NOTIFY TECHNOLOGY CORP, 10KSB, 1998-12-16

NOTIFY TECHNOLOGY CORP
10KSB, 1998-12-16
TELEPHONE & TELEGRAPH APPARATUS

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-KSB

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(MARK ONE)
[X]ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998

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

COMMISSION FILE NUMBER 000-23025

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NOTIFY TECHNOLOGY CORPORATION
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

CALIFORNIA 77-0382248
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

1054 S. DE ANZA BLVD. SUITE 105 95129
SAN JOSE, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL
EXECUTIVE OFFICES)

ISSUER'S TELEPHONE NUMBER: (408) 777-7920

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SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT:

NONE

SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:

UNITS
COMMON STOCK
CLASS A WARRANTS

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Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90
days. Yes [X] No [_]

Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-
KSB or any amendment to this Form 10-KSB. [_]

State issuer's revenues for its most recent fiscal year. $1,638,268.

The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, based upon the closing sale price of the
Common Stock on December 11, was approximately $6,319,558. Shares of Common
Stock held by officers and directors and their affiliated entities have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily conclusive for other
purposes.

The number of shares outstanding of Registrant's common stock, $0.001 par
value at December 11, 1998 was 3,541,569 shares.

Portions of the Company's proxy statement for its Annual Meeting of
Shareholders to be held on February 25, 1999 is incorporated herein by
reference.

Transitional Small Business Disclosure Format (check one): Yes [_] No [X]

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PART I

ITEM 1. DESCRIPTION OF BUSINESS

Notify Technology Corporation (the "Company") was incorporated in the State
of California in August 1994. The Company is engaged in the development,
manufacture, marketing and sale of computer telephony products for the
business, Small Office Home Office ("SOHO") and residential marketplaces. In
recent years, the number of individuals and businesses relying on their
telephone company service provider to provide them with services such as voice
mail and CENTREX, a business-oriented service that eliminates the need for on-
premise telephone switching equipment, has increased dramatically. The
Company's products are designed to enhance the convenience and utility of these
services by providing customers with features that are either not available or
not included in standard service packages. The Company's MessageAlert product
increases the timeliness and ease of message retrieval for voice mail
subscribers by providing a visual indication that a message has been received.
The Company's Centex Receptionist product gives business and SOHO customers a
cost-effective means of ensuring that incoming calls are properly routed even
when a human attendant is not available. The Company's planned Caller-ID
products will incorporate MessageAlert features with support for various
telephone company provided Caller-ID services.

PRODUCTS

MessageAlert

The MessageAlert is a visual indicator for telephone company provided voice
mail (a "voice message waiting indicator", or "VMWI"). Telephone companies
typically use one of two signaling standards to alert voice mail subscribers
that they have a message waiting: stutter dial tone signaling and "CLASS"
signaling, which enables detection of a voice mail message without taking the
line off-hook.

The MessageAlert is the only battery powered stutter and CLASS compatible
VMWI on the market. The Company has been granted a patent on the MultiSense
Technology incorporated in it that enables it to work with both signaling
standards. The Company markets the MessageAlert under the name "MessageAlert".
The MessageAlert is also marketed by certain other telephone companies under
their own names. In addition, the Company markets a version of the
MessageAlert, "MessageAlert PBX," which is specifically adapted for PBX
environments.

Centrex Receptionist

Small businesses that use CENTREX services generally must maintain a human
attendant to answer incoming calls, or the calls will go unanswered or they
will be transferred into the business' general voice mail mailbox. The Centrex
Receptionist is a stand-alone unit that provides the CENTREX customer with
automatic call answer and transfer capability 24 hours a day. The Centrex
Receptionist provides thirty minutes of recorded announcement time, special
after hours or holiday announcements, and nine main menu items. Each main menu
item supports nine selections that can be either a transfer to a telephone
number or announcement. The Centrex Receptionist also provides extension
dialing, name directory services and call statistics. The unit has a battery
back-up that will last up to three days. The Centrex Receptionist is remotely
configured by Notify Technology Customer Service but locally programmable by
the user for voice mail messages and voice name directories using a touch tone
telephone. It has password protection for all administrative programming. The
current Centex Receptionist model supports two to four incoming CENTREX lines.

Caller-ID

The Company has developed a family of Caller-ID products. The Company's
Caller-ID products will incorporate the MessageAlert visual message waiting
indication technology and support for combinations of

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telephone company services such as voice mail, Caller-ID, call waiting Caller-
ID and deluxe call waiting. The Company has not yet officially released these
products or received any revenue from their sale.

SALES, MARKETING AND DISTRIBUTION

The Company's domestic and international marketing and sales activities for
the MessageAlert to date have been focused on direct sales to large telephone
companies. The MessageAlert is being either private labeled or joint marketed
by GTE Communication Systems Corporation, Pacific Bell, BellSouth Corporation,
Ameritech Corporation, Century Telephone Enterprises Inc., Commonwealth
Telephone Company, Standard Telephone Company and Aliant Communications, Inc.
Except with respect to Pacific Bell, the Company's relationship with these
companies has not been reduced to a formal agreement or contract and none of
these companies is obligated to purchase any product from the Company. The
Company manufactures product based on purchase orders and forecasts of
purchases received from Regional Bell Operating Companies ("RBOCs") and Local
Exchange Carriers ("LECs"). The Company believes large telephone companies
typically do business in this manner and does not intend to seek long-term
contractual commitments from its telephone company customers. Sales to RBOCs
and LECs constituted 71% and 86% of revenue for the fiscal years ended
September 30, 1998 and 1997, respectively. In addition, two customers accounted
for 50% and 17% of sales for the fiscal year ended September 30, 1998, and one
customer accounted for 70% of sales in the fiscal year ended September 30,
1997.

The Company is marketing the Centrex Receptionist to the same group of large
telephone companies it has targeted for the MessageAlert product. The Company
currently has entered into a contract with a major telephone company to sell
its Centrex Receptionist through its ongoing Customer Premise Equipment (CPE)
channel. The Company believes that having established itself as a qualified
supplier or joint marketing partner with respect to the MessageAlert product
will help shorten the sales cycle with respect to the Centrex Receptionist. In
particular, the Company believes the Centrex Receptionist and the MessageAlert
product can be marketed together by the telephone companies to the business
market.

The Company believes its success, if any, will be largely dependent on its
ability to either sell its products to or enter into joint marketing
arrangements with the seven RBOCs and approximately 20 large LECs in the United
States. In particular, the Company believes that its MessageAlert product can
be sold profitably only if it is sold to or in conjunction with the RBOCs and
LECs. The Company also expects to rely significantly on the RBOCs and LECs as a
channel for its Centrex Receptionist product. To date, the Company has sold its
products to five RBOCs and twelve LECs. A failure by the Company to develop
significantly enhanced relationships with the RBOCs and LECs would have a
materially adverse effect on the Company's business and operating results.

The Company is marketing its products outside North America by using sales
representatives in various countries. The Company has entered into a sales
representative agreement to market products in France and another agreement to
market products in the United Kingdom, Germany, Netherlands, Spain, Sweden, and
Switzerland. No significant revenue was generated from the international market
in fiscal 1998.

TECHNICAL AND MARKETING SUPPORT

The Company has developed product collateral and marketing programs for the
Centrex Receptionist and MessageAlert products. The Company intends to expand
its ongoing marketing programs. These marketing programs will include
augmentation of collateral material, advertising and trade shows, supplemented
with public relations campaigns.

The Company provides back-up technical support to large telephone companies
and resellers. The Company's support personnel perform all technical support.
In the future, the Company's support organization will provide both sales and
technical support. Sales support consists of sales and marketing training at
the Company's home office training facility for its own sales force and those
of authorized resellers. The Centrex

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Receptionist requires remote modem support by the Company's customer service
group whenever the user wants to add lines, make directory changes and perform
system back-up on a billable service arrangement.

RESEARCH AND DEVELOPMENT

The Company has incurred $1,376,767 and $745,063 in research and development
expenses in fiscal 1998 and 1997, respectively. The Company has had limited
internal engineering resources and uses contract engineering resources for a
significant portion of its research and development. The Company believes that
its future success, if any, depends significantly on its ability to continue to
enhance its existing products and to develop new products, and the Company
intends to continue to incur continued research and development costs. The
Company expects that its research and development efforts will be focused in
three areas: cost reduction and feature enhancement of the MessageAlert product
line; further development of the Company's combination Caller-ID/visual message
waiting indicator product line; and completion of a remote telephone access to
e-mail product.

MANUFACTURING

The Company has primarily used domestic contract manufacturing to minimize
resources devoted to manufacturing and to maximum flexibility and response
time. At times, the Company uses offshore turnkey manufacturing when production
volume makes it a cost-effective alternative. To the extent possible, the
Company uses standard parts and components for its products although certain
components are custom designed and/or are available only from a single source
or limited sources.

GOVERNMENTAL REGULATION AND INDUSTRY STANDARDS

The Company's products must comply with a variety of regulations and
standards including regulations and standards set by the Federal Communications
Commission, Underwriters Laboratories, National Registered Testing
Laboratories, and Bell Communications Research. As the Company enters
international markets it will be required to comply with whatever governmental
regulations and industry standards exist in those markets. In addition, the
U.S. telecommunications market is evolving rapidly in part due to recently
enacted laws revamping the telecommunications regulatory structure. Additional
legislative or regulatory changes are possible. A failure by the Company to
comply with existing regulations and standards or to adapt to new regulations
and standards could have a material adverse effect on the Company's business
and operating results.

COMPETITION

The Company currently has several direct competitors in the market for VMWI
products. Solopoint, Inc. produces the S025 Message Waiting Light, a stutter
dial tone and CLASS/FSK signal AC-powered VMWI. The Company believes that
Bellsouth is the only telephone company marketing the S025. Consumerware, Inc.
produces VoiceMail Lite, a battery powered, stutter tone only VMWI. The Company
believes the retail store unit of GTE is the only telephone company which
markets the VoiceMail Lite. SNI Innovation, Inc. produces VisuAlert, a dual
standard VMWI that requires an AC adapter. The Company believes that no large
telephone company is reselling or marketing the VisuAlert product. AASTRA
TELECOM of Canada produces Call Answer Lite, a dual standard VMWI that requires
an AC Adapter. The Company believes competition in the VMWI market is based on
support of signaling standards, type of power source, other features, price and
quality. The Company believes it competes favorably with respect to all of
these factors.

