran may be deemed to be a beneficial owner of all of
     the shares held by Wexford Insight LLC.
 
(14) The address of Mr. Raghavendran and Mr. Horing is c/o Insight Venture
     Associates, LLC, 122 East 42nd Street, Ste 2300, New York, New York 10168.
 
(15) Includes 1,209,054 shares held by Insight Venture Partners I, L.P., 520,779
     shares held by Insight Capital Partners II, L.P., 61,198 shares held by
     Insight Capital Partners (Cayman) II, L.P. and 1,766,752 shares held by
     Wexford Insight LLC. Mr. Horing is a managing member of Insight Capital
     Partners and as such he may be deemed to be a beneficial owner of all of
     the shares held by entities affiliated with Insight Capital Partners. In
     addition, Insight Venture Partners I, L.P., Insight Capital Partners II,
     L.P. and Insight Capital Partners (Cayman) II, L.P. may be deemed to be
     beneficial owners of all of the shares held by Wexford Insight LLC (see
     Notes 3, 4 and 5), and as a managing member of Insight Capital Partners,
     Mr. Horing may be deemed to be a beneficial owner of all of the shares held
     by Wexford Insight LLC.
 
(16) Does not include 20,000 shares subject to options that are not exercisable
     within 60 days of June 30, 1998.
 
                                       52
57
 
                          DESCRIPTION OF CAPITAL STOCK
 
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
 
     The authorized capital stock of the Company consists of 30,000,000 shares
of Common Stock, par value $.001 per share, and 10,000,000 shares of preferred
stock, par value $.001 per share ("Preferred Stock"). Upon consummation of the
Offering, no shares of Preferred Stock and 9,716,740 shares of Common Stock
(10,166,740 shares if the Underwriters' over-allotment option is exercised in
full) will be outstanding. The following summary is qualified in its entirety by
reference to the Company's Charter and By-laws.
 
COMMON STOCK
 
     As of June 30, 1998, there were 7,716,740 shares of Common Stock
outstanding held of record by 68 stockholders, assuming the conversion of all
shares of Convertible Preferred Stock into an aggregate of 3,779,510 shares of
Common Stock upon closing of this Offering. The holders of Common Stock are
entitled to one vote per share on all matters to be voted upon by the
stockholders. Subject to preferences that may be applicable to any outstanding
Preferred Stock, the holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by the Board out of
funds legally available therefor. In the event of liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities, subject to prior
distribution rights of Preferred Stock, if any, then outstanding. The Common
Stock has no preemptive or conversion rights or other subscription rights. There
are no redemption or sinking fund provisions applicable to the Common Stock. All
outstanding shares of Common Stock are fully paid and nonassessable, and the
shares of Common Stock offered by the Company in the Offering will, when issued,
be fully paid and nonassessable.
 
PREFERRED STOCK
 
     The Board has the authority to issue the Preferred Stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, liquidation preferences and the number of shares
constituting any series or the designation of such series, without further vote
or action by the Company's stockholders. The issuance of Preferred Stock may
have the effect of delaying, deferring or preventing a change in control of the
Company and may adversely affect the voting and other rights of the holders of
Common Stock. At present, the Company has no plans to issue any shares of
Preferred Stock.
 
CERTAIN ANTI-TAKEOVER, LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
 
  DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS
 
     The Charter provides for the division of the Board into three classes as
nearly equal in size as practicable with staggered three-year terms, effective
upon consummation of this Offering. See "Management -- Board of Directors". A
director may be removed only for cause and then only by the vote of a majority
of the shares entitled to vote for the election of directors.
 
     The Charter empowers the Board of Directors, when considering a tender
offer or merger or acquisition proposal, to take into account factors in
addition to potential economic benefits to stockholders. Such factors may
include (i) comparison of the proposed consideration to be received by
stockholders in relation to the then current market price of the Company's
capital stock, the estimated current value of the Company in a freely negotiated
transaction or the estimated future value of the Company as an independent
entity and (ii) the impact of such a transaction on the employees, suppliers and
customers of the Company and its effect on the communities in which the Company
operates.
 
                                       53
58
 
     The Charter and By-laws provide that, effective upon consummation of the
Offering, any action required or permitted to be taken by the stockholders of
the Company may be taken only at a duly called annual or special meeting of the
stockholders and that special meetings may be called only by the Chairman of the
Board, the President or a majority of the entire Board. These provisions could
have the effect of delaying until the next annual stockholders meeting
stockholder actions which are favored by the holders of a majority of the
outstanding voting securities of the Company, including actions to remove
directors. These provisions may also discourage another person or entity from
making a tender offer for the Company's Common Stock, because such person or
entity, even if it acquired all or a majority of the outstanding voting
securities of the Company, would be able to take action as a stockholder (such
as electing new directors or approving a merger) only at a duly called
stockholders meeting, and not by written consent.
 
     The Delaware General Corporation Law ("DGCL") provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless a corporation's certificate of incorporation or by-laws, as the case may
be, requires a greater percentage. The Charter requires the affirmative vote of
a majority of the entire Board and the holders of at least 66 2/3% of the
outstanding voting stock of the Company to amend or repeal any of the foregoing
Charter provisions or to reduce the number of authorized shares of Common Stock
and Preferred Stock. A 66 2/3% vote is also required to amend or repeal the
Company's By-laws. Such stockholder vote would in either case be in addition to
any separate class vote that might in the future be required pursuant to the
terms of any Preferred Stock that might be outstanding at the time any such
amendments are submitted to stockholders. The By-laws may also be amended or
repealed by a majority vote of the Board of Directors.
 
     The By-laws provide that for nominations for the Board or for other
business to be properly brought by a stockholder before an annual meeting of
stockholders, the stockholder must first have given timely notice thereof in
writing to the Secretary of the Company. To be timely, a stockholder's notice
generally must be delivered not later than 120 days in advance of the first
anniversary of the date that the Company's proxy statement to stockholders is
delivered in connection with the prior year's annual meeting of stockholders or
90 days prior to the date of the meeting if no such proxy statement was
delivered to the stockholders. The notice must contain, among other things,
certain information about the stockholder delivering the notice and, as
applicable, background information about each nominee or a description of the
proposed business to be brought before the meeting. Business transacted at a
special meeting is limited to the purposes for which the meeting is called.
 
     The foregoing provisions could have the effect of making it more difficult
for a third party to acquire, or of discouraging a third party from attempting
to acquire, control of the Company. See "Risk Factors -- Effect of Anti-takeover
Provisions".
 
     The Charter contains certain provisions permitted under the DGCL relating
to the liability of directors. These provisions eliminate a director's liability
for monetary damages for a breach of fiduciary duty, except in certain
circumstances involving certain wrongful acts, such as the breach of a
director's duty of loyalty or acts or omissions which involve intentional
misconduct or a knowing violation of law. The Charter and By-laws also contain
provisions indemnifying the directors and officers of the Company to the fullest
extend permitted by the DGCL. The Company expects to obtain, prior to the
consummation of the Offering, a directors and officers liability insurance
policy which provides for indemnification of its directors and officers against
certain liabilities incurred in their capacities as such, which may include
liabilities under the Securities Act of 1933, as amended (the "Securities Act").
The Company believes that these provisions will assist the Company in attracting
and retaining qualified individuals to serve as directors.
 
     The Company is subject to the provisions of Section 203 of the DGCL.
Subject to certain exceptions, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the interested stock-
 
                                       54
59
 
holder attained such status with the approval of the Board or unless the
business combination is approved in a prescribed manner. A "business
combination" includes certain mergers, assets sales and other transactions
resulting in a financial benefit to the interested stockholder. Subject to
certain exceptions, an "interested stockholder" is a person who, together with
his or her affiliates and associates, owns, or owned within three years prior
15% or more of the corporation's voting stock.
 
TRANSFER AGENT AND REGISTRAR
 
     The Transfer Agent and Registrar for the Common Stock is BankBoston, N.A.
 
                        SHARES ELIGIBLE FOR FUTURE SALE
 
     Upon completion of this Offering, the Company will have 9,716,740 shares of
Common Stock outstanding (assuming no exercise of the Underwriters'
over-allotment option and no exercise of outstanding options under the Company's
1996 Plan or other options after June 30, 1998). Of such shares, the 3,000,000
shares sold in this Offering will be freely transferable without restriction or
further registration under the Securities Act, except for any shares held by an
existing "affiliate" of the Company, as that term is defined by the Securities
Act (an "Affiliate"), which shares will be subject to the resale limitations of
Rule 144 adopted under the Securities Act. As of the date of this Prospectus,
7,716,740 "restricted shares" as defined in Rule 144 will be outstanding. Of
such shares, and without consideration of the contractual restrictions described
below, no shares would be available for immediate sale in the public market
without restriction pursuant to Rule 144(k). Beginning 90 days after the date of
this Prospectus, and without consideration of the contractual restrictions
described below, 939,067 shares would be eligible for sale in reliance upon Rule
144 promulgated under the Securities Act and 1,330,595 shares would be eligible
for sale in reliance upon Rule 701 promulgated under the Securities Act.
 
     In general, under Rule 144 as currently in effect, beginning 90 days after
the Offering, a person (or persons whose shares are aggregated) who owns shares
that were purchased from the Company (or any Affiliate) at least one year
previously, including a person who may be deemed an Affiliate of the Company, is
entitled to sell within any three-month period a number of shares that does not
exceed the greater of (i) 1% of the then outstanding shares of the Common Stock
(approximately 97,167 shares immediately after the Offering) or (ii) the average
weekly trading volume of the Common Stock on the Nasdaq National Market during
the four calendar weeks preceding the date on which notice of the sale is filed
with the Securities and Exchange Commission (the "Commission"). Sales under Rule
144 are also subject to certain manner of sale provisions, notice requirements
and the availability of current public information about the Company. Any person
(or persons whose shares are aggregated) who is not deemed to have been an
Affiliate of the Company at any time during the 90 days preceding a sale, and
who owns shares within the definition of "restricted securities" under Rule 144
under the Securities Act that were purchased from the Company (or any Affiliate)
at least two years previously, would be entitled to sell such shares under Rule
144(k) without regard to the volume limitations, manner of sale provisions,
public information requirements or notice requirements.
 
     Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its employees,
directors, officers, consultants or advisers prior to the date the issuer
becomes subject to the reporting requirements of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), pursuant to written compensatory benefit
plans or written contracts relating to compensation of such persons. In
addition, the Commission has indicated that Rule 701 will apply to the typical
stock options granted by an issuer before it becomes subject to the reporting
requirements of the Exchange Act, along with the shares acquired upon exercise
of such options (including exercises after the date of this Prospectus).
Securities issued in reliance on Rule 701 are restricted securities and, subject
to the contractual restrictions described above,
 
                                       55
60
 
beginning 90 days after the date of this Prospectus, may be sold (i) by persons
other than Affiliates, subject only to the manner of sale provisions of Rule
144, and (ii) by Affiliates under Rule 144 without compliance with its one-year
holding period requirement.
 
     All stockholders of the Company, including the officers, directors and
Selling Stockholders, have agreed not to sell any of their shares of Common
Stock for 180 days after the date of this Prospectus without the prior written
consent of the representatives of the Underwriters. As a result of these
contractual restrictions and subject to the provisions of Rules 144(k), 144 and
701, as applicable, 2,651,892 shares subject to restriction will be eligible for
sale upon expiration of the Lock-Up Agreements 180 days after the date of this
Prospectus. See "Underwriting".
 
     The Company has agreed not to offer, sell or otherwise dispose of any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock or any rights to acquire Common Stock for a period
of 180 days after the date of this prospectus, without the prior written consent
of the Representatives of the Underwriters, subject to certain limited
exceptions. See "Underwriting".
 
     After the Offering, the holders of 6,025,310 shares of Common Stock or
their respective transferees, would be entitled to certain rights with respect
to the registration of such shares under the Securities Act. Registration of
such shares under the Securities Act would result in such shares becoming freely
tradable without restriction under the Securities Act (except for shares
purchased by Affiliates) immediately upon the effectiveness of such
registration.
 
     The Company intends to file a registration statement under the Securities
Act covering all shares of Common Stock subject to outstanding stock options as
well as all shares of Common Stock reserved for issuance under the Company's
Stock Plans. Such registration statement is expected to be filed within 90 days
after the date of this Prospectus and will automatically become effective upon
filing. Following such filing, shares registered under such registration
statement will, subject to the Lock-Up Agreements, Rule 144 volume limitation
applicable to Affiliates and the lapsing of the Company's repurchase rights, be
available for sale in the open market upon the exercise of vested options 90
days after the effective date of this Prospectus. At July 15, 1998, options to
purchase 2,085,408 shares were issued and outstanding under the 1996 Plan and no
options were issued and outstanding outside of the 1996 Plan.
 
                                 LEGAL MATTERS
 
     The validity of the Common Stock offered hereby will be passed upon for the
Company by Bingham Dana LLP, Boston, Massachusetts. Certain legal matters in
connection with the Offering will be passed upon for the Underwriters by Ropes &
Gray, Boston, Massachusetts.
 
