Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

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

For the fiscal year ended December 31, 2001
 
OR

[   ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)                
 
Commission file number 000-27687

BSQUARE CORPORATION

(Exact name of registrant as specified in its charter)

Washington		91-1650880
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3150 — 139th Avenue NE, Suite 500
Bellevue, Washington 98005-4081
(Address of principal executive offices)
 
(425) 519-5900
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no 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 [   ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

     The aggregate market value of voting stock of the registrant held by non-affiliates of the registrant as of February 28, 2002 was approximately $75.0 million based on the closing sales price of the registrant’s common stock as reported on The Nasdaq National Market. For the purposes of this response, executive officers, directors and persons who own 5% or more of the outstanding shares of common stock are deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for any other purpose. The registrant had 35,160,119 shares of common stock, no par value, outstanding at February 28, 2002.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive proxy statement to be delivered to shareholders in connection with the annual meeting of shareholders to be held on April 30, 2002 are incorporated by reference into Part III of this Form 10-K.

Table of Contents

BSQUARE CORPORATION
 
FORM 10-K
 
TABLE OF CONTENTS

			Page
PART I				3
	Item 1.      Business			3
	Item 2.      Properties			22
	Item 3.      Legal Proceedings			23
	Item 4.      Submission of Matters to a Vote of Security Holders			23
PART II				23
	Item 5.      Market for Registrant’s Common Equity and Related Shareholder Matters			23
	Item 6.      Selected Financial Data			24
	Item 7.      Management’s Discussion and Analysis of Results of Operations and Financial Condition			25
	Item 7A.   Quantitative and Qualitative Disclosures About Market Risk			34
	Item 8.      Financial Statements and Supplementary Data			36
	Item 9.      Changes in and Disagreements with Accountants on Auditing and Financial Disclosure			56
PART III				56
	Item 10.    Directors and Executive Officers of the Registrant			56
	Item 11.    Executive Compensation			56
	Item 12.    Security Ownership of Certain Beneficial Owners and Management			56
	Item 13.    Certain Relationships and Related Transactions			56
PART IV				57
	Item 14.    Exhibits, Financial Statement Schedules and Reports on Form 8-K			57
	Signatures			59

2

Table of Contents

PART I

Item 1. Business

FORWARD-LOOKING STATEMENTS

     This Form 10-K and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 based on current expectations, estimates and projections about our industry and our management’s beliefs and assumptions. When used in this Form 10-K and elsewhere, the words “believes,” “plans,” “estimates,” “intends,” “anticipates,” “seeks” and “expects” and similar expressions are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements that are not historical facts. These forward-looking statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Accordingly, actual results may differ materially from those anticipated or expressed in such statements as a result of a variety of factors, including those set forth below under “Risk Factors”. Such forward-looking statements include, but are not limited to, statements with respect to the following:

	•		the growth in number of Internet users and market for business to business Internet transactions;
	•		the development of the smart device market and our ability to address its challenges;
	•		the emergence of Windows CE, Windows NT Embedded and Windows XP Embedded as operating systems of choice for many hardware and software applications vendors;
	•		our business plan, its advantages and our strategy for implementing our plan;
	•		our ability to expand our strategic relationships with hardware and software vendors and continue to build on our relationship with Microsoft;
	•		our ability to expand our international presence;
	•		our ability to attain increased product sales and revenue growth attributable to original equipment manufacturers and semiconductor vendors;
	•		our ability to return to profitability in 2002;
	•		our ability to develop our technology and expand our product and service offerings; and
	•		our anticipated working capital and capital expenditure requirements, including our ability to meet our anticipated cash needs.

     Readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date made. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Readers, however, should carefully review the factors set forth in this and other reports or documents that we file from time to time with the Securities and Exchange Commission.

RISK FACTORS

     In addition to other information in this Form 10-K report, investors evaluating our business and us should carefully consider the following risk factors. These risks may impair our operating results and business prospects and the market price of our stock. The risks set forth below and elsewhere in this Form 10-K report could cause actual results to differ materially from those projected.

Unanticipated fluctuations in our quarterly operating results due to factors such as adverse changes in our relationship with Microsoft or a decline in the market for Windows-based smart devices could cause our stock price to decline significantly.

3

Table of Contents

Our operating results have fluctuated in the past, and we expect that they will continue to do so. We believe that period-to-period comparisons of our operating results are not meaningful, and you should not rely on such comparisons to predict our future performance. If our operating results fall below the expectations of stock analysts and investors, the price of our common stock may fall. Factors that have in the past and may continue in the future to cause our quarterly operating results to fluctuate include:

	•		adverse changes in our relationship with Microsoft, from which a substantial portion of our revenue is generated and on which we rely to continue to develop and promote Windows CE and other Windows-based operating systems, including changes such as the reduction in our billing rates and the number of our engineers assigned to Microsoft projects resulting from the recent renewal of our contract with Microsoft;
	•		the failure or perceived failure of Windows CE, the operating system upon which demand for the majority of our products and services is dependent, to achieve widespread market acceptance;
	•		the failure of the smart device market to develop;
	•		our inability to develop and market new and enhanced products and services on a timely basis;
	•		unanticipated delays, or announcement of delays, by Microsoft of Windows product releases, which could cause us to delay our product introductions or delay commencement of service contracts and adversely affect our customer relationships;
	•		changes in demand for our products and services, including the early termination of customer contracts;
	•		increased competition and changes in our pricing as a result of increased competitive pressure;
	•		our ability to control our expenses, a large portion of which are relatively fixed and which are budgeted based on anticipated revenue trends, in the event that customer projects, particularly Microsoft projects, are delayed, curtailed or discontinued;
	•		changes in the mix of our services and product revenue, which have different gross margins;
	•		underestimates by us of the costs to be incurred in significant fixed-fee service projects; and
	•		varying customer buying patterns, which are often influenced by year-end budgetary pressures.

     In addition, our stock price may fluctuate due to conditions unrelated to our operating performance, including general economic conditions in the software industry and the market for technology stocks.

A substantial portion of our revenue, including 40% of our total revenue for the year ended December 31, 2001, is generated from our relationship with Microsoft, which can be modified or terminated by Microsoft at any time.