The Company has one direct competitor in the market for auto-attendant
products specifically designed for the Centrex market. SoloPoint, Inc. produces
an auto-attendant product that has basic call answering and call routing
features but is missing one or more of the features of the Company's Centrex
Receptionist. The Centrex Receptionist features include multiple levels of
menus, pre-recorded system prompts, interactive voice response for
configuration, name directory functionality, and call statistics for up to four
incoming ports. The

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Company believes competition in the auto-attendant market is based on features
(including ease of use, availability of a name directory, amount of recording
time and number of menu levels), price and quality. The Company believes it
competes favorably with respect to all of these factors.

The Company expects that to the extent that the market for any of its
products develops, competition will intensify and new competitors will enter
the market. As the Company progresses into the Caller-ID market, it is likely
to experience competition from additional companies such as Consumerware, Inc.
and intensified competition from existing competitors such as CIDCO
Incorporated, IT Systems and AASTRA TELECOM. There can be no assurance that the
Company will be able to compete successfully against existing and new
competitors as the market for its products evolves and the level of competition
increases. A failure to compete successfully against existing and new
competitors would have a materially adverse effect upon the Company's business
and results of operations.

Certain manufacturers of competing products have greater financial,
technical and marketing resources than the Company. In addition, there are
several companies with substantially greater technical, financial and marketing
resources than the Company that could produce competing products. These
companies include telephone equipment manufacturers such as CIDCO Incorporated,
Northern Telecom Limited, Lucent Technologies Inc. and Philips Consumer
Communication L.P.

PROPRIETARY RIGHTS

The Company relies on a combination of patent and trade secret law,
nondisclosure agreements and technical measures to establish and protect its
proprietary rights in its products. The Company has a design patent issued on
the MessageAlert design. The MessageAlert design is unique in that it provides
a visual message waiting indicator light packaged in the form of a 3M Post-
it(R) Note holder. In addition, the Company was granted a patent in October
1998 relating to the MultiSense technology used in the MessageAlert product.
The Company's MultiSense technology automatically detects and reacts to either
stutter or CLASS signaling. The Company intends to continue to apply for
patents, as appropriate, for its future technologies and products.

There are few barriers to entry into the market for the Company's products,
and there can be no assurance that any patents applied for by the Company will
be granted or that the scope of the Company's patent or any patents granted in
the future will be broad enough to protect against the use of similar
technologies by the Company's competitors. There can be no assurance,
therefore, that any of the Company's competitors, some of whom have far greater
resources than the Company, will not independently develop technologies that
are substantially equivalent or superior to the Company's technology. Further,
the Company intends to distribute its products in a number of foreign
countries. The laws of those countries may not protect the Company's
proprietary rights to the same extent as the laws of the United States.

The Company may be involved from time to time in litigation to determine the
enforceability, scope and validity of any proprietary rights of the Company or
of third parties asserting infringement claims against the Company. Any such
litigation could result in substantial costs to the Company and diversion of
efforts by the Company's management and technical personnel.

The Company has entered into a non-exclusive license agreement with Active
Voice Corporation ("Active Voice") pursuant to which the Company has paid an
up-front fee on sales of its MessageAlert product in exchange for certain
rights with respect to a patent issued to Active Voice covering stutter dial
tone detection.

EMPLOYEES

As of September 30, 1998, the Company employed sixteen persons of whom three
were engaged in research and development, two in manufacturing, eight in sales,
marketing, and customer support, and three in general administration and
finance. The Company contemplates increasing its staff at a pace consistent
with the

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Company's business and growth. None of the Company's employees is currently
represented by a labor union. The Company considers its relations with its
employees to be good.

The Company's success, if any, will be dependent on its ability to attract
and retain highly skilled technical personnel as well as marketing and sales
personnel. If the Company is unable to hire the necessary personnel, the
development of new products and enhancements to current products would likely
be delayed or prevented. Competition for highly-skilled technical, managerial,
sales, and marketing personnel is intense. There can be no assurance that the
Company will be successful in retaining its key personnel and in attracting and
retaining the personnel it requires for expansion.

RISK FACTORS

Limited Operating History; History of Losses; Working Capital; Anticipation
of Negative Cash Flow; No Assurance of Future Profitability. The Company
commenced operations in August 1994 and through January 1996 was engaged
primarily in research and development. For the fiscal years ended September 30,
1997 and 1996, the Company incurred a net losses of $1,382,910 and $1,657,219,
respectively. The Company incurred a net loss of $2,617,561 for fiscal 1998 and
as of September 30, 1998, the Company had an accumulated deficit of $6,083,752
and working capital of $2,573,009. The Company anticipates having a negative
cash flow from operating activities in future quarters and years and expects to
incur further operating losses in future quarters and years and until such
time, if ever, as there is a substantial increase in orders for the Company's
products and product sales generate sufficient revenue to fund its continuing
operations. There can be no assurance that sales of the Company's products will
ever generate significant revenue, that the Company will ever generate positive
cash flow from its operations or that the Company will attain or thereafter
sustain profitability in any future period. See "--Sales, Marketing and
Distribution."

Liquidity and Capital Resources. At September 30, 1998, the Company had an
accumulated deficit of $6.1 million and incurred a net loss of $2.6 million for
the year ended September 30,1998. Management's planned expenditures for fiscal
1999 approximate current cash and cash equivalents. The Company's recently
developed products will need to attain favorable market acceptance to continue
its research and development activities and fund operating expenses at current
levels. Management believes that sufficient funds will be available from cash,
cash equivalents, and operating activities to support planned operations
through September 30, 1999. There can be no assurance that the Company's new
products will attain favorable market acceptance. If the Company is unable to
attain its revenue goals, significant reductions in spending and the delay or
cancellation of planned activities or more substantial restructuring of the
Company may be necessary. In such an event, the Company intends to implement
expense reduction plans in a timely manner to enable the Company to meet its
cash requirements through at least September 30, 1999. These actions would have
material adverse effects on the Company's business, results of operations, and
prospects.

Possible Fluctuations in Quarterly Results. The Company anticipates that it
may experience significant fluctuations in operating results in the future.
Fluctuations in operating results may result in volatility in the price of the
Company's Securities. Operating results may fluctuate as a result of many
factors, including the Company's level of research and development and sales
and marketing activities, announcements by the Company and its competitors,
volume and timing of orders received, if any, during the period, the timing of
commercial introduction of future products and enhancements or competitive
products and the impact of price competition on the Company's average selling
prices. Almost all of these factors are beyond the Company's control.

For example, during the third and fourth quarters of fiscal 1997, the
Company recorded revenue of approximately $2.8 million primarily as the result
of one customer conducting a particularly large marketing program using the
Company's MessageAlert product during that quarter. Though the Company
anticipates that the customer will run similar programs in the future, the
customer is not committed to doing so and the timing of any such additional
programs is uncertain.

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Notwithstanding the difficulty in forecasting future sales, the Company
generally must undertake its research and development and sales and marketing
activities and other commitments months or years in advance. Accordingly, any
shortfall in product revenues in a given quarter may materially adversely
affect the Company's financial condition and results of operations due to the
inability to adjust expenses during the quarter to match the level of product
revenues, if any, for the quarter. Due to these and other factors, the Company
believes that quarter to quarter comparisons of its results of operations are
not necessarily meaningful and should not be relied upon as indications of the
future performance.

Uncertainty of Product Acceptance. The Company sold its first MessageAlert
in January 1996, its first Auto Attendant in December 1996 and its first
Centrex Receptionist in March 1998. To date, the Company has received only
limited revenue from the sale of these products. The Company has not yet sold
any of its recently developed Caller-ID products. While the Company believes
that its products are commercially viable, developing products for the consumer
and business marketplaces is inherently difficult and uncertain. The Company
does not believe its sales to date are sufficient to determine whether or not
there is meaningful consumer or business demand for its products. The Company
intends to devote significant resources to its sales and marketing efforts and
to promote consumer and business interest in its products. There can be no
assurance that such efforts will be successful or that significant market
demand for the Company's products will ever develop. See "--Products."

Dependence on Limited Number of Potential Customers; Need to Develop
Marketing Channels. The Company believes its success, if any, will be largely
dependent on its ability to either sell its products to or enter into joint
marketing arrangements with the seven Regional Bell Operating Companies and
approximately 20 large Local Exchange Carriers in the United States. In
particular, the Company believes that its MessageAlert product and Caller-ID
products can be sold profitably only if they are sold to or in conjunction with
the RBOCs and LECs. The Company also expects to rely significantly on the RBOCs
and LECs as a channel for its Centex Receptionist product. To date, the Company
has sold its products to five RBOCs and twelve LECs. Qualifying its product and
developing the marketing relationships necessary to make these sales took
substantially longer than the Company originally anticipated. RBOCs and LECs
tend to be hierarchical organizations characterized by distributed decision-
making authority and an institutional reluctance to take risks. Selling a
product to or entering into a marketing relationship with an RBOC or LEC is
generally a lengthy process requiring multiple meetings with numerous people in
the organization. A failure by the Company to develop significantly enhanced
relationships with the RBOCs and LECs would have a materially adverse effect on
the Company's business and operating results.

Sales to RBOCs and LECs constituted 71% and 86% of revenue for the fiscal
years ended September 30, 1998 and 1997, respectively. In addition, two
customers accounted for 50% and 17% of sales for the fiscal year ended
September 30, 1998, and one customer accounted for 70% of sales in the fiscal
year ended September 30, 1997.

The Company also intends to develop other distribution channels for its
products including certain Competitive Local Exchange Carriers ("CLECs").
Development of these channels will require the expenditure of time and effort
by the Company's management. Because the Company's marketing efforts have been
largely focused on the RBOCs and LECs, its management has had only limited
experience in selling the Company's products through these channels. There can
be no assurance that the Company will be able to implement such a marketing and
distribution program or that any marketing efforts undertaken by or on behalf
of the Company will be successful. See "--Sales, Marketing and Distribution."