                                    EXPERTS
 
     The consolidated financial statements of Exchange Applications, Inc. as of
December 31, 1996 and 1997, and for each of the three years in the period ended
December 31, 1997 included in this Prospectus and Registration Statement have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto, and included herein in reliance
upon the authority of said firm as experts in giving said reports.
 
                             ADDITIONAL INFORMATION
 
     The Company has filed with the Securities and Exchange Commission (the
"Commission"), 450 Fifth Street, N.W., Washington, D.C. 20549, a Registration
Statement on Form S-1 (Reg. No. 333-01752) (the "Registration Statement") under
the Securities Act with respect to the Common Stock offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits to the Registration Statement. For further
information
                                       56
61
 
with respect to the Company and the Common Stock offered hereby, reference is
made to the Registration Statement and the exhibits filed as part of the
Registration Statement. Statements contained in this Prospectus concerning the
contents of any contract or any other document are not necessarily complete;
reference is made in each instance to the copy of such contract or any other
document filed as an exhibit to the Registration Statement. Each such statement
is qualified in all respects by such reference to such exhibit. The Registration
Statement, including exhibits thereto, may be inspected without charge at the
Commission's principal office in Washington, D.C., and copies of all or any part
thereof may be obtained from such office after payment of fees prescribed by the
Commission.
 
                                       57
62
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
                                                              ----
Report of Independent Public Accountants....................  F-2
Consolidated Balance Sheets.................................  F-3
Consolidated Statements of Operations.......................  F-4
Consolidated Statements of Stockholders' Equity (Deficit)...  F-5
Consolidated Statements of Cash Flows.......................  F-6
Notes to Consolidated Financial Statements..................  F-7
F-1
63
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors of
Exchange Applications, Inc. and subsidiaries:
 
     We have audited the accompanying consolidated balance sheets of Exchange
Applications, Inc., a Delaware corporation, and subsidiaries as of December 31,
1996 and 1997, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of 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 Exchange Applications, Inc.
and subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
 
                                          ARTHUR ANDERSEN LLP
 
Boston, Massachusetts
June 16, 1998 (Except with
respect to the matters discussed
in Note 17, as to which the
date is July 15, 1998)
 
                                       F-2
64
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
JUNE 30, 1998
                                                                 DECEMBER 31,      --------------------
                                                              ------------------              PRO FORMA
                                                               1996       1997      ACTUAL    (NOTE 3)
                                                              -------   --------   --------   ---------
                                                                                       (UNAUDITED)
ASSETS
Current assets:
  Cash and cash equivalents.................................  $   361   $  5,273   $  3,977   $  3,977
  Marketable securities.....................................       --        202        205        205
  Accounts receivable, less allowance for doubtful accounts
    of $43, $206 and $212 at December 31, 1996 and 1997 and
    June 30, 1998, respectively.............................    2,002      3,848      5,240      5,240
  Prepaid expenses and other current assets.................       --        729        727        727
                                                              -------   --------   --------   --------
         Total current assets...............................    2,363     10,052     10,149     10,149
Property and equipment, net.................................      606        913      1,627      1,627
Software development costs, net.............................    1,211         --         --         --
Other assets................................................        9        435        358        358
                                                              -------   --------   --------   --------
         Total assets.......................................  $ 4,189   $ 11,400   $ 12,134   $ 12,134
                                                              =======   ========   ========   ========
 
