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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

FOR THE QUARTER ENDED SEPTEMBER 30, 2002

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

COMMISSION FILE NUMBER 0-26536

SMITH MICRO SOFTWARE, INC.

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 362-5800

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK,
$.001 PAR VALUE

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

YES (X)    NO (  )

         As of October 31, 2002, there were 16,235,416 shares of Common Stock outstanding.

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SMITH MICRO SOFTWARE, INC.

FORM 10-Q

TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SMITH MICRO SOFTWARE, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data)

SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.

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SMITH MICRO SOFTWARE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)

SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.

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SMITH MICRO SOFTWARE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.

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SMITH MICRO SOFTWARE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS — continued
(In Thousands)

SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.

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SMITH MICRO SOFTWARE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Description of Business - Smith Micro Software, Inc. (“Smith Micro” or the “Company”) develops and markets wireless communication and utility software products. The Company designs integrated, cross platform, easy-to-use software for personal computing and business solutions around the world. With a focus on the Internet, wireless, and broadband technologies, the Company’s products and services enable eCommerce, eBusiness, Internet communications (voice-over-IP), video conferencing, wireless communications, and network fax, along with traditional computer telephony. Smith Micro’s complete line of products is available through direct sales, retail stores, value-added resellers (VARs) and original equipment manufacturers (OEMs). The Company also offers professional services consulting which include methodologies to help clients focus, define and prioritize Internet investments; develop eCommerce sites and custom eBusiness applications; implement tools to increase revenue per online transaction and transactions per customer; warehouse, mine and integrate data for enhanced accessibility and effective decision support; and select the right technology infrastructure to support eBusiness. An extension of the Company’s eBusiness activity includes the offering of fulfillment services for customer web stores. A portion of the Company’s sales are made direct to hardware device and personal computer manufacturers under Original Equipment Manufacturer (OEM) agreements. The Company sells communication and diagnostic utility products through independent distributors and retail channels. The Company’s eCommerce products enable websites to be created with standard HTML text and provide fully automated payment processing and order accounting.

         Basis of Presentation - The accompanying unaudited interim consolidated financial statements reflect adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of the Company at September 30, 2002, and the results of its operations and cash flows for the three and nine month periods ended September 30, 2002 and 2001. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”), although the Company believes that the disclosures in the unaudited consolidated financial statements are adequate to ensure the information presented is not misleading. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. The results of operations of interim periods are not necessarily indicative of the operating results for the year.

         Cash and Cash Equivalents - Cash and cash equivalents generally consist of cash, government securities and money market funds. These securities are all held in one financial institution. All have original maturity dates of three months or less.

         Accounts Receivable - The Company sells its products worldwide. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses, and those losses have been within management’s expectations. Allowances for product returns and price protection are included in other adjustments to accounts receivable on the accompanying consolidated balance sheets.

         Inventories - Inventories consist principally of manuals and CDs and are stated at the lower of cost (determined by the first-in, first-out method) or market. The Company regularly reviews its inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on management’s estimated forecast of product demand and production requirements.

         Equipment and Improvements - Equipment and improvements are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets, generally ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.

         Long Lived Assets - The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. This statement addresses financial accounting and reporting for the impairment of long-lived assets and for the disposal of long-lived assets. SFAS No. 144 superseded SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and is effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 on January 1, 2002. In accordance with SFAS No. 144, long-lived assets to be held are reviewed for events or changes in circumstances, which indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of long-lived assets to determine whether or not an impairment to such value has occurred.

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         Goodwill and Other Intangibles - Goodwill represents the excess purchase cost over the net assets acquired, and until January 1, 2002, was amortized over three to seven years using the straight-line method. Other intangible assets include acquired technology, which is being amortized using the straight-line method over three years. In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which the Company adopted January 1, 2002. SFAS No. 142 requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually and written down when impaired. SFAS No. 142 requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. In accordance with this Standard, the Company no longer amortizes goodwill and indefinite life intangible assets but will evaluate their carrying value at least on an annual basis or when events or circumstances indicate that their carrying value may be impaired. The Company ceased amortizing goodwill as of the beginning of fiscal 2002. In accordance with SFAS No. 142, the Company was required to perform a two-step transitional impairment review. The first step of this review was completed by June 30, 2002 with the determination of the fair value of the Company’s reporting units in order to identify whether the fair value of each reporting unit is less than its carrying amount. In the event that the fair value of the reporting unit is less than the carrying amount, the second step of the test would be required to determine if the carrying value of goodwill exceeds the implied value. The Company completed its review and determined that it did not have a transitional impairment of goodwill. The Company has no indefinite life intangibles. If estimates or conditions change, a materially different impairment conclusion could result.

