BSQUARE CORP /WA, 424B4, 1999-10-20

BSQUARE CORP /WA
424B4, 1999-10-20
BUSINESS SERVICES, NEC

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<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
Registration Statement No. 333-85351

4,000,000 Shares

[COMPANY LOGO]

Common Stock

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

Prior to this offering, there has been no public market for our common
stock. The initial public offering price is $15.00 per share. Our common stock
has been approved for listing on The Nasdaq Stock Market's National Market under
the symbol "BSQR."

We are selling 4,000,000 shares of our common stock, and the underwriters
have an option to purchase a maximum of 600,000 additional shares from selling
shareholders to cover over-allotments of shares.

INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" ON PAGE 6.

<TABLE>
<CAPTION>
UNDERWRITING
DISCOUNTS AND PROCEEDS TO
PRICE TO PUBLIC COMMISSIONS BSQUARE
--------------- ------------- -----------
<S> <C> <C> <C>
Per Share............................................ $15.00 $1.05 $13.95
Total................................................ $60,000,000 $4,200,000 $55,800,000
</TABLE>

Delivery of the shares of common stock will be made on or about October 25,
1999.

Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.

CREDIT SUISSE FIRST BOSTON LEHMAN BROTHERS

A.G. EDWARDS & SONS, INC. WIT CAPITAL CORPORATION

The date of this prospectus is October 19, 1999.
<PAGE> 2
[Description of Artwork]

Front Inside Cover

[BSQUARE LOGO]

[Text]

BSQUARE

BSQUARE provides products and services
that facilitate the integration of the
Windows CE operating system into
intelligent computing devices
in these target markets

TELEVISION SET-TOP BOXES

HANDHELD INDUSTRIAL DEVICES

WINDOWS-BASED TERMINALS

CONSUMER INTERNET APPLIANCES*

PALM-SIZE PCs

GAMING SYSTEMS

*Consumer Internet appliances
include kiosk terminals and
vehicle navigational devices

<PAGE> 3

INSIDE GATEFOLD
[Text]

BSQUARE CORPORATION

BSQUARE - WINDOWS CE SOFTWARE PRODUCTS AND SERVICES PROVIDER

BSQUARE provides:

o software engineering services to Microsoft to help develop the Windows CE
operating system and related integration tools

o comprehensive software products and services to original equipment
manufacturers to help integrate Windows CE into their intelligent
computing devices

o productivity software products, such as bFAX(R), to consumers to extend
the use of intelligent computing devices

Intelligent computing devices include:

o Internet-enabled television set-top boxes

o handheld and palm-size personal computers

o gaming systems

o handheld industrial data collectors

o consumer Internet appliances such as kiosk terminals and vehicle
navigational devices

o Windows-based terminals

Off-the-shelf software products:

o help manufacturers achieve a faster time-to-market
o provide consumers with additional functions for their intelligent
computing devices

BSQUARE's engineering team has been developing Windows
CE-based software solutions since prior to the commercial release of Windows CE

[Pictures reflecting BSQUARE products and models posing
as BSQUARE engineering team]

<PAGE> 4
Inside Gatefold

[Text]

BSQUARE provides software products and services for the development and use of
Windows CE-based intelligent computing devices.

BSQUARE Customers

[Chart reflecting]

Microsoft
Semiconductor Vendors
Intelligent Computing Device Manufacturers (OEMs)
Consumers

Software services for development of Windows CE operating system and
accompanying tools

Software services for development of Windows CE tools and system level software
support

Software products and services for the integration of Windows CE into
devices and consumer applications for bundling on devices

After-market software products to extend the use of intelligent computing
devices

BSQUARE supplies software products and services at all stages of the
intelligent computing device development process

[BSQUARE LOGO]

<PAGE> 5

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
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<S> <C>
PROSPECTUS SUMMARY.................... 3
RISK FACTORS.......................... 6
FORWARD-LOOKING STATEMENTS............ 17
USE OF PROCEEDS....................... 17
DIVIDEND POLICY....................... 17
CAPITALIZATION........................ 18
DILUTION.............................. 19
SELECTED CONSOLIDATED FINANCIAL
DATA................................ 20
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS....................... 21
BUSINESS.............................. 31
</TABLE>

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MANAGEMENT............................ 47
RELATED-PARTY TRANSACTIONS............ 54
PRINCIPAL SHAREHOLDERS................ 55
DESCRIPTION OF CAPITAL STOCK.......... 58
SHARES ELIGIBLE FOR FUTURE SALE....... 61
UNDERWRITING.......................... 63
NOTICE TO CANADIAN RESIDENTS.......... 65
LEGAL MATTERS......................... 66
EXPERTS............................... 66
WHERE TO FIND ADDITIONAL DOCUMENTS.... 66
INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS.......................... F-1
</TABLE>

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

YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO
WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL
TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT MAY ONLY BE ACCURATE
ON THE DATE OF THIS DOCUMENT.

DEALER PROSPECTUS DELIVERY OBLIGATION

UNTIL NOVEMBER 13, 1999 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING),
ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE DEALER'S OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS AN
UNDERWRITER AND WITH RESPECT TO UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
<PAGE> 6

PROSPECTUS SUMMARY

The following summary highlights information that we present more fully
elsewhere in this prospectus. You should read this entire prospectus carefully.

BSQUARE CORPORATION

We provide a broad range of software products and services that both
facilitate the integration of the Microsoft Windows CE operating system into a
variety of devices we call intelligent computing devices and enhance the
functionality of those devices. Original equipment manufacturers, semiconductor
vendors and Windows CE software developers rely on our products and services to
help bring customized intelligent computing devices and intelligent computing
device applications to market in a timely fashion. We have been providing
Windows CE-based software services since prior to the commercial release of
Windows CE in September 1996, and therefore we believe that we offer a greater
breadth and depth of Windows CE expertise than any of our current competitors.

Intelligent computing devices are an emerging class of products with
sophisticated processing power that are designed for specific computing and
communications applications. These devices are described as "intelligent" to
distinguish them from rudimentary single-purpose computing devices with only
limited functionality. Examples of intelligent computing devices include
television "set-top boxes," which sit on top of television sets and provide
users with advanced cable TV access services, sophisticated video gaming
features and Internet access; handheld and palm-size PCs; gaming systems;
handheld industrial data collectors; consumer "Internet appliances" such as
kiosk terminals and navigational devices in cars and trucks; and Windows-based
terminals. Compared to traditional computers, intelligent computing devices are
often less expensive and more adaptable in terms of their size, weight and
shape, while still providing sophisticated computing and communications
capabilities, including Internet connectivity.