                            LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
  Current portion of obligations under capital leases.......  $    22   $    212   $    232   $    232
  Current portion of notes payable to related parties.......    1,000         --         --         --
  Accounts payable..........................................      535        422      1,234      1,234
  Accrued expenses..........................................    1,313      3,247      3,445      3,445
  Deferred revenue..........................................      346        922      1,723      1,723
                                                              -------   --------   --------   --------
         Total current liabilities..........................    3,216      4,803      6,634      6,634
Obligations under capital leases, net of current portion....       34        237        128        128
Notes payable to related parties, net of current portion....    2,234         --         --         --
Commitments (Note 9)
Redeemable Preferred Stock (Notes 10 and 11)................       --      7,088      7,208         --
Stockholders' equity (deficit):
  Preferred Stock; $.001 par value --
    10,000,000 shares authorized; 2,300,000 shares issued
    and outstanding at December 31, 1996....................        2         --         --         --
  Series C Preferred Stock, $.001 par value --
    1,223,954 shares designated, issued and outstanding at
    December 31, 1997 and June 30, 1998, actual.............       --          1          1         --
  Common Stock, $.001 par value --
    12,078,698 shares authorized; 2,484,375, 4,234,971,
    4,298,305 shares issued at December 31, 1996 and 1997
    and June 30, 1998, actual, respectively, and 8,077,815
    shares issued on a pro forma basis at June 30, 1998.....        2          4          4          8
  Additional paid-in capital................................      868      4,837      4,878     12,083
  Accumulated deficit.......................................   (2,167)    (5,450)    (6,649)    (6,649)
  Due from officer..........................................       --       (125)      (125)      (125)
  Cumulative translation adjustment.........................       --          2         50         50
  Unrealized gain on marketable securities..................       --          3          5          5
  Treasury stock, at cost; 354,825 shares at December 31,
    1997 and 361,075 shares at June 30, 1998, actual and pro
    forma...................................................       --         --         --         --
                                                              -------   --------   --------   --------
         Total stockholders' equity (deficit)...............   (1,295)      (728)    (1,836)     5,372
                                                              -------   --------   --------   --------
         Total liabilities and stockholders' equity
           (deficit)........................................  $ 4,189   $ 11,400   $ 12,134   $ 12,134
                                                              =======   ========   ========   ========
The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       F-3
65
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
               (IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
YEARS ENDED                    SIX MONTHS ENDED
                                                     DECEMBER 31,                       JUNE 30,
                                        --------------------------------------   -----------------------
                                           1995          1996          1997         1997         1998
                                        ----------   ------------   ----------   ----------   ----------
                                         (NOTE 1)      (NOTE 1)                        (UNAUDITED)
Revenues:
  Software license fees...............  $       --    $    1,500    $    5,765   $    1,793   $    5,816
  Services and maintenance............       1,693         4,534         6,904        3,029        4,602
                                        ----------    ----------    ----------   ----------   ----------
         Total revenues...............       1,693         6,034        12,669        4,822       10,418
Cost of revenues:
  Software license fees...............          --           890         1,707          863          129
  Services and maintenance............       1,012         3,205         5,227        2,297        3,302
                                        ----------    ----------    ----------   ----------   ----------
         Total cost of revenues.......       1,012         4,095         6,934        3,160        3,431
                                        ----------    ----------    ----------   ----------   ----------
Gross profit..........................         681         1,939         5,735        1,662        6,987
Operating expenses:
  Sales and marketing.................         128         1,007         3,602        1,268        4,163
  Research and development............         708         1,325         2,599        1,031        2,716
  General and administrative..........         352         1,018         2,158          813        1,216
                                        ----------    ----------    ----------   ----------   ----------
         Total operating expenses.....       1,188         3,350         8,359        3,112        8,095
                                        ----------    ----------    ----------   ----------   ----------
Loss from operations..................        (507)       (1,411)       (2,624)      (1,450)      (1,108)
Interest income (expense):
  Interest income.....................          --             2            89           39           56
  Interest expense....................         (47)         (197)          (64)         (49)         (27)
                                        ----------    ----------    ----------   ----------   ----------
         Total interest income
           (expense)..................         (47)         (195)           25          (10)          29
                                        ----------    ----------    ----------   ----------   ----------
Net loss..............................        (554)       (1,606)       (2,599)      (1,460)      (1,079)
Accretion of discount and dividends on
  preferred stock.....................          --            --          (684)        (565)        (120)
                                        ----------    ----------    ----------   ----------   ----------
Net loss applicable to common
  stockholders........................  $     (554)   $   (1,606)   $   (3,283)  $   (2,025)  $   (1,199)
                                        ==========    ==========    ==========   ==========   ==========
Net loss per share (Note 2(c)):
  Basic and diluted net loss per share
    applicable to common
    stockholders......................  $    (0.46)   $    (1.33)   $    (1.12)  $    (0.82)  $    (0.33)
                                        ==========    ==========    ==========   ==========   ==========
  Basic and diluted weighted average
    common shares outstanding.........   1,200,016     1,205,041     2,919,775    2,477,683    3,597,711
                                        ==========    ==========    ==========   ==========   ==========
Pro forma net loss per share (Note
  2(c)):
  Pro forma basic and diluted net loss
    per share.........................  $    (0.19)   $    (0.55)   $    (0.48)  $    (0.31)  $    (0.15)
                                        ==========    ==========    ==========   ==========   ==========
  Pro forma basic and diluted
    weighted average common shares
    outstanding.......................   2,925,016     2,930,041     5,390,779    4,682,560    7,377,221
                                        ==========    ==========    ==========   ==========   ==========
The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                       F-4
66
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
SERIES C
                                                                          PREFERRED STOCK          PREFERRED STOCK
                                                          NET PARENT   ----------------------   ----------------------
                                                           COMPANY     NUMBER OF      $.001     NUMBER OF      $.001
                                                          INVESTMENT     SHARES     PAR VALUE     SHARES     PAR VALUE
                                                          ----------   ---------    ---------   ---------    ---------
Balance, January 1, 1995................................   $    (7)            --      $--              --      $--
 Net loss...............................................      (554)            --       --              --       --
 Comprehensive net loss for the year ended December 31,
   1995.................................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, December 31, 1995..............................      (561)            --       --              --       --
 Net loss prior to incorporation of the Company.........    (2,093)            --       --              --       --
 Capitalization of the Company..........................     2,654             --       --              --       --
 Issuance of Preferred Stock............................        --      2,300,000        2              --       --
 Issuance of common stock...............................        --             --       --              --       --
 Net income after incorporation of the Company..........        --             --       --              --       --
 Comprehensive net loss for the year ended December 31,
   1996.................................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, December 31, 1996..............................        --      2,300,000        2              --       --
 Issuance costs relating to the sale of Series B
   Preferred Stock......................................        --             --       --              --       --
 Conversion of Preferred Stock to common stock..........        --     (2,300,000)      (2)             --       --
 Compensation expense relating to stock options.........        --             --       --              --       --
 Sale of Series C Preferred Stock, net of issuance costs
   of $13...............................................        --             --       --       1,223,954        1
 Accretion of discount and dividends on Series A
   Preferred Stock......................................        --             --       --              --       --
 Loan to officer........................................        --             --       --              --       --
 Issuance of common stock...............................        --             --       --              --       --
 Exercise of common stock options.......................        --             --       --              --       --
 Cumulative translation adjustment......................        --             --       --              --       --
 Unrealized gain on marketable securities...............        --             --       --              --       --
 Net loss...............................................        --             --       --              --       --
 Comprehensive net loss for the year ended December 31,
   1997.................................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, December 31, 1997..............................        --             --       --       1,223,954        1
 Accretion of dividends on Series A Preferred Stock.....        --             --       --              --       --
 Exercise of common stock options.......................        --             --       --              --       --
 Cumulative translation adjustment......................        --             --       --              --       --
 Unrealized gain on marketable securities...............        --             --       --              --       --
 Net loss...............................................        --             --       --              --       --
 Comprehensive net loss for the six months ended June
   30, 1998.............................................        --             --       --              --       --
                                                           -------     ----------      ---      ----------      ---
Balance, June 30, 1998 (unaudited)......................        --             --       --       1,223,954        1
 Cancellation of Series A Preferred Stock...............        --             --       --              --       --
 Conversion of Series B Preferred Stock to common
   stock................................................        --             --       --              --       --
 Conversion of Series C Preferred Stock to common
   stock................................................        --             --       --      (1,223,954)      (1)
                                                           -------     ----------      ---      ----------      ---
Pro Forma Balance, June 30, 1998 (unaudited) (Note 3)...   $    --             --      $--              --      $--
                                                           =======     ==========      ===      ==========      ===
COMMON STOCK
                                                          ---------------------   ADDITIONAL                            CUMULATIVE
                                                          NUMBER OF     $.001      PAID-IN     ACCUMULATED   DUE FROM   TRANSLATION
                                                           SHARES     PAR VALUE    CAPITAL       DEFICIT     OFFICER    ADJUSTMENT
                                                          ---------   ---------   ----------   -----------   --------   -----------
Balance, January 1, 1995................................        --       $--       $    --       $    --      $  --        $--
 Net loss...............................................        --       --             --            --         --         --
 Comprehensive net loss for the year ended December 31,
   1995.................................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, December 31, 1995..............................        --       --             --            --         --         --
 Net loss prior to incorporation of the Company.........        --       --             --            --         --         --
 Capitalization of the Company..........................        --       --             --        (2,654)        --         --
 Issuance of Preferred Stock............................        --       --            868            --         --         --
 Issuance of common stock...............................  2,484,375       2             --            --         --         --
 Net income after incorporation of the Company..........        --       --             --           487         --         --
 Comprehensive net loss for the year ended December 31,
   1996.................................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, December 31, 1996..............................  2,484,375       2            868        (2,167)        --         --
 Issuance costs relating to the sale of Series B
   Preferred Stock......................................        --       --           (111)           --         --         --
 Conversion of Preferred Stock to common stock..........  1,725,000       2             --            --         --         --
 Compensation expense relating to stock options.........        --       --             77            --         --         --
 Sale of Series C Preferred Stock, net of issuance costs
   of $13...............................................        --       --          3,986            --         --         --
 Accretion of discount and dividends on Series A
   Preferred Stock......................................        --       --             --          (684)        --         --
 Loan to officer........................................        --       --             --            --       (125)        --
 Issuance of common stock...............................    15,500       --             10            --         --         --
 Exercise of common stock options.......................    10,096       --              7            --         --         --
 Cumulative translation adjustment......................        --       --             --            --         --          2
 Unrealized gain on marketable securities...............        --       --             --            --         --         --
 Net loss...............................................        --       --             --        (2,599)        --         --
 Comprehensive net loss for the year ended December 31,
   1997.................................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, December 31, 1997..............................  4,234,971       4          4,837       $(5,450)      (125)         2
 Accretion of dividends on Series A Preferred Stock.....        --       --             --          (120)        --         --
 Exercise of common stock options.......................    63,334       --             41            --         --         --
 Cumulative translation adjustment......................        --       --             --            --         --         48
 Unrealized gain on marketable securities...............        --       --             --            --         --         --
 Net loss...............................................        --       --             --        (1,079)        --         --
 Comprehensive net loss for the six months ended June
   30, 1998.............................................        --       --             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Balance, June 30, 1998 (unaudited)......................  4,298,305       4          4,878        (6,649)      (125)        50
 Cancellation of Series A Preferred Stock...............        --       --          3,209            --         --         --
 Conversion of Series B Preferred Stock to common
   stock................................................  2,555,556       3          3,996            --         --         --
 Conversion of Series C Preferred Stock to common
   stock................................................  1,223,954       1             --            --         --         --
                                                          ---------      --        -------       -------      -----         --
Pro Forma Balance, June 30, 1998 (unaudited) (Note 3)...  8,077,815      $8        $12,083       $(6,649)     $(125)       $50
                                                          =========      ==        =======       =======      =====        ===
UNREALIZED
                                                           GAIN ON
                                                          MARKETABLE             COMPREHENSIVE
                                                          SECURITIES    TOTAL    INCOME (LOSS)
                                                          ----------   -------   -------------
Balance, January 1, 1995................................      $--      $    (7)     $    --
 Net loss...............................................      --          (554)        (554)
                                                                                    -------
 Comprehensive net loss for the year ended December 31,
   1995.................................................      --            --      $  (554)
                                                              --       -------      =======
Balance, December 31, 1995..............................      --          (561)
 Net loss prior to incorporation of the Company.........      --        (2,093)     $(2,093)
 Capitalization of the Company..........................      --            --
 Issuance of Preferred Stock............................      --           870
 Issuance of common stock...............................      --             2
 Net income after incorporation of the Company..........      --           487          487
                                                                                    -------
 Comprehensive net loss for the year ended December 31,
   1996.................................................      --            --      $(1,606)
                                                              --       -------      =======
Balance, December 31, 1996..............................      --        (1,295)
 Issuance costs relating to the sale of Series B
   Preferred Stock......................................      --          (111)
 Conversion of Preferred Stock to common stock..........      --            --
 Compensation expense relating to stock options.........      --            77
 Sale of Series C Preferred Stock, net of issuance costs
   of $13...............................................      --         3,987
 Accretion of discount and dividends on Series A
   Preferred Stock......................................      --          (684)
 Loan to officer........................................      --          (125)
 Issuance of common stock...............................      --            10
 Exercise of common stock options.......................      --             7
 Cumulative translation adjustment......................      --             2      $     2
 Unrealized gain on marketable securities...............       3             3            3
 Net loss...............................................      --        (2,599)      (2,599)
                                                                                    -------
 Comprehensive net loss for the year ended December 31,
   1997.................................................      --            --      $(2,594)
                                                              --       -------      =======
Balance, December 31, 1997..............................       3          (728)
 Accretion of dividends on Series A Preferred Stock.....      --          (120)
 Exercise of common stock options.......................      --            41
 Cumulative translation adjustment......................      --            48      $    48
 Unrealized gain on marketable securities...............       2             2            2
 Net loss...............................................      --        (1,079)      (1,079)
                                                                                    -------
 Comprehensive net loss for the six months ended June
   30, 1998.............................................      --            --      $(1,029)
                                                              --       -------      =======
Balance, June 30, 1998 (unaudited)......................       5        (1,836)
 Cancellation of Series A Preferred Stock...............      --         3,209
 Conversion of Series B Preferred Stock to common
   stock................................................      --         3,999
 Conversion of Series C Preferred Stock to common
   stock................................................      --            --
                                                              --       -------
Pro Forma Balance, June 30, 1998 (unaudited) (Note 3)...      $5       $ 5,372
                                                              ==       =======
The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-5
67
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
SIX MONTHS
                                                                      YEARS ENDED                 ENDED
                                                                     DECEMBER 31,               JUNE 30,
                                                              ---------------------------   -----------------
                                                               1995      1996      1997      1997      1998
                                                              -------   -------   -------   -------   -------
                                                                                               (UNAUDITED)
Cash flows from operating activities:
  Net loss..................................................  $  (554)  $(1,606)  $(2,599)  $(1,460)  $(1,079)
  Adjustments to reconcile net loss to net cash provided by
    (used in) operating activities --
  Amortization of software development costs................       --       712     1,211       641        --
  Depreciation and other amortization.......................       49       176       275        99       228
  Noncash compensation expense..............................       --        --        77        36        --
  Changes in operating assets and liabilities --
    Accounts receivable.....................................     (452)   (1,549)   (1,846)       (5)   (1,392)
    Prepaid expenses and other current assets...............       --        --      (476)     (232)        2
    Accounts payable........................................      150       385      (113)     (296)      812
    Accrued expenses........................................      525       872     2,105       181       198
    Deferred revenue........................................      418       (72)      576       (54)      802
                                                              -------   -------   -------   -------   -------
        Net cash provided by (used in) operating
          activities........................................      136    (1,082)     (790)   (1,090)     (429)
                                                              -------   -------   -------   -------   -------
Cash flows from investing activities:
  Purchase of marketable securities.........................       --        --      (200)       --        --
  Purchases of property and equipment.......................     (303)     (441)     (102)     (102)     (923)
  Increase in software development costs....................   (1,107)     (703)       --        --        --
  Increase (decrease) in other assets.......................       (6)       (3)     (679)     (599)       77
                                                              -------   -------   -------   -------   -------
        Net cash used in investing activities...............   (1,416)   (1,147)     (981)     (701)     (846)
                                                              -------   -------   -------   -------   -------
Cash flows from financing activities:
  Proceeds from notes payable to related parties............    1,800     2,100        --        --        --
  Payments of notes payable to related parties..............       --        --    (1,000)   (1,000)       --
  Repayments under capital leases...........................      (20)      (12)      (86)      (10)     (110)
  Due from officer..........................................       --        --      (125)       --        --
  Exercise of common stock options..........................       --        --         7        --        41
  Issuance of common stock..................................       --         2        10        --        --
  Issuance of Series B Preferred Stock, net of offering
    costs...................................................       --        --     3,888     3,888        --
  Issuance of Series C Preferred Stock, net of offering
    costs...................................................       --        --     3,987        --        --
                                                              -------   -------   -------   -------   -------
        Net cash provided by financing (used in)
          activities........................................    1,780     2,090     6,681     2,878       (69)
                                                              -------   -------   -------   -------   -------
Effect of exchange rate changes on cash and cash
  equivalents...............................................       --        --         2        --        48
                                                              -------   -------   -------   -------   -------
Net increase (decrease) in cash and cash equivalents........      500      (139)    4,912     1,087    (1,296)
                                                              -------   -------   -------   -------   -------
Cash and cash equivalents, beginning of period..............       --       500       361       361     5,273
                                                              -------   -------   -------   -------   -------
Cash and cash equivalents, end of period....................  $   500   $   361   $ 5,273   $ 1,448   $ 3,977
                                                              =======   =======   =======   =======   =======
Supplemental disclosure of cash flow information --
  Cash paid for interest....................................  $    35   $   155   $    19   $     4   $    13
                                                              =======   =======   =======   =======   =======
  Cash paid for income taxes................................  $    --   $    --   $   476   $   198   $    --
                                                              =======   =======   =======   =======   =======
Supplemental disclosure of noncash financing and investing
  activities:
  Equipment acquired under capital leases...................  $    81   $    35   $   479   $   186   $    20
                                                              =======   =======   =======   =======   =======
  Conversion of amounts due to a related party to Preferred
    Stock...................................................  $    --   $   870   $    --   $    --   $    --
                                                              =======   =======   =======   =======   =======
  Conversion of Preferred Stock to common stock.............  $    --   $    --   $     2   $     2   $    --
                                                              =======   =======   =======   =======   =======
  Conversion of notes payable to related parties to Series A
    Preferred Stock.........................................  $    --   $    --   $ 2,405   $ 2,405   $    --
                                                              =======   =======   =======   =======   =======
  Accretion of discount and dividends on preferred stock....  $    --   $    --   $   684   $   565   $   120
                                                              =======   =======   =======   =======   =======
The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-6
68
 
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(1)  BACKGROUND AND BASIS OF PRESENTATION
 
     Exchange Applications, Inc. and its subsidiaries (the "Company") is a
leading provider of customer optimization software and solutions that enable
businesses to maximize the economic value of their customers. The Company's
Continuous Customer Management ("CCM") solution, including its VALEX software
and related consulting and integration services, enables businesses to retain
and expand existing profitable customer relationships and to acquire new
customers by: (i) analyzing enterprise-wide databases of customer information;
(ii) identifying and prioritizing opportunities; (iii) creating customized
streams of targeted, real-time, event-triggered customer communications, such as
special offers, follow-up communications, special discounts, new products or
service offerings and other marketing campaigns; (iv) selecting the most
effective channels through which to communicate with customers, such as direct
mail, call centers, the Internet and sales forces; and (v) continuously
evaluating the impact of individual and collective customer communications on
marketing strategies and customer profitability.
 
     The Company was incorporated in Delaware on November 7, 1996. Prior to
incorporation, the Company operated as a division of two entities, Grant &
Partners, Inc. ("GPI") and Grant & Partners L.P. ("GPLP").
 
     GPI was incorporated in June 1993 and was primarily engaged in providing
management consulting services. In November 1994, the Company began operations
when it acquired the rights to certain intellectual property and hired employees
to commence the development of the VALEX software product.
 
     On March 28, 1995, GPI entered into a limited partnership agreement with
Cyrk, Inc. ("Cyrk") to form GPLP. GPI, as the general partner, contributed all
of its assets and liabilities to GPLP for a 50% limited partnership interest.
Cyrk purchased the remaining 50% limited partnership interest in GPLP. Upon
entering into the partnership agreement, GPI became a holding company, with no
substantial operations.
 
     GPLP was established to provide marketing and customer management services
for companies in a wide range of industries including retailing, transportation,
banking and manufacturing. GPLP operated as two separate divisions, Exchange
Applications ("EA") and Exchange Partners ("EP"). EA's focus was marketing
program design and execution and customer database and technology development.
EP's focus was providing a variety of management consulting services for
marketing organizations.
 
     On November 15, 1996, the Company and GPLP entered into an assignment and
assumption agreement whereby GPLP contributed EA to the Company in exchange for
2,300,000 shares of preferred stock ("Preferred Stock") of the Company. In
addition, the Company issued 2,484,375 shares of common stock to certain
employees. The Preferred Stock held by GPLP contained voting rights equal to two
votes for each share of common stock into which the Preferred Stock would
convert. As a result, GPLP held approximately 70% of the voting rights of the
Company, thereby retaining a controlling interest over the Company.
 
     In March 1997, the Company restructured its ownership interests through the
conversion of the 2,300,000 shares of Preferred Stock into 1,725,000 shares of
common stock, the conversion of notes payable to related parties (Cyrk and GPLP)
into 2,900,000 shares of Series A redeemable preferred stock ("Series A
Preferred Stock") (see Note 10), the payment of $1,000,000 to discharge certain
indebtedness to Cyrk, and the sale of 2,555,556 shares of Series B redeemable
convertible preferred stock ("Series B Preferred Stock") to venture capital
investors. As a result of the issuance of Series B Preferred Stock, GPLP and
Cyrk's ownership of the Company decreased

                                       F-7
69
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
to approximately 11% and 38%, respectively, on an as-converted basis.
Accordingly, neither GPLP nor Cyrk retained a controlling interest in the
Company.
 
