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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

Commission File Number 000-19462

ARTISOFT, INC.
(Exact Name of Registrant as Specified in Its Charter)

        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 o    No ý

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes o    No ý

        Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

FORWARD-LOOKING STATEMENTS

        This Quarterly Report on Form 10-Q includes 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 that are subject to a number of risks and uncertainties. All statements, other than statements of historical fact, included in this Quarterly Report on Form 10-Q, including statements regarding our strategy, future operations, financial position, estimated revenues, projected costs, prospects, plans and objectives of management, are forward-looking statements. When used in this Quarterly Report on Form 10-Q, the words "will", "believe", "anticipate", "intend", "estimate", "expect", "project" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We cannot guarantee future results, levels of activity, performance or achievements, and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any financings, future acquisitions, mergers, dispositions, joint ventures or strategic alliances. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the risks described in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. The forward-looking statements provided by Artisoft in this Quarterly Report on Form 10-Q represent Artisoft's estimates as of the date this report is filed with the SEC. Forward-looking statements contained herein do not reflect events transpiring subsequent to that date. We anticipate that subsequent events and developments will cause our estimates to change. However, while we may elect to update our forward-looking statements in the future, we specifically disclaim any obligation to do so. Our forward-looking statements should not be relied upon as representing our estimates as of any date subsequent to the date this report is filed with the SEC.

ARTISOFT, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX

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PART I—FINANCIAL INFORMATION

Item 1—FINANCIAL STATEMENTS

ARTISOFT, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

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ARTISOFT, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.

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ARTISOFT, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.

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ARTISOFT, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) BASIS OF PRESENTATION

        Artisoft, Inc., ("Artisoft", the "Company" or the "Registrant") develops, markets and sells computer telephony software applications and integrated computer telephony products. The Company's principal products are TeleVantage and InstantOffice.

        The Company's principal executive offices are located at 5 Cambridge Center, Cambridge, Massachusetts 02142. The telephone number at that address is (617) 354-0600. The Company was incorporated in November 1982 and reincorporated by merger in Delaware in July 1991.

        The unaudited condensed consolidated financial statements include the accounts of Artisoft and its four wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

        The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC") and the PCAOB. The balance sheet amounts at June 30, 2004 in this report were derived from the Company's audited financial statements included in its Annual Report on Form 10-K for the fiscal year ended June 30, 2004. In the opinion of management, the accompanying financial statements include all adjustments of a normal recurring nature, which are necessary for a fair presentation of the financial results for the interim periods presented. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to such rules and regulations. Although the Company believes that the disclosures are adequate to make the information presented not misleading, the Company recommends that these financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2004 on file with the SEC. The results of operations for the three months ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year or any other future periods.

        The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities at the date of the financial statements and revenues and expenses during the reported period. Areas where significant judgments are made include, but are not limited to revenue recognition as well as the accounting for our recent acquisition of Vertical Networks Inc. ("VNI") discussed below. Actual results could differ materially from these estimates. The accounting policies applied are consistent with those disclosed in the Company's Annual Report on Form 10-K as disclosed in Note 1.

Acquisition of Vertical Networks Inc.

        On September 28, 2004, Artisoft completed the acquisition of substantially all of the assets, other than patents and patent rights, of Vertical Networks Inc., pursuant to the terms of an asset purchase agreement entered into on September 23, 2004. Vertical Networks is a leading provider of distributed IP-PBX software and communications solutions to large enterprises. Artisoft has also received a patent license for the use of all of Vertical Networks' patents and patent applications other than Vertical Networks' rights under specified patents that do not relate to the business purchased by Artisoft. In addition, Artisoft assumed specific liabilities of Vertical Networks. The operational results of this acquisition have been included herein since September 28, 2004, the date that the acquisition was consummated.