Increasingly, intelligent computing devices are able to connect directly to
the Internet, either through wired or wireless telecommunications systems. As
businesses and consumers increasingly use the Internet to transact business and
as demand for smaller and more mobile devices grows, original equipment
manufacturers are developing new intelligent computing devices to better meet
the needs of end users. Because of space constraints and other design and
resource limitations inherent in the intelligent computing device environment,
original equipment manufacturers require a computer operating system that is
both scaleable and highly customizable, with lower system requirements than
traditional PC operating systems. While there are several different operating
systems that can be used in intelligent computing devices, Windows CE, a
versatile and highly adaptable operating system modeled after Microsoft Windows,
is gaining market acceptance among original equipment manufacturers as an
operating system that meets these requirements. As increased use of the Internet
by consumers and businesses helps fuel the growth of the intelligent computing
device market, we believe that the market for Windows CE will in turn benefit.

We develop products and provide services that facilitate the development of
Windows CE-based intelligent computing devices. We generate revenue in three
distinct ways. First, we provide code-writing and related engineering services
to Microsoft and semiconductor vendors to adapt Windows CE to different
microprocessors and to enhance Windows CE's user-specific features and
functions. For the six months ended June 30, 1999, 87% of our revenue was
generated under our master development and license agreement with Microsoft.
Second, we offer a comprehensive set of software products and services that help
original equipment manufacturers cost-effectively integrate Windows CE into
their intelligent computing devices. These offerings include original equipment
manufacturer adaptation kits, software products and test programs, along with
engineering and quality assurance services, all designed to ensure that Windows
CE works properly with the original equipment manufacturer's computer boards,
which are the internal hardware constituting the core of their intelligent
computing devices. Third, we license a wide range of Windows CE-based software
applications to both original equipment manufacturers and intelligent computing
device consumers to provide additional functions to Windows CE-based intelligent
computing devices, such as printing and faxing capabilities.

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<PAGE> 7

We intend to become a primary provider of software products and services
for facilitating the integration of operating systems into intelligent computing
devices. Generally, an operating system provided by vendors in its original form
will not be readily compatible with the increasingly wide variety of
semiconductors and intelligent computing devices that are becoming available and
therefore will need to be adapted in order to function. We refer to this process
as "integration." The key elements of our strategy include building on our
expertise as a provider of Windows CE software products and services, expanding
our strategic relationships with semiconductor vendors and original equipment
manufacturers, maintaining and expanding our relationship with Microsoft,
developing additional software applications and expanding our international
presence.

We were incorporated in the State of Washington in July 1994. Our principal
executive offices are located at 3633 136th Place S.E., Suite 100, Bellevue,
Washington 98006, and our telephone number is (425) 519-5900. Our World Wide Web
address is www.bsquare.com. Information on our website does not constitute a
part of this prospectus.

4
<PAGE> 8

THE OFFERING

<TABLE>
<S> <C>
Common stock offered by us...................... 4,000,000 shares

Common stock to be outstanding after this
offering...................................... 32,196,656 shares

Use of proceeds................................. For general corporate purposes, including planned
relocation expenses. See "Use of Proceeds" on page
17.

Nasdaq National Market Symbol................... BSQR
</TABLE>

Unless otherwise indicated, the information in this prospectus reflects the
number of shares outstanding on August 31, 1999, after giving effect to the sale
of 1,518,378 shares of common stock to Vulcan Ventures Incorporated in September
1999, and assumes the conversion of all outstanding shares of preferred stock
into common stock upon the closing of this offering.

Please see "Capitalization" on page 18 for a more complete discussion
regarding the outstanding shares of common stock, options to purchase common
stock and other related matters.

SUMMARY CONSOLIDATED FINANCIAL DATA

The pro forma consolidated balance sheet data summarized below gives effect
to the issuance of 1,518,378 shares of common stock to Vulcan Ventures in
September 1999 and the conversion of all outstanding preferred stock into common
stock upon completion of this offering. The pro forma as adjusted consolidated
balance sheet data summarized below reflects the application of the net proceeds
from the sale of the 4,000,000 shares of common stock offered by us and after
deducting the underwriting discounts and commissions and estimated offering
expenses.

<TABLE>
<CAPTION>
JUNE 30, 1999 (UNAUDITED)
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................ $ 9,284 $27,986 $82,786
Working capital.......................................... 10,675 29,377 84,177
Total assets............................................. 18,749 37,451 92,251
Long term obligations, net of current portion............ 210 210 210
Mandatorily redeemable convertible preferred stock....... 14,475 -- --
Shareholders' equity (deficit)........................... (255) 32,922 87,722
</TABLE>

5
<PAGE> 9

RISK FACTORS

You should carefully consider the following risk factors and all other
information contained in this prospectus before purchasing our common stock.
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.

UNANTICIPATED FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS DUE TO FACTORS
SUCH AS ADVERSE CHANGES IN OUR RELATIONSHIP WITH MICROSOFT OR A DECLINE IN THE
MARKET FOR WINDOWS CE-BASED INTELLIGENT COMPUTING DEVICES COULD CAUSE OUR STOCK
PRICE TO DECLINE SIGNIFICANTLY.

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

- the failure or perceived failure of Windows CE, the operating system upon
which demand for our products and services is dependent, to achieve
widespread market acceptance;

- the failure of the intelligent computing device market to develop;

- adverse changes in our relationship with Microsoft, from whom a
substantial portion of our revenue is generated and on whom we rely to
continue to develop and promote Windows CE;

- our inability to develop and market new and enhanced products and
services on a timely basis;

- unanticipated delays, or announcement of delays, by Microsoft of Windows
CE product releases, which could cause us to delay our product
introductions and adversely affect our customer relationships;

- changes in demand for our products and services;

- increased competition and changes in our pricing as a result of increased
competitive pressure;

- our ability to control our expenses, a large portion of which are
relatively fixed and which are budgeted based on anticipated revenue
trends, in the event that customer projects, particularly Microsoft
projects, are delayed, curtailed or discontinued;

- changes in the mix of our services and product revenue, which have
different gross margins;

- underestimates by us of the costs to be incurred in significant fixed-fee
service projects; and

- varying customer buying patterns which are often influenced by year-end
budgetary pressures.