     The accompanying consolidated financial statements prior to the formation
of the Company represent the financial results of the EA division as included in
the consolidated financial statements of GPI from January 1, 1995 to March 27,
1995 and of GPLP from March 28, 1995 to November 14, 1996.
 
     General corporate overhead costs related to corporate headquarters and
shared administrative support were allocated by GPI and GPLP to EA based on a
number of factors, including, for example, personnel and space utilized.
Management believes these allocations were reasonable and the costs of the
services charged to the Company were not materially different from the costs
that would have been incurred if the Company had performed these functions as a
standalone entity.
 
(2)  SIGNIFICANT ACCOUNTING POLICIES
 
     The accompanying consolidated financial statements reflect the application
of certain significant accounting policies as described in this note and
elsewhere in the accompanying consolidated financial statements and notes.
 
  (a) PRINCIPLES OF CONSOLIDATION
 
          The accompanying consolidated financial statements include the
     accounts of the Company and its wholly owned subsidiaries. All significant
     intercompany balances have been eliminated in consolidation.
 
  (b) INTERIM FINANCIAL STATEMENTS
 
          The accompanying consolidated financial statements as of June 30, 1997
     and 1998 are unaudited but, in the opinion of management, include all
     adjustments, consisting only of normal recurring adjustments, necessary for
     a fair presentation of results of operations for the interim period.
     Certain financial information and footnote disclosures normally included in
     financial statements prepared in accordance with generally accepted
     accounting principles have been omitted with respect to the six-month
     periods, although the Company believes that the disclosures included are
     adequate to make the information presented not misleading. The results for
     the six months ended June 30, 1998 are not necessarily indicative of the
     results that may be expected for the entire year.
 
  (c) NET LOSS PER SHARE
 
          In accordance with Statement of Financial Accounting Standards
     ("SFAS") No. 128, Earnings per Share, basic and diluted net loss per common
     share is calculated by dividing the net loss applicable to common
     stockholders by the weighted average number of vested common shares
     outstanding (See Note 12(b)) for all periods presented. For the year ended
     December 31, 1995 and for the period from January 1, 1996 to November 14,
     1996 (representing the period prior to the Company's incorporation), the
     calculation of basic and diluted net loss per share applicable to common
     stockholders includes the number of shares of common stock that were vested
     upon issuance (November 15, 1996) as if those shares had been outstanding
     for the entire period. Pro forma basic and diluted net loss per share is
     calculated by dividing net loss by the weighted average number of vested
     shares of common stock and preferred stock, on an as-converted basis,
     outstanding during the period. For the years ended
 
                                       F-8
70
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     December 31, 1995 and for the period from January 1, 1996 to November 14,
     1996 (representing the period prior to the Company's formation), the
     calculation of pro forma net loss per share includes 1,725,000 shares of
     common stock issued in March 1997 upon the conversion of the 2,300,000
     shares of Preferred Stock that were issued on November 15, 1996 (See Note
     10) as if those shares had been outstanding for the entire period.
 
          The Company has applied the provisions of SFAS No. 128 retroactively
     to all periods presented. In accordance with Securities and Exchange
     Commission ("SEC") Staff Accounting Bulletin ("SAB") No. 98, the Company
     has determined that there were no nominal issuances of potential common
     stock in the twelve months prior to the Company's planned initial public
     offering. The dilutive effect of potential common shares, consisting of
     outstanding stock options and convertible preferred stock, is determined
     using the treasury stock method and the as-converted method, respectively,
     in accordance with SFAS No. 128. The following table reconciles the
     weighted average common shares outstanding to the shares used in the
     computation of basic and diluted and pro forma basic and diluted weighted
     average common shares outstanding:
SIX MONTHS ENDED
                                   YEARS ENDED DECEMBER 31,              JUNE 30,
                               ---------------------------------   ---------------------
                                 1995        1996        1997        1997        1998
                               ---------   ---------   ---------   ---------   ---------
Weighted average common
  shares outstanding.........  2,484,375   2,484,375   3,575,244   3,283,947   3,889,609
Less: Weighted average
  unvested common shares
  outstanding................  1,284,359   1,279,334     655,469     806,264     291,898
                               ---------   ---------   ---------   ---------   ---------
Basic and diluted weighted
  average common shares
  outstanding................  1,200,016   1,205,041   2,919,775   2,477,683   3,597,711
                               ---------   ---------   ---------   ---------   ---------
Add: Weighted average common
  shares issuable upon
  conversion of preferred
  stock......................  1,725,000   1,725,000   2,471,004   2,204,877   3,779,510
                               ---------   ---------   ---------   ---------   ---------
Pro forma basic and diluted
  weighted average common
  shares outstanding.........  2,925,016   2,930,041   5,390,779   4,682,560   7,377,221
                               =========   =========   =========   =========   =========
Diluted weighted average shares outstanding for all periods presented
     exclude the potential common shares from stock options, unvested common
     stock and convertible preferred stock, because to include such shares would
     have been antidilutive. As of December 31, 1996 and 1997, and June 30,
     1998, 3,004,334, 5,598,003 and 5,886,927 potential common shares were
     outstanding, respectively.
 
  (d) CASH EQUIVALENTS AND MARKETABLE SECURITIES
 
          The Company accounts for cash equivalents and marketable securities in
     accordance with SFAS No. 115, Accounting for Certain Investments in Debt
     and Equity Securities. Cash equivalents are short-term, highly liquid
     investments with original maturity dates of three months or less. Cash
     equivalents are carried at cost, which approximates fair market value. The
     Company's marketable securities are classified as available-for-sale and
     are recorded at fair value with any unrealized gain or loss recorded as an
     element of stockholders' equity (deficit).
 

                                       F-9
71
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     As of December 31, 1997 and June 30, 1998, the Company's marketable
     securities consisted of investment-grade corporate bonds. As of December
     31, 1997 and June 30, 1998, the Company had recorded unrealized gains of
     approximately $3,000 and $5,000, respectively.
 
  (e) LONG-LIVED ASSETS
 
          In accordance with the provisions of SFAS No. 121, Accounting for
     Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed
     Of, the Company evaluates the realizability of its long-lived assets at
     each reporting period based on projected future cash flows. As of December
     31, 1996 and 1997 and June 30, 1998, the Company has determined that no
     material adjustment was required to the carrying value of its long-lived
     assets.
 
  (f) SOFTWARE DEVELOPMENT COSTS
 
          The Company's VALEX software is highly technical and required a
     significant engineering and development effort. In accordance with SFAS No.
     86, Accounting for the Costs of Computer Software To Be Sold, Leased or
     Otherwise Marketed, during 1994, 1995 and 1996, the Company capitalized
     certain software development costs relating to VALEX incurred from the date
     technological feasibility of the software development project had been
     established through June 1996. These costs were amortized over an estimated
     useful life of 18 months commencing with the general availability of the
     product in July 1996. For the years ended December 31, 1995, 1996 and 1997
     and the six months ended June 30, 1997, the Company charged approximately
     $0, $712,000, $1,211,000 and $641,000, respectively, to cost of software
     license fee revenues for the amortization of these costs. As of December
     31, 1997, capitalized software development costs were fully amortized.
 
          The software development costs incurred subsequent to the commercial
     release of VALEX were primarily related to product enhancements and product
     maintenance. Consequently, software development costs that would otherwise
     be capitalized were not material and, therefore, were expensed as incurred.
 
  (g) INCOME TAXES
 
          The Company accounts for income taxes in accordance with the
     provisions of SFAS No. 109, Accounting for Income Taxes. This statement
     requires the Company to recognize a current tax liability or asset for
     current taxes payable or refundable and to record a deferred tax asset or
     liability for the estimated future tax effects of temporary differences and
     carryforwards to the extent they are realizable. A deferred tax provision
     or benefit results from the net change in deferred tax assets and
     liabilities during the year. A deferred tax valuation allowance is required
     if it is "more likely than not" that all or a portion of recorded deferred
     tax assets will not be realized.
 
  (h) FINANCIAL INSTRUMENTS
 
          SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
     requires disclosures about the fair value of financial instruments.
     Financial instruments consist principally of cash equivalents, marketable
     securities, accounts receivable, accounts payable, notes payable to related
     parties and redeemable preferred stock. The estimated fair value of these
     financial instruments approximates their carrying value.
 
                                      F-10
72
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
  (i) CONCENTRATION OF CREDIT RISK
 
          SFAS No. 105, Disclosure of Information About Financial Instruments
     with Off-Balance-Sheet Risk and Financial Instruments with Concentrations
     of Credit Risk, requires disclosure of any significant off-balance-sheet
     and credit risk concentrations. The Company has no significant
     off-balance-sheet concentration of credit risk such as foreign exchange
     contracts, option contracts or other foreign hedging arrangements.
     Financial instruments that potentially subject the Company to
     concentrations of credit risk are principally cash equivalents, marketable
     securities and accounts receivable. Concentration of credit risk with
     respect to accounts receivable is limited to certain customers to whom the
     Company makes substantial sales. The Company performs periodic credit
     evaluations of its customers and has recorded allowances for estimated
     losses.
 
          The following table summarizes the number of customers that
     individually comprise greater than 10% of total revenue and/or total
     accounts receivable and their aggregate percentage of the Company's total
     revenues and accounts receivable.
REVENUE              ACCOUNTS RECEIVABLE
                                               -----------------------    ------------------------
                                                            PERCENT OF                 PERCENT OF
                                               NUMBER OF      TOTAL       NUMBER OF    TOTAL TRADE
                                               CUSTOMERS     REVENUE      CUSTOMERS    RECEIVABLES
                                               ---------    ----------    ---------    -----------
Year Ended --
      December 31, 1995......................      4            78%           3            48%
      December 31, 1996......................      3            41            4            74
      December 31, 1997......................      2            56            2            66
    Six Months Ended --
      June 30, 1997..........................      3            76            3            86
      June 30, 1998..........................      3            41            2            28
(j) FOREIGN CURRENCY
 
          The functional currencies of the Company's wholly owned subsidiaries
     in the United Kingdom and Australia are the local currencies. The financial
     statements of the subsidiaries are translated to United States dollars
     using period-end exchange rates for assets and liabilities and average
     exchange rates during the corresponding period for revenues, cost of
     revenues and expenses. Translation gains and losses are deferred and
     accumulated as a component of stockholders' equity (deficit). Net gains and
     losses resulting from foreign exchange transactions are included in the
     consolidated statements of operations and were not significant during the
     periods presented.
 
  (k) REVENUE RECOGNITION
 
          The Company generates revenue from licensing the rights to use its
     software to end users and certain re-sellers. The Company also generates
     service and maintenance revenues from integrating its software with its
     customers' operating environments, the sale of maintenance services and the
     sale of certain other consulting and development services.
 
          The Company has recognized revenue in accordance with the provisions
     of Statement of Position ("SOP") No. 91-1, Software Revenue Recognition. In
     October 1997, the American Institute of Certified Public Accountants
     ("AICPA") issued SOP 97-2, Software Revenue Recognition, which supercedes
     SOP 91-1 and is effective for transactions entered into for fiscal
 
                                      F-11
73
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     years beginning after December 15, 1997. The Company adopted the provisions
     of SOP 97-2 for the year ended December 31, 1997. The adoption of this
     statement did not have a material impact on the Company's results of
     operations or financial position.
 
          Revenues from software license fee agreements are recognized upon
     execution of a license agreement and delivery of the software, provided
     that the fee is fixed or determinable and deemed collectible by management.
     If conditions for acceptance are required subsequent to delivery, revenues
     are recognized upon customer acceptance. Revenues from software maintenance
     agreements are recognized ratably over the term of the maintenance period,
     which is typically one year. Revenues from professional service
     arrangements are recognized on either a time and materials or
     percentage-of-completion basis as the services are performed, provided that
     amounts due from customers are fixed or determinable and deemed collectible
     by management. Amounts collected or billed prior to satisfying the above
     revenue recognition criteria are reflected as deferred revenue or as
     customer deposits.
 
          Cost of software license fee revenues consists of costs to distribute
     the product, including the cost of the media on which it is delivered and
     royalty payments to third party vendors, as well as the amortization of
     software development costs. Cost of service and maintenance revenues
     consists primarily of consulting and support personnel salaries and related
     costs.
 
  (l) ACCOUNTING FOR STOCK-BASED COMPENSATION
 
          In 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based
     Compensation. As permitted by SFAS No. 123, the Company has continued to
     account for employee stock options in accordance with Accounting Principles
     Board Opinion No. 25, Accounting for Stock Issued to Employees, and has
     included the pro forma disclosures required by SFAS No. 123 for all periods
     presented.
 
  (m) NEW ACCOUNTING STANDARDS
 
          In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of
     Start-Up Activities, which requires that all nongovernmental entities
     expense the costs of start-up activities, including organizational costs,
     as those costs are incurred. The Company has historically recorded all such
     costs as expense, in the period incurred.
 