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(2) SIGNIFICANT ACCOUNTING POLICIES

Stock-Based Compensation

        The Company applies APB Opinion No. 25 in accounting for its stock incentive plan and accordingly, compensation cost has been recognized for certain of its stock options in the financial statements where the exercise price had been below the fair market value of the underlying stock on the grant date. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net loss and net loss per common equivalent share for the three-month period ended September 30, 2004 and 2003 would have been increased to the pro forma amounts indicated below (in thousands, except per share amounts):

        Generally, options become exercisable over a four-year period commencing on the date of the grant. Options granted prior to September 28, 2004 vest 25% at the first anniversary of the grant date with the remaining 75% vesting in equal monthly increments over the remaining three years of the vesting period. Options granted on September 28, 2004 vest 2.08333% monthly. The fair value of options granted was calculated using the Black-Scholes option-pricing model with the following weighted average assumptions:

(3) ACQUISITION OF VERTICAL NETWORKS AND FINANCING

        On September 28, 2004, Artisoft completed the acquisition of substantially all of the assets of Vertical Networks, a leading provider of distributed IP-PBX software and communications solutions to large enterprises, other than patents and patent rights, pursuant to the terms of an asset purchase agreement entered into on September 23, 2004. Artisoft has also received a patent license for the use of all of Vertical Networks' patents and patent applications other than Vertical Networks' rights under specified patents that do not relate to the business purchased by Artisoft. In addition, Artisoft assumed specified liabilities of Vertical Networks.

        The acquisition of Vertical Networks provides Artisoft with a complementary product line and access to distributed large enterprise customers and a direct sales channel through systems integrator partners including IBM and AT&T.

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        The purchase price for Vertical Networks consisted of: $13.5 million in cash, paid at closing except for $1.0 million held in escrow to secure Vertical Networks' indemnification obligations to Artisoft, the assumption of most liabilities of Vertical Networks and up to $5.5 million in cash payable under an earn-out provision in an amount equal to the first $5.5 million of non-refundable software license revenues received in cash by Artisoft from CVS Pharmacy, Inc. with respect to various types of Vertical Networks software to be used by CVS in connection with a rapid prescription refill project that it plans to roll out to its stores and other projects. Neither the $1.0 million held in escrow nor the $5.5 million earn-out provision were included in the total purchase price in the table below. The $1.0 million held in escrow is presented on the Balance Sheet as Restricted Cash and the $5.5 million earn-out provision is not included in the accompanying financial statements. This contingent payment will be recorded as a component of the purchase price if and when the related contingency is resolved.

        The acquisition was financed with a portion of the proceeds from a $27.5 million common stock financing completed in two tranches on September 28, 2004 and October 1, 2004. Artisoft sold a total of 24,159,468 shares of its common stock at a per share purchase price of $1.1386 to several investors, including M/C Venture Partners. In connection with, or prior to the financing, the holders of all shares of Artisoft's preferred stock converted those shares into common stock. Following the issuance and sale of common stock in the financing and the conversions of Artisoft's preferred stock to common stock, M/C Venture Partners is now the largest beneficial holder of Artisoft's common stock, with a 51.69% beneficial ownership interest.

        The stock purchase agreement for the financing provides that the size of Artisoft's board of directors be set at seven members, with the board initially consisting of (1) the chief executive officer of Artisoft (William Y. Tauscher—class II director), (2) one member designated by the former holders of Artisoft's series B preferred stock (Robert J. Majteles—class II director), (3) one member designated by the former holders of Artisoft's series C preferred stock (R. Randy Stolworthy—class II director), (4) two members designated by M/C Venture Partners (John P. Ward and Matthew J. Rubins—class III directors) and (5) two other directors designated by mutual agreement of M/C Venture Partners and Artisoft's board of directors (Michael P. Downey and Francis E. Girard—class I directors).

        Following March 28, 2005, the stock purchase agreement provides that Artisoft's board of directors will consist of (1) its chief executive officer (a class II director), (2) one member designated by Special Situations Fund III, L.P. (an affiliate of Austin W. Marxe and David M. Greenhouse) so long as Special Situations Fund III, L.P. and its affiliates continue to beneficially own at least 50% of the shares of Artisoft's common stock acquired upon the conversion of their shares of Artisoft's series B preferred stock, and otherwise, one member designated by the former holders of Artisoft's series B preferred stock and series C preferred stock (a class II director), (3) two members designated by M/C Venture Partners (class III directors) and (4) three directors with relevant industry experience designated by M/C Venture Partners and Artisoft's board of directors (class I directors).

        The investors' designees are entitled to membership on the compensation and nominating committees of the board of directors.