         Revenue Recognition - Software revenue is recognized in accordance with the Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended. SOP 97-2 provides guidance on when revenue should be recognized for licensing, selling, leasing or otherwise marketing computer software. The Company generally recognizes revenues from sales of its software as completed products are shipped and title passes and from royalties generated as authorized customers duplicate the Company’s software, assuming collectibility is reasonably assured. The Company may permit customers to return or exchange product and may provide price protection on products unsold by a customer. In accordance with SFAS No. 48, Revenue Recognition when Right of Return Exists, revenue is recorded net of an allowance for estimated returns, exchanges, markdowns, price concessions, and warranty costs. Such reserves are based upon management’s evaluation of historical experience, current industry trends and estimated costs. While returns and other concessions have historically been within management’s estimates, the amount of estimated reserves could change as new information becomes available. In July of 2002, the Company signed a new distribution agreement with its primary distributor. As a result of the new distribution agreement and other related factors, the Company has decided to begin recording revenue from distributors only upon sell-through, rather than upon shipment to the distributor. The impact of this change was to defer recognition certain sales during the quarter and increase reserves for inventory currently in the channel, totaling approximately $200,000. The Company also provides technical support to its customers. Such costs have historically been insignificant.

         Consulting services and hosting revenues are recognized as services are provided or as milestones are delivered and accepted by customers.

         Sales Incentives - In 2001 the Emerging Issues Task Force issued EITF 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Product). Effective January 1, 2002, the Company has adopted EITF 01-09. Pursuant to the consensus of Issue 01-09, the cost of sales incentives the Company offers without charge to customers that can be used in, or that are exercisable by a customer as a result of, a single exchange transaction is required to be accounted for as a reduction of revenue. The Company’s consolidated financial statements for prior periods presented for comparative purposes have been reclassified to comply with the revised income statement display requirements. The result of this adoption was a decrease in revenue with a corresponding decrease in selling and marketing expense of $214,000 and $526,000 in the three and nine months ended September 30, 2001, respectively. There were no significant sales incentives in the three months ended September 30, 2002. The impact for the nine months ended September 30, 2002 is lower revenue and lower selling and marketing expense of $227,000.

         Software Development Costs - Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. The Company considers technological feasibility to be established when all planning, designing, coding and testing has been completed according to design specifications. After technological feasibility is established, any additional costs are capitalized. Through June 30, 2002, software has been substantially completed concurrently with the establishment of technological feasibility; and, accordingly, no costs have been capitalized to date.

         Income Taxes - The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes. This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in the Company’s financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the

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future consequences of differences between financial reporting bases and the tax bases of the Company’s assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. During the three months ended September 30, 2002, the Company was able to quantify and recognize a tax benefit of $1,070,000 related to previously reserved net operating loss carryforwards. The related refund was received in September, 2002.

         Stock-Based Compensation - The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.

         Net Income (Loss) per Share - Pursuant to SFAS No. 128, Earnings per Share, the Company is required to provide dual presentation of “basic” and “diluted” earnings (loss) per share (EPS). Basic EPS amounts are based upon the weighted average number of common shares outstanding. Diluted EPS amounts are based upon the weighted average number of common and common equivalent shares outstanding. Common equivalent shares include stock options using the treasury stock method. Common equivalent shares are excluded from the calculation of diluted EPS in loss years, as the impact is antidilutive. Therefore, there was no difference between basic and diluted EPS for each period presented. Additionally, Due to the relationship between the current market price of the Company’s common stock and the exercise price of outstanding stock options, all stock options were antidilutive for the period ended September 30, 2002.

         Fulfillment Services - The Company currently holds approximately $500,000 of consigned inventory for a customer, which is used to fulfill internet orders. As the Company does not hold title to the inventory, it is not recorded in the accompanying consolidated balance sheet. In addition, the Company receives cash for internet fulfillment orders which is paid out to the fulfillment customer on a monthly basis. Such cash and the related payable are recorded on a net basis due to the right of offset.