     For the years ended December 31, 1999, 2000 and 2001, approximately 85%, 58% and 40% of our revenue, respectively, was generated under our master development and license agreement with Microsoft. The master agreement, the current term of which concludes in July 2002, includes a number of project-specific work plans. On July 16, 2001, we announced that we had negotiated in principle a renewal of the master agreement with Microsoft. As a result of the concluded negotiations, effective July 1, 2001 we accepted a 10% reduction in bill rates and a scheduled reduction in the number of our engineers assigned to Microsoft projects. The number of engineers assigned to Microsoft projects declined 10% for the third quarter of 2001, an additional 24% for the fourth quarter of 2001 and is scheduled to decline an additional 31% for the first quarter of 2002; all compared to the second quarter 2001 assignment of 102 engineers

     We bill Microsoft on a time-and-materials basis, although each project has a maximum dollar cap. As of January 31, 2002, we had dedicated 35 of our 273 engineers to these projects. However, the master agreement and each of the individual work plans may be terminated or modified by Microsoft at any time. In addition, there is no guarantee that Microsoft will continue to enter into additional work plans with us. We do not believe that we could replace the Microsoft revenue in the short- or medium-term if existing work plans were canceled or curtailed, and such cancellations or curtailments would therefore substantially reduce our revenue. Microsoft is a publicly traded company that files financial reports and information with the Securities and Exchange Commission. These reports are publicly available under Microsoft’s Exchange Act filing number, 000-14278.

4

Table of Contents

If the market for the Windows CE operating system fails to develop fully or develops more slowly than we expect, our business and operating results will be materially harmed.

     Windows CE is one of many operating systems developed for the smart device market and the extent of its future acceptance is uncertain. Because the majority of our revenue to date has been generated by software products and services dependent on the Windows CE operating system, if the market for Windows CE fails to develop fully or develops more slowly than we expect, our business and operating results will be significantly harmed. Market acceptance of Windows CE will depend on many factors, including:

	•		Microsoft’s development and support of the Windows CE market. As the developer and primary promoter of Windows CE, if Microsoft were to decide to discontinue or lessen its support of the Windows CE operating system, potential customers could select competing operating systems, which would reduce the demand for our Windows CE-based software products and services;
	•		the ability of the Windows CE operating system to compete against existing and emerging operating systems for the smart device market including: VxWorks and pSOS from WindRiver Systems Inc., VRTX from Mentor Graphics Corporation, JavaOS from Sun Microsystems, Inc. and Linux. In particular, in the market for palm-size devices, Windows CE faces intense competition from PalmOS from Palm Incorporated, and to date has had limited success in this market. In the market for cellular phones, Windows CE faces competition from the EPOC operating system from Symbian, a joint venture among several of the largest manufacturers of cellular phones. Windows CE may be unsuccessful in capturing a significant share of these two segments of the smart device market, or in maintaining its market share in those other segments of the smart device market on which our business currently focuses, including the markets for Internet-enabled television set-top boxes, handheld industrial devices, consumer Internet appliances such as kiosk terminals and vehicle navigational devices, and Windows-based terminals;
	•		the acceptance by original equipment manufacturers and consumers of the mix of features and functions offered by Windows CE; and
	•		the willingness of software developers to continue to develop and expand the applications that run on Windows CE. To the extent that software developers write applications for competing operating systems that are more attractive to smart device end users than those available on Windows CE, potential purchasers could select competing operating systems over Windows CE.

We cannot assure you that our revenue growth rate will not continue to decline or that we will be able to return to profitability.

     The rate of growth of our revenue over the prior year was 60% from 1998 to 1999, 53% from 1999 to 2000, and a decline of 3% from 2000 to 2001. We anticipate that the rate of growth of our revenue over prior periods may continue to decline, especially in light of the anticipated reductions in revenue from Microsoft resulting from the recent renegotiation of our master agreement. In addition, the slowdown in the U.S. economy generally and recent terrorist attacks upon the United States have added economic and consumer uncertainty that could adversely affect our revenue growth. We anticipate that our expenses will increase substantially in the foreseeable future as we continue to develop our technology and expand our product and service offerings. These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenue sufficiently to offset these higher expenses. We have recently initiated a number of cost-cutting measures in an effort to reduce our expenses. We cannot assure you, however, that these measures will be successful. If we fail to increase our revenue to keep pace with our expenses, we may continue to experience losses.

If we do not respond on a timely basis to technological advances and evolving industry standards, our future product sales could be negatively impacted.

     The market for Windows-based embedded products and services is new and evolving. As a result, the life cycles of our products are difficult to estimate. To be successful, we must continue to enhance our current product line and develop new products. We have experienced delays in enhancements and new product release dates in the past and may be unable to introduce enhancements or new products successfully or in a timely manner in the future. Our business may be harmed if we must delay releases of our products and product enhancements or if these products and product enhancements fail to achieve market acceptance when released. In addition, our customers may defer or forego purchases of our products if we, Microsoft, our competitors or major hardware, systems or

5

Table of Contents

software vendors introduce or announce new products or product enhancements. Such deferrals or failures to purchase would decrease our revenue.

If the market for smart devices fails to develop fully or develops more slowly than we expect, our revenue will not grow as fast as anticipated, if at all.

     The market for smart devices is emerging and the potential size of this market and the timing of its development are not known. As a result, our profit potential is uncertain and our revenue may not grow as fast as we anticipate, if at all. We are dependent upon the broad acceptance by businesses and consumers of a wide variety of Windows-based smart devices, which will depend on many factors, including:

	•		the development of content and applications for smart devices;
	•		the willingness of large numbers of businesses and consumers to use devices such as handheld and palm-size PCs and handheld industrial data collectors to perform functions currently carried out manually or by traditional PCs, including inputting and sharing data, communicating among users and connecting to the Internet; and
	•		the evolution of industry standards that facilitate the distribution of content over the Internet to these devices via wired and wireless telecommunications systems, satellite or cable.

If Microsoft adds features to its Windows operating system that directly compete with software products and services we provide, our revenue could be reduced and our profit margins could suffer.

     As the developer of Windows, Microsoft could add features to its operating system that directly compete with the software products and services we provide to our customers. Such features could include, for example, faxing, hardware-support packages and quality-assurance tools. The ability of our customers or potential customers to obtain software products and services directly from Microsoft that compete with our software products and services could harm our business. Even if the standard features of future Microsoft operating system software were more limited than our offerings, a significant number of our customers and potential customers might elect to accept more limited functionality in lieu of purchasing additional software. Moreover, the resulting competitive pressures could lead to price reductions for our products and reduce our profit margins.

If we do not maintain our favorable relationship with Microsoft, we will have difficulty marketing our software products and services and may not receive developer releases of Windows CE, and our revenue and operating margins will suffer.