        Artisoft has agreed to register, under the Securities Act of 1933, the shares issued and sold under the stock purchase agreement for resale by the investors. Artisoft has agreed to file with the Securities and Exchange Commission the registration statement with respect to this registration by November 12, 2004 and to use its best efforts to cause the registration statement to become effective on or before December 31, 2004. Artisoft has not yet filed the registration statement. If the registration statement is

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not declared effective by the SEC on or prior to March 31, 2005 or if the registration statement, after being declared effective, ceases to be effective and available for any continuous period that exceeds 30 days or for one or more periods that exceed in the aggregate 60 days in any 12-month period, Artisoft will be required to pay each investor in the financing liquidated damages in an amount equal to 1% of the aggregate purchase price paid by the investor under the purchase agreement (not to exceed 9% of such purchase price, in the aggregate). Artisoft has also made other customary agreements regarding this registration, including matters relating to indemnification; maintenance of the registration statement; payment of expenses; and compliance with state "blue sky" laws. As of the date of this filing, the Company has not filed this registration statement, is in breach of its obligation to do so, and can make no assurance that the registration statement, when filed, will be declared effective on or before March 31, 2005.

        Artisoft also agreed to several negative covenants under the stock purchase agreement. Artisoft's negative covenants relate to obligations not to, without the prior consent of M/C Venture Partners, enter into a transaction involving a change in control of Artisoft; incur indebtedness in excess of $3.0 million; create any security with an equity component unless that security is junior to the common stock or, subject to specified exceptions, issue any equity securities; transfer its intellectual property; repurchase, redeem or pay dividends on any shares of capital stock (subject to limited exceptions); grant stock options that are not authorized by a vote of the board of directors or its compensation committee; liquidate or dissolve; change the size of Artisoft's board of directors; amend Artisoft's certificate of incorporation or bylaws; change the nature of Artisoft's business; or alter the voting rights of shares of Artisoft's capital stock in a disparate manner.

        As a result of the sale of common stock under the stock purchase agreement, the exercise price of all of the warrants to purchase an aggregate of 466,664 shares of common stock issued in Artisoft's 2001 financing and all of the warrants to purchase an aggregate of 2,627,002 shares of common stock issued in Artisoft's 2003 financing was reduced to $1.1386 per share pursuant to the terms of those warrants. Immediately prior to the sale of common stock under the purchase agreement, the exercise price of the warrants issued in 2001 was $1.50 per share, and the exercise price of the warrants issued in 2003 was $1.88 per share. The reduction of the exercise price of these warrants resulted in the recording of a non-cash deemed dividend equal to approximately $1.5 million in the first quarter of fiscal 2005. Additionally, under a consent, amendment and waiver agreement, all warrants issued in the 2001 and 2003 financings were amended to delete the price protection provisions of those warrants. Therefore, as so amended, the per share exercise price of those warrants will no longer be subject to adjustment in the event of sales of securities by Artisoft, except for customary adjustments for stock splits, dividends, recapitalizations and other organic changes. On September 28, 2004 the Company completed the acquisition of the business operations of Vertical Networks. The transaction was structured such that the Company acquired substantially all the assets and assumed certain liabilities of VNI. The results of VNI operations have been included in the consolidated financial statements of the Company for the period September 28, 2004 through September 30, 2004. The aggregate purchase price was $13.5 million, including $1 million that was placed in escrow for a period of one year to secure certain VNI representations and warranties. This $1 million has been excluded from the purchase price in the table below and will be recorded if and when it is released from escrow. Additionally, a payment of another $5.5 million may be required in the event of future revenues related to software product sales to one customer are realized. This amount has also been excluded from the purchase price in the table below and will be recorded if and when the contingency is resolved.

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        The following table represents the preliminary allocation of the purchase price for our acquisition of Vertical Networks over the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition. Artisoft is in the process of assembling the information necessary for it to allocate the total purchase price and obtain supporting third party valuations of any tangible and intangible assets, assumed liabilities and acquired deferred revenue. Thus, the allocation of the purchase price is subject to change upon completion of this assessment process.