         Segment Information - The Company operates in two business segments: software products and Internet solutions. The software products operating segment develops and markets the Company’s software products, except for eCommerce software. Within software products the Company further concentrates on wireless and broadband products, Macintosh products and the related retail products for each of these concentrations. The Internet solutions segment provides eCommerce software solutions, eBusiness strategy and integration of new infrastructure solutions into existing systems. The Internet solutions segment also includes hosting revenue. The Company does not separately allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of sales and gross profit, as this information and the geographic information described below are the primary information provided to the chief executive officer.

         The following table shows the net revenues, cost of revenues and gross profit (in thousands) generated by each segment.

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Three Months Ended September 30, 2002

Three Months Ended September 30, 2001

Nine Months Ended September 30, 2002

Nine Months Ended September 30, 2001

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

         Comprehensive Income - SFAS No. 130, Reporting Comprehensive Income establishes standards for the reporting of comprehensive income and its components. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from nonowner sources. For each of the periods ended September 30, 2002 and 2001, there was no difference between net income (loss), as reported, and comprehensive income (loss).

         Reclassifications - Certain reclassifications have been made to the 2001 financial statements to conform to the 2002 presentation.

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2. NEW ACCOUNTING PRONOUNCEMENTS

         In June 2001, the FASB issued two new pronouncements: SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 prohibits the use of the pooling-of-interest method for business combinations initiated after June 30, 2001 and also applies to all business combinations accounted for by the purchase method that are completed after June 30, 2001. The adoption of SFAS No. 141, did not have a material impact on the consolidated financial statements. There are also transition provisions that apply to business combinations completed before July 1, 2001, that were accounted for by the purchase method. SFAS No. 142 requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually and written down when impaired. SFAS No. 142 requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. In accordance with this Standard, the Company no longer amortizes goodwill and indefinite life intangible assets but will evaluate their carrying value at least on an annual basis or when events or circumstances indicate that their carrying value may be impaired. The Company ceased amortizing goodwill as of the beginning of fiscal 2002. In accordance with SFAS No. 142, the Company is required to perform a two-step transitional impairment review. The first step of this review was completed by June 30, 2002 with the determination of the fair value of the Company’s reporting units in order to identify whether the fair value of each reporting unit is less than its carrying amount. In the event that the fair value of the reporting unit is less than the carrying amount, the second step of the test would be required to determine if the carrying value of goodwill exceeds the implied value. The Company determined that it did not have a transitional impairment of goodwill. The Company had no indefinite life intangibles as of January 1, 2002. If estimates change, a materially different impairment conclusion could result. In accordance with this pronouncement, effective January 1, 2002, Smith Micro no longer amortizes goodwill. For comparison, goodwill amortization expense was $136,000 and $408,000 in the three and nine months ended September 30, 2001.

         In October 2001, the FASB issued SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and addresses financial accounting and reporting for the impairment and disposal of long-lived assets. This statement is effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 did not have a material impact on the consolidated financial statements.

         In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. We will adopt the provisions of SFAS 146 for exit or disposal activities that are initiated after December 31, 2002.

3. GOODWILL

         In connection with the Company’s acquisitions of all the outstanding capital stock of STF Technologies, Inc. the total excess cost over the fair value of the net assets acquired of $2.3 million was allocated to goodwill and was being amortized over a useful life of seven years. In connection with the Company’s acquisition of the eBusiness consulting practice of Quickstart Technologies, Inc., the excess cost over the fair value of the net assets acquired of $600,000 was allocated to goodwill and was being amortized over a useful life of three years. These amortization costs were recorded in general and administrative expense. The Company ceased amortizing goodwill as of the January 1, 2002 in accordance with SFAS No. 142 and did not recognize approximately $136,000 and $408,000 of amortization expense that was recognized in the three and nine months ended September 30, 2001. As of June 30, 2002 the Company completed the required initial step of a transitional impairment test and has determined that goodwill is not impaired. Any impairment loss resulting from the transitional impairment test would have been recorded retroactively as a cumulative effect of a change in accounting principle. Subsequent impairment losses, if any, will be reflected in operating income (loss) in the statement of operations. The Company will evaluate the carrying value of goodwill of $1.7 million at least annually or when events or circumstances indicate that their carrying value may be impaired.

         At September 30, 2002 the amount of goodwill allocated to Products is $1,380,000. The amount of goodwill allocated to Services is $335,000.