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

SUBSTANTIALLY ALL OF OUR REVENUE, INCLUDING 87% OF OUR TOTAL REVENUE FOR THE SIX
MONTHS ENDED JUNE 30, 1999, IS GENERATED FROM OUR RELATIONSHIP WITH MICROSOFT,
WHICH CAN BE MODIFIED OR TERMINATED BY MICROSOFT AT ANY TIME.

In 1997 and 1998, and for the six months ended June 30, 1999, 39%, 79% and
87% of our revenue, respectively, was generated under our master development and
license agreement with Microsoft. The master agreement, the current renewable
term of which concludes in July 2000, includes a number of project-specific work
plans. We bill Microsoft on a time-and-materials basis, although each project
has a maximum dollar cap. We expect the revenue generated from work plans with
Microsoft will continue to comprise the majority of our revenue for the next
several years. We presently have dedicated approximately 200 of our 270
engineers to these projects. However, the master agreement and each of the
individual work plans may be terminated or modified by Microsoft at any time. In
addition, there is no guarantee that Microsoft will continue to enter into
additional work plans with us. In the past, Microsoft has modified the timing
and scope of certain projects, requesting that our engineers be moved from one
project to another, as well as our

6
<PAGE> 10

relationships with our customers. For example, in late 1997 Microsoft decided to
contract with us to provide Windows CE support services to semiconductor vendors
with whom we had previously contracted directly. As a result, from late 1997
through late 1998 our revenue shifted from being generated by a variety of
semiconductor vendors to being generated primarily by Microsoft. We do not
believe that we could replace the Microsoft revenue in the short- or medium-term
if existing work plans were canceled or curtailed, and such cancellations or
curtailments would substantially reduce our revenue. Microsoft is a publicly
traded company that files financial reports and information with the Securities
and Exchange Commission. These reports are publicly available under Microsoft's
Exchange Act filing number, 000-14278. For a description of where this
information can be obtained, see "Where to Find Additional Documents."

IF THE MARKET FOR THE WINDOWS CE OPERATING SYSTEM FAILS TO DEVELOP FULLY OR
DEVELOPS MORE SLOWLY THAN WE EXPECT, OUR BUSINESS AND OPERATING RESULTS WILL BE
MATERIALLY HARMED.

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

- Microsoft's development and support of the Windows CE market. As the
developer and primary promoter of Windows CE, if Microsoft were to decide
to discontinue or lessen its support of the Windows CE operating system,
potential customers could select competing operating systems, which would
reduce the demand for our Windows CE-based software products and
services. In addition, Microsoft has developed a version of its Windows
NT operating system for intelligent computing devices and could decide to
shift its support to this operating system to the detriment of Windows
CE;

- the ability of the Windows CE operating system to compete against
existing and emerging operating systems for the intelligent computing
device market including: VxWorks from WindRiver Systems Inc., pSOS from
Integrated Systems, Inc., VRTX from Mentor Graphics Corporation, JavaOS
from Sun Microsystems, Inc. and LINUX. In particular, in the market for
palm-size devices, Windows CE faces intense competition from PalmOS used
on 3Com Corporation's Palm devices and to date has had limited success in
this market. In the market for cellular phones, Windows CE faces intense
competition from the EPOC operating system from Symbian, a joint venture
between several of the largest manufacturers of cellular phones, which
recently announced it has agreed to discuss cross-licensing its
technology with the Palm Computing unit of 3Com. Windows CE may be
unsuccessful in capturing a significant share of these two segments of
the intelligent computing device market, or in maintaining its market
share in those other segments of the intelligent computing device market
on which our business currently focuses, including the markets for
Internet-enabled television set-top boxes, handheld industrial devices,
consumer Internet appliances such as kiosk terminals and vehicle
navigational devices, and Windows-based terminals;

- the acceptance by original equipment manufacturers and consumers of the
mix of features and functions offered by Windows CE; and

- the willingness of software developers to continue to develop and expand
the applications that run on Windows CE. To the extent that software
developers write applications for competing operating systems that are
more attractive to intelligent computing device end users than those
available on Windows CE, potential purchasers could select competing
operating systems over Windows CE.

IF THE MARKET FOR INTELLIGENT COMPUTING DEVICES FAILS TO DEVELOP FULLY OR
DEVELOPS MORE SLOWLY THAN WE EXPECT, OUR REVENUE WILL NOT GROW AS FAST AS
ANTICIPATED, IF AT ALL.

The market for intelligent computing devices is emerging and the potential
size of this market and the timing of its development are not known. As a
result, our profit potential is uncertain and our revenue may not grow as fast
as we anticipate, if at all. We are dependent upon the broad acceptance by
businesses and

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<PAGE> 11

consumers of a wide variety of Windows CE-based intelligent computing devices,
which will depend on many factors, including:

- the development of content and applications for intelligent computing
devices;

- the willingness of large numbers of businesses and consumers to use
devices such as handheld and palm-size PCs and handheld industrial data
collectors to perform functions currently carried out manually or by
traditional PCs, including inputing and sharing data, communicating among
users and connecting to the Internet; and

- the evolution of industry standards that facilitate the distribution of
content over the Internet to these devices via wired and wireless
telecommunications systems, satellite or cable.

IF MICROSOFT ADDS FEATURES TO ITS WINDOWS CE OPERATING SYSTEM THAT DIRECTLY
COMPETE WITH SOFTWARE PRODUCTS AND SERVICES WE PROVIDE, OUR REVENUE COULD BE
REDUCED AND OUR PROFIT MARGINS COULD SUFFER.

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

IF WE DO NOT MAINTAIN OUR FAVORABLE RELATIONSHIP WITH MICROSOFT, WE WILL HAVE
DIFFICULTY MARKETING OUR SOFTWARE PRODUCTS AND SERVICES AND MAY NOT RECEIVE
DEVELOPER RELEASES OF WINDOWS CE, AND OUR REVENUE AND OPERATING MARGINS WILL
SUFFER.

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

UNANTICIPATED DELAYS, OR ANNOUNCEMENT OF DELAYS, BY MICROSOFT OF WINDOWS CE
PRODUCT RELEASES COULD ADVERSELY AFFECT OUR SALES.