        The estimated values of current assets and liabilities were based upon their historical costs in the hands of the seller on the date of acquisition due to their short-term nature. Property and equipment was also estimated based upon its historical cost as there was no appreciated real estate and the historical costs of the office equipment, furniture and machinery most closely approximated fair value. This amount may be adjusted subsequently when we complete our assessment of the property and equipment that will be utilized in the combined operations and those that will be disposed. The preliminary estimated value of deferred revenue was based upon the guidance in EITF 01-03, Accounting in a Business Combination for Deferred Revenue of an Acquiree, and was calculated as the estimated cost for the Company to fulfill the contractual obligations acquired under various customer contracts plus a fair value profit margin. This estimate is subject to change once we complete a thorough analysis of our post acquisition cost structure, particularly with respect to these contracts. Additionally, of the total acquired deferred revenue, only approximately $0.8 million will result in future cash in flows as the majority of these contracts were prepaid when consummated in the pre-acquisition period.

        In the table above, we have assumed that the entire amount of the purchase price in excess of the value of the tangible assets acquired and liabilities assumed is allocable to goodwill and that there are no identifiable intangible assets. Upon completion of a third party valuation of the tangible and intangible assets and liabilities acquired, certain identifiable intangible assets may be recorded that would be subject to amortization. Assuming a three-year life, every $1.0 million of identifiable intangible assets recorded would result in approximately $333,000 of annual amortization expense in the pro forma statements of operations. Additionally, with respect to deferred revenue, for every $100,000

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change in the recorded fair value (increase or decrease), there will be an estimated corresponding increase or decrease in post acquisition revenue of approximately $2,000 per month.

        Since Artisoft has not completed its valuation of the tangible and intangible assets and liabilities acquired, the final allocation of the excess of purchase price over the book value of the net assets acquired could differ materially.

        The deferred revenue associated with contracts acquired from Vertical Networks was valued at $5.8 million prior to the acquisition but has been written down to $2.3 million, which represents the cost basis of the remaining obligations under those contracts uplifted for reasonable profit margin.

        The following pro forma unaudited condensed financial information give effect to Artisoft's acquisition of Vertical Networks as if it had occurred on July 1, 2003 for each period presented. The following information is based on historical results of operations of Artisoft for the three months ended September 30, 2003 and 2004 and of Vertical Networks for the same historical periods. The pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the future financial position or future results of operations of the consolidated company that would have actually occurred had the acquisition of Vertical Networks been effected as of July 1 for each period presented.

        The following adjustments have been reflected in the audited pro forma condensed combined statement of operations:

        (a)   To adjust Vertical's historical reported revenues from the sale of telephone systems ("systems") to the amount that would have been reported under Artisoft's revenue recognition policy. In 2002 and 2003, Vertical entered into multiple element arrangements consisting of an extended warranty arrangement, software license agreements with rights for updates and upgrades on a when and if available basis and an agreement to specify pricing of uncommitted future telephone systems. Under Vertical's policy, the extended warranty and software license arrangements were recognized over the term of the arrangements. The telephone system pricing agreement was assessed for significant and incremental discounts and future telephone systems were recognized upon shipment if all other revenue recognition criteria of SAB 104 had been met.

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        However, under Artisoft's revenue recognition policy, the software license agreement for the telephone systems' core software that provides when and if available updates and upgrades ("extended software support arrangement") and the telephone system sales are considered multiple element arrangements. The extended software support agreement would apply to all previous and future system sales. As Vertical had not historically sold extended software support separately to other customers or on a renewal basis, sufficient vendor-specific objective evidence of fair value does not exist to allocate the arrangement fee to the systems and the extended software support arrangement. Accordingly, the fee for previous and future system sales considered to be part of a multiple element arrangement, or combined unit of accounting, with the extended software support arrangement is recognized ratably over the term of the extended software support arrangement along with the extended support fee. The pro forma adjustment reduces revenues to the amount that would have been recognized under Artisoft's policy in order to provide a better indication of what the results of operations would have been had the transaction occurred at the beginning of the period presented.

        (b)   Prior to the Vertical Networks acquisition, Vertical Networks had deferred revenue relating to certain software licenses, extended software support arrangements and an extended hardware warranty arrangement over the terms of the support arrangements. The Company evaluated their legal obligation that would have been assumed under these contracts if the acquisition had occurred on July 1, 2003. The Company estimated the fair value of this assumed liability. The book value of the deferred revenue on July 1, 2003 was written down by $5.4 million to reflect the fair value of the assumed liabilities and the related amortization was adjusted down by $.2 million per quarter.