Risk of Product Defects. The Company's products incorporate a combination of
reasonably sophisticated computer chip design, electric circuit design and
telephony technology. The Company has devoted substantial resources to
researching and developing each of these elements. In order to reduce the
manufacturing costs, limit the power consumption and otherwise enhance the
operation of its products, the Company has from time to time redesigned its
products. The Company expects that in the future it will engage in similar
redesigns of its products. In addition, the Company is in the process of
developing new, similarly complex products. Though the Company extensively
tests its products before marketing them, any new,

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redesigned or current product may contain design flaws that are undetected by
the Company's testing procedures. For example, in August 1996, the Company
recalled 6,500 of an earlier version of its MessageAlert product as a result of
a design flaw and, in November 1996, the Company recalled 14,000 of its
MessageAlert product, also as a result of a design flaw. The direct cost to re-
work and repair the defective products in these instances was approximately
$29,000 and $13,000, respectively. In addition, the Company relies on
subcontractors to manufacture and assemble its products. Though the Company has
quality control procedures designed to detect manufacturing errors, there can
be no assurance that the Company will identify all defective products. The
Company believes that reliable operation will be an important purchase
consideration for both its consumer and business customers. A failure by the
Company to detect and prevent a design flaw or a widespread product defect
could materially adversely affect the sales of the affected product and the
Company's other products and materially adversely affect the Company's
business, financial condition and operating results. See "--Products" and "--
Manufacturing."

Competition. The Company believes the market for its products is highly
competitive and that competition is likely to intensify. In the market for
visual message waiting indicators, the Company competes with Solopoint, Inc.,
Voicewaves, Inc., Consumerware, Inc., SNI Innovation, Inc. and AASTRA TELECOM.
Certain of these companies have greater financial, technical and marketing
resources than the Company. In addition, there are several companies with
substantially greater technical, financial and marketing resources than the
Company that could produce competing products. These companies include
telephone equipment manufacturers such as CIDCO Incorporated, Northern Telecom,
Inc., and Lucent Technologies, Inc. In the market for auto-attendant products,
the Company competes directly with Solopoint, Inc. The Company expects that to
the extent that the market for its products develops, competition will
intensify and new competitors will enter the market. There can be no assurance
that the Company will be able to compete successfully against existing and new
competitors as the market for its products evolves and the level of competition
increases. A failure to compete successfully against existing and new
competitors would have a materially adverse effect upon the Company's business
and results of operations. See "--Competition."

Dependence on Key Personnel. The Company's success depends to a significant
extent upon certain key management employees, including its Chairman, President
and Chief Executive Officer, Mr. Paul F. DePond, its Vice President of
Operations, Gaylan Larson and its Chief Financial Officer, Gerald W. Rice. The
Company has obtained three-year key-man term life insurance on Mr. DePond in
the amount of $2,000,000 and has entered into employment agreements with him
along with Mr. Larson and Mr. Rice. The loss of their services or those of any
of the Company's other key employees would have a materially adverse effect on
the Company. The Company's success, if any, will also be dependent on its
ability to attract and retain highly skilled technical personnel as well as
marketing and sales personnel. If the Company were unable to hire the necessary
personnel, the development of new products and enhancements to current products
would likely be delayed or prevented. Competition for highly-skilled technical,
managerial, sales, and marketing personnel is intense. There can be no
assurance that the Company will be successful in retaining its key personnel
and in attracting and retaining the personnel it requires for expansion. See
"--Employees."

Risks of Limited Protection for Company's Intellectual Property and
Proprietary Rights and Infringement of Third Parties' Rights. The Company
regards various features and design aspects of its products as proprietary and
relies primarily on a combination of patent and trademark laws and employee and
third-party nondisclosure agreements to protect its proprietary rights. The
Company has been issued a patent covering the design of it MessageAlert
products, and a patent covering the MultiSense technology used in its
MessageAlert product. The Company intends to continue to apply for patents, as
appropriate, for its future technologies and products. There are few barriers
to entry into the market for the Company's products, and there can be no
assurance that any patents applied for by the Company will be granted or that
the scope of the Company's patent or any patents granted in the future will be
broad enough to protect against the use of similar technologies by the
Company's competitors. There can be no assurance, therefore, that any of the
Company's competitors, some of whom have far greater resources than the
Company, will not independently develop technologies that are substantially
equivalent or superior to the Company's technology. Further, the Company

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intends to distribute its products in a number of foreign countries. The laws
of those countries may not protect the Company's proprietary rights to the same
extent as the laws of the United States. See "--Competition."

Dependence on Single Supplier; No Contracts or Agreements. Certain key
components used in the Company's products are currently available only from
single or limited sources. The Company does not have long term supply contracts
with these or any other component vendors and purchases all of its components
on a purchase order basis. No assurance can be given that component shortages
will not occur or that the Company will be able to obtain the components it
needs in a timely manner and on a commercially reasonable basis. In particular,
the microcontroller which forms the core of the Company's MessageAlert product
is manufactured only by Microchip Technology, Inc. From time to time, the
semiconductor industry has experienced extreme supply constraints. An inability
of the Company to obtain sufficient quantities of microcontrollers from
Microchip Technology, Inc. would have a materially adverse effect on the
Company's business and operating results.

The Company subcontracts the manufacture of its board level assemblies to
third parties, and there can be no assurance that these subcontractors will be
able to support the manufacturing requirements of the Company. An inability to
obtain sufficient quantities of sole-source components or subassemblies, or to
develop alternative sources as required in the future, could result in delays
or reductions in product shipments or could force the Company to redesign its
products, either of which could materially adversely effect the Company's
business and operating results. See "--Manufacturing."

Compliance with Government Regulations and Industry Standards. The Company's
products must comply with a variety of regulations and standards including
regulations and standards set by the Federal Communications Commission,
Underwriters Laboratories, National Registered Testing Laboratories, and Bell
Communications Research. As the Company enters international markets it will be
required to comply with whatever governmental regulations and industry
standards exist in those markets. In addition, the U.S. telecommunications
market is evolving rapidly in part due to recently enacted laws revamping the
telecommunications regulatory structure. Additional legislative or regulatory
changes are possible. A failure by the Company to comply with existing
regulations and standards or to adapt to new regulations and standards could
have a material adverse effect on the Company's business and operating results.
See "--Governmental Regulation and Industry Standards."

Risks Associated with Planned Growth. The Company plans to expand its
operations during fiscal year 1999, which could place a strain on its limited
personnel, financial, management and other resources. In order to manage its
planned growth, the Company will need to maintain its product development
program and expand its sales and marketing capabilities and personnel. In
addition, the Company will need to adapt its financial planning, accounting
systems and management structure to accommodate such growth if it occurs. A
failure by the Company to properly anticipate or manage its growth, if any,
could adversely affect its business, operating results and financial condition.

Shares Available for Future Sale; Registration Rights. Future sales of
Common Stock by existing shareholders pursuant to Rule 144 under the Securities
Act of 1933, as amended (the "Securities Act"), or otherwise, could have an
adverse effect on the price of the Company's securities. Pursuant to an
agreement entered into in connection with a 1997 bridge financing (the "Bridge
Financing", and the warrants issued in connection therewith, the "Bridge
Warrants") the Company agreed to register for resale 425,000 Bridge Warrants
and the underlying securities upon expiration of the one-year restriction on
transferability to which the Bridge Financing investors having agreed.
2,154,206 outstanding shares of Common Stock and options and warrants to
purchase Common Stock are "restricted securities" within the meaning of Rule
144 under the

8
<PAGE>

Securities Act. Pursuant to Rule 144, substantially all of these restricted
shares are eligible for resale subject to the restrictions on transferability
relating to the 1,369,744 shares of Common Stock or Warrants to purchase shares
of Common Stock placed in an Escrow in connection with the IPO. The holder of
an option to purchase 160,000 Units at a price per Unit of $7.00 (the "Unit
Purchase Option") has certain demand and "piggy-back" registration rights
covering its securities. The exercise of such rights could involve substantial
expense to the Company. Sales of Common Stock or the possibility of such sales,
in the public market may adversely affect the market price of the Company's
securities.

Effect of Outstanding Options and Warrants. The Company has outstanding
1,600,000 Warrants to purchase 1,600,000 shares of Common Stock for $6.50 per
share (subject to adjustment in certain circumstances). In addition, the
Company has outstanding 425,000 Bridge Warrants to purchase 425,000 shares of
Common Stock, the Unit Purchase Option to purchase an aggregate of 320,000
shares of Common Stock assuming exercise of the underlying warrants, additional
warrants to purchase 212,786 shares of Common Stock and 198,125 shares of
Common Stock reserved for issuance under the Company's 1997 Stock Plan, under
which 54,000 options were outstanding as of September 30, 1998 subject to
vesting requirements. Holders of such options and warrants may exercise them at
a time when the Company would otherwise be able to obtain additional equity
capital on terms more favorable to the Company. Moreover, while these options
are outstanding, the Company's ability to obtain financing on favorable terms
may be adversely affected.

Possible Volatility of Stock Price. The Company believes factors such as
quarterly fluctuations in financial results and announcements of new technology
or products or regulatory developments in the telephone industry may cause the
market price of the Company's securities to fluctuate, perhaps substantially.
These fluctuations, as well as general economic conditions, such as recessions
or high interest rates, may adversely affect the market price of the Company's
securities.

Possible Delisting of Securities from The Nasdaq Stock Market. While the
Company's Units, Common Stock and Warrants are currently listed on the Nasdaq
SmallCap Market there can be no assurance that the Company will continue to
meet the criteria for continued listing. Such requirements are (i) either at
least $2,000,000 in tangible assets, a $35,000,000 market capitalization or net
income of at least $500,000 in two of the three prior years, (ii) at least
500,000 shares in the public float valued at $1,000,000 or more, (iii) a
minimum Common Stock bid price of $1.00, (iv) at least two active market
makers, and (v) at least 300 holders of the Common Stock. For a period late in
fiscal year 1998, the bid price for the Company's Common Stock fell below
$1.00. While the bid price has since risen above $1.00, if the Company is
unable to satisfy Nasdaq's maintenance requirements, its securities may be
delisted from Nasdaq. In such event, trading, if any, in the Units, Common
Stock and Warrants would thereafter be conducted in the over-the-counter market
in the so-called "pink sheets" or the NASD's "Electronic Bulletin Board."
Consequently, the liquidity of the Company's securities could be impaired, not
only in the number of securities which could be bought and sold, but also
through delays in the timing of transactions and lower prices for the Company's
securities than might otherwise be attained.