Unanticipated delays, or announcement of delays, in Microsoft's delivery
schedule for new versions of its Windows CE operating system could cause us to
delay our product introductions and impede our ability to complete customer
projects on a timely basis. These delays or announcements by Microsoft could
also cause our customers to delay or cancel their project development activities
or product introductions. Any resulting delays in, or cancellations of, our
planned product introductions or in our ability to commence or complete
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<PAGE> 12

customer projects may adversely affect our revenue and could cause our quarterly
operating results to fluctuate. For example, in 1998 Microsoft delayed the
release of a version of its Windows CE Platform Builder, which delayed our
introduction of a complementary product for an original equipment manufacturer
customer.

WE HAVE SIGNED A NON-COMPETITION PROVISION WITH MICROSOFT WHICH COULD LIMIT OUR
ABILITY TO SUSTAIN OR GROW OUR BUSINESS.

We must receive written permission from Microsoft in order to design or
develop products, or provide services in connection with products, which compete
with the Microsoft Windows CE operating system or related products in existence
as of October 1, 1998 or which Microsoft is developing or intends to develop or
acquire. The term of our non-competition provision coincides with the term of
our master agreement with Microsoft, which concludes in July 2000. Therefore, if
there is a significant shift away from Microsoft operating systems in the
intelligent computing device market segments that we are targeting, including
the markets for Internet-enabled television set-top boxes, handheld and
palm-size PCs, handheld industrial data collectors, consumer Internet appliances
such as kiosk terminals and vehicle navigational devices, and Windows-based
terminals, we will be unable to target and support other operating system
platforms during the term of our non-competition provision. Similarly, because
the non-competition provision effectively requires us to devote all of our
resources to supporting the Windows CE operating system, if our relationship
with Microsoft is curtailed or terminated we would be required to invest
significant time and resources to transition our operations to target and
support competing operating systems. Moreover, to the extent that Microsoft
challenges any of our activities which we believe are not prohibited by the
non-competition provision, we may become involved in litigation to enforce our
rights under the agreement. Litigation, whether successful or not, could harm
our relationship with Microsoft, result in substantial costs and divert our
resources, any of which could harm our business.

THE FIXED-FEE ARRANGEMENTS WE HAVE WITH MANY OF OUR CUSTOMERS EXPOSE US TO THE
RISK THAT WE MAY UNDERESTIMATE OUR COSTS FOR PROJECTS, WHICH COULD LOWER OUR
PROFIT MARGINS.

In addition to the capped-fee arrangements we have with Microsoft, we
provide our services to many of our customers under fixed-fee arrangements. In
1998 and for the six months ended June 30, 1999, approximately 12% and 10%,
respectively, of our total revenue was derived from fixed-fee contracts. In the
event that we underestimate the scope or work effort required for a customer's
project, we may be required to complete the project at a loss or at a
significantly reduced gross margin. If we underestimate the fees for a series of
projects and/or a very large project, our gross margins for a fiscal period may
decline. In addition, revenue from these contracts is recognized on the
percentage-of-completion method, measured by the cost incurred to date relative
to the estimated total cost for the contract. If we underestimate the time
necessary to complete these projects, we may be required to recognize revenue at
a later time than we had anticipated, which would have a negative impact on our
financial condition and cause our quarterly results to fluctuate.

IF WE FAIL TO SECURE CONTRACTS ON SUFFICIENTLY PROFITABLE TERMS, OR AT ALL, WITH
THE LIMITED NUMBER OF MARKET-LEADING ORIGINAL EQUIPMENT MANUFACTURERS OUR
REVENUE AND PROFIT MARGINS WOULD SUFFER.

Currently substantially all of our non-Microsoft revenue is generated from
sales to original equipment manufacturers. For the six months ended June 30,
1999, approximately 13% of our revenue was from sales to original equipment
manufacturer customers. There are a limited number of original equipment
manufacturer customers that are capable of building and shipping large
quantities of intelligent computing devices. In some market segments, one or two
original equipment manufacturers account for a majority of all unit sales.
Competition for the business of these original equipment manufacturers is
intense. If we fail to secure and maintain service and licensing contracts with
the limited number of original equipment manufacturers in these markets we may
not be able to participate in those market segments. In addition, as a result of
their strong market position, these companies are typically able to secure
favorable terms, including favorable pricing, in their technology licensing and
service agreements. Further, many of these potential original equipment
manufacturer customers have the capability to replace our services and products
by utilizing

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<PAGE> 13

internal resources. For these reasons, there is no guarantee that we will be
able to secure contracts on profitable terms, or at all, with the market-leading
original equipment manufacturers, which could harm our business.

OUR MARKET IS BECOMING INCREASINGLY COMPETITIVE, WHICH MAY RESULT IN PRICE
REDUCTIONS, LOWER GROSS MARGINS AND LOSS OF MARKET SHARE.

The market for Windows CE-based software products and services is becoming
increasingly competitive. Increased competition may result in price reductions,
lower gross margins and loss of market share, which would harm our business. We
face competition from:

- our current and potential customers' internal research and development
departments that may seek to develop their own proprietary solutions;

- large professional engineering services firms such as Cadence Design
Systems, Inc. and Electronic Data Systems Corporation that may enter the
market;

- established intelligent computing device software and tools manufacturers
such as Applied Microsystems Corporation, Spyglass, Inc., Phoenix
Technologies, Inc., Mentor Graphics and Integrated Systems;

- small- and medium-size engineering services companies such as VenturCom,
Inc., Eclipse International, Inc., BlueWater Systems, Inc. and Vadem; and

- software and component distributors such as Avnet/Hamilton Hallmark,
Pioneer and Annasoft Systems.

As we develop new products, particularly products focused on specific
industries, we may begin competing with companies with whom we have not
previously competed. It is also possible that new competitors will enter the
market or that our competitors will form alliances, including alliances with
Microsoft, that may enable them to rapidly increase their market share. Although
we are subject to a non-competition provision with Microsoft, Microsoft has not
agreed to any exclusive arrangement with us nor has it agreed not to compete
with us. The barrier to entering the market as a provider of Windows CE-based
intelligent computing device software and services is low. In addition,
Microsoft has created a marketing program to encourage systems integrators to
work on Windows CE. These systems integrators are given the same access by
Microsoft to the Windows CE technology as we are with respect to system
integration. New competitors may have lower overhead than us and therefore be
able to offer advantageous pricing. We expect that competition will increase as
other established and emerging companies enter the Windows CE-based intelligent
computing device market and as new products and technologies are introduced.