(4) LIQUIDITY

        The Company has incurred losses and negative cash flows from operations in every fiscal period since 1996 and has an accumulated deficit, including non-cash equity charges, of $46 million as of September 30, 2004. For the three months ended September 30, 2004 the Company incurred a net loss of approximately $1.4 million, which includes negative cash flows from operations of approximately $2.4 million. Management expects that operating losses and negative cash flows will continue in the near future and anticipates that losses will increase somewhat from current levels as a result of the cost of absorbing the operations acquired from Vertical Networks on September 28, 2004. The Company anticipates that it, with available cash of $7.3 million at September 30, 2004 in addition to $5 million received on October 1, 2004 relating to the completion of the common stock financing, combined with increased revenues and cash-flows, will meet its anticipated cash requirements during and through our fiscal 2005 year. The Company expects to increase its revenue and cash flows in the foreseeable future as the result of the acquisition of the InstantOffice product line and its resellers and systems integrators.

        There can be no assurance that the available cash and increased revenues will be sufficient to meet the Company's cash requirements. If the Company is unable to satisfy such cash requirements from these sources, the Company's ability to continue as a going concern and to achieve its intended business objectives could be adversely affected. In such case, the Company could be required to adopt one or more alternatives, such as reducing or delaying marketing and promotional activities, reducing or delaying capital expenditures, developing restructuring plans to reduce discretionary costs deemed nonessential, and selling additional shares of the Company's capital stock. Additionally, changes in circumstances could necessitate that the Company seek additional debt or equity capital. There can be no assurance that any such additional financing will be available when needed or on acceptable terms

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to allow the Company to successfully achieve its operating plan or fund future investment in its TeleVantage and InstantOffice product lines.

(5) PREFERRED STOCK

        Prior to September 28, 2004, the Company had authorized 11,433,600 shares of preferred stock par value $1.00 per share, of which 5,427,002 shares had been issued as of June 30, 2004. On December 6, 1994, the Board of Directors of the Company authorized the designation and reservation of 50,000 shares of preferred stock as "Series A Participating Preferred Stock" subject to a Rights Agreement dated December 23, 1994. The reserved shares were to be automatically adjusted to reserve such number of shares as may be required in accordance with the provisions of the Series A Participating Preferred Stock and the Rights Agreement. The Rights Agreement was to expire in December 2004. In connection with the issuance of the series B preferred stock in 2001, the Company's Board of Directors terminated the Rights Agreement effective December 31, 2001.

        2001 Financing Series B Preferred Stock.    In August and November 2001, Artisoft issued and sold an aggregate of 2,800,000 shares of its series B convertible preferred stock to investors in a private placement at a per share price equal to $2.50. The investors also received warrants to purchase up to 466,666 shares of Artisoft's common stock at an initial per share exercise price equal to $1.50. Gross proceeds from the financing were $7.0 million.

        Each share of series B preferred stock was initially convertible into one-sixth of a share of common stock, subject to adjustment. Under certain circumstances, Artisoft has the right to effect the automatic conversion of the series B preferred stock to common stock in the event the closing per share bid price of the common stock exceeds $30.00 for 30 consecutive trading days. Prior to financing transaction of September 28, 2004 all shares of series B preferred stock were converted to common stock.

        The holders of the series B preferred stock, as a class, were also initially entitled to elect two directors of the Company. In August 2002, the holders of our series B preferred stock exercised this right, in part, to elect Robert J. Majteles as an Artisoft director.

        The warrants will expire on September 30, 2006. The expiration date, the per share exercise price and the number of shares issuable upon exercise of the warrants were initially subject to adjustment in certain events. Following the September 2004 financing, the per share exercise price of the warrants is $1.1386, and the per share exercise price and the number of shares issuable upon exercise of the warrants are no longer subject to adjustment. The warrants have a call provision that provides that if the closing per share bid price of the common stock exceeds $45.00 for 30 consecutive trading days and certain other conditions are met, Artisoft has the right to require the warrant holders to exercise their warrants for common stock.