          In June 1997, the Financial Accounting Standards Board ("FASB") issued
     SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires
     disclosure of all components of comprehensive income on an annual and
     interim basis. Comprehensive income is defined as the change in
     stockholders' equity (deficit) of a business enterprise during a period
     from transactions and other events and circumstances from nonowner sources.
     The Company adopted SFAS No. 130, effective January 1, 1998, and has
     disclosed comprehensive income (loss) for all periods presented in the
     accompanying consolidated statements of stockholders' equity (deficit).
 
          In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments
     of an Enterprise and Related Information. SFAS No. 131 requires certain
     financial and supplementary information to be disclosed on an annual and
     interim basis for each reportable segment of an enterprise. SFAS No. 131 is
     effective for fiscal years beginning after December 15, 1997. Unless
     impracticable, companies would be required to restate prior period
     information upon adoption. The Company does not believe the adoption of
     this accounting pronouncement will have a significant impact on the
     Company's financial statements.
 
                                      F-12
74
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
  (n) POSTRETIREMENT BENEFITS
 
          The Company has no obligations for postretirement benefits.
 
  (o) 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, the
     disclosure of contingent assets and liabilities at the date of the
     financial statements, and the reported amounts of revenues and expenses
     during the reporting periods. Actual results could differ from those
     estimates.
 
(3)  PRO FORMA CONVERSION AND RETIREMENT OF PREFERRED STOCK
 
     On July 15, 1998, the Board of Directors of the Company authorized
management to pursue an initial public offering ("IPO") of the Company's common
stock. Upon closing of the Company's proposed IPO, all of the Company's Series B
and C Preferred Stock will automatically convert into 3,779,510 shares of common
stock. In addition, based on the terms of the redemption preference of the
Series A Preferred Stock, Series A Preferred Stock will be cancelled and the
Company will not be required to pay the redemption preference of $3,209,000. As
a result, such amount will be reclassified to additional paid-in capital (see
Note 10). The pro forma effect of the conversion and cancellation of the
preferred stock on stockholders' equity (deficit) has been presented separately
in the Company's accompanying consolidated balance sheets and consolidated
statements of stockholders' equity (deficit) and Note 11, assuming the
conversion and cancellation had occurred as of June 30, 1998.
 
(4)  PROPERTY AND EQUIPMENT
 
     Property and equipment are stated at cost, net of accumulated depreciation
and amortization. The Company provides for depreciation and amortization using
the straight-line method to allocate the cost of property and equipment over
their estimated useful lives. Property and equipment, at cost, and their
estimated useful lives are as follows:
DECEMBER 31,
                                                   ESTIMATED        ---------------    JUNE 30,
                                                  USEFUL LIFE       1996      1997       1998
                                                  -----------       ----      ----     --------
                                                                          (IN THOUSANDS)
Computers and equipment......................       4 years         $ 621    $  912     $1,322
Furniture and fixtures.......................      10 years           156       307        557
Purchased software...........................       3 years            45        60        292
Leasehold improvements.......................  Life of the lease        8        39         89
                                                                    -----    ------     ------
                                                                      830     1,318      2,260
Less -- Accumulated depreciation and
  amortization...............................                         224       405        633
                                                                    -----    ------     ------
                                                                    $ 606    $  913     $1,627
                                                                    =====    ======     ======
Depreciation and amortization expense for the years ended December 31,
1995, 1996 and 1997 and the six months ended June 30, 1997 and 1998 was
approximately $49,000, $176,000, $275,000, $99,000 and $228,000, respectively.
 
                                      F-13
75
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(5)  ACCRUED EXPENSES
 
     Accrued expenses at December 31, 1996 and 1997 and June 30, 1998 consisted
of the following:
DECEMBER 31,
                                                         ----------------    JUNE 30,
                                                          1996      1997       1998
                                                         ------    ------    --------
                                                                (IN THOUSANDS)
Payroll and related costs..............................  $  859    $1,508     $1,474
Royalties..............................................     153       283         --
Other..................................................     301     1,456      1,971
                                                         ------    ------     ------
                                                         $1,313    $3,247     $3,445
                                                         ======    ======     ======
(6)  INCOME TAXES
 
     No provision for federal or state income taxes has been recorded, as the
Company incurred net operating losses for all periods presented. The Company had
net operating loss carryforwards of approximately $792,000 at December 31, 1997
to reduce future income taxes, if any. These carryforwards expire through 2013
and are subject to review and possible adjustment by the Internal Revenue
Service ("IRS").
 
     The Tax Reform Act of 1986 contains provisions that may limit the amount of
net operating loss and credit carryforwards that the Company may utilize in any
one year in the event of certain cumulative changes in ownership over a
three-year period in excess of 50%, as defined. The Company believes it has
experienced a change in ownership in excess of 50%. The Company does not believe
that this change in ownership will significantly impact the Company's ability to
utilize its net operating loss carryforwards.
 
     The approximate tax effects of temporary differences that give rise to
significant portions of the Company's deferred tax assets are as follows:
DECEMBER 31,
                                                            --------------
                                                            1996     1997
                                                            ----     ----
                                                            (IN THOUSANDS)
Nondeductible expenses and reserves.......................  $ 365    $ 465
Net operating loss carryforwards..........................     --      318
                                                            -----    -----
                                                              365      783
                                                            -----    -----
Less -- Valuation allowance...............................   (365)    (783)
                                                            -----    -----
          Net deferred tax asset..........................  $  --    $  --
                                                            =====    =====
It is the Company's objective to become a profitable enterprise and to
realize the benefits of its deferred tax assets. However, in evaluating the
realizability of these deferred tax assets, management has considered the
Company's short operating history, the volatility of the market in which it
competes, the operating losses incurred to date, and believes that given the
significance of this evidence, a full valuation reserve against its deferred tax
assets is required as of December 31, 1996 and 1997. The increase in the
valuation allowance during these periods relates primarily to the Company's
operating results.
 
                                      F-14
76
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(7)  REVOLVING NOTE AGREEMENT
 
     In December 1997, the Company entered into a $2,000,000 revolving note
agreement (the "Note") with a bank. Borrowings and the face amount of
outstanding letters of credit are limited to 75% of qualified receivables. As of
December 31, 1997 and June 30, 1998, letters of credit totaling $945,000 and
$971,000, respectively, were outstanding. Borrowings under the Note bear
interest at the bank's prime rate (8.5% at June 30, 1998) plus .75% per annum,
payable monthly in arrears. The Note, which expires May 31, 1999, is secured by
substantially all assets of the Company. As of December 31, 1997 and June 30,
1998, no borrowings were outstanding under the Note.
 
     Under the Note agreement as amended, the Company must comply with certain
restrictive financial covenants. As of December 31, 1997 and June 30, 1998, the
Company had received waivers from the bank for all events of default.
 
(8)  RELATED PARTY TRANSACTIONS
 
  (a) NOTES PAYABLE
 
          As of December 31, 1996, the Company had outstanding demand notes
     payable totaling $2,960,000 to Cyrk and $274,000 to GPLP. These notes bore
     interest at the prime rate payable monthly in arrears. Interest expense on
     the demand notes payable amounted to approximately $41,000, $193,000 and
     $43,000 for the years ended December 31, 1995 and 1996 and the six months
     ended June 30, 1997, respectively. On March 18, 1997, $1,000,000 of
     principal and accrued interest was repaid and the remaining principal
     balance on the Notes was converted into 2,900,000 shares of Series A
     Preferred Stock (see Note 11).
 
  (b) TRANSACTIONS WITH GPLP
 
          As discussed in Note 1, on November 15, 1996, the Company and GPLP
     entered into an assignment and assumption agreement whereby the Company
     received the EA business from GPLP in exchange for 2,300,000 shares of the
     Company's convertible preferred stock. At the date of transfer, the total
     liabilities of the EA business exceeded its total assets by approximately
     $1,700,000. GPLP contributed $870,000 of its advances to EA to the capital
     of the Company.
 
  (c) EXCHANGE MARKETING GROUP
 
          In March 1997, the Company entered into an employment termination
     agreement with an officer of the Company. Upon termination, the officer
     established Exchange Marketing Group ("EMG"). The Company repurchased
     341,125 shares of common stock from the officer and six other employees who
     also terminated their employment with the Company.
 
          In March 1997, the Company loaned EMG $350,000, as evidenced by a note
     receivable. This note accrued interest at 9% per annum with quarterly
     interest payments due commencing June 30, 1997. This note and all accrued
     interest were repaid in February 1998.
 
(9)  COMMITMENTS
 
  (a) LEASE OBLIGATIONS
 
          The Company leases certain equipment under agreements that are
     accounted for as capital leases and expire at various dates through year
     2000. Interest rates on these leases range from 12.0% to 14.5%.
 
                                      F-15
77
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
          The Company has certain noncancellable operating leases for facilities
     and equipment. The operating leases expire at various dates through the
     year 2003. The Company has letters of credit outstanding with a bank (see
     Note 7) for $971,000 as collateral on its leased facilities and certain
     equipment. Total rent expense under these agreements was approximately
     $17,000, $239,000, $399,000, $155,000 and $254,000 for the years ended
     December 31, 1995, 1996 and 1997 and the six months ended June 30, 1997 and
     1998, respectively.
 
          At December 31, 1997, the minimum lease commitments for all leased
     facilities and equipment with an initial or remaining term in excess of one
     year are as follows:
CAPITAL    OPERATING
                                                           LEASES      LEASES
                                                           -------    ---------
                                                              (IN THOUSANDS)
1998.....................................................   $ 258      $1,409
1999.....................................................     196       1,412
2000.....................................................      62       1,407
2001.....................................................      --       1,293
2002.....................................................      --       1,080
Thereafter...............................................      --         450
                                                            -----      ------
          Total minimum payments.........................     516      $7,051
                                                                       ======
Less -- Amount representing interest.....................      67
                                                            -----
          Principal obligation...........................     449
Less -- Current portion..................................     212
                                                            -----
                                                            $ 237
                                                            =====
As of December 31, 1997, the Company had entered into two sublease
agreements that will reduce rent expense by approximately $275,000, $550,000,
$355,000 and $236,000 for the years ended December 31, 1998, 1999, 2000, and
2001, respectively.
 
  (b) ROYALTY
 
          The Company licensed certain intellectual property from a third party,
     which has been integrated with VALEX, under a royalty-bearing agreement.
     Under the terms of the license agreement, the Company is required to pay
     royalties to the licensor totaling approximately $656,000 on the first
     $10,000,000 of cumulative VALEX license fees. For the years ended December
     31, 1995, 1996 and 1997 and the six months ended June 30, 1997 and 1998,
     the Company charged royalties of approximately $0, $114,000, $456,000
     $160,000 and $86,000, respectively, to the cost of software license fees
     relating to this agreement. As of June 30, 1998, the aggregate sales of
     VALEX had exceeded the $10,000,000 limit. Accordingly, the Company has no
     further royalty obligation under this agreement.
 
(10)  PREFERRED STOCK
 
     At incorporation on November 7, 1996, the Company authorized 10,000,000
shares of $.001 par value Preferred Stock for future issuance in one or more
series. On November 15, 1996, the Company issued 2,300,000 shares of Preferred
Stock to GPLP in consideration for a capital contribution of $870,000, as
discussed in Note 1 and Note 8(b).
 
                                      F-16
78
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     On March 18, 1997, the Company converted all of its previously outstanding
shares of Preferred Stock into 1,725,000 shares of common stock. The Company
then amended its certificate of incorporation to reduce the number of authorized
shares of its $.001 par value preferred stock to 5,455,556 shares, of which
2,900,000 shares were designated as Series A Preferred Stock and 2,555,556
shares were designated Series B Preferred Stock. The 2,900,000 shares of Series
A Preferred Stock were issued upon the conversion of $2,405,000 of notes payable
to the related parties, as discussed in Note 8(a). The 2,555,556 shares of
Series B Preferred Stock were sold to venture capital investors at a price of
$1.565 per share, with net proceeds to the Company of $3,888,000.
 
     On December 4, 1997, the Company authorized an additional 1,223,954 shares
of $.001 par value Preferred Stock and designated these shares as Series C
Convertible Preferred Stock (Series C Preferred Stock). The 1,223,954 shares of
the Series C Preferred Stock were sold to venture capital investors at a price
of $3.268 per share, with net proceeds to the Company of $3,987,000.
 
     The Company loaned $125,000 to an officer for the purchase of approximately
38,000 shares of Series B Preferred Stock from another stockholder. The loan is
evidenced by a note that bears interest at the prime rate and is secured by the
38,000 shares of Series B Preferred Stock the officer purchased. The Company has
accounted for this loan as a stock subscription receivable classified as Due
from Officer in the accompanying consolidated statements of stockholders' equity
(deficit) as of December 31, 1997 and June 30, 1998.
 