Risk of Low-Price ("Penny") Stocks. If the Company's securities were to be
delisted from Nasdaq, they could become subject to Rule 15g-9 under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), which imposes
additional sales practice requirements on broker-dealers which sell such
securities to persons other than established customers and "accredited
investors" (generally, individuals with a net worth in excess of $1,000,000 or
annual incomes exceeding $200,000, or $300,000 together with their spouses).
For transactions covered by this rule, a broker-dealer must make a special
suitability determination for the purchaser and have received the purchaser's
written consent to the transaction prior to sale. Consequently, the rule may
adversely affect the ability of broker-dealers to sell the Company's
securities.

Commission regulations define a "penny stock" to be any non-Nasdaq equity
security that has a market price (as therein defined) of less than $5.00 per
share or with an exercise price of less than $5.00 per share, subject to
certain exceptions. For any transaction involving a penny stock, unless exempt,
the rules require

9
<PAGE>

delivery, prior to any transaction in a penny stock, of a disclosure schedule
prepared by the Commission relating to the penny stock market. Disclosure is
also required to be made about commissions payable to both the broker-dealer
and the registered representative and current quotations for the securities.
Finally, monthly statements are required to be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stocks.

The foregoing penny stock restrictions will not apply to the Company's
securities if such securities are listed on Nasdaq and have certain price and
volume information provided on a current and continuing basis or if the Company
meets certain minimum net tangible assets or average revenue criteria. There
can be no assurance that the Company's securities will qualify for exemption
from these restrictions. In any event, even if the Company's securities were
exempt from such restrictions, it would remain subject to Section 15(b)(6) of
the Exchange Act, which gives the Commission the authority to prohibit any
person that is engaged in unlawful conduct while participating in a
distribution of a penny stock from associating with a broker-dealer or
participating in a distribution of a penny stock, if the Commission finds that
such a restriction would be in the public interest. If the Company's securities
were subject to the rules on penny stocks, the market liquidity for the
Company's securities could be severely adversely affected.

ITEM 2. DESCRIPTION OF PROPERTY.

The Company's principal executive offices are located at 1054 South DeAnza
Boulevard, Suite 105, San Jose, California 95129. The facilities consist of
approximately 4,982 square feet of office space pursuant to a lease that
expires March 31, 1999. The Company will either renew its lease and acquire
more space if available or enter into a lease for new premises in the local
area.

ITEM 3. LEGAL PROCEEDINGS.

The Company is not a party to any litigation.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote by security holders during the fourth
quarter of fiscal 1998.

10
<PAGE>

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

(a) 1. Market for Common Equity.

Since August 28, 1997, the effective date of the Company's initial public
offering, the Company's Common Stock, Class A Warrants and Units consisting of
one share of Common Stock and one Class A Warrant were listed on the Nasdaq
SmallCap Market under the symbols NTFY, NTFYW and NTFYU, respectively.

The quarterly high and low sales prices of the Company's Common Stock since
August 28, 1997, the effective date of the Company's initial public offering,
are as follows:

NTFY Common Stock

<TABLE>
<CAPTION>
FISCAL YEAR ENDED CLOSING SALES DAILY AVERAGE
SEPTEMBER 30, 1998 HIGH LOW PRICES TRADING VOLUME
- ------------------- ------ ------ ------------- --------------
<S> <C> <C> <C> <C>
First Quarter....................... $3.750 $2.125 $2.125 4,410
Second Quarter...................... $2.188 $1.625 $2.188 951
Third Quarter....................... $4.000 $2.000 $2.375 12,349
Fourth Quarter...................... $2.750 $0.938 $0.969 4,585
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30, 1997
- -------------------
<S> <C> <C> <C> <C>
Fourth Quarter...................... $4.500 $3.875 $4.000 7,806
</TABLE>

The quarterly high and low sales prices of the Company's Class A Warrants
since August 28, 1997 the effective date of the Company's initial public
offering, are as follows:

NTFYW Warrants

<TABLE>
<CAPTION>
FISCAL YEAR ENDED CLOSING SALES DAILY AVERAGE
SEPTEMBER 30, 1998 HIGH LOW PRICES TRADING VOLUME
- ------------------- ------ ------ ------------- --------------
<S> <C> <C> <C> <C>
First Quarter....................... $1.500 $0.375 $0.750 5,409
Second Quarter...................... $0.750 $0.375 $0.500 1,595
Third Quarter....................... $0.750 $0.375 $0.563 3,680
Fourth Quarter...................... $0.563 $0.156 $0.156 1,890
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30, 1997
- -------------------
<S> <C> <C> <C> <C>
Fourth Quarter...................... $1.250 $1.000 $1.063 7,639
</TABLE>

The quarterly high and low sales prices of the Company's Units since August
28, 1997 the effective date of the Company's initial public offering, are as
follows:

NTFYU Units

<TABLE>
<CAPTION>
FISCAL YEAR ENDED CLOSING SALES DAILY AVERAGE
SEPTEMBER 30, 1998 HIGH LOW PRICES TRADING VOLUME
- ------------------- ------ ------ ------------- --------------
<S> <C> <C> <C> <C>
First Quarter....................... $5.000 $2.500 $2.500 17,054
Second Quarter...................... $3.000 $2.125 $3.000 6,003
Third Quarter....................... $4.625 $2.250 $3.000 3,864
Fourth Quarter...................... $3.000 $1.000 $1.250 2,781
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30, 1997
- -------------------
<S> <C> <C> <C> <C>
Fourth Quarter...................... $5.313 $5.000 $5.000 63,360
</TABLE>

These quotations reflect inter-dealer prices, without retail mark-up,
markdown or commission, and may not represent actual transactions.

11
<PAGE>

Shareholders. As of December 11, 1998, there were 64 holders of record of
the Company's Common Stock and Class A Warrants.

Dividends. The Company has never declared or paid any cash dividends on its
Common Stock. The Company currently anticipates that it will retain all future
earnings for the expansion and operation of its business and does not
anticipate paying cash dividends in the foreseeable future.

2. Recent Sales of Unregistered Securities.

The Registrant did not engage in any transactions during the fiscal year
ended September 30, 1998 involving sales of Registrant's securities that were
not registered under the Securities Act of 1933, as amended (the "Securities
Act").

(b) Use of Proceeds

The Company completed its IPO pursuant to a Registration Statement on Form
SB-2 (No. 333-23369), declared effective on August 28, 1997 and issued
1,600,000 of its Units to the public at a price of $5.00 per Unit. The Units
consisted of one share of the Company's Common Stock and one Class A Warrant to
purchase one share of the Company's Common Stock at an exercise price of $6.50
per share. The underwriter for the IPO was D.H. Blair Investment Banking Corp.
The offering has been terminated and all Units have been sold. The Company
incurred expenses of approximately $1,846,000, of which $800,000 represented
underwriting discounts and commissions and $1,046,000 represented other
expenses. The net proceeds of the IPO to the issuer after total expenses was
$6,154,000.

The Company used an aggregate of $1,606,000 of the net proceeds of the IPO
to repay indebtedness, of which indebtedness $211,000 represented repayment of
indebtedness to Michael Ballard, a director of the Company, and $106,000
represented repayment of indebtedness to Paul DePond, President and Chief
Executive Officer of the Company. The Company used an aggregate of $2,068,000
of the net proceeds from the IPO for working capital, $1,143,000 for product
development, $585,000 for sales and marketing and $115,000 for additional
inventory. This use of the proceeds of the IPO does not reflect a material
change in the use of proceeds described in the prospectus filed as a part of
the Registration Statement filed in connection with the IPO.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
INCLUDING STATEMENTS THAT INCLUDE THE WORDS "BELIEVES", "EXPECTS",
"ANTICIPATES" OR SIMILAR EXPRESSIONS. FORWARD-LOOKING STATEMENTS INCLUDE, BUT
ARE NOT LIMITED TO, THOSE ITEMS IDENTIFIED WITH A FOOTNOTE (1) SYMBOL. SUCH
FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND
OTHER FACTORS THAT MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE
COMPANY TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-
LOOKING STATEMENTS. SUCH FACTORS INCLUDE, AMONG OTHERS, THE FACTORS DISCUSSED
BELOW UNDER THE CAPTION "FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" AND
ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-KSB. THE READER SHOULD CAREFULLY
CONSIDER, TOGETHER WITH THE OTHER MATTERS REFERRED TO HEREIN, THE FACTORS SET
FORTH UNDER THE CAPTION "RISK FACTORS". THE COMPANY CAUTIONS THE READER,
HOWEVER, THAT THESE FACTORS MAY NOT BE EXHAUSTIVE.

OVERVIEW

The Company was founded in August 1994 to develop, manufacture, market and
sell computer telephony products for the business, SOHO and residential
markets. From inception until January 1996, the

12
<PAGE>

Company was engaged primarily in research and development. In January 1996, the
Company shipped the first version of its MessageAlert product and in December
1996 shipped its first Centex Auto Attendant product and in March 1998 shipped
it first Centrex Receptionist product. Substantially most of the Company's
revenue has been derived from sales of its MessageAlert product.

The Company completed its IPO in September 1997, with net proceeds of
approximately $6.2 million. Prior to the IPO, the Company's working capital
requirements were met through the sale of equity and debt securities and, to a
lesser extent, product revenue and the Company's line of credit. The Company
has sustained significant operating losses in every fiscal period since
inception and expects to incur substantial quarterly operating losses in the
future. The Company's limited operating history makes the prediction of future
operating results difficult if not impossible. Future operating results will
depend on many factors, including the demand for the Company's products, the
level of product and price competition, the ability of the Company to expand
its existing and to create new distribution channels, and the ability of the
Company to develop and market new products and control costs. There can be no
assurance that the Company's revenue will grow or be sustained in future
periods or that the Company will ever achieve profitability.