WE DEPEND ON THE CONTINUED SERVICES OF OUR PRESIDENT AND CHIEF EXECUTIVE
OFFICER, AND OUR SUCCESS DEPENDS UPON OUR CONTINUED ABILITY TO ATTRACT, TRAIN
AND RETAIN ADDITIONAL QUALIFIED PERSONNEL AT ACCEPTABLE COMPENSATION LEVELS.

We depend substantially on the continued services of William T. Baxter, our
chairman of the board, president and chief executive officer. The loss of the
services of Mr. Baxter could harm our business. None of our executive officers,
including Mr. Baxter, has a contract that guarantees employment. In addition, we
depend on our ability to attract, train and retain qualified personnel,
specifically those with management, technical and product development skills.
Competition for such personnel is intense, particularly in geographic areas
recognized as high technology centers such as the greater-Seattle area, where
substantially all of our employees are located. There can be no assurance that
we will be able to attract, train or retain additional highly qualified
technical and managerial personnel in the future, which could harm our business.
Moreover, to remain competitive we have had to increase employee compensation
and our gross margins have been adversely impacted. To the extent such
competitive wage pressure continues or increases our gross margins could suffer.

10
<PAGE> 14

IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS
MAY BE ABLE TO USE OUR TECHNOLOGY OR TRADEMARKS, WHICH COULD WEAKEN OUR
COMPETITIVE POSITION, REDUCE OUR REVENUE AND INCREASE OUR COSTS.

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

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

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

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

THIRD PARTIES COULD ASSERT THAT OUR SOFTWARE PRODUCTS AND SERVICES INFRINGE
THEIR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD EXPOSE US TO ADDITIONAL COSTS
AND LITIGATION.

Third parties may claim that our current or future software products and
services infringe their proprietary rights, and these claims, regardless of
their merit, could increase our costs and harm our business. We have not
conducted patent searches to determine whether the technology used in our
products infringes patents held by third parties. In addition, it is difficult
to determine whether our software products and services infringe third-party
intellectual property rights, particularly in a rapidly evolving technological
environment in which there may be numerous patent applications pending, many of
which are confidential when filed, with regard to similar technologies. If we
were to discover that one of our software products violated a third party's
proprietary rights, we may not be able to obtain a license on commercially
reasonable terms, or at all, to continue offering that software product.
Moreover, any indemnification we obtain against claims that the technology we
license from third parties infringes the proprietary rights of others may not

11
<PAGE> 15

always be available or may be limited in scope or amount. Even if we receive
broad third-party indemnification, these indemnitors may not have the financial
capability to indemnify us in the event of infringement. In addition, in some
circumstances we could be required to indemnify our customers for claims made
against them that are based on our solutions.

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

IF WE DO NOT RESPOND ON A TIMELY BASIS TO TECHNOLOGICAL ADVANCES AND EVOLVING
INDUSTRY STANDARDS, OUR FUTURE PRODUCT SALES COULD BE NEGATIVELY IMPACTED.

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

OUR FIVE-YEAR OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR FUTURE
PROSPECTS, AND WE CANNOT ASSURE YOU THAT OUR REVENUE GROWTH RATE WILL NOT
DECLINE OR THAT WE WILL BE ABLE TO SUSTAIN OR INCREASE OUR PROFITABILITY.

We were founded in July 1994, generated our first revenue in October 1994
and shipped our first product in November 1996. Accordingly, we have a limited
operating history and you should not rely on our past results to predict our
future performance. The rate of growth of our revenue over the prior year was
245% from 1996 to 1997 and 71% from 1997 to 1998. The rate of growth of our
revenue over prior periods may continue to decline. We anticipate that our
expenses will increase substantially in the foreseeable future as we continue to
develop our technology and expand our product and service offerings. These
efforts may prove more expensive than we currently anticipate, and we may not
succeed in increasing our revenue sufficiently to offset these higher expenses.
If we fail to increase our revenue to keep pace with our expenses, we may
experience losses.

IF WE ARE UNABLE TO MANAGE OUR GROWTH OUR BUSINESS WILL SUFFER.

Our rapid growth has placed, and is expected to continue to place, a
significant strain on our managerial, technical, operational and financial
resources. From August 1996 to July 1999, we grew from 21 employees to 348
employees, and we expect this rapid growth to continue for the foreseeable
future. To manage our growth, we must implement additional management
information systems, further develop our operational, administrative and
financial systems and expand, train and manage our work force. We will also need
to manage an increasing number of complex relationships with customers,
marketing partners and other third parties. We cannot guarantee that our
systems, procedures or controls will be adequate to support our current or
future operations or that our management will be able to effectively manage our
expansion. Our failure to do so could seriously harm our ability to deliver
products and services in a timely fashion, fulfill existing customer commitments
and attract and retain new customers.

12
<PAGE> 16

OUR INTERNATIONAL OPERATIONS EXPOSE US TO GREATER INTELLECTUAL PROPERTY,
MANAGEMENT, COLLECTIONS, REGULATORY AND OTHER RISKS.

In late 1998 we opened offices in Munich, Germany and Tokyo, Japan. For the
six months ended June 30, 1999, less than 1% of our total revenue was generated
by our international offices. Our international operations expose us to a number
of risks, including the following:

- greater difficulty in protecting intellectual property due to less
stringent foreign intellectual property laws and enforcement policies;

- greater difficulty in managing foreign operations due to the lack of
proximity between our home office and our foreign operations;

- longer collection cycles in Japan than we typically experience in the
U.S.;

- unfavorable changes in regulatory practices and tariffs;

- adverse changes in tax laws;

- seasonal European sales declines in the summer months;

- the impact of fluctuating exchange rates between the U.S. dollar and
foreign currencies; and

- general economic and political conditions in Asian and European markets.

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

IF WE CONDUCT FUTURE ACQUISITIONS, THEY COULD PROVE DIFFICULT TO INTEGRATE,
DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE AND ADVERSELY AFFECT OUR
OPERATING RESULTS.

Although we currently have no specific understandings, commitments or
agreements for any acquisition, we may make investments in complementary
companies, services and technologies in the future. We have not made any
material acquisitions or investments to date, and therefore our ability as an
organization to conduct acquisitions or investments is unproven. If we fail to
properly evaluate and execute acquisitions and investments, they may seriously
harm our business and prospects. To successfully complete an acquisition, we
must properly evaluate the technology, accurately forecast the financial impact
of the transaction, including accounting charges and transaction expenses,
integrate and retain personnel, combine potentially different corporate cultures
and effectively integrate products and research and development, sales,
marketing and support operations. Our non-compete provision with Microsoft could
impede our acquisition of companies or technologies that compete with the
Windows CE operating system or related products. If we fail to do any of these,
we may suffer losses or our management may be distracted from our day-to-day
operations. In addition, if we conduct acquisitions using debt or equity
securities, existing shareholders may be diluted, which could affect the market
price of our stock.