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         Summarized below are the effects on net loss per share data, if the Company had followed the amortization provisions of SFAS 142 for all periods presented (in thousands, except per share amounts):

Financial Accounting Standards Board Standards Nos. 141 and 142 on Business Combinations and Goodwill and Other Intangible Assets also require that the Company disclose the following information related to its intangible assets still subject to amortization. Amortized intangible assets balance as of September 30, 2002 and December 31, 2001 (in thousands):

The estimated amortization expense for acquired technology for each of the remaining useful lives of the acquired technology is approximately $283,000, $125,000 and $40,000 for fiscal years ending December 31, 2002, 2003 and 2004, respectively.

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

         CERTAIN STATEMENTS IN THIS REPORT, INCLUDING STATEMENTS REGARDING THE COMPANY’S STRATEGY, FINANCIAL PERFORMANCE AND REVENUE SOURCES, ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATES SECURITIES LITIGATION REFORM ACT OF 1995, SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AND SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND ARE SUBJECT TO THE SAFE HARBORS CREATED BY THOSE SECTIONS. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS AND ENTAIL VARIOUS RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY’S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS SET FORTH UNDER “RISK FACTORS” AND ELSEWHERE IN THIS REPORT. READERS ARE URGED TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE BY THE COMPANY IN THIS REPORT AND IN THE COMPANY’S OTHER REPORTS FILED WITH THE SEC, INCLUDING THE COMPANY’S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001 AND OUR SUBSEQUENT REPORTS ON FORMS 10-Q AND 8-K, THAT ATTEMPT TO ADVISE INTERESTED PARTIES OF CERTAIN RISKS AND FACTORS THAT MAY AFFECT THE COMPANY’S BUSINESS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES OCCURRING AFTER THE DATE HEREOF. YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH THE COMPANY’S CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO CONTAINED ELSEWHERE IN THIS REPORT.

Overview

         We are a developer and marketer of wireless, communications, diagnostic, utility and eCommerce software products as well as a provider of Internet consulting and hosting services. We design integrated, cross platform, easy-to-use software for personal computing and business solutions. Our software includes products developed for the wireless, Internet and broadband technologies, products that enable wireless communications, eCommerce, Internet communications (voice-over-IP), video conferencing, general system utility and diagnostic products and network fax along with traditional computer telephony. An extension of the Company’s eBusiness activity includes the offering of fulfillment services for customer web stores.

         We continue to develop new products that leverage off our core technologies. We also leverage our experience and position with original equipment manufacturers, commonly known as OEM’s, to deploy these new product releases. Additionally, we are expanding our customer base to include wireless service providers and manufacturers that produce wireless handsets and produce devices that take advantage of the high bandwidth Internet connectivity such as cable and xDSL modems. Our corporate products are designed to provide cost effective and efficient methods of communicating that take advantage of corporate local and wide area networks, including the Internet or intranets.

         We were first incorporated in California in 1983 and later reincorporated in Delaware in 1995. In 1985, we shipped our first data communication software product. At that time, we generated revenues primarily from the market acceptance of our OEM fax and data communication software products. We began providing video communication products in 1996 to both OEM and retail customers. In January 1998, we purchased certain fax software assets of Mitek Systems, Inc. to provide LAN, Internet and Internet fax transmission solutions designed for the corporate market. In September 1998, we shipped our first Internet communications software product. This multi-purpose product provides for integrated telephony, multimedia e-mail, video surety, fax, video conferencing and text based chat functionality over the Internet and other IP protocol services such as LAN’s and WAN’s. Designed to take advantage of high bandwidth technology, this product functions over a variety of IP connectivity hardware including xDSL modems, cable modems, network interface devices and analog modems.

         In April 1999, we expanded our Macintosh products with the acquisition of STF Technologies, Inc. This acquisition enhanced our ability to develop and sell communications (primarily fax) software to the Macintosh market. In September 1999, we acquired Pacific Coast Software so that we could offer eCommerce business solutions. In July 2000, we acquired the TouchStone CheckIt® product line. We market these products under the Smith Micro CheckIt® brand including CheckIt® Firewall. Finally, in September 2000 we acquired the consulting practice unit of QuickStart Technologies, Inc., a provider of integrated Internet business services to middle market companies.