RESULTS OF OPERATIONS

Revenue

To date, substantially all of the Company's revenue has been derived from
the sale of its MessageAlert and Centrex Receptionist products. Revenue
consists of gross revenue less product returns. Revenue for the fiscal year
ended September 30, 1998 decreased to $1,638,268 from $3,735,773 for the fiscal
year ended September 30, 1997. Sales to RBOCs and LECs constituted 71% and 86%
of revenue for the fiscal year ended September 30, 1998 and the fiscal year
ended September 30, 1997, respectively. In addition, two customers accounted
for 50% and 17% of sales in fiscal 1998, and one customer accounted for 70% of
sales in the fiscal year ended September 30, 1997.

Cost of Sales

Cost of sales consists primarily of the cost to manufacture the Company's
products. Cost of sales decreased to $1,582,042 in the fiscal year ended
September 30, 1998 from $2,760,380 in the fiscal year ended September 30, 1997.
This decrease was the result of decreased sales of the Company's products for
the use in telephone company promotional programs. As a result of significant
reserves for slow moving inventory taken in the fourth quarter, the Company's
gross margin decreased to 3% in fiscal 1998 from 26% in fiscal 1997.

Research and Development

Research and development expense consists principally of personnel costs,
contract design services, development tooling and supply expenses. Research and
development expense increased to $1,376,767 for the fiscal year ended September
30, 1998 from $745,063 for the fiscal year ended September 30, 1997. This
increase was primarily the result of an aggressive program to develop and
expand the Company's product offerings that has significantly increased
expenditures for engineers, outside consulting and development materials.

The Company expects that the investment will continue at, or near, the
current level for the first quarter of fiscal 1999 to complete the products
under development and enhance its current products. (1) See "Business--Research
and Development."

Sales and Marketing

Sales and marketing expense consists primarily of personnel, consulting and
travel costs and sales commissions related to the Company's sales and marketing
efforts. Sales and marketing expenses decreased to

13
<PAGE>

$589,295 for the fiscal year ended September 30, 1998 from $666,930 for the
fiscal year ended September 30, 1997. These decreases were attributable
primarily to personnel changes and lower commissions earned.

The Company anticipates that certain sales and marketing expenses will vary
with revenue in future quarters.1 See "Business--Sales, Marketing and
Distribution."

General and Administrative

General and administrative expense consists of general management and
finance personnel, occupancy costs and professional fees and other general
corporate expenses. General and administrative expenses increased to $884,442
for the fiscal year ended September 30, 1998 from $633,584 for the fiscal year
ended September 30, 1997. These increases were primarily the result of
additional legal, accounting and printing expense and increases in executive
salaries. The Company expects that it will need to hire additional accounting
and financial personnel in order to support anticipated growth and comply with
the reporting and investor relations obligations of a public company./1/

Income Taxes

There was no provision for federal or state income taxes in fiscal 1997 or
1998 as the Company incurred net operating losses. As of September 30, 1998,
the Company had federal and state net operating loss carryforwards of
approximately $5,061,000, which will expire in years 2002 through 2013. The
research and development tax credit carryforwards for federal and state
purposes of approximately $50,000 and $30,000, respectively, will expire in the
years 2010 through 2013, if not utilized. Utilization of the net operating
losses and credits may be subject to a substantial annual limitation due to
ownership change limitations provided by the Internal Revenue Code of 1986, as
amended, and similar state provisions. The annual limitation may result in the
expiration of net operating loss and credit carryforwards before full
utilization. For financial reporting purposes, deferred tax assets primarily
related to the net operating loss carryforwards recognized under Financial
Accounting Standard No. 109, "Accounting for Income Taxes," have been fully
offset by a valuation allowance, as the realization of these assets is
dependent on future earnings, the timing and amount of which are uncertain.

Release of Escrow Securities

In the event any Escrow Securities owned by securityholders of the Company
who are officers, directors, consultants or employees of the Company are
released from escrow, compensation expense will be recorded for financial
reporting purposes. Therefore, in the event the Company attains any of the
earnings or stock price thresholds required for the release of the Escrow
Securities, the release will be treated, for financial reporting purposes, as
compensation expense of the Company. Accordingly, the Company will, in the
event of the release of the Escrow Securities, recognize during the period that
the earnings or stock price thresholds are met a substantial noncash charge to
earnings that would increase the Company's loss or reduce or eliminate
earnings, if any, at such time. The amount of this charge will be equal to the
aggregate market price of such Escrow Securities at the time of release from
escrow. Although the amount of compensation expense recognized by the Company
will not affect the Company's total shareholders' equity or cash flow, it may
have a depressive effect on the market price of the Company's securities.

LIQUIDITY AND CAPITAL RESOURCES

14
<PAGE>

expenses at current levels. Management believes that sufficient funds will be
available from cash, cash equivalents, and operating activities to support
planned operations through September 30, 1999. There can be no assurance that
the Company's new products will attain favorable market acceptance. If the
Company is unable to attain certain revenue goals, significant reductions in
spending and the delay or cancellation of planned activities or more
substantial restructuring of the Company may be necessary. In such an event,
the Company intends to implement expense reduction plans in a timely manner to
enable the Company to meet its cash requirements through at least September 30,
1999. These actions would have material adverse effects on the Company's
business, results of operations, and prospects.

Prior to the IPO, the Company financed its operations primarily through
sales of equity and debt securities and bank lines of credit. In the fiscal
years ended September 30, 1998 and 1997, the Company's net cash used in
operating activities equaled $2,617,101 and $1,298,708, respectively. The
Company anticipates that it will have a negative cash flow from operating
activities in future quarters and years.

In August 1997, the Company completed its IPO which consisted of the sale of
1.6 million Units, each consisting of one share of Common Stock of the Company
and one Class A Warrant to purchase one share of Common Stock of the Company at
an exercise price of $6.50. The net proceeds of the IPO, after deducting the
underwriting discounts and commissions and other expenses of the IPO was
approximately $6.2 million.

In March 1997, the Company completed the Bridge Financing which consisted of
the sale of $850,000 principal amount of Bridge Notes bearing interest at an
annual rate of 10% and Bridge Warrants to purchase an aggregate of 425,000
shares of Common Stock. The net proceeds of the Bridge Financing of
approximately $735,000 were utilized by the Company to repay certain
indebtedness and for working capital purposes including general and
administrative expense and expenses of the IPO. The Company repaid the
principal and accrued interest on the Bridge Notes with a portion of the
proceeds of the IPO. The Company recognized a non-recurring charge of
approximately $130,000 representing the aggregate amount of unamortized debt
discount and debt issuance costs associated with the Bridge Financing at the
time of repayment. See Note 3 of Notes to Financial Statements.

IMPACT OF THE YEAR 2000 ISSUE

The Year 2000 ("Y2K") issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Computer
programs that have date sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. To be in "Year 2000 compliance" a
computer program must be written using four digits to define years.

The Company has developed a three-phase program to limit or eliminate Y2K
exposures. Phase I is to identify those systems, application and third-party
relationships which have exposure to Y2K disruptions in operations. Phase II is
the development and implementation of action plans to achieve Y2K compliance in
all areas prior to the end of fiscal 1999. Also included in Phase II is the
development of contingency plans which would be implemented should Y2K
compliance not be achieved in order to minimize disruptions in operations.
Phase III is the final testing or equivalent certification of testing of each
major area of exposure to ensure compliance. The Company intends to complete
all phases before the end of fiscal 1999.

The Company has identified three major areas determined to be critical for
successful Y2K compliance: Area 1, which includes financial, research and
development and administrative informational systems applications reliant on
system software; Area 2, which includes research, development and quality
applications reliant on computer programs embedded in microprocessors; and Area
3, which includes third-party relationships which may be affected by Area 1 or
Area 2 exposures which exist in other companies.

With respect to Area 1, the Company is conducting an internal review and
contacting all software suppliers to determine major areas of Y2K exposure.
With respect to Area 2, in research, development and quality applications, the
Company is working with equipment manufacturers to identify exposures. With
respect

15
<PAGE>

to Area 3, the Company plans to evaluate its reliance on third parties in order
to determine whether their Y2K compliance will adequately assure uninterrupted
operations.

The Company has not yet completed Phase I of the Y2K program with respect to
all three of the major areas. The Company believes that it relies on systems,
applications and third-party relationships which, if not Y2K compliant prior to
the end of fiscal 1999, could have material adverse impact on business,
financial condition and results of operations. Because the Company has not
completed Phase II contingency planning, it cannot describe what action it
would take in any of the areas should Y2K compliance not be achievable in time.

As of September 30, 1998, the Company has not identified any cost related to
replacement or remediation testing of our Area 1 computer information systems.
Not having completed Phase I and Phase II evaluations, the Company has no basis
for estimating the potential cost of its Y2K compliance programs. The funds for
these costs will be part of the Company's cash flow from operations and capital
expenditures.

The cost of the Y2K due to the interruption of venors supplying product for
the Company is unknown. Any interruption of product supply in conjunction with
obligations to deliver product for customer promotional programs could have a
detrimental affect on the results of operations. The cost to the Company would
be directly related to the size and timing of any such interrupted program. The
Company will be making special efforts to avoid such an occurrence but there
cannot be any assurance that the Company will obtain the cooperation of vendors
and customers to prevent such an event.

Since the Company depends on third party turn-key manufacturers to produce
its product in volume, it plans to mitigate its dependence on a single vendor,
where practical, so that a contingency plan is in place if a primary vendor's
ability to manufacture is interrupted by Y2K. There is no assurance that a
contingency plan would not result in additional cost to the Company and that
its implementation would be successful. In addition, there can be no assurance
that the failure to ensure Y2K capability by a supplier or another third party
would not have a material effect on the Company.

16
<PAGE>

ITEM 7. FINANCIAL STATEMENTS.

NOTIFY TECHNOLOGY CORPORATION

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................... F-2
Balance Sheet............................................................... F-3
Statements of Operations.................................................... F-4
Statements of Shareholders' Equity (Net Capital Deficiency)................. F-5
Statements of Cash Flows.................................................... F-6
Notes to Financial Statements............................................... F-7
</TABLE>

F-1
<PAGE>

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders
Notify Technology Corporation

We have audited the accompanying balance sheet of Notify Technology
Corporation as of September 30, 1998, and the related statements of operations,
shareholders' equity (net capital deficiency), and cash flows for the years
ended September 30, 1998 and 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Notify Technology
Corporation at September 30, 1998, and the results of its operations and its
cash flows for the years ended September 30, 1998 and 1997, in conformity with
generally accepted accounting principles.