     In addition to our master agreement with Microsoft, we also maintain a marketing relationship Microsoft. In the event that our relationship with Microsoft were to deteriorate, then our efforts to market and sell our software products and services to original equipment manufacturers could be adversely affected and our business would be harmed. Microsoft has great influence over the development plans and buying decisions of original equipment manufacturers utilizing Windows CE for smart devices. Microsoft refers many of our original equipment manufacturer customers to us. Moreover, Microsoft controls the marketing campaigns related to its operating systems, including Windows CE. Microsoft’s marketing activities, including trade shows, direct mail campaigns and print advertising, are important to the continued promotion and market acceptance of Windows CE and, consequently, of our Windows CE-based software products and services. We must maintain a successful relationship with Microsoft so that we may continue to participate in joint marketing activities with Microsoft, including participating in “partner pavilions” at trade shows and listing our services on Microsoft’s website, and to receive referrals from Microsoft. In the event that we are unable to continue our joint marketing efforts with Microsoft or fail to receive referrals from Microsoft, we would be required to devote significant additional resources and incur additional expenses to market our software products and services directly to potential customers. In addition, we depend on receiving from Microsoft developer releases of new versions of and upgrades to Windows CE and related Microsoft software in order to timely develop and ship our products and provide services. If we are unable to receive these developer releases, our revenue and operating margins would suffer.

Unanticipated delays, or announcement of delays, by Microsoft of Windows CE product releases could adversely affect our sales.

     Unanticipated delays, or announcement of delays, in Microsoft’s delivery schedule for new versions of its Windows CE operating system could cause us to delay our product introductions and impede our ability to complete customer projects on a timely basis. These delays or announcements by Microsoft of delays could also cause our customers to delay or cancel their project development

6

Table of Contents

activities or product introductions. Any resulting delays in, or cancellations of, our planned product introductions or in our ability to commence or complete customer projects may adversely affect our revenue and could cause our quarterly operating results to fluctuate. For example, in 1998 Microsoft delayed the release of a version of its Windows CE Platform Builder, which delayed our introduction of a complementary product for an original equipment manufacturer customer.

Our market is becoming increasingly competitive, which may result in price reductions, lower gross margins and loss of market share.

     The market for Windows-based software products and services is becoming increasingly competitive. In addition, competition is intense for the business of the limited number of original equipment manufacturer customers that are capable of building and shipping large quantities of smart devices. Increased competition may result in price reductions, lower gross margins and loss of market share, which would harm our business. We face competition from:

	•		our current and potential customers’ internal research and development departments that may seek to develop their own proprietary solutions;
	•		professional engineering services firms;
	•		established smart device software and tools vendors; and
	•		software and component distributors.

     As we develop new products, particularly products focused on specific industries, we may begin competing with companies with whom we have not previously competed. It is also possible that new competitors will enter the market or that our competitors will form alliances, including alliances with Microsoft, that may enable them to rapidly increase their market share. Microsoft has not agreed to any exclusive arrangement with us nor has it agreed not to compete with us. In fact, in light of the recent renewal negotiations of our master agreement with Microsoft, we believe that Microsoft has decided to bring more of the core development services and expertise that we provide in-house to Microsoft. The barrier to entering the market as a provider of Windows-based smart device software and services is low. In addition, Microsoft has created a marketing program to encourage systems integrators to work on Windows. These systems integrators are given the same access by Microsoft to the Windows technology as we are. New competitors may have lower overhead than us and may therefore be able to offer advantageous pricing. We expect that competition will increase as other established and emerging companies enter the Windows-based smart device market and as new products and technologies are introduced.

If we fail to adequately protect our intellectual property rights, competitors may be able to use our technology or trademarks, which could weaken our competitive position, reduce our revenue and increase our costs.

     If we fail to adequately protect our intellectual property, our competitive position could be weakened and our revenue adversely affected. We rely primarily on a combination of patent, copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect our intellectual property. These laws and procedures provide only limited protection. We have applied for a number of patents relating to our engineering work. These patents, if issued, may not provide sufficiently broad protection or they may not prove to be enforceable against alleged infringers. There can be no assurance that any of our pending patents will be granted. Even if granted, these patents may be circumvented or challenged and, if challenged, may be invalidated. Any patents obtained may provide limited or no competitive advantage to us. It is also possible that another party could obtain patents that block our use of some, or all, of our products and services. If that occurred, we would need to obtain a license from the patent holder or design around their patent. The patent holder may or may not choose to make a license available to us at all or on acceptable terms. Similarly, it may not be possible to design around such a blocking patent.

     In general, there can be no assurance that our efforts to protect our intellectual property rights through patent, copyright, trade secret and trademark laws will be effective to prevent misappropriation of our technology, or to prevent the development and design by others of products or technologies similar to or competitive with those developed by us. We frequently license the source code of our products and the source code results of our services to customers. There can be no assurance that customers with access to our source code will comply with the license terms or that we will discover any violations of the license terms or, in the event of discovery of violations that we will be able to successfully enforce the license terms and/or recover the economic value lost from such violations. To license many of our software products, we rely in part on “shrinkwrap” and “clickwrap” licenses that are not signed by the end user

7

Table of Contents

and, therefore, may be unenforceable under the laws of certain jurisdictions. As with other software products, our products are susceptible to unauthorized copying and uses that may go undetected, and policing such unauthorized use is difficult.

     A significant portion of our marks include the word “BSQUARE” or the preface “b.” Other companies use forms of “BSQUARE” or the preface “b” in their marks alone or in combination with other words, and we cannot prevent all such third-party uses. We license certain trademark rights to third parties. Such licensees may not abide by our compliance and quality control guidelines with respect to such trademark rights and may take actions that would harm our business.

     The computer software market is characterized by frequent and substantial intellectual property litigation, which is often complex and expensive, and involves a significant diversion of resources and uncertainty of outcome. Litigation may be necessary in the future to enforce our intellectual property or to defend against a claim of infringement or invalidity. Litigation could result in substantial costs and the diversion of resources and could harm our business and operating results.

Third parties could assert that our software products and services infringe their intellectual property rights, which could expose us to additional costs and litigation.

     Third parties may claim that our current or future software products and services infringe their proprietary rights, and these claims, regardless of their merit, could increase our costs and harm our business. We have not conducted patent searches to determine whether the technology used in our products infringes patents held by third parties. In addition, it is difficult to determine whether our software products and services infringe third-party intellectual property rights, particularly in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. If we were to discover that one of our software products violated a third party’s proprietary rights, we may not be able to obtain a license on commercially reasonable terms, or at all, to continue offering that software product. Moreover, any indemnification we obtain against claims that the technology we license from third parties infringes the proprietary rights of others may not always be available or may be limited in scope or amount. Even if we receive broad third-party indemnification, these indemnitors may not have the financial capability to indemnify us in the event of infringement. In addition, in some circumstances we could be required to indemnify our customers for claims made against them that are based on our solutions.