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         Our products for the consumer and business markets are available through Internet sales, retail stores, direct sales, eTailers and value-added resellers (VARs). Retail outlets that sell our products include CompUSA, Office Depot, Micro Center, Staples, Circuit City, PC Connections, Multiplezones, and Fry’s Electronics. Our products can be purchased at many online locations, including Buy.com, Beyond.com and Amazon.com. In the original equipment manufacturers (or OEM) market we are a supplier of communication and diagnostic utility software, having shipped over 40 million copies of products. Our OEM customers include manufacturers of wireless devices and services, personal computers, digital cameras and data modems. We currently maintain OEM relationships with several companies including Verizon, Tektronix, Hughes Network Systems, Apple, Hewlett Packard, Gateway, Brother International, Philips Consumer Electronics, Viking Components, Zoom, D-Link, Audiovox, LGIC, and Kyocera.

         The Internet Solutions Division services include supporting our WebCatalog product, complete website design and installation, website hosting and co-location services and application service provider services for WebCatalog. Our eCommerce customers include Kyocera/Infocomm, Harmon Multimedia, Diedrich’s Coffee and Boomtown Casino, among others. An extension of the Company’s eBusiness activity includes the offering of fulfillment services for customer web stores.

RESULTS OF OPERATIONS

         The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of total revenue.

Three and nine months ended September 30, 2002 and 2001

Revenues

         Total net revenues were $1.8 million and $2.3 million for the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $462,000, or 20.0%, from 2001 to 2002. Total net revenues were $5.4 million and $6.3 million for the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of $966,000, or 15.3%, from 2001 to 2002.

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         Products. Net product revenues were $1.6 million and $1.7 in the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $117,000, or 6.7%, from 2001 to 2002. Wireless and Broadband sales increased quarter to quarter as the result of increased sales and the absence of the significant order delays experienced in 2001. Sales by the Macintosh division increased as a result of the release of FaxSTF for OS X. These increases were offset by the decreased revenue in our Internet Solutions Division caused by the cessation of Microsoft products consulting announced in the first quarter of 2002 and the decrease in Retail sales due to the overall sluggishness of the retail software sector and the increase in our retail reserves discussed in Footnote 1. Products revenue accounted for 88.7% of total revenues in the three months ended September 30, 2002 compared with 76.0% of total revenues in the comparable period of 2001.

         Net product revenues were $4.4 million and $4.3 million in the nine months ended September 30, 2002 and 2001, respectively, representing an increase of $163,000, or 3.8%, from 2001 to 2002. Wireless and Broadband sales increased in the nine months ended September 30, 2002 as result increased sales and the absence of the significant order delays experienced in 2001. The delays were related to carrier and handset manufacturer issues relating to the rollout of new high-speed data services and supporting handsets. In addition, sales in our Macintosh division increased as a result of the release of FaxSTF for OS X. These increases were offset by decreases in Retail sales and sales in the Internet Solutions Division discussed previously. Products revenue accounted for 83.0% of total revenues in the nine months ended September 30, 2002 compared with 67.8% of total revenues in the comparable period of 2001.

         Services. Services revenues were $209,000 and $554,000 in the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $345,000 or 62.3%, from 2001 to 2002. The announcement of a new strategic direction for our Internet Solutions Division has resulted in the cessation of significant Microsoft Product consulting in 2002, which amounted to 86% of service revenue in the comparable period of 2001. Services revenue accounted for 11.3% of total revenues in the three months ended September 30, 2002 compared with 24.0% of total revenues in the comparable period of 2001.

         Services revenues were $909,000 and $2.0 million in the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of $1.1 million or 55.4%, from 2001 to 2002. As discussed, the announcement of a new strategic direction for our Internet Solutions Division has resulted in the cessation of significant Microsoft Product consulting in 2002, which amounted to 85% of service revenue in the comparable period of 2001. Services revenue accounted for 17.0% of total revenues in the nine months ended September 30, 2002 compared with 32.2% of total revenues in 2001.

Cost of Revenues

         Cost of Product Revenues. Cost of product revenues was $507,000 and $268,000 in the three months ended September 30, 2002 and 2001, respectively, representing an increase of $239,000, or 89.2%, from 2001 to 2002. Cost of product revenue as a percentage of product revenues was 31.0% and 15.3% for 2002 and 2001, respectively. Cost of product revenues was $1.1 million and $1.2 million in the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of $49,000, or 4.2%, from 2001 to 2002. Cost of product revenue as a percentage of product revenues was 25.0% and 27.1% for 2002 and 2001, respectively. The increase in the cost of product revenue in 2002 highlights the sales of QuickLink Mobile wireless data connectivity kits that include a cable, resulting in higher costs of revenue than pure software sales.