/s/ Ernst & Young LLP

San Jose, California
October 20, 1998

F-2
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

BALANCE SHEET

<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................... $ 2,117,613
Accounts receivable, net of allowance for doubtful accounts of
$16,555........................................................ 88,868
Note receivable................................................. 50,000
Inventories..................................................... 828,323
Other current assets............................................ 42,757
-----------
Total current assets............................................. 3,127,561
Property and equipment, net...................................... 125,358
Other assets..................................................... 155,443
-----------
$ 3,408,362
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 234,180
Other accrued liabilities....................................... 171,661
Accrued payroll and related..................................... 56,448
Customer overpayment............................................ 92,263
-----------
Total current liabilities........................................ 554,552
Commitments
Shareholders' equity:
Preferred stock, $0.001 par value:
Authorized shares 5,000,000
Issued and outstanding none.................................... --
Common stock, $0.001 par value:
Authorized shares 15,000,000................................... 3,542
Issues and outstanding 3,541,569 in 1998.......................
Additional paid-in capital...................................... 8,945,417
Notes receivable from shareholders.............................. (11,397)
Accumulated deficit............................................. (6,083,752)
-----------
Total shareholders' equity....................................... 2,853,810
-----------
Total liabilities and shareholders' equity....................... $ 3,408,362
===========
</TABLE>

F-3
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
Product sales..................................... $ 1,638,268 $ 3,735,773
Cost of sales..................................... 1,582,042 2,760,380
------------ ------------
Gross profit...................................... 56,226 975,393
Operating costs and expenses:
Research and development......................... 1,376,767 745,063
Sales and marketing.............................. 589,295 666,930
General and administrative....................... 884,442 633,584
------------ ------------
Total operating costs and expenses............... 2,850,504 2,045,577
------------ ------------
Loss from operations.............................. (2,794,278) (1,070,184)
Interest expense.................................. (2,990) (199,133)
Other income and expense, net..................... 179,707 16,761
------------ ------------
Net loss before extraordinary item (2,617,561) (1,252,556)
Extraordinary item loss from early extinguishment
of
bridge notes..................................... -- (130,354)
------------ ------------
Net loss.......................................... $ (2,617,561) $ (1,382,910)
============ ============
Basic and diluted net loss per share before
extraordinary item............................... $ (1.13) $ (2.52)
============ ============
Basic and diluted net loss per share.............. $ (1.13) $ (2.78)
============ ============
Weighted-average shares used in computing net loss
per share........................................ 2,296,449 497,157
============ ============
Pro forma net loss per share...................... $ (1.82)
============
Weighted-average shares used in computing pro
forma net loss per share......................... 760,693
============
</TABLE>

F-4
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)

<TABLE>
<CAPTION>
TOTAL
CONVERTIBLE NOTES SHAREHOLDERS'
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE EQUITY (NET
----------------------- -------------------- PAID-IN FROM ACCUMULATED CAPITAL
SHARES AMOUNT SHARES AMOUNT CAPITAL SHAREHOLDERS DEFICIT DEFICIENCY)
---------- ----------- --------- --------- ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
September 30, 1996.... 4,500,000 $ 1,850,000 885,125 $ 58,619 $ -- $(17,650) $(2,083,281) $ (192,312)
Repayments of notes
receivable from
shareholders......... -- -- -- -- -- 4,075 -- 4,075
Issuances of common
stock to employees... -- -- 33,057 12,200 -- (9,200) -- 3,000
Repurchases of common
stock from
shareholder.......... -- -- (27,722) (7,000) -- 7,000 -- --
Issuances of common
stock pursuant to
conversion of
convertible
promissory notes and
accrued interest..... -- -- 165,694 761,476 -- -- -- 761,476
Issuance of bridge
warrants............. -- -- -- 116,875 -- -- -- 116,875
Conversion of no par
common stock to
$0.001 par common
stock................ -- -- -- (941,114) 941,114 -- -- --
Issuance of common
shares pursuant to
initial public
offering (net of
expenses)............ -- -- 1,600,000 1,600 6,152,533 -- -- 6,154,133
Conversion of
preferred A and
preferred B shares to
common shares
pursuant to initial
public offering...... (4,500,000) (1,850,000) 891,060 891 1,849,109 -- -- --
Option purchased by
underwriter.......... -- -- -- -- 160 -- -- 160
Net loss.............. -- -- -- -- -- -- (1,382,910) (1,382,910)
---------- ----------- --------- --------- ---------- -------- ----------- -----------
Balance at
September 30, 1997.... -- -- 3,547,214 3,547 8,942,916 (15,775) (3,466,191) 5,464,497
Repurchases of common
stock from
shareholder.......... -- -- (7,544) (7) (550) -- -- (557)
Repayment of notes
receivable from
shareholders......... -- -- -- -- -- 4,378 -- 4,378
Proceeds from exercise
of options and
warrants............. -- -- 1,899 2 3,051 -- -- 3,053
Net loss.............. -- -- -- -- -- -- (2,617,561) (2,617,561)
---------- ----------- --------- --------- ---------- -------- ----------- -----------
Balance at
September 30, 1998.... -- $ -- 3,541,569 $ 3,542 $8,945,417 $(11,397) $(6,083,752) $ 2,853,810
========== =========== ========= ========= ========== ======== =========== ===========
</TABLE>

F-5
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.......................................... $ (2,617,561) $ (1,382,910)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization................... 54,207 38,038
Deferred financing charges and accretion related
to bridge notes................................ -- 232,375
Conversion of accrued interest on convertible
notes to common stock.......................... -- 29,351
Changes in operating assets and liabilities:
Accounts receivable........................... 348,037 (302,223)
Inventory..................................... 267,255 (515,649)
Other current assets.......................... (214,142) (25,293)
Accounts payable.............................. (481,174) 598,557
Other accrued liabilities..................... 26,277 29,046
------------ ------------
Net cash used in operating activities............. (2,617,101) (1,298,708)
INVESTING ACTIVITIES
Expenditures for property and equipment........... (65,825) (58,874)
------------ ------------
Net cash used in investing activities............. (65,825) (58,874)
FINANCING ACTIVITIES
Proceeds from exercise of options and warrants.... 3,052 160
Proceeds from issuance of common stock............ -- 3,000
Proceeds from issuance of convertible notes
payable.......................................... -- 125,000
Net proceeds from bridge notes.................... -- 734,500
Repayment of bridge note payable.................. -- (850,000)
Advances under line of credit..................... -- 44,000
Repayments under line of credit................... (36,665) (57,335)
Proceeds from notes payable to shareholders....... -- 265,000
Payments on notes payable to shareholders......... (200,000) (295,000)
Payments of notes receivable from shareholders.... 4,175 4,075
Payments on repurchase of unvested stock.......... (354) --
Proceeds from initial public offering, net........ -- 6,154,133
------------ ------------
Net cash provided by (used in) financing
activities....................................... (229,792) 6,127,533
------------ ------------
Net increase (decrease) in cash and cash
equivalents...................................... (2,912,718) 4,769,951
Cash and cash equivalents at beginning of period.. 5,030,331 260,380
------------ ------------
Cash and cash equivalents at end of period........ $ 2,117,613 $ 5,030,331
============ ============
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING
ACTIVITIES
Common stock issued for notes receivable from
shareholders..................................... $ -- $ 9,200
============ ============
Conversion of convertible preferred stock to
common stock..................................... $ -- $ 1,850,000
============ ============
Common stock retired for notes receivable from
shareholders..................................... $ -- $ 7,000
============ ============
Conversion of convertible notes payable and
accrued interest to common stock................. $ -- $ 761,476
============ ============
Value ascribed to warrants issued in conjunction
with private placement........................... $ -- $ 116,875
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest............................ $ 1,949 $ 71,140
============ ============
</TABLE>

F-6
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 1998

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business

On February 25, 1998, the Company changed its name from Notify Corporation
to Notify Technology Corporation. Notify Technology Corporation (the Company)
develops, manufactures and markets computer telephony products.

Liquidity and Capital Resources

The Company's financial statements are prepared and presented on a basis
assuming it continues as a going concern. At September 30, 1998, the Company
had an accumulated deficit of $6.1 million and incurred a net loss of $2.6
million for the year ended September 30, 1998. Management's planned
expenditures for fiscal 1999 approximate current cash and cash equivalents. The
Company's recently developed products will need to attain favorable market
acceptance to continue its research and development activities and fund
operating expenses at current levels. Management believes that sufficient funds
will be available from cash, cash equivalents, and operating activities to
support planned operations through September 30, 1999. There can be no
assurance that the Company's new products will attain favorable market
acceptance. If the Company is unable to attain certain revenue goals,
significant reductions in spending and the delay or cancellation of planned
activities or more substantial restructuring of the Company may be necessary.
In such event, the Company intends to implement expense reduction plans in a
timely manner to enable the Company to meet its cash requirements through at
least September 30, 1999. These actions would have material adverse effects on
the Company's business, results of operations, and prospects.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The Company is exposed to
credit risk in the event of default by the financial institutions to the extent
of amounts recorded on the balance sheet.

Inventories

Inventories are stated at the lesser of actual cost, on a first-in, first-
out basis, or fair value and consist of the following:

<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
<S> <C>
Raw materials.................................................. $567,457
Work-in-process................................................ 117,588
Finished goods................................................. 143,278
--------
$828,323
========
</TABLE>

Increases in the Company's inventory reserve account in 1998 and 1997 were
approximately $437,000 and $162,000, respectively. Inventory written off and
deducted from the reserve account in each of those years was $0 and $2,800,
respectively.

F-7
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

SEPTEMBER 30, 1998

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

Property and Equipment

Property and equipment is stated at cost and depreciated or amortized on a
straight-line basis of the lesser of the estimated useful lives of the asset or
the lease term. The estimated useful lives range from three to five years.

Other Assets

At September 30, 1998, other assets primarily consist of a prepaid royalty
for certain technology rights, which is being amortized on a straight-line
basis over a three-year period.