     The rights and preferences of the Company's preferred stock are as follows:
 
  DIVIDENDS
 
          Each outstanding share of Series A Preferred Stock accrues a
     cumulative annual dividend of 8.25%. Holders of Series B Preferred Stock
     and Series C Preferred Stock are entitled to a proportionate share of any
     cash or noncash common stock dividend as though they were holders of the
     number of shares of common stock into which their shares were convertible
     as of the date declared. To date, no dividends have been declared. The
     Company has provided for Series A Preferred Stock cumulative dividends by
     accreting charges against the accumulated deficit with corresponding
     increases to the carrying value of the Series A Preferred Stock. Such
     increases aggregated approximately $189,000, $70,000 and $120,000 for the
     year ended December 31, 1997 and the six months ended June 30, 1997 and
     1998, respectively.
 
  LIQUIDATION PREFERENCE
 
          Upon liquidation, the holders of Series C Preferred Stock are entitled
     to receive $3.268 per share, plus all accrued or declared but unpaid
     dividends, prior to any distribution to any holder of any share of any
     other class or series of capital stock. If available assets are sufficient
     to permit payment of the full preferential amounts on the Series C
     Preferred Stock, then holders of Series B Preferred Stock are entitled to
     receive out of any additional assets up to $1.565 per share, plus all
     accrued or declared but unpaid dividends, and then holders of Series A
     Preferred Stock are entitled to receive out of any additional assets up to
     $1.00 per share, plus all accrued or declared but unpaid dividends. If the
     assets available for distribution with respect to any such series of
     capital stock are insufficient to permit the payment of the full
     preferential amount on such series, as described above, then the holders of
     such series shall share ratably on the distribution of assets within that
     series of stock. If the remaining assets of the Company permit a
     distribution to common stockholders, then holders of Series B Preferred
     Stock are entitled to

                                      F-17
79
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     share ratably in such distribution with the holders of common stock as if
     their shares had been converted to common stock.
 
  REDEMPTION
 
          The Company may at any time redeem all or any portion of the shares of
     Series A Preferred Stock then outstanding at $1.00 per share, plus all
     accrued or declared but unpaid dividends. The number of shares to be
     redeemed by each holder shall be equal to each specific holder's pro rata
     share of the total amount outstanding.
 
          If upon any redemption of Series A Preferred Stock the assets
     available for redemption are insufficient to pay to the holders of Series A
     Preferred Stock the full redemption value, the holders of a majority of
     Series A Preferred Stock may elect (i) that no redemption be made (in which
     event all rights in respect of the shares to be redeemed shall continue in
     full force and effect) or (ii) that the holders shall share ratably in the
     redemption according to the respective amounts which would have been
     payable to them.
 
          Upon an IPO with gross proceeds of at least $20,000,000 at an offering
     price per common share such that the amount obtained by multiplying such
     offering price by the number of common stock equivalents, as defined,
     outstanding immediately after such offering would be at least $130,000,000
     (a "Qualified Offering"), all shares of Series A Preferred Stock shall be
     automatically canceled and the shares outstanding prior to such closing
     shall no longer be deemed to be outstanding.
 
          In the event that the Company completes an IPO that is not a Qualified
     Offering, holders of Series A Preferred Stock have the option to redeem all
     shares held for $1.00 per share. All shares surrendered under such
     redemption shall be canceled. Subsequent to redemption, all rights in
     respect of the Series A Preferred Stock, except the right to receive the
     liquidation preference, shall cease and terminate, and such shares shall no
     longer be deemed to be outstanding.
 
          Upon an IPO, all shares of Series B Preferred Stock will automatically
     convert into shares of common stock. In the event that the Company
     completes an IPO that is not a Qualified Offering, the Company, in addition
     to converting such Series B Preferred Stock to Common Stock, shall pay to
     each holder of Series B Preferred Stock being thereby converted, $1.565 per
     share, prior and in preference to any distribution to any holder of any
     class or series of capital stock of the Company.
 
          Upon the closing of a qualified sale of the Company, as defined,
     holders of Series B Preferred Stock not selling shares as part of the sale
     of the Company may redeem their Series B Preferred Stock at the liquidation
     preference or convert all or any part of such shares into shares of common
     stock. Subsequent to redemption, all rights in respect of the Series B
     Preferred Stock, except the right to receive the liquidation preference,
     shall cease and terminate, and such shares shall no longer be deemed to be
     outstanding.
 
          In connection with the proposed IPO, the Company expects to satisfy
     the conditions of a Qualified Offering. Accordingly, upon the closing of
     the IPO, Series A Preferred Stock will be reclassified to $3,209,000 of
     additional paid-in capital and the Series B Preferred Stock, at a
     redemption value of $3,999,000, will be converted into 2,555,556 shares of
     Common Stock without any cash payment required to be made to the holders of
     Series B Preferred Stock.
 
                                      F-18
80
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
          The Company has presented the Series A and Series B Preferred Stock
     outside of stockholders' equity (deficit) due to the existence of
     redemption rights beyond the control of the Company. A summary of the
     activity of Series A and Series B Preferred Stock is provided in Note 11.
 
  VOTING
 
          Holders of Series A Preferred Stock do not have voting rights. Each
     share of Series B and Series C Preferred Stock votes ratably with the
     common stockholders as if their shares had been converted to common stock.
 
  CONVERSION
 
          Holders of Series B and Series C Preferred Stock have the option to
     convert any such shares into common shares at any time. Upon a conversion
     of each share of Series B and Series C Preferred Stock the number of common
     shares to be issued is an amount equal to (i) their respective liquidation
     preferences divided by (ii) the product of the number of shares being
     converted and the conversion price at that time, as defined.
 
          The conversion price shall initially be the respective per share
     liquidation preference for each series of preferred stock and is subject to
     adjustment in the event that common stock or common stock equivalents are
     issued for less per share than the conversion price, subject to certain
     exceptions.
 
          Upon closing of any IPO, all outstanding shares of preferred stock
     shall be automatically converted into that number of shares of common stock
     as would have been the case in the event of an optional conversion. All
     rights with respect to the preferred stock shall be deemed automatically
     waived upon such conversion.
 
          In connection with the proposed IPO, the Company expects to satisfy
     the conditions of a Qualified Offering. Accordingly, upon the closing of
     the IPO, all 2,555,556 outstanding shares of Series B Preferred Stock will
     be converted into 2,555,556 shares of common stock, and all 1,223,954
     outstanding shares of Series C Preferred Stock will be converted into
     1,223,954 shares of common stock.
 
                                      F-19
81
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(11)  REDEEMABLE PREFERRED STOCK
 
     The following is a summary of the activity for the Series A and Series B
Preferred Stock:
SERIES A                  SERIES B
                                          REDEEMABLE          CONVERTIBLE REDEEMABLE
                                        PREFERRED STOCK           PREFERRED STOCK
                                    -----------------------   -----------------------     TOTAL
                                    NUMBER OF    REDEMPTION   NUMBER OF    REDEMPTION   REDEMPTION
                                      SHARES       VALUE        SHARES       VALUE        VALUE
                                    ---------    ----------   ---------    ----------   ----------
                                            (IN THOUSANDS, EXCEPT SHARE DATA)
BALANCE, DECEMBER 31, 1996........          --    $    --             --    $    --      $    --
  Conversion of notes payable to
     related parties into Series A
     Preferred Stock..............   2,900,000      2,405             --         --        2,405
  Issuance of Series B Preferred
     Stock........................          --         --      2,555,556      3,999        3,999
  Accretion of discount and
     dividends on Series A
     Preferred Stock..............          --        684             --         --          684
                                    ----------    -------     ----------    -------      -------
BALANCE, DECEMBER 31, 1997........   2,900,000      3,089      2,555,556      3,999        7,088
  Accretion of dividends on Series
     A Preferred Stock............          --        120             --         --          120
                                    ----------    -------     ----------    -------      -------
BALANCE, JUNE 30, 1998
  (UNAUDITED).....................   2,900,000      3,209      2,555,556      3,999        7,208
Pro forma effect of proposed IPO:
  Retirement of Series A Preferred
     Stock........................  (2,900,000)    (3,209)            --         --       (3,209)
  Conversion of Series B Preferred
     Stock to common stock........          --         --     (2,555,556)    (3,999)      (3,999)
                                    ----------    -------     ----------    -------      -------
PRO FORMA BALANCE, JUNE 30, 1998
  (UNAUDITED) (Note 3)............          --    $    --             --    $    --      $    --
                                    ==========    =======     ==========    =======      =======
During 1997, the Company issued Series A Preferred Stock at a discount of
$495,000 from its redemption value. The Company accreted this discount to the
Series A Preferred Stock through a charge to accumulated deficit upon issuance.
 
(12)  STOCKHOLDERS' EQUITY (DEFICIT)
 
  (a) COMMON STOCK
 
          At incorporation, the Company authorized 10,000,000 shares of $.001
     par value common stock. In March 1997 and December 1997, the Company
     amended its certificate of incorporation to increase the number of
     authorized shares of $.001 par value common stock to a total of 12,078,698
     shares.
 
          The Company has reserved 3,779,510 shares of common stock for the
     potential conversion of Series B and Series C Preferred Stock into common
     stock. The Company also has reserved 3,124,963 shares of common stock for
     the issuance of stock options under the 1996 Stock Incentive Plan.
     Subsequent to June 30, 1998, the Company reserved additional shares of
     common stock in connection with the adoption of the 1998 Stock Incentive
     Plan, an Employee Stock Purchase Plan and a Directors' Stock Option Plan.
     (See Note 17).
 
    
                                      F-20
82
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
  (b) RESTRICTED COMMON STOCK
 
          At incorporation, the Company issued 2,484,375 shares of common stock
     to the Company's founders and employees at $.001 per share, the fair market
     value as determined by the Board of Directors at the time of issuance.
 
          In connection with the issuance of common stock, the Company and two
     of its founders signed a Founder Restricted Stock Agreement (the Founder
     Agreement). These shares vested 50% immediately with the balance vesting
     ratably on an annual basis through January 1, 1999.
 
          As provided in the Founder Agreement, if the employment of the
     founders is terminated, the Company has the option (the Company Option) to
     purchase their unvested stock. This Company Option shall be exercisable by
     the Company at a price equal to the lesser of the issue price or the fair
     market value of the stock as determined by the Board of Directors. In March
     1997, one of the founders terminated employment, resulting in the Company's
     repurchase of unvested common shares (see Note 8(c)).
 
          In addition, on November 15, 1996, the Company and all of its
     employees holding common stock, excluding the two founders, signed
     restricted stock agreements (the Restricted Stock Agreements) providing for
     shares issued from the 1996 Stock Incentive Plan to vest retroactively, 25%
     on the respective employee's date of hire with an additional 25% on each
     anniversary thereafter.
 
          According to the Restricted Stock Agreements, if an employee ceases to
     provide services to the Company either as a consultant or employee prior to
     the third anniversary of the date of hire, the Company has the right to
     repurchase the unvested stock from the employee at the price paid by the
     employee.
 
          In the event of a change of control, as defined, all remaining
     unvested stock held by the founders and employees issued under the Founder
     Agreement and Restricted Stock Agreements shall be deemed vested and the
     Company's options to repurchase unvested shares of restricted common stock
     shall immediately terminate.
 
          During 1997, the Company repurchased 341,125 shares of unvested common
     stock at $.001 per share from an officer and six employees who terminated
     their employment with the Company. (See Note 8(c)). The Company also
     repurchased 13,700 shares and 6,250 shares of unvested common stock at
     $.001 per share in July 1997 and June 1998, respectively, from other
     terminated employees.
 
(13)  STOCK OPTIONS
 
     In November 1996, the Company adopted the 1996 Stock Incentive Plan (the
1996 Plan), which provides for the grant of incentive stock options,
nonqualified stock options and restricted common stock to officers, employees
and directors who are also employees of the Company. Nonemployee directors and
outside consultants to the Company are eligible to receive nonqualified options
and restricted common stock only.
 
     The 1996 Plan is administered by the Board of Directors, which determines
the fair market value and the purchase price for such options. Options generally
vest over a four-year period and expire 10 years from the date of grant.
Restricted common stock awards entitle recipients to purchase shares of the
Company's common stock subject to restrictions concerning the sale, transfer and
other disposition of the shares issued until such shares are vested. The shares
subject to options
 
                                      F-21
83
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
that expire or are not exercised for other reasons, or any restricted common
stock that is repurchased by the Company will be available for future grant
under the 1996 Plan.
 
     In addition, the 1996 Plan provides for the granting of time accelerated
incentive stock options. During 1997 and 1998, approximately 590,000 time
accelerated incentive stock options were granted to certain employees. These
options vest and become exercisable 25% annually upon the achievement of certain
performance criteria (the Criteria) as approved by the Company on an annual
basis, or after nine years from the date of grant. The Criteria, which are set
each year by the Board of Directors, allows for vesting upon the achievement of
the Criteria as of December 31 for that year.
 