     There can be no assurance that infringement or invalidity claims related to the software products and services we provide or arising from the incorporation by us of third-party technology, and claims for indemnification from our customers resulting from such claims, will not be asserted or prosecuted against us. We expect that software product developers will be increasingly subject to infringement claims, as the number of products and competitors in the software industry grows and the functionality of products in different industry segments overlaps. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources in addition to potential product redevelopment costs and delays.

Our international operations expose us to greater intellectual property, management, collections, regulatory and other risks.

     In late 1998 we opened offices in Munich, Germany and Tokyo, Japan. For the year ended December 31, 2001, our international offices generated approximately 7% of our total revenue. Our international operations expose us to a number of risks, including the following:

	•		greater difficulty in protecting intellectual property due to less stringent foreign intellectual property laws and enforcement policies;
	•		greater difficulty in managing foreign operations due to the lack of proximity between our home office and our foreign operations;
	•		longer collection cycles in Japan than we typically experience in the U.S.;
	•		unfavorable changes in regulatory practices and tariffs;
	•		adverse changes in tax laws;
	•		seasonal European sales decline in the summer months;
	•		the impact of fluctuating exchange rates between the U.S. dollar and foreign currencies; and

8

Table of Contents

•

general economic and political conditions in Asian and European markets.

     These risks could have a material adverse effect on the financial and managerial resources required to operate our foreign offices, as well as on our future international revenue, which could harm our business.

Recent and future acquisitions could prove difficult to integrate, disrupt our business, dilute shareholder value and adversely affect our operating results.

     During the year ended December 31, 2001, we acquired the business operations of a managed device service company, and during the year ended December 31, 2000 we acquired BlueWater Systems, Inc. and Mainbrace Corporation, among others. We may acquire or make investments in complementary companies, services and technologies in the future. If we fail to properly evaluate, execute and integrate acquisitions and investments, including these recent acquisitions, our business and prospects may be seriously harmed. To successfully complete an acquisition, we must properly evaluate the technology, accurately forecast the financial impact of the transaction, including accounting charges and transaction expenses, integrate and retain personnel, combine potentially different corporate cultures and effectively integrate products and research and development, sales, marketing and support operations. If we fail to do any of these, we may suffer losses and impair relationships with our employees, customers and strategic partners, and our management may be distracted from our day-to-day operations. We also may be unable to maintain uniform standards, controls, procedures and policies, and significant demands may be placed on our management and our operations, information services and financial, legal and marketing resources. Finally, acquired businesses sometimes result in unexpected liabilities and contingencies, which could be significant. In addition, acquisitions using debt or equity securities dilute the ownership of existing shareholders, which could affect the market price of our stock.

If we are unable to license key software from third parties our business could be harmed.

     We often integrate third-party software with our internally developed software to provide software products and services for our original equipment manufacturer customers. If our relationships with our third-party vendors were to deteriorate, we might be unable to obtain licenses on commercially reasonable terms, if at all, for newer versions of their software required to maintain compatibility. In the event that we are unable to obtain additional licenses, we would be required to develop this technology internally, which could delay or limit our ability to introduce enhancements or new products or to continue to sell existing products.

Our software products or the third-party hardware or software integrated with our software products and services may suffer from defects or errors that could impair our ability to sell our software products and services.

     Software and hardware components as complex as those needed for smart devices frequently contain errors or defects, especially when first introduced or when new versions are released. We have had to delay commercial release of certain versions of our software products until software problems were corrected, and in some cases have provided product enhancements to correct errors in released products. Some of our contracts require us to repair or replace products that fail to work. To the extent that we repair or replace products our expenses may increase, resulting in a decline in our gross margins. In addition, it is possible that by the time defects are fixed the market opportunity may have been missed which may result in lost revenue. Moreover, errors that are discovered after commercial release could result in loss of revenue or delay in market acceptance, diversion of development resources, damage to our reputation or increased service and warranty costs, all of which could harm our business.

We may be subject to product liability claims that could result in significant costs.

     Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that these provisions may be ineffective under the laws of certain jurisdictions. Although we have not experienced any product liability claims to date, the sale and support of our software products and services entail the risk of such claims and we may be subject to such claims in the future. A product liability claim brought against us, whether successful or not, could harm our business and operating results.

The lengthy sales cycle of our products and services makes our revenue susceptible to fluctuations.

     Our sales cycle is typically three to nine months because the expense and complexity of our products and services generally require a lengthy customer approval process, and may be subject to a number of significant risks over which we have little or no control, including:

	•		customers’ budgetary constraints and internal acceptance review procedures;
	•		the timing of budget cycles; and
	•		the timing of customers’ competitive evaluation processes.

     In addition, to successfully sell our products and services, we frequently must educate our potential customers about the full benefits of our products and services, which can require significant time. If our sales cycle lengthens unexpectedly, it could adversely affect the timing of our revenue, which could cause our quarterly results to fluctuate.

The volatility of the stock markets could adversely affect our stock price.

     Stock markets are subject to significant price and volume fluctuations which may be unrelated to the operating performance of particular companies, and the market price of our common stock may therefore frequently change. The market price of our common stock could also fluctuate substantially due to a variety of other factors, including quarterly fluctuations in our results of operations, our ability to meet analysts’ expectations, adverse circumstances affecting the introduction and market acceptance of new products and services offered by us, announcements of new products and services by competitors, changes in the information technology environment, changes in earnings estimates by analysts, changes in accounting principles, sales of our common stock by existing holders and the loss of key personnel. In the past, following periods of volatility in the market price of a company’s stock, class action securities litigation has often been instituted against such companies. Such litigation, if instituted, could result in substantial costs and diversion of management’s attention and resources which would materially adversely affect our business, financial condition and operating results.

A small number of our existing shareholders can exert control over us.

     Our executive officers, directors and principal shareholders holding more than 5% of our common stock together control a majority of our outstanding common stock. As a result, these shareholders, if they act together, could control our management and affairs of the company and all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control of us and might affect the market price of our common stock.

It might be difficult for a third party to acquire us even if doing so would be beneficial to our shareholders.

     Certain provisions of our amended and restated articles of incorporation, bylaws and Washington law may discourage, delay or prevent a change in the control of us or a change in our management even if doing so would be beneficial to our shareholders. Our board of directors has the authority under our amended and restated articles of incorporation to issue preferred stock with rights superior to the rights of the holders of common stock. As a result, preferred stock could be issued quickly and easily with terms calculated to delay or prevent a change in control of our company or make removal of our management more difficult. In addition, our board of directors is divided into three classes. The directors in each class serve for three-year terms, one class being elected each year by our shareholders. This system of electing and removing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of our company because it generally makes it more difficult for shareholders to replace a majority of our directors.