Revenue Recognition

Product sales are recognized upon product shipment. In fiscal 1998, two
customers accounted for 50% and 17% of sales. In fiscal 1997, one customer
accounted for 70% of sales.

Income Taxes

The Company follows Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). Under SFAS 109, the liability method
is used to account for income taxes. Under this method, deferred tax assets and
liabilities are measured using the enacted tax rates and laws that will be in
effect when the differences are expected to reverse.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Concentration of Credit Risk

The Company sells its products primarily to regional bell operating
companies and local exchange carriers in the United States. The Company
performs on-going credit evaluations and generally requires no collateral. The
Company maintains reserves for credit losses, and such losses have been within
management's expectations. As of September 30, 1998, two customer accounted for
60% and 14% of accounts receivable. One product accounted for 81% and 91% of
total revenues in fiscal 1998 and 1997, respectively.

Stock Options

The Company accounts for its stock option plan in accordance with provisions
of the Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees" (APB Opinion No. 25). In 1995, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" (SFAS 123), that provides an alternative to APB
Opinion No 25. The Company will continue to account for its employee stock
plans in accordance with the provisions of APB Opinion No 25 with footnote
disclosures of the material impact of SFAS 123. The number of stock options
granted in fiscal years ended 1998 and 1997 are not material; therefore, the
effect of applying the SFAS 123 fair value-based method to the Company's option
grants would not result in pro forma net loss materially

F-8
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

SEPTEMBER 30, 1998

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

Stock Options--(Continued)

different from historical amounts reported. Therefore, such pro forma
information specified in SFAS 123 are vnot separately presented herein. Future
pro forma net income results may be materially different from actual amounts
reported.

Net Loss Per Share

Net loss per share is computed using the weighted-average number of shares
of common stock outstanding during the periods presented. Potential common
shares are excluded from the computation as their effect is antidilutive. In
1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings per Share." (SFAS 128). SFAS 128 replaced the previously reported
primary and fully diluted earnings per share, with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share excludes
any dilutive-effects of options, warrants, and convertible securities. All
earnings per share amounts for all periods have been presented, and where
necessary, restated to conform to the SFAS 128 requirements. The weighted
average number of common shares used in the net loss per share calculation was
reduced by the common stock, and potential common shares placed in escrow in
connection with the Company's initial public offering.

Pro forma net loss per share has been computed as described above and also
gives effect to the conversion of preferred stock that converted to common
stock upon completion of the Company's initial public offering.

Recently Issued Accounting Standards

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
130). The statement established standards for the reporting and display of
comprehensive income and its components. Comprehensive income is defined as the
change in equity of a business enterprise during a period from transactions and
other events and circumstances from nonowner sources. It includes all changes
in equity during a period except those resulting from investments by owners and
distributions to owners. This standard will require that an enterprise display
an amount representing total comprehensive income for the period. SFAS 130 will
be effective for fiscal year 1999. The Company does not expect the adoption of
SFAS 130 to have a significant impact on the Company's reported results of
operations.

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131). SFAS 131 establishes new
requirements for the reporting of information regarding operating segments,
products, services, geographic areas, and major customers. SFAS 131 will be
effective for fiscal year 1999. The Company does not expect the adoption of
SFAS 131 to have a significant impact on the Company's segment disclosure.

2. NOTE RECEIVABLE

In fiscal 1998, the Company issued an unsecured $50,000 note receivable to a
supplier, which is due in fiscal 1999. The note is repayable in services
through the due date, at which time any remaining balance is due in cash.

F-9
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

SEPTEMBER 30, 1998

3. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
<S> <C>
Furniture and office equipment................................. $ 241,682
Leasehold improvements......................................... 2,245
---------
243,927
Less accumulated depreciation and amortization................. (118,569)
---------
$ 125,358
=========
</TABLE>

4. FINANCING ARRANGEMENTS

During February 1997, the Company issued a $65,000 promissory note to a
shareholder, which accrued interest at the rate of 10% and was repaid from the
proceeds of the Company's public offering. The shareholder also received a
warrant to purchase 11,535 shares of common stock of the Company at $3.00 per
share. During fiscal 1998, the note was repaid from the proceeds of the
offering discussed below.

In April 1997, the Company issued a $200,000 promissory note to a
shareholder, which accrues interest at 10% per annum and was due and payable in
October 1997. In conjunction with this promissory note, the Company also issued
the shareholder a warrant to purchase 2,970 shares of the Company's common
stock at an exercise price of $5.00. During fiscal 1998, the note was repaid
from the proceeds of the offering discussed below.

5. COMMITMENTS

The Company currently occupies a facility under an operating lease, which
expires in March 1999, and contains renewal options to extend the lease term
for one two-year period. Future minimum payments under this lease for the year
ended September 30, 1999 and 2000 are $48,000 and $68,000.

Rent expense totaled $112,000 and $73,000 for the years ended September 30,
1998 and 1997, respectively.

6. SHAREHOLDERS' EQUITY

Initial Public Offering of Units and Related Matters

In August 1997, the Company completed an offering to the public (the
Offering) of 1,600,000 units at $5.00 per unit. Each unit consisted of one
share of common stock, $0.001 par value and one Class A warrant. The proceeds
of the offering were approximately $6,200,000, net of issuance costs. Each
Class A warrant entitles the holder to purchase one share of common stock at an
exercise price of $6.50, subject to adjustment, at any time through the fifth
anniversary of the offering. Commencing one year from the date of the offering,
the warrants are subject to redemption by the Company, at $0.05 per warrant,
under certain circumstances, on 30 days written notice. Additionally, the
Company agreed to grant to an underwriter an option to purchase, for nominal
consideration, up to 160,000 units exercisable at $7.00 per unit during a two-
year period that commences three years from the date of the offering.

F-10
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

SEPTEMBER 30, 1998

6. SHAREHOLDERS' EQUITY--(CONTINUED)

Common Stock

The following table summarizes shares of common stock reserved for future
issuance by the Company:

<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
<S> <C>
1997 stock option plan....................................... 198,125
Warrant agreements........................................... 2,105,944
---------
2,304,069
=========
</TABLE>

Warrants

In March 1997, the Company issued 425,000 warrants in connection with a
bridge loan. Each bridge warrant automatically converted, upon the closing of
the offering, into one Class A warrant, which is identical in all respects to a
Class A warrant issued in the offering. The fair value of the bridge warrants,
amounting to approximately $117,000, together with the cost of the issuance of
bridge notes, approximately $115,000 were treated as additional interest
expense over the term of the bridge notes. Upon repayment of the notes in
fiscal 1997, the unamortized portion of the value ascribed the warrants and
debt issuance costs, of approximately $130,000 were recorded as an
extraordinary item.

At September 30, 1998, warrants issued in connection with various
financings, including 2,025,000 Class A warrants, were outstanding to purchase
2,237,786 shares of the Company's common stock (including 123,554 and 29,702
warrants held by three directors and two employees, respectively) at prices
ranging from $0.25 to $6.50 per share. These warrants are exercisable at any
time and expire at dates ranging from April 2000 to April 2002.

During fiscal 1997 and 1996, the Company issued 48,272 and 7,920 warrants in
connection with certain financings with exercise prices of $0.25 and $5.05,
respectively. These warrants expire in fiscal 2001.

In August 1997, the Company issued a warrant that entitles an officer of the
Company to purchase 24,752 shares of common stock at an exercise price of $5.00
per share. This warrant is exercisable any time and expires in April 2002.

1997 Stock Option Plan

In January 1997, the Company adopted the Notify Corporation 1997 Stock Plan
(the Plan), which provides for the granting of stock options to employees,
officers, consultants, and directors of the Company. Stock options are granted
at fair market value on the date of grant with terms of up to ten years. A
total of 200,000 shares of the Company's common stock were reserved for
issuance under the Plan. Under the terms of these option grants, 25% of the
options vest upon the first anniversary of the date of grant and an additional
1/36 of the unvested shares vest ratably over the following 36 months.

F-11
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

SEPTEMBER 30, 1998

6. SHAREHOLDERS' EQUITY--(CONTINUED)

The following table summarizes stock option activity:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------
SHARES
AVAILABLE PRICE WEIGHTED
FOR NUMBER PER AVERAGE
GRANT OF SHARES SHARE PRICE
--------- --------- ------------- --------
<S> <C> <C> <C> <C>
Balance at January 1, 1997....... -- -- $ -- $ --
Shares reserved................ 200,000 -- $ -- $ --
Grants......................... (17,500) 17,500 $4.75 $4.750
------- -------
Balance at September 30, 1997.... 182,500 17,500 $4.75 $4.750
Grants......................... (79,875) 79,875 $1.625-$3.25 $2.145
Cancellations.................. 41,500 (41,500) $1.625-$3.625 $3.094
Exercises...................... -- (1,875) $1.625 $1.625
------- -------
Balance at September 30, 1998.... 144,125 54,000 $1.625-$3.625 $2.742
======= =======
</TABLE>

The following table summarizes outstanding and exercisable options at
September 30, 1998:

<TABLE>
<CAPTION>
OPTIONS EXERCISABLE OPTIONS OUTSTANDING
------------------------------------- --------------------------------
WEIGHTED NUMBER OF WEIGHTED
RANGE OF NUMBER OF AVERAGE OPTIONS AVERAGE
EXERCISE OPTIONS REMAINING EXERCISABLE EXERCISE
PRICES OUTSTANDING LIFE IN YEARS SHARES PRICE
-------- ----------- ------------- ----------- --------
<S> <C> <C> <C> <C>
$1.625 28,000 9.40 1,875 $1.625
$1.875 10,000 9.95 -- $1.875
$2.438 16,000 9.75 -- $2.438
------ -----
54,000 9.61 1,875 $1.912
====== =====
</TABLE>

The weighted average fair value of options granted was $1.40 in 1998 and
$2.55 in 1997.

Escrow Securities

In connection with the Offering, holders of the Company's common and
preferred stock agreed to place 1,247,786 of their shares into escrow, and
holders of certain warrants agreed to place warrants to purchase 126,759 shares
of common stock into escrow. The securities will be released to the holders in
the event specified levels of pretax income of the Company for the years ended
September 30, 1998 to 2003 are achieved, or the market price of the Company's
common stock attains specified targets during a 36-month period commencing from
the effective date of the registration statement relating to the Company's
public offering. Any securities remaining in escrow on September 30, 2003 will
be forfeited, which securities will then be contributed to the Company's
capital. The pretax income levels are subject to proportionate adjustment upon
the issuance of certain securities subsequent to the Company's initial public
offering.