IF WE ARE UNABLE TO LICENSE KEY SOFTWARE FROM THIRD PARTIES OUR BUSINESS COULD
BE HARMED.

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

OUR SOFTWARE PRODUCTS OR THE THIRD-PARTY HARDWARE OR SOFTWARE INTEGRATED WITH
OUR SOFTWARE PRODUCTS AND SERVICES MAY SUFFER FROM DEFECTS OR ERRORS THAT COULD
IMPAIR OUR ABILITY TO SELL OUR SOFTWARE PRODUCTS AND SERVICES.

Software and hardware components as complex as those needed for intelligent
computing devices frequently contain errors or defects, especially when first
introduced or when new versions are released. We
13
<PAGE> 17

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

WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN SIGNIFICANT
COSTS.

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

THE LENGTHY SALES CYCLE OF OUR PRODUCTS AND SERVICES MAKES OUR REVENUE
SUSCEPTIBLE TO FLUCTUATIONS.

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

- customers' budgetary constraints and internal acceptance review
procedures;

- the timing of budget cycles; and

- the timing of customers' competitive evaluation processes.

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

A SMALL NUMBER OF OUR EXISTING SHAREHOLDERS CAN EXERT CONTROL OVER US.

After this offering, our executive officers, directors and principal
shareholders holding more than 5% of our common stock, consisting of nine
persons and the several entities affiliated with such persons, will together
control approximately 82% of our outstanding common stock. As a result, these
shareholders, if they act together, will be able to control our management and
affairs of the company and all matters requiring shareholder approval, including
the election of directors and approval of significant corporate transactions.
This concentration of ownership may have the effect of delaying or preventing a
change in control of us and might affect the market price of our common stock.

IT MIGHT BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD BE
BENEFICIAL TO OUR SHAREHOLDERS.

Certain provisions of our amended and restated articles of incorporation,
bylaws and Washington law may discourage, delay or prevent a change in the
control of us or a change in our management even if doing so would be beneficial
to our shareholders. Our board of directors has the authority under our amended
and restated articles of incorporation to issue preferred stock with rights
superior to the rights of the holders of common stock. As a result, preferred
stock could be issued quickly and easily with terms calculated to delay or
prevent a change in control of our company or make removal of our management
more difficult. In addition, as of the first annual meeting of shareholders
following the closing of this offering, our board of directors will be divided
into three classes. The directors in each class will serve for three-year terms,
one class being elected each year by our shareholders. This system of electing
and removing directors may tend to

14
<PAGE> 18

discourage a third party from making a tender offer or otherwise attempting to
obtain control of our company because it generally makes it more difficult for
shareholders to replace a majority of our directors.

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

WE WILL HAVE BROAD DISCRETION IN THE USE OF THE PROCEEDS OF THIS OFFERING. OUR
FAILURE TO APPLY SUCH FUNDS EFFECTIVELY COULD HARM OUR BUSINESS.

We have not designated any specific use for a substantial portion of the
net proceeds from this offering. We intend to use the net proceeds primarily for
general corporate purposes, including working capital and relocation expenses.
Management will have significant flexibility in applying the net proceeds of the
offering. Our failure to apply such funds effectively could harm our business.

THE SUBSTANTIAL NUMBER OF SHARES THAT WILL BE ELIGIBLE FOR SALE IN THE FUTURE
MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.

Sales of a substantial number of shares of our common stock in the public
market following this offering could adversely affect the market price of the
common stock. As additional shares of our common stock become available for
resale in the public market, the supply of our common stock will increase which
could decrease the price. The number of shares of common stock available for
sale in the public market is limited by restrictions under the federal
securities laws and under agreements some of our shareholders, directors and
employees have entered into with the underwriters. The following table shows the
timing of when shares outstanding on August 31, 1999 may be eligible for resale
in the public market after this offering:

<TABLE>
<CAPTION>
DAYS AFTER DATE OF THIS PROSPECTUS SHARES FIRST ELIGIBLE FOR RESALE COMMENT
- ---------------------------------- -------------------------------- -------------------------------
<S> <C> <C>
- - Upon effectiveness............ 4,000,000 - Freely tradable shares sold
in this offering
- - Upon filing of Form S-8
registration statement
immediately after effectiveness
of this offering.............. 63,702 - Outstanding shares registered
on Form S-8 and not locked up
- - 90 days....................... 47,200 - Shares eligible for sale
under Rules 144 and 701 and
not previously registered on
Form S-8 or locked up
- - 181 days...................... 28,085,754 - Freely tradable upon
expiration of lock-up
agreements
</TABLE>

NEW INVESTORS WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION.

Investors in our common stock in this offering will experience immediate
and substantial dilution in the net tangible book value of their shares. At the
initial public offering price of $15.00 per share, dilution to new investors
will be $12.27 per share. Additional dilution will occur upon exercise of
outstanding stock options.

15
<PAGE> 19

YEAR 2000 ISSUES MAY NEGATIVELY IMPACT OUR BUSINESS.

Many computer systems are not currently capable of distinguishing 21st
century dates from 20th century dates. As a result, beginning on January 1,
2000, computer systems and software used by many companies and organizations in
a wide variety of industries, including technology, transportation, utilities,
finance and telecommunications, will produce erroneous results or fail unless
they have been modified or upgraded to process date information correctly.
Significant uncertainty exists in the software industry and other industries
concerning the scope and magnitude of problems associated with the century
change.

We may discover that some or all of our software products are not "Year
2000 compliant" -- that is, they are not capable of adequately distinguishing
21st century dates from 20th century dates. In the majority of our software
licenses, we have warranted that dates on or after January 1, 2000 will not
adversely affect the performance of our products. In addition, our software is
generally integrated into customer products involving sophisticated hardware and
complex software products. If this third-party equipment or our own products do
not operate properly with respect to the Year 2000, we may face claims or incur
unexpected expenses to remedy any resulting problems. The costs of defending and
resolving Year 2000-related disputes, regardless of the merits of such disputes,
and any liability we may have for Year 2000-related damages, including
consequential damages, could adversely affect our operating results. Moreover,
if third parties cannot provide us with products, services or systems that meet
the Year 2000 requirements on a timely basis, our business could be harmed.