     In addition, Chapter 19 of the Washington Business Corporation Act generally prohibits a “target corporation” from engaging in certain significant business transactions with a defined “acquiring person” for a period of five years after the acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation’s board of directors prior to the time of acquisition. This provision may have the effect of delaying, deterring or preventing a change in control of our company. The existence of these anti-takeover provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

BUSINESS

     We provide a broad range of products and services that facilitate the creation and deployment of a class of devices we call smart devices. Original Equipment Manufacturers (OEMs), semiconductor vendors, original design manufacturers, software developers, value-added resellers, Internet service providers and network service providers rely on our products and services to help bring

10

Table of Contents

customized smart devices and their applications to market quickly at lower cost and with higher quality. We believe customers are attracted to our products and services because we cost-effectively apply our in-depth understanding of operating systems, compilers and debuggers, and platform software tools to solving customer needs. We have supplied Windows-based software services and products for over seven years, enabling us to become one of the leading providers of comprehensive solutions for smart devices.

     Smart devices are an emerging class of products with sophisticated processing power that are designed for specific computing and communications applications. Examples of smart devices include television “set-top boxes,” which sit on top of television sets and provide users with interactive cable TV services, sophisticated video gaming features and Internet access; handheld and palm-size PCs; gaming systems; handheld industrial data collectors; consumer “Internet appliances,” kiosk terminals, and navigational devices used in cars and trucks; and Windows-based terminals, Webpads, E-books and Pocket PCs used both in the workplace and at home. Compared to traditional computers, smart devices are often less expensive and more adaptable in terms of size, weight, shape and mobility, while still providing sophisticated computing and communications capabilities, including Internet connectivity.

     Smart devices are at the root of emerging markets, delivering access to data at the point of use in a wide variety of scenarios, from the factory floor to the mobile workforce to the home. Supermarkets deploy smart devices as mobile, wireless barcode scanners facilitating inventory control. Factories use smart devices as remote equipment monitors or sophisticated man-machine interfaces. Fleet managers use smart devices to efficiently dispatch and track trucks and drivers over a wide territory through least cost, wireless communication. Cable operators deploy and manage sophisticated smart devices such as Webpads and set-top boxes, offering advanced services for the home.

     The successful development and deployment of smart devices present many challenges: rapidly advancing technology, such as new microprocessors and chipsets, connectivity issues, interface design and usability, remote device management and in-field support, security, the pervasive influence of the World Wide Web, evolving business models, and time to market, a paramount concern. We offer a strategic set of products and services to address these challenges.

     Increasingly, Internet technologies and communications demands are driving the design of smart devices. Original equipment manufacturers are developing new smart devices to help businesses and consumers use the Internet to transact business, through wired and wireless telecommunications systems. The growth of wireless communications is expanding through the development of many new technologies, including Bluetooth, 3G, and 802.11 standards. We combine our own advanced wireless expertise with strategic partnerships to enable the adoption of these technologies.

     Our products and services offer customers a broad range of solutions to rapidly bring products to market. We have been providing Windows CE-based software services since before the commercial release of Windows CE in September 1996. We expanded the breadth of our service offerings with Windows NT Embedded integration services in late 1999 and Windows XP Embedded integration services in late 2001. Since January 2000, our product line of tools for developers of smart devices has included the Windows operating systems Windows 98, Windows 2000, Windows NT and Windows NT Embedded. In December 2001, we were awarded the Windows Embedded Partner of the Year Award in the category of Systems Integrator from Microsoft in recognition of our technical aptitude with Windows Embedded platforms and proven business excellence. Also in 2001, we became a Texas Instruments-licensed independent OMAP™ Technology Center, offering development assistance in the creation of multimedia-rich applications such as streaming video, video conferencing, and high-fidelity audio. We continue to provide standard manufacturable designs of popular smart devices such as Webpads, Smart Phones, Pocket PCs, E-books and portable data tablets.

     We generate revenue in four distinct ways. First, we create software development tools and provide related engineering services to Microsoft and semiconductor vendors, adapting Windows CE to different microprocessors and enhancing the operating system and its tools. Second, we offer a comprehensive set of software products and services that enable original equipment manufacturers to cost-effectively develop and deploy smart devices. These offerings include OEM adaptation kits, software development products, test products and Microsoft Windows licensing, along with engineering and quality assurance services and training. Third, we license a wide range of Windows-based software applications to OEMs, value added resellers, Internet service providers, network service providers and smart device consumers to provide additional functions to smart devices, such as printing and faxing capabilities, voice-over internet protocol, remote device management and wireless connectivity. Fourth, we license standard manufacturing design of smart devices for use in such devices as Webpads, Smart Phones, Pocket PCs, E-books and portable data tablets and bundle our products and integration services for our customers.

11

Table of Contents

Industry Background

     The increasingly widespread use of electronic communications, including the Internet, enables networks of businesses and consumers to collaborate, access information and conduct business and personal interactions more effectively. As the number of Internet users grows, so does the diversity of content, services and applications available via the Internet. While the Internet is already having a significant and highly visible impact on business-to-consumer and consumer-to-consumer relationships, the market for business-to-business Internet transactions is also growing.

     As more businesses and consumers access the Internet, new ways of conducting business electronically are emerging. Examples of users who are leveraging this ability to communicate electronically include:

	•		businesses that use mobile computing devices to permit their employees to access server-based network applications and the Internet from remote sites;
	•		retail businesses that use handheld point-of-sale terminals to provide real-time inventory tracking, automate their procurement processes and publish information instantly to both internal and external users via the Internet;
	•		healthcare professionals who use mobile computing devices to record and access patient information that can then be shared via the Internet among a broader group of professionals responsible for providing medical care; and
	•		consumers who use Internet-enabled television set-top boxes, smart cellular phones, gaming systems and other devices to access Internet content, communicate and conduct transactions online.