        The closing of the issuance and sale of shares of common stock in the September 2002 financing resulted in anti-dilution adjustments to the series B preferred stock and the warrants issued in Artisoft's 2001 financing. As a result of these anti-dilution adjustments, each share of series B preferred stock was convertible into approximately 2.38 shares of common stock. Prior to the issuance and sale of shares of common stock under this agreement each share of series B preferred stock was convertible into one share of common stock. In addition, the per share exercise price of each warrant was reduced from $3.75 to $1.05. These adjustments resulted in a significant increase in potential common shares outstanding. Prior to the September 2004 financing, the remaining outstanding series B preferred stock

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was converted into common stock at a rate of approximately 1.22 shares of common stock for each share of series B preferred stock.

        In September 2003, Artisoft issued and sold an aggregate of 2,627,002 shares of its series C convertible preferred stock to investors in a private placement at a per share price equal to $1.50. The investors also received warrants to purchase up to 2,627,002 shares of Artisoft's common stock at a per share exercise price equal to $1.88. Gross proceeds from the financing were $3.9 million.

        The shares of series C preferred stock were initially convertible into a like number of shares of common stock, subject to adjustment. Each share of series C preferred stock generally received .8152 of a vote, subject to adjustment, when voting on matters presented for the approval of Artisoft's stockholders. The holders of the series C preferred stock, as a class, were also entitled to elect a director of the Company. In September 2003, the holders of our series C preferred stock exercised this right to elect Steven C. Zahnow as an Artisoft director.

        The holders of series C preferred stock were entitled, before any distributions were made to the holders of common stock, to an amount equal to $1.50 per share, subject to adjustment. For purposes of this liquidation preference, the series C preferred stock ranked on a parity with the series B preferred stock, which carried a similar liquidation preference in the amount of $2.50 per share.

        The holders of the series C preferred stock were entitled to receive dividends only when and if declared by the board of directors of the Company. Any such dividends were to be paid to the holders of the series C preferred stock and series B preferred stock prior to any distribution to holders of common stock, on a per share basis equal to the number of shares of common stock into which each share of preferred stock is then convertible.

        The warrants will expire on June 27, 2010. The expiration date, the per share exercise price and the number of shares issuable upon exercise of the warrants were initially subject to adjustment in certain events. Following the September 2004 financing, the per share exercise price of the warrants is $1.1386, and the per share exercise price and the number of shares issuable upon exercise of the warrants are no longer subject to adjustment. Prior to the September 2004 financing, the remaining outstanding series C preferred stock was converted into common stock at a rate of one share of common stock for each share of series C preferred stock.

(6) GUARANTEES

        We enter into standard indemnification agreements in our ordinary course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our business partners or customers, in connection with any patent or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. Accordingly, we have no liabilities recorded for these agreements.

        We warrant that our software products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the licensed products to the customer for 90 days. We warrant that our maintenance services will be performed consistent with generally accepted industry standards through completion of the agreed upon services. Accordingly, we

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have no liabilities recorded for these agreements. Additionally, we warrant that our hardware products, those associated with the InstantOffice products, will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the products to the customer for one year, with the exception of shipments to Staples which have warranties that expire sixteen months after the date of shipment. We have an extended warranty agreement with CVS Pharmacy that allows CVS Pharmacy to submit warranty claims after the initial one-year period. This agreement terminates on December 1, 2005. We have no liabilities recorded for this agreement since any warranty claims will be expensed as they occur to match the associated deferred revenue. We provide for the estimated cost of hardware product warranties based on specific warranty claims and claim history. If necessary, we would provide for the estimated cost of the software and services warranties based on specific warranty claims and claim history, however, we have never incurred any significant expenses under our product or service warranties.

(7) COMPUTATION OF NET LOSS PER SHARE

        Net loss per basic and diluted share are based upon the weighted average number of common shares outstanding. Common equivalent shares, consisting of outstanding stock options, convertible preferred shares and warrants to purchase common stock are included in the diluted per share calculations where the effect of their inclusion would be dilutive. Common stock equivalents have been excluded for all periods presented as they are antidilutive.

(8) INVENTORIES

        Inventories at September 30, 2004 and June 30, 2004 consist of the following (in thousands):