     Stock option activity from the 1996 Plan's inception through June 30, 1998
is as follows:
NUMBER OF       RANGE OF        WEIGHTED AVERAGE
                                               SHARES      EXERCISE PRICES     EXERCISE PRICE
                                              ---------    ---------------    ----------------
Outstanding, December 31, 1995..............     --        $     --                $   --
  Granted...................................    968,575         0.001               0.001
  Exercised.................................   (968,575)        0.001               0.001
                                              ---------    ---------------         ------
Outstanding, December 31, 1996..............     --              --                    --
  Granted...................................  1,449,475      0.65 -   1.35           0.74
  Exercised.................................    (10,096)        0.65                 0.65
  Canceled..................................    (40,154)     0.65 -   0.85           0.66
                                              ---------    ---------------         ------
Outstanding, December 31, 1997..............  1,399,225      0.65 -   1.35           0.74
  Granted...................................    572,000      1.35 -  14.50           4.51
  Exercised.................................    (63,334)     0.65 -   0.85           0.65
  Canceled..................................    (23,333)     0.65 -   3.50           1.31
                                              ---------    ---------------         ------
Outstanding, June 30, 1998 (unaudited)......  1,884,558    $ 0.65 - $14.50         $ 1.88
                                              =========    ===============         ======
Exercisable, June 30, 1998 (unaudited)......    324,232    $ 0.65 - $ 1.35         $ 0.72
                                              =========    ===============         ======
Subsequent to June 30, 1998, the Company granted options to purchase
200,850 shares of common stock at $14.50 per share.
 
     The Company has computed the pro forma disclosures required under SFAS No.
123 for options granted during 1996 and 1997 using the Black-Scholes option
pricing model prescribed by SFAS No. 123. The weighted average assumptions used
were as follows:
1996         1997
                                                                ----         ----
Risk-free interest rate.....................................    6.3%         5.96%
Expected dividend yield.....................................     --           --
Expected lives..............................................   4 years      4 years
Expected volatility.........................................     76%          79%
Weighted average grant date fair value......................    $.002        $.46
Weighted average remaining contractual life of options
  outstanding...............................................  9.9 years    9.1 years
F-22
84
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
     Had compensation expense for the Company's stock option plans been
determined consistent with SFAS No. 123, net loss and net loss per share would
have been approximately as follows:
1996         1997
                                                              ---------    ---------
                                                              (IN THOUSANDS, EXCEPT
                                                                 PER SHARE DATA)
As reported --
  Net loss applicable to common stockholders................   $(1,606)     $(3,283)
                                                               =======      =======
  Basic and diluted net loss per share......................   $ (1.33)     $ (1.12)
                                                               =======      =======
Pro forma --
  Net loss applicable to common stockholders................   $(1,607)     $(3,455)
                                                               =======      =======
  Basic and diluted net loss per share......................   $ (1.33)     $ (1.18)
                                                               =======      =======
(14)  EMPLOYEE BENEFIT PLAN
 
     The Company has a qualified 401(k) savings plan (the 401(k) Plan) covering
all of the Company's eligible full-time employees. Under this plan, participants
may elect to defer a portion of their compensation, subject to certain IRS
limitations. The Company does not currently provide employer matching
contributions under the 401(k) Plan.
 
(15)  GEOGRAPHIC INFORMATION
 
     Revenues by geographic destination as a percentage of total revenues are as
follows:
SIX MONTHS
                                                      YEARS ENDED            ENDED
                                                      DECEMBER 31,          JUNE 30,
                                                  --------------------    ------------
                                                  1995    1996    1997    1997    1998
                                                  ----    ----    ----    ----    ----
United States...................................   81%     96%     86%    100%     78%
United Kingdom..................................   --      --       5      --      14
Canada..........................................   19       4       8      --       7
Other...........................................   --      --       1      --       1
                                                  ---     ---     ---     ----    ---
                                                  100%    100%    100%    100%    100%
                                                  ===     ===     ===     ====    ===
(16)  ALLOWANCE FOR DOUBTFUL ACCOUNTS
 
     A summary of the allowance for doubtful accounts is as follows:
DECEMBER 31,
                                                   ---------------------    JUNE 30,
                                                   1995    1996     1997      1998
                                                   ----    ----     ----    --------
                                                            (IN THOUSANDS)
Balance, beginning of period.....................  $ --    $  75    $ 43      $206
  Provision for doubtful accounts................   121       99     180        55
  Write-offs.....................................   (46)    (131)    (17)      (49)
                                                   ----    -----    ----      ----
Balance, end of period...........................  $ 75    $  43    $206      $212
                                                   ====    =====    ====      ====
F-23
85
                  EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
 
(17)  STOCK PLANS AND AMENDMENT TO CERTIFICATE OF INCORPORATION
 
     On July 15, 1998, the Board of Directors and stockholders approved (i) the
adoption of the 1998 Stock Incentive Plan pursuant to which 2,700,000 additional
shares of the Company's common stock have been reserved for future issuance,
(ii) the adoption of an Employee Stock Purchase Plan pursuant to which 200,000
shares of the Company's common stock have been reserved for future issuance,
(iii) the adoption of a Directors' Stock Option Plan pursuant to which 100,000
shares of the Company's common stock have been reserved for future issuance,
(iv) an increase in the number of authorized shares of common stock to
30,000,000 shares and (v) the authorization of 10,000,000 shares of $.001 par
value preferred stock, of which the Board of Directors has full authority to
issue and fix the voting powers, preferences, rights, qualifications,
limitations or restrictions thereof, including dividend rights, conversion
rights, redemption privileges and liquidation preferences and the number of
shares constituting any series or designation of such series.
 
                                      F-24
86
 
                                  UNDERWRITING
 
     Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
Underwriters named below, and each of such Underwriters, for whom Goldman, Sachs
& Co., BT Alex. Brown Incorporated and Hambrecht & Quist LLC are acting as
representatives, has severally agreed to purchase from the Company and the
Selling Stockholders, the respective number of shares of Common Stock set forth
opposite its name below:
NUMBER OF
                                                               SHARES OF
                        UNDERWRITER                           COMMON STOCK
                        -----------                           ------------
Goldman, Sachs & Co. .......................................
BT Alex. Brown Incorporated.................................
Hambrecht & Quist LLC.......................................
 
                                                                --------
          Total.............................................
                                                                ========
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.
 
     The Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus, and in part to certain securities dealers at such
price less a concession of $     per share. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $     per share to certain
brokers and dealers. After the shares of Common Stock are released for sale to
the public, the offering price and other selling terms may from time to time be
varied by the representatives.
 
     Certain of the Selling Stockholders have granted the Underwriters an option
exercisable for 30 days after the date of this Prospectus to purchase up to an
aggregate of 450,000 additional shares of Common Stock solely to cover
over-allotments, if any. If the Underwriters exercise their over-allotment
option, the Underwriters have severally agreed, subject to certain conditions,
to purchase approximately the same percentage thereof that the number of shares
to be purchased by each of them, as shown in the foregoing table, bears to the
3,000,000 shares of Common Stock offered.
 
     The Company, the Selling Stockholders and certain other stockholders have
agreed that, during the period beginning from the date of this Prospectus and
continuing to and including the date 180 days after the date of this Prospectus,
they will not offer, sell, contract to sell or otherwise dispose of any
securities of the Company (other than pursuant to employee stock option plans
existing, or on the conversion or exchange of convertible or exchangeable
securities outstanding, on the date of this Prospectus) which are substantially
similar to the shares of Common Stock or which are convertible or exchangeable
into securities which are substantially similar to the shares of Common Stock
without the prior written consent of the representatives except for the shares
of Common Stock offered in connection with the Offering and shares of Common
Stock acquired in the public market after the date of this Prospectus. The
representatives have informed the Company that the Underwriters have no current
intention to release shares from the Lock-Up Agreements prior to expiration of
the [180] -day term of such agreements. Any request for release would be
evaluated by the representatives, and the decision whether or not to permit
early release of shares would be made dependent upon the facts and circumstances
existing at the time of the request.
 
                                       U-1
87
 
     The representatives of the Underwriters have informed the Company that they
do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed five percent of the total number of shares of
Common Stock offered by them.
 
     Prior to the Offering, there has been no public market for the shares of
Common Stock. The initial public offering price was negotiated among the
Company, the Selling Stockholders and the representatives. Among the factors
considered in determining the initial public offering price of the Common Stock,
in addition to prevailing market conditions, were the Company's historical
performance, estimates of the business potential and earnings prospects of the
Company, an assessment of the Company's management and the consideration of the
above factors in relation to market valuation of companies in related
businesses.
 
     The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "EXAP," subject to official notice of issuance.
 
     The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act.
 
                                       U-2
88
BUILDING A CAMPAIGN WITH VALEX

1.   VALEX Desktop allows users to define the core CCM process steps needed to
     to run a campaign. Users quickly structure and schedule campaigns with the
     time and event triggers by selecting "Campaign Management" to bring up the
     applications associated with designing customer communication streams.

[Back page Graphic]

2.   In this example, users drag and drop icons to design a three-branch 
     campaign. The first branch targets prospects; the middle branch targets
     existing customers ripe for cross-selling; the third branch attempts to
     retain customers likely to defect. Each branch connects to the most
     appropriate touch point for delivery of the customer communication stream.
     Promotion history is captured for all three branches in order to measure
     campaign effectiveness.

[Back page Graphic]

3.   Users can easily schedule dates and times to run campaigns. In this
     example, the user has set the "Likely to Leave" campaign to run every third
     day, at which time VALEX automatically selects the appropriate customers 
     and delivers information to the selected customer touchpoint. 

[Back page Graphic]

 
                                   [ART WORK]

          [A graphic depicting a recreation of screens from a desktop
                 PC showing the VALEX Campaign decision tree.]
89
 
==========================================================

  NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.

                             ----------------------
 
                               TABLE OF CONTENTS
PAGE
                                           ----
Prospectus Summary.......................    1
Risk Factors.............................    4
The Company..............................
Use of Proceeds..........................   11
Dividend Policy..........................   11
Capitalization...........................   12
Dilution.................................   13
Selected Consolidated Financial Data.....   14
Management's Discussion and Analysis of
  Financial Condition and Results of
  Operations.............................   16
Business.................................   27
Management...............................   41
Certain Transactions.....................   49
Principal and Selling Stockholders.......   51
Description of Capital Stock.............   53
Shares Eligible for Future Sale..........   55
Legal Matters............................   56
Experts..................................   56
Additional Information...................   56
Index to Consolidated Financial
  Statements.............................  F-1
Underwriting.............................  U-1
----------------------
 
  THROUGH AND INCLUDING             , 1998 (THE 25TH DAY AFTER THE DATE OF THIS
PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.

==========================================================

                                3,000,000 SHARES
 
                                    EXCHANGE
                               APPLICATIONS, INC.
 
                                  COMMON STOCK
                          (PAR VALUE $.001 PER SHARE)

                             ----------------------
 
                          [EXCHANGE APPLICATION LOGO]

                             ----------------------
 
                              GOLDMAN, SACHS & CO.
                                 BT ALEX. BROWN
                               HAMBRECHT & QUIST
                      REPRESENTATIVES OF THE UNDERWRITERS

==========================================================
90
 
                                    PART II
 
                     INFORMATION NOT REQUIRED IN PROSPECTUS
 
ITEM 13.  Other Expenses of Issuance and Distribution
 
     Expenses of the Registrant in connection with the issuance and distribution
of the securities being registered, other than the underwriting discount, are
estimated as follows:
TOTAL
                                                                -----
SEC Registration Fee........................................  $16,284.00
NASD Fees...................................................  $ 6,020.00
NASDAQ Listing Fees.........................................  $22,250.00
Printing and Engraving Expenses.............................  $        *
Legal Fees and Expenses.....................................  $        *
Accountants' Fees and Expenses..............................  $        *
Expenses of Qualification Under State Securities Laws,
  Including Attorneys' Fees.................................  $        *
Transfer Agent and Registrar's Fees.........................  $        *
Miscellaneous Costs.........................................  $        *
                                                              ----------
          Total.............................................  $        *
                                                              ==========
---------------
* To be provided by amendment.
 
ITEM 14.  Indemnification of Directors, Officers and Employees
 
     Section 145 of the Delaware General Corporation law empowers a Delaware
corporation to indemnify its officers and directors and certain other persons to
the extent and under the circumstances set forth therein.
 
     The Amended and Restated Certificate of Incorporation of the Company and
the Amended and Restated By-laws of the Company, copies of which are filed as
Exhibits 3.1 and 3.2, provide for indemnification of officers and directors of
the Company and certain other persons against liabilities and expenses incurred
by any of them in certain stated proceedings and under certain stated
conditions.
 
ITEM 15.  Recent Sales of Unregistered Securities
 
     On November 15, 1996, in connection with the organization of the
Registrant, the Registrant entered into Restricted Stock Agreements dated as of
such date (Restricted Stock Agreements) with certain key employees of the
Registrant. Pursuant to the Restricted Stock Agreements, the Registrant issued
968,575 shares of restricted Common Stock under the Registrant's 1996 Stock
Incentive Plan to such employees for an aggregate consideration of $968.58 at a
purchase price of $.001 per share.
 