     The increasing need for connectivity among both business and consumer users is driving demand for easy-to-use, cost-effective and customizable methods of electronic communication. Although the PC has been the traditional means of electronically connecting suppliers, partners and customers, a new class is emerging. This includes Internet-enabled television “set-top boxes,” handheld and palm-size PCs, gaming systems, handheld industrial data collectors, and consumer “Internet appliances” such as kiosk terminals, Internet-enabled television “set-top”, vehicle navigational devices, Webpads, E-books and Pocket PCs. These smart devices are particularly attractive to business and consumer users because they are often less expensive than traditional computers; have adaptable configurations, including size, weight and shape; and are able to support a variety of customized applications and user interfaces that can be designed for particular tasks. In addition, these devices are typically compatible with existing business information systems. According to information received in November 2001 from eTForecasts, a market research firm specializing in the personal computer and information appliance industry, worldwide information appliance sales (excluding Smart Phones) is projected to grow from 30.5 million units in 2001 to approximately 145 million units by 2005. The respective worldwide revenue in 2001 from the sale of information appliances (excluding Smart Phones) exceeded $9.5 billion and is projected to grow to over $40 billion by 2005.

     Because smart devices can be used for a number of purposes, from consumer information to industrial automation, and can be designed for a range of unique applications, the smart device industry is characterized by a wide variety of hardware configurations and end-user applications, each often designed for a specific market. To accommodate these diverse characteristics in a cost-effective manner, semiconductor vendors and original equipment manufacturers require operating systems that can be integrated with a number of different smart devices and can support an expanding range of industry-specific content and applications. The Microsoft Windows family of operating systems, specifically Windows CE, Windows NT Embedded and Windows XP Embedded, helps satisfy these requirements because it leverages the existing industry-wide base of Microsoft Windows developers and technology standards; can be customized to operate across a variety of smart devices and integrate with existing information systems; offers Internet connectivity; and reduces systems requirements compared to traditional PC operating systems. Because of these characteristics, we believe Windows CE, Windows NT Embedded and Windows XP Embedded are emerging as operating systems of choice for many hardware and software applications vendors.

     To take advantage of the multiple benefits of these Windows operating systems, many original equipment manufacturers and semiconductor vendors require software products and services from a provider with the breadth of experience and depth of capabilities to fully support the Windows CE, Windows NT Embedded and Windows XP Embedded. These products and services should encompass the full cycle of the smart device development process, including hardware support, software development products and services, system validation and end-user software applications. In addition, these products and services should use existing Microsoft and other industry technologies and standards to promote rapid low-cost development, reduced time-to-market and integration with existing enterprise software applications. These products and services should also be designed to accommodate the varying industry-specific needs of semiconductor, equipment and software developers without compromising functionality and performance.

12

Table of Contents

General

     We provide a broad range of products and services facilitating the creation and deployment of smart devices. Original equipment manufacturers, semiconductor vendors, original design manufacturers, software developers, value added resellers, internet service providers and network service providers rely on our products and services to help bring customized smart devices and their applications to market quickly, at lower cost and with higher quality. Key elements of our solutions include:

     A broad set of end-to-end development products, software applications, manufacturing designs, and software services to support a diverse range of smart device hardware, systems and applications:

	•		Development products. We provide software products that facilitate the integration of new hardware and peripherals into Windows operating systems; a family of testing and verification tools for quality assurance; licensing and integration of wired and wireless connectivity technologies, or stacks for Bluetooth and Universal Serial Bus (USB); and user interface design and development tools.
	•		Software applications. We license software applications packages that provide high-level functionality for smart devices such as faxing, printing, least-cost routing and remote device management. We also integrate, enhance and license third-party applications.
	•		Smart device design packages. We provide standard design packages for smart devices such as Webpads, Smart Phones, Pocket PCs, E-books and portable data tablets. We license these designs and bundle them with our software products and services to provide rapid development and deployment for a variety of customers.
	•		Software services. We provide professional engineering services to a diverse customer base, including custom development services, product adaptations and system quality assurance services. We also provide software development and testing services to Microsoft in connection with its ongoing development and modification of the Windows CE operating system. We also provide these services to both Microsoft and semiconductor vendors to assist with the creation of software development tools sold in conjunction with Windows CE and the integration of Windows CE with various microprocessors. By using our services, Microsoft can draw on our extensive expertise and experience with Windows CE and can devote its internal resources to other projects.

     We have provided Windows Embedded based services for the development, integration and deployment of Windows Embedded operating systems and industry-specific applications since prior to the commercial release of Windows CE in September 1996. In addition, we have developed strategic relationships with Microsoft, including our master development and license agreement and our distributor agreement with Microsoft, and through other arrangements. Specifically, we are a preferred Provider of Visual Tools to Microsoft, a member of Microsoft’s Third Party Tools Provider Program, a Microsoft-sanctioned Windows CE systems integrator (receiving the Microsoft Windows Embedded Partner of the Year award in the SI category for 2001), a Gold-level member of Microsoft Windows Embedded Partner Program, the premiere partner in Microsoft’s Porting Program, a Windows CE and NT Embedded Preferred Provider (distributor) and a Microsoft Certified Solution Provider, as well as a developer of Windows Embedded based software applications. Moreover, we have worked with several semiconductor vendors to integrate Windows CE with their proprietary microprocessors. This depth and breadth of experience enable us to bring tangible benefits to Microsoft and to a variety of original equipment manufacturers, semiconductor vendors, software developers, value added resellers, Internet service providers and network service providers. Such benefits include:

	•		Reduced time-to-market. By using our software services, pre-configured software components and smart device design packages, our customers can take advantage of our experience with the Windows-based platforms to help bring quality smart devices to market faster than if they had chosen to develop their hardware, operating systems and software applications internally.
	•		Lower development costs and reduced risks. By using our extensive library of software tools for developing and testing Windows CE-based smart devices, instead of developing these tools internally, our customers can reduce the implementation and training time required for their engineers and lower their smart device development costs. Our software components are thoroughly tested for performance and reliability, reducing the risk of project failure.

13

Table of Contents

	•		Rapidly customizable graphical user interfaces. A graphical user interface is the set of visual images through which the user interacts with the smart device. Our software development solutions enable our customers to more rapidly design user-specific and industry-specific graphical user interfaces to meet the needs of smart device users across a variety of markets.
	•		Enhanced smart device functionality. Our pre-developed software components enable original equipment manufacturer customers to quickly add new and differentiating application features to their existing smart device hardware components, which can help extend product life cycles.

Strategy

     Currently, the market for providing solutions for the development of smart devices is very fragmented. Our strategy is to become one of the primary providers of products and services for facilitating the rapid and cost efficient development and deployment of smart devices. Key elements of our strategy include:

     Continue to enhance our position as a provider of Windows-based integration services. We intend to enhance our leadership position in the development and provision of Windows-based integration services to support a wide variety of smart devices. We intend to continue to utilize our expertise by maintaining strong, quality-focused engineering groups, developing market-focused products and services, and undertaking sales and marketing activities that highlight key design wins, product awards and other third-party endorsements. In addition, we believe that our experience with Windows as an embedded operating system provides a foundation of technical and engineering process expertise to offer our customers.