In the event that the foregoing earnings or market price levels are attained
and the escrowed securities released, the Securities and Exchange Commission
has adopted the position that the release of escrowed securities to officers,
directors, employees, and consultants of the Company will be compensatory and,
accordingly, will result in compensation expense for financial reporting
purposes. The expense will equal the fair value of the escrowed securities on
the date of release and will result in a material charge to operations.

F-12
<PAGE>

NOTIFY TECHNOLOGY CORPORATION

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

SEPTEMBER 30, 1998

7. RELATED PARTY TRANSACTIONS

The Company has an ongoing business relationship with a literature and
product fulfillment company owned by a director of the Company. The Company
uses this fulfillment company on a project by project basis to facilitate the
distribution of its products. The Company paid this fulfillment company $61,100
and $97,835 during fiscal 1998 and 1997, respectively.

8. INCOME TAXES

Due to operating losses, there is no provision for income taxes for 1998 or
1997. The expected statutory tax rate of 34% is offset by the inability to
recognize an income tax benefit from the net operating losses.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets for federal and state income taxes are as
follows:

<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................. $ 2,023,000 $ 1,279,000
Research credit carryforwards.................... 75,000 35,000
Other temporary differences...................... 226,000 75,000
----------- -----------
Total deferred tax assets........................ 2,324,000 1,389,000
----------- -----------
Valuation allowance................................ (2,324,000) (1,389,000)
----------- -----------
Net deferred tax assets............................ $ -- $ --
=========== ===========
</TABLE>

Realization of deferred tax assets is dependent on future earnings, the
timing and amount of which are uncertain. Accordingly, a valuation allowance,
in an amount equal to the net deferred tax asset has been established to
reflect these uncertainties. The change in the valuation allowance was a net
increase of $935,000 and $534,000 for fiscal years 1998 and 1997, respectively.

As of September 30, 1998, the Company had net operating loss carryforwards
of approximately $5,061,000 for federal and California tax purposes, which will
expire in years 2002 through 2013. As of September 30, 1998, the Company also
had research and development tax credit carryforwards, for federal and
California tax purposes, of approximately $50,000 and $30,000, respectively.
The credits will expire in years 2010 through 2013, if not utilized.
Utilization of net operating loss and tax credit carryforwards may be subject
to a substantial annual limitation due to the ownership change limitations
provided by the Internal Revenue Code of 1986, as amended, and similar state
provisions. The annual limitation may result in the expiration of net operating
loss and tax credit carryforwards before full utilization.

ITEM 7. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

F-13
<PAGE>

PART III

The information required in Items 9-12 is hereby incorporated by reference
from the Company's definitive proxy statement for the Annual Meeting of
Shareholders to be held on February 25, 1999.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

<TABLE>
<C> <S>
3.1* Restated Articles of Incorporation of Registrant.
3.2 Certificate of Amendment to the Articles of Incorporation of
Registrant.
3.3* Bylaws of Registrant, as amended to date.
10.1*+ Employment Agreement dated as of March 1, 1997 between the Company and
Paul DePond (as amended).
10.2*+ Employment Agreement dated as of March 1, 1997 between the Company and
Gaylan Larson (as amended).
10.3*+ Employment Agreement dated as of March 1, 1997 between the Company and
Gerald Rice (as amended).
10.4* Escrow Agreement by and between Registrant, the American Stock Transfer
& Trust Company and certain security holders of the Registrant (as
amended).
10.5*+ Registrant's 1997 Stock Plan.
10.6* Lease between Registrant and C.C. Poon.
10.7*+ Nonexclusive Technology License Agreement between Registrant and Active
Voice Corporation dated April 30, 1997.
10.8* Form of Warrant Agreement.
10.9* Form of Underwriter's Unit Purchase Option.
23.1 Consent of Independent Auditors.
24.1 Power of Attorney (see page III-2).
27.1 Financial Data Schedule.
</TABLE>
- --------
* Incorporated by reference to exhibits filed in response to Item 27,
"Exhibits," of the Company's Registration Statement on Form SB-2 (File No.
333-23369), declared effective on August 28, 1997.

+ Confidential treatment has been granted with respect to portions of this
exhibit.

+ The item listed is a compensatory plan.

(b) Reports on Form 8-K

During the quarter ended September 30, 1998, the Company filed no reports on
Form 8-K.

III-1
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, duly authorized, in the City of San Jose,
California, on the 16th day of December, 1998.

NOTIFY TECHNOLOGY CORPORATION

Dated:December 16, 1998 By: /s/ Paul F. DePond
--------------------- ---------------------------------
Paul F. DePond
President and Chief Executive
Officer

POWER OF ATTORNEY

Know All Men By These Presents that each person whose signature appears
below constitutes and appoints Paul F. DePond, Gerald W. Rice and Henry P.
Massey, Jr. and each of them, as his true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign any and all
amendments to this Report on Form 10-KSB, and to file the same with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or either of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.

In accordance with the requirements of the Securities Exchange Act of 1934,
this Report was signed by the following persons in the capacities indicated
below and on the dates stated.

SIGNATURE TITLE DATE
<S> <C> <C>
/s/ Paul DePond President, Chief Executive December 16, 1998
- ------------------------- Officer and
Paul DePond Chairman (Principal Executive
Officer)

/s/ Gerald Rice Chief Financial Officer December 14, 1998
- ------------------------- (Principal Financial
Gerald Rice and Accounting Officer)

/s/ Gaylan Larson Vice President, Operations December 14, 1998
- ------------------------- and Director
Gaylan Larson

/s/ Michael Ballard Director December 16, 1998
- -------------------------
Michael Ballard

</TABLE>

III-2
<PAGE>

SIGNATURE TITLE DATE
<S> <C> <C>
/s/ Michael Smith Director December 16, 1998
- -------------------------
Michael Smith

/s/ Andrew Plevin Director December 14, 1998
- -------------------------
Andrew Plevin
</TABLE>

III-3
<PAGE>

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
3.1* Restated Articles of Incorporation of Registrant.
3.2 Certificate of Amendment to Articles of Incorporation of
Registrant.
3.3* Bylaws of Registrant, as amended to date.
10.1*+ Employment Agreement dated as of March 1, 1997 between the Company
and Paul DePond (as amended).
10.2*+ Employment Agreement dated as of March 1, 1997 between the Company
and Gaylan Larson (as amended).
10.3*+ Employment Agreement dated as of March 1, 1997 between the Company
and Gerald Rice (as amended).
10.4* Escrow Agreement by and between Registrant, the American Stock
Transfer & Trust Company and certain security holders of the
Registrant (as amended).
10.5*+ Registrant's 1997 Stock Plan.
10.6* Lease between Registrant and C.C. Poon.
10.7*+ Nonexclusive Technology License Agreement between Registrant and
Active Voice Corporation dated April 30, 1997.
10.8* Form of Warrant Agreement.
10.9* Form of Underwriter's Unit Purchase Option.
23.1 Consent of Independent Auditors.
24.1 Power of Attorney (see page III-2).
27.1 Financial Data Schedule.
</TABLE>
- --------
* Incorporated by reference to exhibits filed in Registration Statement on
Form SB-2 (File No. response to Item 27, "Exhibits," of the Company's 333-
23369), declared effective on August 28, 1997.

+ Confidential treatment has been granted with respect to portions of this
exhibit.

+ The item listed is a compensatory plan.

III-4

<PAGE>
EXHIBIT 3.2

CERTIFICATE OF AMENDMENT OF THE
ARTICLES OF INCORPORATION OF
NOTIFY CORPORATION

Paul F. DePond and Gerald W. Rice hereby certify that:

ONE: They are the duly elected and acting President and Secretary,
respectively, of Notify Corporation, a California corporation (the "Corporation"
or the "Company").

TWO: That Article I of the Company's Amended and Restated Articles of
Incorporation is amended to read in its entirety as follows:

The name of the Corporation is Notify Technology Corporation."

THREE: The foregoing amendment of the articles of incorporation has been
duly approved by the Board of Directors of this Company.

FOUR: The foregoing amendment of the articles of incorporation has been
duly approved by the required vote of shareholders in accordance with Section
902 and 903 of the California Corporations Code. The total number of
outstanding shares entitled to vote with respect to the foregoing amendment was
3,547,237 shares of Common Stock. The number of shares voting in favor of the
amendment equaled or exceeded the vote required. The percentage vote required
was a majority of the outstanding shares of Common Stock.

We further declare under penalty of perjury that the matters set forth in
the foregoing certificate are true and correct of our own knowledge.

Executed at San Jose, California, on February 26, 1998.

/s/ Paul F. DePond
------------------
Paul F. DePond, President

/s/ Gerald W. Rice
------------------
Gerald W. Rice, Secretary

<PAGE>

EXHIBIT 23.1

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-59307) pertaining to the 1997 Stock Option Plan of Notify
Technology Corporation of our report dated October 20, 1998, with respect to
the financial statements of Notify Technology Corporation included in the
Annual Report (Form 10-KSB) for the year ended September 30, 1998.

/s/ Ernst & Young LLP

San Jose, California
December 11, 1998

<PAGE>

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 2,117,613
<SECURITIES> 0
<RECEIVABLES> 88,868
<ALLOWANCES> (16,555)
<INVENTORY> 828,323
<CURRENT-ASSETS> 3,127,561
<PP&E> 125,358
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,408,362
<CURRENT-LIABILITIES> 554,553
<BONDS> 0
0
0
<COMMON> 3,542
<OTHER-SE> 2,853,810
<TOTAL-LIABILITY-AND-EQUITY> 3,408,363
<SALES> 1,638,268
<TOTAL-REVENUES> 1,638,268
<CGS> 1,582,042
<TOTAL-COSTS> 1,582,042
<OTHER-EXPENSES> 2,850,503
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,990
<INCOME-PRETAX> (2,617,560)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,617,560)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,617,560)
<EPS-PRIMARY> (1.13)
<EPS-DILUTED> (1.13)

</TABLE>