         Cost of Service Revenues. Cost of service revenues was $110,000 and $543,000 in the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $433,000 or 79.8%, from 2001 to 2002. Cost of service revenue as a percentage of service revenues was 52.6% and 98.0% for 2002 and 2001, respectively. Cost of service revenues was $660,000 and $1.6 million in the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of $970,000 or 59.5%, from 2001 to 2002. Cost of service revenue as a percentage of service revenues was 72.6% and 80.0% for 2002 and 2001, respectively. Cost of service revenues includes the cost of our consulting personnel and the cost of hiring outside contractors to support our staff of consultants. The absolute dollar decrease in the total cost of service revenues was primarily the result of our cost reduction measures, which consisted primarily of reductions in headcount. In addition, with many of our consulting projects being deferred by our customers, our consulting workforce was under utilized in the three and nine months ended September 30, 2001.

Operating Expenses

         Selling and Marketing. Selling and marketing expenses were $516,000 and $876,000 in the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $360,000, or 41.1%, from 2001 to 2002. Our selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary significantly from quarter to quarter based on the timing of trade shows and product introductions. Selling and marketing expenses were

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$1.7 million and $3.8 million in the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of $2.1 million, or 54.3%, from 2001 to 2002. The decrease in our selling and marketing expenses in both the three and nine months ended September 30, 2002 over the comparable periods of 2001 were primarily the result of the cost reduction measures undertaken beginning in the second quarter of 2001 which consisted of reductions in headcount, compensation and professional services.

         Research and Development. Research and development expenses were $503,000 and $636,000 in the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $133,000, or 20.1%, from 2001 to 2002. Our research and development expenses consist primarily of personnel and equipment costs required to conduct our software development efforts. We remain focused on the development and expansion of our technology, particularly our wireless, diagnostic, utility and Internet software technologies. Research and development expenses were $1.6 million and $2.5 million in the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of $912,000, or 36.9%, from 2001 to 2002. The decrease in our research and development expenses in both the three and nine month ended September 30, 2002 over 2001 is primarily due to the cost reduction efforts implemented in 2001, most notably a reduction in headcount and the closure of our Oregon and Colorado offices in the second quarter of 2001. This reduction realigns our research and development cost base consistent with current revenues.

         General and Administrative. General and administrative expenses were $602,000 and $752,000 in the three months ended September 30, 2002 and 2001, respectively, representing a decrease of $150,000, or 20.0%, from 2001 to 2002. General and administrative expenses were $1.7 million and $3.1 million in the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of $1.4 million, or 44.3%, from 2001 to 2002. The decrease in our general and administrative expenses in the both periods ended September 30, 2002 over 2001 is due primarily to cost reductions efforts undertaken in 2001, which consisted of reductions in headcount, compensation and professional services. In addition, the three and nine months ended September 30, 2001 included amortization of goodwill of $136,000 and $408,000, respectively, not included in 2002 as a result of the adoption of SFAS No. 142.

         Restructuring Costs. In the three months ended September 30, 2001, we reported a restructuring charge in the amount of $35,000. In the nine months ended September 30, 2001, we reported a restructuring charge in the amount of $380,000. This amount includes a $230,000 lease payment commitment on the office space in Beaverton, Oregon, which was closed, and personnel costs incurred as a result of a company wide reduction in staff of 40 people or 37.8%. As of September 30, 2002, $221,000 has been paid and $159,000 remains in accrued liabilities. The accrued liability will be paid over the remaining lease term for the facility closed in the second quarter of 2001.

         Interest Income (Expense). Net interest expense was $3,000 in the three months ended September 30, 2002 and net interest income was $11,000 in the three months ended September 30, 2001, representing a decrease of $14,000, or 127.3%, from 2001 to 2002. Net interest expense was $25,000 in the nine months ended September 30, 2002 and net interest income was $76,000 in the nine months ended September 30, 2001, representing a decrease of $101,000, or 132.9%, from 2001 to 2002. The decrease in our net interest income is directly related to our lower cash balance and declining interest rates. We have not changed our investment strategy during the periods being reported on, with our excess cash consistently being invested in short term marketable securities. Interest expenses in each period consist of credit card processing fees.