Further, many of our computer systems are connected to Microsoft's computer
systems, and we depend on this connectivity to communicate and transact business
with Microsoft on various levels. Any failure of this connectivity or of
Microsoft's computers to be Year 2000 compliant may disrupt our communications
with Microsoft and interfere with our ability to transact business.

In addition, we believe that the purchasing patterns of our customers and
potential customers may be affected by Year 2000 issues as companies expend
significant resources to correct or upgrade their current software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products and services such as those we offer. To the extent
Year 2000 issues cause a significant delay in, or cancellation of, decisions to
purchase our products or services, our business would be harmed. If we fail to
identify and remediate all significant Year 2000 problems on a timely basis, our
business could be harmed. Remediation efforts may involve significant time and
expense, and unremediated problems could harm our business. For a more detailed
description of our Year 2000 preparedness, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000
Compliance" on page 29.

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<PAGE> 20

FORWARD-LOOKING STATEMENTS

Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements. These statements relate to future events or our
future financial performance. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "could," "expects,"
"plans," "intends," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of such terms and other comparable
terminology. These statements involve known and unknown risks, uncertainties and
other factors, including those listed under "Risk Factors," that may cause our
actual results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements. Although
we believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements.

USE OF PROCEEDS

We expect to receive approximately $54.8 million in net proceeds from the
sale of the shares of common stock in this offering. If the underwriters
exercise their over-allotment option to purchase additional shares, we will not
receive any proceeds from this purchase because all of these shares are being
sold by eight of our shareholders.

The principal purposes of this offering are to create a public market for
our stock and to raise working capital. We plan to use approximately $4.0
million of the net proceeds for capital equipment purchases associated with our
planned relocation of our principal administrative, sales, marketing, support
and research and development facilities in October 1999. We have no specific
uses planned for the remainder of the net proceeds other than for general
corporate purposes. Pending such uses, we intend to invest the net proceeds of
this offering in investment grade, interest-bearing securities. We may use a
portion of the net proceeds to acquire additional businesses, products and
technologies or to establish joint ventures that we believe will complement our
current or future business. However, we have no specific plans, agreements or
commitments to do so, and are not currently engaged in any negotiations for any
such acquisition or joint venture.

DIVIDEND POLICY

We have never paid cash dividends on our common stock other than the
distribution of S corporation earnings prior to October 1997, when we converted
to a C corporation. We currently intend to retain any future earnings to fund
the development and growth of our business. Therefore, we do not currently
anticipate paying any cash dividends in the foreseeable future. In addition, the
terms of our current credit facility prohibit us from paying dividends without
our lender's consent.

17
<PAGE> 21

CAPITALIZATION

The following table sets forth our capitalization as of June 30, 1999 on
the following three bases:

- on an actual basis;

- on a pro forma basis after giving effect to the issuance of 1,518,378
shares of common stock to Vulcan Ventures in September 1999 and the
conversion of 8,333,333 outstanding shares of mandatorily redeemable
convertible preferred stock into shares of common stock; and

- on a pro forma as adjusted basis after giving effect to our receipt of
the net proceeds from the sale of 4,000,000 shares of common stock in
this offering.

The outstanding share information excludes 2,996,562 shares of common stock
that are reserved for issuance upon exercise of stock options under our stock
option plan outstanding as of June 30, 1999 at a weighted average exercise price
of $0.73 per share.

The capitalization information set forth in the table below is qualified by
and should be read in conjunction with the more detailed consolidated financial
statements and related notes appearing elsewhere in this prospectus.

<TABLE>
<CAPTION>
JUNE 30, 1999 (UNAUDITED)
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Long-term obligations, net of current portion.............. $ 210 $ 210 $ 210
Mandatorily redeemable convertible preferred stock, no par
value: 10,000,000 shares authorized, 8,333,333 shares
issued and outstanding, actual; 10,000,000 shares
authorized, no shares issued and outstanding, pro forma
and pro forma as adjusted................................ 14,475 -- --
Shareholders' equity:
Common stock, no par value: 50,000,000 authorized,
18,225,205 shares issued and outstanding, actual;
50,000,000 authorized, 28,076,916 outstanding, pro
forma; 50,000,000 authorized, 32,076,916 shares issued
and outstanding, pro forma
as adjusted........................................... 3,209 36,386 91,186
Deferred stock option compensation....................... (1,157) (1,157) (1,157)
Stock subscription....................................... (29) (29) (29)
Cumulative foreign currency translation adjustment....... (61) (61) (61)
Retained earnings (accumulated deficit).................. (2,217) (2,217) (2,217)
------- ------- -------
Total shareholders' equity (deficit)............. (255) 32,922 87,722
------- ------- -------
Total capitalization........................ $14,430 $33,132 $87,932
======= ======= =======
</TABLE>

18
<PAGE> 22

DILUTION

If you invest in our common stock, your interest will be diluted to the
extent of the difference between the public offering price per share of our
common stock and the pro forma as adjusted net tangible book value per share of
our common stock after this offering. We calculate net tangible book value per
share by dividing the net tangible book value, which equals total assets less
intangible assets and total liabilities, by the number of outstanding shares of
common stock.

At June 30, 1999, our pro forma net tangible book value, after giving
effect to the issuance of 1,518,378 shares of common stock to Vulcan Ventures in
September 1999 and the automatic conversion of all outstanding shares of
mandatorily redeemable convertible preferred stock into 8,333,333 shares of
common stock upon the closing of this offering, was $32.9 million, or $1.17 per
share of common stock. After giving effect to the sale of the 4,000,000 shares
of common stock in this offering at the initial public offering price of $15.00
per share, less estimated underwriting discounts and commissions and estimated
expenses we expect to pay in connection with this offering, our pro forma as
adjusted net tangible book value at June 30, 1999 would have been $87.7 million,
or $2.73 per share. This represents an immediate increase in the pro forma as
adjusted net tangible book value of $1.56 per share to existing shareholders and
an immediate dilution of $12.27 per share to new investors, or approximately 82%
of the offering price of $15.00 per share.