     On November 15, 1996, in addition to the shares of restricted Common Stock
issued pursuant to the Registrant's 1996 Stock Incentive Plan, (i) the
Registrant issued 848,800 shares of restricted Common Stock to Andrew J. Frawley
for an aggregate consideration of $848.80 pursuant to a Restricted Stock
Agreement entered into between the Registrant and Andrew J. Frawley, and (ii)
the Registrant issued 667,000 shares of restricted Common Stock to Michael J.
Feldman for an aggregate consideration of $667.00 pursuant to a Restricted Stock
Agreement entered into between the Registrant and Michael J. Feldman.
 
     The Registrant has, from time to time, repurchased an aggregate of 361,075
shares of Common Stock from its employees for an aggregate consideration of
$361.08.
 
                                      II-1
91
 
     On November 15, 1996, in connection with the organization of the
Registrant, the Registrant entered into an Assignment and Assumption Agreement
dated as of such date (Assignment Agreement) with Grant & Partners Limited
Partnership (GPLP) pursuant to which the Registrant issued 2,300,000 shares of
Series A Convertible Preferred Stock to GPLP and assumed certain liabilities of
GPLP in exchange for certain assets of GPLP.
 
     On March 18, 1997, the Registrant entered into a Securities Purchase
Agreement dated as of such date (Securities Purchase Agreement) with certain of
its existing stockholders and certain new investors. Pursuant to the Securities
Purchase Agreement, (i) the Registrant issued 1,154,775 shares of Series B
Preferred Stock to Insight Venture Partners II, L.P. for an aggregate
consideration of $1,807,222.88, (ii) the Registrant issued 1,154,775 shares of
Series B Preferred Stock to Wexford Insight LLC for an aggregate consideration
of $1,807,222.88, (iii) the Registrant issued 246,006 shares of Series B
Convertible Preferred Stock to GAP Coinvestment Partners, L.P. for an aggregate
consideration of $384,999.39, (iv) the Registrant converted 2,300,000 shares of
Series A Convertible Preferred Stock held by GPLP to 1,725,000 shares of Common
Stock, (v) the Registrant issued 377,408 shares of a newly designated Series A
Preferred Stock to GPLP in consideration of the cancellation of certain
indebtedness owed by the Registrant to GPLP, and (vi) the Registrant issued
2,522,592 shares of Series A Preferred Stock to Cyrk, Inc. (Cyrk) in
consideration of the cancellation of certain indebtedness owed by the Registrant
to Cyrk.
 
     On October 3, 1997, the Registrant entered into a Subscription Agreement
dated as of such date with Michael Caccavale pursuant to which the Registrant
issued 15,500 shares of Common Stock to Michael Caccavale for an aggregate
consideration of $13,175.
 
     On December 4, 1997, the Registrant entered into a Securities Purchase
Agreement dated as of such date with Insight Capital Partners II, L.P. and
Wexford Insight LLC pursuant to which (i) the Registrant issued 611,977 shares
of Series C Convertible Preferred Stock to Insight Capital Partners II, L.P. for
an aggregate consideration of $2,000,000, and (ii) the Registrant issued 611,977
shares of Series C Convertible Preferred Stock to Wexford Insight LLC for an
aggregate consideration of $2,000,000.
 
     The Registrant has, from time to time, issued an aggregate of 73,430 shares
of restricted Common Stock to various employees upon the exercise of options
granted pursuant to the Registrant's 1996 Stock Incentive Plan for an aggregate
consideration of $47,979.50 at an average exercise price of $0.65 per share.
 
     No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relating to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of certain restricted shares, options to purchase
Common Stock and shares issuable upon the exercise of such options, Rule 701 of
the Act. All of the foregoing securities are deemed restricted securities for
purposes of the Act.
 
                                      II-2
92
 
ITEM 16.  Exhibits and Financial Statement Schedules
 
     (a) The following is a list of exhibits filed as a part of this
registration statement:
EXHIBITS
--------
1.1      Form of Underwriting Agreement.
  3.1      Form of Amended and Restated Certificate of Incorporation of
           the Registrant.
  3.2      Form of Amended and Restated By-laws of the Registrant.
  4.1*     Specimen Certificate for Shares of the Registrant's Common
           Stock, $0.001 par value.
  5.1*     Opinion of Bingham Dana LLP with respect to the legality of
           the shares being registered.
 10.1*     Form of 1998 Stock Incentive Plan, with related forms of
           stock option agreements.
 10.2      1996 Stock Incentive Plan, as amended, with related forms of
           stock option agreements and form of restricted stock
           agreement.
 10.3      Form of 1998 Director Stock Option Plan, with related form
           of stock option agreement.
 10.4      Form of 1998 Employee Stock Purchase Plan.
 10.5      401(k) Plan.
 10.6      Employment Agreement, dated November 15, 1996, between the
           Registrant and Andrew J. Frawley.
 10.7      Restricted Stock Agreement, dated November 8, 1996, between
           the Registrant and Andrew J. Frawley.
 10.8      Consulting Agreement, dated March 18, 1997, between the
           Registrant and Exchange Marketing Group, LLC.
 10.9      Securities Purchase Agreement, dated March 18, 1997.
 10.10     Securities Purchase Agreement, dated December 4, 1997.
 10.11     Stock Purchase and Waiver Agreement, dated December 4, 1997.
 10.12     Promissory Note, dated December 4, 1997, by Andrew J.
           Frawley payable to the Registrant.
 10.13     Amended and Restated Stockholders Agreement dated
           December 4, 1997.
 10.14     Amended and Restated Registration Rights Agreement dated
           December 4, 1997.
 10.15     Letter Agreement, dated December 22, 1997, between the
           Registrant and Fleet National Bank, as amended, and the
           related Promissory Note.
 10.16     Stock Purchase Agreement, dated June 25, 1998, and the
           related Waiver Agreement to the Amended and Restated
           Stockholders Agreement, dated June 25, 1998.
 10.17     Office lease for 89 South Street, Boston, Massachusetts.
 21.1      Subsidiaries of Registrant.
 23.1      Consent of Arthur Andersen LLP.
 23.2*     Consent of Bingham Dana LLP, counsel to Registrant (included
           in Exhibit 5.1).
 24.1      Power of Attorney (included in signature page to
           Registration Statement).
 27.1      Financial Data Schedule (6 months ended June 30, 1998)
 27.2      Financial Data Schedule (12 months ended December 31, 1997)
 27.3      Financial Data Schedule (12 months ended December 31, 1996)
---------------
* To be filed by amendment
 
     (b) Financial Statement Schedules
 
                                      II-3
93
 
  SCHEDULES
 
     All schedules have been omitted because either they are not required, are
not applicable or the information is otherwise set forth in the Consolidated
Financial Statements and notes thereto.
 
ITEM 17.  Undertakings
 
     Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described in Item 14 hereof, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
 
     The undersigned Registrant hereby undertakes:
 
          (1) To provide the Underwriter at the closing specified in the
     Underwriting Agreement certificates in such denominations and registered in
     such names as required by the Underwriter to permit prompt delivery to each
     purchaser.
 
          (2) That for purposes of determining any liability under the
     Securities Act of 1933, the information omitted from the form of prospectus
     filed as part of this registration statement in reliance upon Rule 430A and
     contained in a form of prospectus filed by the Registrant pursuant to Rule
     424(b)(1) or (4), or 497(h) under the Securities Act shall be deemed to be
     part of this registration statement as of the time it was declared
     effective.
 
          (3) That for the purpose of determining any liability under the
     Securities Act of 1933, each post-effective amendment that contains a form
     of prospectus shall be deemed to be a new registration statement relating
     to the securities offered therein, and the Offering of such securities at
     that time shall be deemed to be the initial bona fide offering thereof.
 
                                      II-4
94
 
                                   SIGNATURES
 
     Pursuant to the requirements of the Securities Act of 1933, the registrant,
Exchange Applications, Inc., certifies that it has reasonable grounds to believe
that it meets all of the requirements for filing on Form S-1 and has duly caused
this registration statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Boston, Commonwealth of Massachusetts,
on this 22nd day of July, 1998.
 
                                          EXCHANGE APPLICATIONS, INC.
 
                                          By: /s/  ANDREW J. FRAWLEY
                                            ------------------------------------
                                                     Andrew J. Frawley
                                              Chairman of the Board, President
                                                and Chief Executive Officer
 
                               POWER OF ATTORNEY
 
     Each person whose signature appears below hereby appoints Andrew J. Frawley
and John G. O'Brien, each of them severally, acting alone and without the other,
his/her true and lawful attorney-in-fact with the authority to execute in the
name of each such person, and to file with the Securities and Exchange
Commission, together with any exhibits thereto and other documents therewith,
any and all amendments (including without limitation post-effective amendments)
to this Registration Statement necessary or advisable to enable the Registrant
to comply with the Securities Act of 1933, as amended (the "Act"), and any
rules, regulations and requirements of the Securities and Exchange Commission in
respect thereof, and to sign any registration statement for the same offering
covered by this Registration Statement that is to be effective upon filing
pursuant to Rule 462(b) promulgated under the Act, which amendments may make
such other changes in the Registration Statement as the aforesaid
attorney-in-fact executing the same deems appropriate.
 
     Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated:
SIGNATURE                                      TITLE                     DATE
                     ---------                                      -----                     ----
/s/ ANDREW J. FRAWLEY                 Chairman of the Board, President,    July 22, 1998
---------------------------------------------------  Chief Executive Officer and
                 Andrew J. Frawley                   Director (Principal Executive
                                                     Officer)
 
              /s/ DEAN F. GOODERMOTE                 Director                             July 22, 1998
---------------------------------------------------
                Dean F. Goodermote
 
                /s/ JEFFREY HORING                   Director                             July 22, 1998
---------------------------------------------------
                  Jeffrey Horing
 
             /s/ RAMANAN RAGHAVENDRAN                Director                             July 22, 1998
---------------------------------------------------
               Ramanan Raghavendran
 
                /s/ JOHN G. O'BRIEN                  Vice President, Chief Financial      July 22, 1998
---------------------------------------------------  Officer, Treasurer and Secretary
                  John G. O'Brien                    (Principal Financial and Accounting
                                                     Officer)
II-5
95
 
                                 EXHIBIT INDEX
EXHIBIT
  NO.                              DESCRIPTION
--------                           -----------
1.1      Form of Underwriting Agreement.
  3.1      Form of Amended and Restated Certificate of Incorporation of
           the Registrant.
  3.2      Form of Amended and Restated By-laws of the Registrant.
  4.1*     Specimen Certificate for Shares of the Registrant's Common
           Stock, $0.001 par value.
  5.1*     Opinion of Bingham Dana LLP with respect to the legality of
           the shares being registered.
 10.1*     Form of 1998 Stock Incentive Plan, with related forms of
           stock option agreements.
 10.2      1996 Stock Incentive Plan, as amended, with related forms of
           stock option agreements and form of restricted stock
           agreement.
 10.3      Form of 1998 Director Stock Option Plan, with related form
           of stock option agreement.
 10.4      Form of 1998 Employee Stock Purchase Plan.
 10.5      401(k) Plan.
 10.6      Employment Agreement, dated November 15, 1996, between the
           Registrant and Andrew J. Frawley.
 10.7      Restricted Stock Agreement, dated November 8, 1996, between
           the Registrant and Andrew J. Frawley.
 10.8      Consulting Agreement, dated March 18, 1997, between the
           Registrant and Exchange Marketing Group, LLC.
 10.9      Securities Purchase Agreement, dated March 18, 1997.
 10.10     Securities Purchase Agreement, dated December 4, 1997.
 10.11     Stock Purchase and Waiver Agreement, dated December 4, 1997.
 10.12     Promissory Note, dated December 4, 1997, by Andrew J.
           Frawley payable to the Registrant.
 10.13     Amended and Restated Stockholders Agreement dated December
           4, 1997.
 10.14     Amended and Restated Registration Rights Agreement dated
           December 4, 1997.
 10.15     Letter Agreement, dated December 22, 1997, between the
           Registrant and Fleet National Bank, as amended, and the
           related Promissory Note.
 10.16     Stock Purchase Agreement, dated June 25, 1998, and the
           related Waiver Agreement to the Amended and Restated
           Stockholders Agreement, dated June 25, 1998.
 10.17     Office lease for 89 South Street, Boston, Massachusetts.
 21.1      Subsidiaries of Registrant.
 23.1      Consent of Arthur Andersen LLP.
 23.2*     Consent of Bingham Dana LLP, counsel to Registrant (included
           in Exhibit 5.1).
 24.1      Power of Attorney (included in signature page to
           Registration Statement).
 27.1      Financial Data Schedule (6 months ended June 30, 1998)
 27.2      Financial Data Schedule (12 months ended December 31, 1997)
 27.3      Financial Data Schedule (12 months ended December 31, 1996)
---------------
* To be filed by amendment