         Provision for Income Taxes. In the three months ended September 30, 2002, we reported an income tax benefit in the amount of $1.1 million. This benefit is the result of a net operating loss carryback, which allowed the Company to file for a refund of income taxes paid in 1996. The provision for income taxes was $3,000 in the three months ended September 30, 2001, which related to taxes paid on foreign sales. The income tax benefit was $1.1 million while the provision for income taxes was $92,000 in the nine months ended September 30, 2002 and 2001, respectively, representing an increase of $1.2 million, from 2001 to 2002. The tax expense for the nine months ended September 30, 2001 relates to amounts assessed as the result of an audit of the Company’s 1996 Federal tax return.

Liquidity and Capital Resources

         Since our inception, we have financed operations primarily through cash generated from operations and from proceeds of $18.1 million generated by our initial public offering in 1995. Our principal sources of liquidity as of September 30, 2002 consisted primarily of cash and cash equivalents of $3.9 million.

         Net cash provided by operating activities was $635,000 in the nine months ended September 30, 2002 compared to $2.3 million used in operating activities in the comparable period of 2001. Net cash provided during the nine months ended September 30, 2002 primarily related to decreases in accounts receivable and the income tax refund, partially offset by operating losses and the decrease in

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current liabilities. The primary operating use of cash during the 2001 period was funding our net loss, partially offset by the decrease in accounts receivable.

         During the nine months ended September 30, 2002, we used $11,000 in investing activities compared to $100,000 in the same period of 2001.

         At September 30, 2002, we had $3.9 million in cash and cash equivalents and $3.6 million of working capital. Our accounts receivable balance, net of allowance for doubtful accounts and other adjustments was $937,000 at September 30, 2002. We have no significant capital commitments, and currently anticipate that capital expenditures will not vary significantly from recent periods. We believe that our existing cash, cash equivalents and investment balances and cash flow from operations will be sufficient to finance our working capital and capital expenditure requirements through at least the next 12 months. We may require additional funds to support our working capital requirements or for other purposes and may seek to raise additional funds through public or private equity or debt financing or from other sources. If additional financing is needed, we cannot assure you that such financing will be available to us at commercially reasonable terms or at all.

RISK FACTORS

BEFORE DECIDING TO INVEST IN OUR COMPANY OR TO MAINTAIN OR INCREASE YOUR INVESTMENT, YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS REPORT AND IN OUR OTHER FILINGS WITH THE SEC, INCLUDING OUR SUBSEQUENT REPORTS ON FORMS 10-Q AND 8-K. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY ALSO AFFECT OUR BUSINESS OPERATIONS. IF ANY OF THESE RISKS ACTUALLY OCCUR, THAT COULD SERIOUSLY HARM OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS. IN THAT EVENT, THE MARKET PRICE FOR OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT.

Our quarterly operating results may fluctuate and cause the price of our common stock to fall.

         Our quarterly revenues and operating results have fluctuated significantly in the past and may continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, our stock price may decline. Fluctuations in our operating results may be due to a number of factors, including the following:

	•		the volume of our product sales and pricing concessions on volume sales;
	•		the size and timing of orders from and shipments to our major customers, including our largest distributor;
	•		the size and timing of any return product requests for our products;
	•		our ability to maintain or increase gross margins;
	•		general economic and market conditions;
	•		variations in the our sales channels or the mix of our product sales;
	•		the gain or loss of a key customer;
	•		our ability to specify, develop, complete, introduce, market and transition to volume production new products and technologies in a timely manner;
	•		the availability and pricing of competing products and technologies and the resulting effect on sales and pricing of our products;
	•		the effect of new and emerging technologies;

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	•		deferrals of orders by our customers in anticipation of new products, applications, product enhancements or operating systems; and
	•		the success of our cost-cutting measures.

         A large portion of our operating expenses, including rent, depreciation, amortization, and capital lease expenditures, is fixed and difficult to reduce or change. Accordingly, if our total revenue does not meet our expectations, we probably would not be able to adjust our expenses quickly enough to compensate for the shortfall in revenue. In that event, our business, financial condition and results of operations would be materially and adversely affected.

         Due to all of the foregoing factors, and the other risks discussed in this report, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of future performance.