     Expand our strategic relationships with hardware and software vendors. We intend to continue to strengthen and extend our relationships with third-party hardware and software vendors who are designing products based on Windows. We believe that the use of our products and services by a broad group of industry leaders is important in increasing market awareness and generating new business opportunities.

     Continue to build on our relationship with Microsoft. We have developed a close working relationship with Microsoft and under the terms of our master agreement are a preferred Provider of Visual Tools to Microsoft. We are also Microsoft’s premiere partner in their Porting Partners Program, for which we provide software engineering services to microprocessor vendors seeking compatibility with Windows CE. Currently, we create software development tools and provide related engineering services to Microsoft for a number of different Windows CE projects and we intend to continue this relationship in the future.

     Utilize our extensive Windows expertise to develop additional software applications. We believe that as the smart device market grows, there will be an increasing demand for complete, end-to-end software applications that enhance the capabilities of smart devices. We intend to use our embedded systems expertise, alliances with original equipment manufacturers and third party application developers, and our relationship with Microsoft to develop a leading position in the market. We currently offer a variety of personal productivity software applications for smart devices. We intend to continue to make use of our Windows expertise to develop additional applications to address the evolving requirements of this market.

     Provide a comprehensive solution capability for rapid development and deployment of smart devices. Our breadth of products including software development tools, quality assurance tools, applications for connectivity, device management, transaction development, user application and smart device designs provides a broad portfolio of capabilities needed by the market. The development and deployment of smart devices has expanded beyond traditional customers such as OEMs and software developers and includes new types of customers such as value added resellers, original design manufacturers, Internet service providers and network service providers. The capabilities of these customers range from sophisticated engineering teams capable of building full solutions internally to companies without engineering capability seeking to outsource development of fully functioning devices. We intend to support this growing base of customers through a comprehensive solution capability.

     Expand our international presence. We intend to continue to expand internationally in order to enhance our profile and market reach. We believe that smart devices are experiencing growing acceptance in the Asian and European markets. These markets are attractive to us because of their high concentration of OEM and original design manufacturer customers. During late 1998, we established sales offices in Tokyo, Japan and Munich, Germany; during 1999 we negotiated relationships with distributors throughout fourteen European countries, Taiwan, Singapore and China. In 2000, we expanded our presence in Japan through the acquisition of one of our distributors, ToolCraft KK, and in 2001 we established partnerships with over twenty distributors in seventeen countries throughout Europe, Latin America and Asia.

14

Table of Contents

Acquisitions

BlueWater Systems, Inc.

     On January 5, 2000, we acquired all of the issued and outstanding shares of BlueWater Systems, Inc., a privately held designer of software development tools for the creation of Windows-based smart devices. The transaction was effected through the exchange of 261,391 shares of our common stock and options to purchase an additional 21,793 shares of our common stock for all of the issued and outstanding shares and options to purchase shares of BlueWater. The merger was accounted for as a pooling of interests.

Mainbrace Corporation

     On May 24, 2000, we acquired all of the issued and outstanding shares of Mainbrace Corporation, an intellectual property licensing and enabling software firm. We paid an aggregate of $10.8 million cash and issued 627,334 shares of our common stock and options to purchase an additional 172,629 shares of our common stock in exchange for all of the outstanding shares and options to purchase shares of Mainbrace. The acquisition was accounted for under the purchase method of accounting.

Other Acquisitions

     Additionally, we have acquired three smaller companies. During 2000, we acquired Embedded Technologies, Inc. and ToolCraft KK for aggregate total cash and stock consideration of approximately $5.0 million. During 2001, we acquired the business operations of a managed device service company. Each of these acquisitions was accounted for using the purchase method of accounting, and the purchase prices were allocated to the fair value of the acquired assets.

Services and Products

     We develop, market and support a wide variety of Windows-based software products, smart device designs and services for the development and deployment of a diverse selection of smart devices.

Services

     We provide professional engineering services to a diverse customer base, including custom development services, product adaptations, and system quality assurance services. We focus on providing integration and support services to original equipment manufacturers developing smart devices based on Windows CE, and Windows NT Embedded and Windows XP. For example, we provide implementation services for companies developing Internet-enabled television set-top boxes, gaming systems, handheld industrial devices, consumer Internet appliances, kiosk terminals, navigational devices in cars and trucks, and Windows-based terminals. Our software engineering services use our existing products, such as our Bluetooth stack, iWin, Remote Device Administrator, CE Xpress Adaptation Kit, and the CEValidator family of products. We often retain a license or other proprietary rights in the resulting work product. At times, we provide new applications or system software development on behalf of original equipment manufacturers. We believe that original equipment manufacturer customers in need of complex adaptations can save time and resources by outsourcing this work to us. In addition, to support our original equipment manufacturer customers, we often “bundle” support services with our software products and other services. These support services help enable our original equipment manufacturer customers to complete smart device development and reduce time-to-market.

Operating system development and accompanying tools

     We provide software development tools and related engineering services to Microsoft and numerous semiconductor vendors to support and enhance the following:

	•		the continued development of the Windows CE operating system;
	•		the continued development of the Microsoft Visual Tools series, a set of software development tools for use with the Windows CE operating system. These tools include compilers, linkers, runtime libraries, debuggers, and customizations to Platform Builder for Windows CE; and
	•		the integration of Windows CE with multiple microprocessors.

15

Table of Contents

     The services we provide these customers include software development and software testing. We provide these services both as a comprehensive solution and on a point basis to address specific needs depending upon individual customer requirements.

Products

     The following table summarizes the key features and benefits of the products we offer to original equipment manufacturers for the creation and deployment of smart devices.

     Product for developing applications and interfaces for smart devices:

iWin™ Internet Appliance Kit		iWin is a User Interface technology that allows customers such as OEMs, VARs, ISVs to create unique and captivating high value interfaces for smart devices that greatly enhance marketability of the devices. It gives customers the power to control all aspects of their device and its usage through standard web based technologies such as HTML and Jscript. This makes the devices ideal for deploying customized smart devices for specific markets, such as home portals, kiosks, set top boxes, and webpads. iWin is designed to work with Windows CE 3.0, Windows NT, Windows 2000, and Windows NT Embedded.
Product for deploying and managing smart devices:
Remote Device Administrator		Remote Device Administrator, or RDA, is a full-feature client server system that allows administrators to control and maintain large numbers of deployed smart devices over a network. RDA allows the administrators to view and configure settings, replace files and even completely replace the operating system of remote devices from one central location. RDA provides the tools needed to solve the configuration and maintenance problems inherent in wide area deployments, such as enterprise thin-clients, consumer webpads and cable set-top boxes. It is based on non-proprietary or open standards and can be integrated into other server-based solutions. RDA supports mixed deployments of Windows CE and Windows NT Embedded devices simultaneously.
Complete intelligent device design solutions:
SmartBuild Design Packages		SmartBuild Design Packages provide complete hardware and software solutions for developing Windows CE-based products. There are six design solutions:
		• Smart Phone
		• Pocket PC
		• Web Pad
		• Data Collection Tablet
		• Portable Data Terminal
		• eBook
		SmartBuild Design packages enable original equipment manufacturers and value-added resellers to develop products quickly and cost-effectively by reducing time to market, lowering

16

Table of Contents

		development risks, and reducing the overall cost of products.
Products for controlling smart device hardware:
WinDK™		WinDK is a complete Windows device driver development tool suite that enables engineers to quickly and efficiently develop high quality device drivers for Windows 2000, Window NT 4.0, Windows NT Embedded, Windows 98, and Windows ME. The suite includes a powerful wizard that automatically generates a driver’s framework. WinDK was named as one of the top embedded development tools of 2000 by EDN.
WinRT™		WinRT is an innovative development toolkit that allows developers to control hardware devices directly without having to write device drivers for the hardware. The toolkit enables rapid prototyping of new hardware systems such as factory floor controls and data collection. WinRT supports Windows 2000, Windows NT, Windows NT Embedded, Windows 98, and Windows 95.
Products for smart device communication:
WinDK™ Extension for Bluetooth		The WinDK Extension for Bluetooth toolkit enables developers to rapidly integrate Bluetooth wireless technology into their Microsoft Windows platform. It is a fully qualified Bluetooth development suite that leverages the Digianswer Bluetooth stack. The toolkit supports Bluetooth hardware on Windows 2000, Windows NT, Windows NT Embedded, and Windows CE.
WinRT-USB™		WinRT-USB allows developers to control Universal Serial Bus hardware directly from Windows applications without the complexity of having to write USB drivers. WinRT-USB supports Windows 98 and Windows 2000.
USB Extension for WinDK™		USB Extension for WinDK extends the power of the WinDK toolkit to enable developers to quickly generate high quality drivers for USB hardware.
Quality assurance and verification testing tools for smart devices:
CEValidator PassPORT™ Platform Tester		PassPORT Platform Tester is a comprehensive set of test tools that provide automated validation of Windows CE integration with target platforms such as smart devices. PassPORT Platform Tester includes a client/server-based test program of more than 9,600 individual test cases for testing compliance and reliability, with an extendable architecture for incorporating additional and custom test programs.
		PassPORT Platform Tester is designed to save original equipment manufacturers time and expense by automating the quality assurance process for testing a port of Windows CE to their target platform.
CEValidator PassCODE™ Application Tester		PassCODE Application Tester provides automatic functional and regression testing for Windows Embedded applications for Windows CE. Designed to shorten time to market for Windows CE applications for smart devices, PassCODE Application Tester

17

Table of Contents

		provides a fast and easy way to create automated test scripts without programming.
CEValidator PassPOINT™ Platform Verifier		PassPOINT Platform Verifier is a set of functional “sniff test” tools that enables an original equipment manufacturer to identify initial Windows CE platform adaptation problems. A client/server-based test program of more than 9,600 individual test cases for testing compliance and reliability, PassPOINT Platform Verifier is designed to facilitate identification and elimination of software bugs during development.
		PassPOINT Platform Verifier offers performance verification during the initial stages of the development process, providing a practical and economical means of automating testing at the earliest stages of engineering.

     To augment our own software products and services, we have entered into license and distribution agreements with third-party software vendors to provide our customers with additional features and functionality. Our ability to license these third-party software products to original equipment manufacturers, in conjunction with our own software products and services, provides our original equipment manufacturer customers with a single source for software products and services for smart devices. We are currently a licensed distributor of software from Insignia, Microsoft, Ansyr, Applied Microsystems, Citrix, Communication Intelligence Corporation, Datalight, Macromedia, M-Systems, Netmotion Wireless, and RealNetworks.

Consumer Software Applications

     We provide a wide range of commercially available personal productivity, utility and communications software to enhance the functionality and usefulness of Windows CE-based smart devices. We market our consumer software applications directly to OEMs and original design manufacturers for bundling with their own products. Our current consumer software application product offerings include:

Product		Description		Benefit
bFAX		• A product family that provides faxing capabilities for smart devices		• Provides a practical and comprehensive faxing solution for Windows CE-based devices
		• bFAX Pro provides send and receive capability for handheld PCs
		• bFAX Express provides send-only capability for handheld and palm-size PCs
bPRINT		• Print management software for handheld and palm-size PCs		• Users can spool jobs for batch printing
				• Increases the variety of printers compatible with Windows CE-based devices
BSQUARE SpreadSheet		• A spreadsheet application for palm- size PCs		• Provides independent functionality while maintaining Pocket Excel compatibility
bUSEFUL Utilities Pak		• Utility suite for handheld and palm- size PCs that contains 12 different utility applications		• Provides utility applications which enhance the performance and functionality of Windows CE-based devices

Customers

     Microsoft is our largest customer, representing approximately 85%, 58% and 40% of our total revenue in 1999, 2000 and 2001, respectively. Our other target customers include semiconductor vendors and original equipment manufacturers seeking to leverage the numerous benefits of Windows-based operation systems in order to develop high quality, full-feature products that meet the complex and evolving requirements of numerous end-markets.

18

Table of Contents

     We maintain strategic relationships with Microsoft to promote its Windows-based operating systems across a broad range of industries and applications. Our relationship with Microsoft extends to the following:

     Development partner. Under the terms of our master agreement, we are a “preferred Microsoft vendor” for Windows CE. As of January 31, 2002, approximately 35 of our 273 software engineers worked on a number of different Windows CE-based projects for Microsoft and on the development of Windows CE-related software tools under various work plans. These software tools are then provided by Microsoft under the Microsoft name to semiconductor vendors and various original equipment manufacturers utilizing Windows CE. We bill Microsoft on a time-and-materials basis, although each project has a maximum dollar cap. A separate work plan is generated for each project, which can then be modified or terminated by Microsoft at any time.

     Porting Partner. We were the exclusive partner of Microsoft for providing software engineering services to semiconductor manufacturers, such as Mitsubishi, Matsushita and Infineon, seeking Windows CE software porting s