The following table illustrates this dilution on a per share basis:

<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $15.00
Pro forma net tangible book value per share at June 30,
1999...................................................... $1.17
Increase per share attributable to new investors............ 1.56
-----
Pro forma as adjusted net tangible book value per share
after this offering....................................... 2.73
------
Dilution per share to new investors......................... $12.27
======
</TABLE>

The following table shows on a pro forma as adjusted basis at June 30,
1999, after giving effect to the sale of 1,518,378 shares of common stock to
Vulcan Ventures in September 1999 and the automatic conversion of all
outstanding shares of mandatorily redeemable convertible preferred stock into
shares of common stock upon the closing of this offering, the number of shares
of common stock purchased from us, the total consideration paid to us and the
average price paid per share by existing shareholders and by new investors
purchasing common stock in this offering, before deducting underwriting
discounts and commissions and estimated offering expenses, at the initial public
offering price of $15.00 per share:

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
--------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing shareholders.............. 28,076,916 87.5% $33,705,000 36.0% $ 1.20
New investors...................... 4,000,000 12.5 60,000,000 64.0 $15.00
---------- ---- ----------- ----
Total.................... 32,076,916 100% $93,705,000 100%
========== ==== =========== ====
</TABLE>

The above computations assume no exercise of options after June 30, 1999.
The number of shares outstanding at June 30, 1999 excludes 2,996,562 shares of
common stock issuable upon exercise of options outstanding as of June 30, 1999
having a weighted average exercise price of $0.73 per share. To the extent the
option holders exercise these outstanding options, or any options we grant in
the future, there will be further dilution to new investors. For a more detailed
discussion of our stock plans and outstanding options to purchase common stock,
see Notes 7 and 8 of the Notes to Consolidated Financial Statements included
elsewhere in this prospectus.

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<PAGE> 23

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data as of and for the years
ended December 31, 1996, 1997 and 1998 are derived from our consolidated
financial statements, which have been audited by Arthur Andersen LLP,
independent public accountants. The consolidated financial data as of and for
the periods ending December 31, 1994 and 1995 are derived from unaudited
financial statements. The consolidated financial data as of and for the six
months ended June 30, 1998 and 1999 are derived from unaudited financial
statements included elsewhere in this prospectus. We have prepared this
unaudited information on the same basis as the audited consolidated financial
statements and have included all adjustments, consisting of only normal
recurring adjustments, that we consider necessary for a fair presentation of our
financial position and operating results. When you read this selected
consolidated financial data, it is important that you also read the historical
consolidated financial statements and related notes included in this prospectus,
as well as the section of this prospectus entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Our historical
results are not necessarily indicative of our future results.

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION SIX MONTHS ENDED
(JULY 15) TO YEAR ENDED DECEMBER 31, JUNE 30,
DECEMBER 31, ----------------------------------------- -----------------
1994 1995 1996 1997 1998 1998 1999
------------ ----------- ------- ------- ------- ------- -------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue............................................ $ 151 $ 1,573 $ 4,179 $14,405 $24,612 $10,802 $18,543
Cost of revenue.................................... 83 795 1,404 5,644 11,301 5,028 8,899
------- ------- ------- ------- ------- ------- -------
Gross profit....................................... 68 778 2,775 8,761 13,311 5,774 9,644
Operating expenses
Research and development......................... -- -- 205 1,391 3,671 1,452 2,960
Selling, general and administrative.............. 4 86 606 2,806 6,470 2,618 5,236
------- ------- ------- ------- ------- ------- -------
Total operating expenses................... 4 86 811 4,197 10,141 4,070 8,196
------- ------- ------- ------- ------- ------- -------
Income from operations............................. 64 692 1,964 4,564 3,170 1,704 1,448
Interest income (expense), net..................... -- 1 7 (12) 319 179 130
------- ------- ------- ------- ------- ------- -------
Income before income taxes......................... 64 693 1,971 4,552 3,489 1,883 1,578
Provision for income taxes......................... -- -- -- 746 1,189 666 712
------- ------- ------- ------- ------- ------- -------
Net income......................................... $ 64 $ 693 $ 1,971 $ 3,806 $ 2,300 $ 1,217 $ 866
======= ======= ======= ======= ======= ======= =======
Basic earnings per share(1)........................ $ -- $ 0.03 $ 0.09 $ 0.18 $ 0.12 $ 0.06 $ 0.04
======= ======= ======= ======= ======= ======= =======
Shares used to compute basic earnings per
share(1)......................................... 21,000 21,000 22,106 21,400 18,372 18,615 18,206
======= ======= ======= ======= ======= ======= =======
Pro forma basic earnings per share(2).............. $ 0.09 $ 0.03
======= =======
Shares used to compute pro forma basic earnings per
share(2)......................................... 26,021 26,539
======= =======
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30, 1999
------------------------------------------------------------- ----------------------
1994 1995 1996 1997 1998 ACTUAL PRO FORMA(3)
----------- ----------- ------- ------- ------------- ------- ------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments............................ $ 61 $ 103 $ 187 $ 2,286 $ 6,906 $ 9,284 $27,986
Working capital.......................... 65 236 658 2,918 10,280 10,675 29,377
Total assets............................. 96 514 1,057 6,453 16,158 18,749 37,451
Long-term obligations, net of current
portion................................ -- -- -- 1,743 289 210 210
Mandatorily redeemable convertible
preferred stock........................ -- -- -- -- 14,417 14,475 --
Shareholders' equity (deficit)........... 66 261 924 2,330 (1,298) (255) 32,922
</TABLE>

- ---------------
(1) See Note 12 to the Consolidated Financial Statements for a reconciliation of
the numerators and denominators used in computing basic and diluted earnings
per share.

(2) Shares used to compute pro forma basic earnings per share is defined as the
weighted average number of shares of common stock outstanding for the period
plus the weighted average number of shares of common stock resulting from
the assumed conversion of all outstanding shares of the mandatorily
redeemable convertible preferred stock as if converted on date of issuance.

(3) Gives effect to the issuance of 1,518,378 shares of common stock to Vulcan
Ventures in September 1999 and the conversion of all outstanding preferred
stock into common stock upon completion of this offering.

20
<PAGE> 24

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We generate revenue in three distinct ways:

- we provide software code-writing and related engineering services to
Microsoft and semiconductor vendors to adapt Windows CE to different
microprocessors and to enhance Windows CE's user-specific features and
functions;

- we offer a comprehensive set of software products and services, or
"integration tool kits," that help original equipment manufacturers
integrate Windows CE into their intelligent computing devices; and

- we license a wide range of Windows CE-based software applications both to
original equipment manufacturers and intelligent computing device
consumers to provide additional functions to Windows CE-based intelligent
computing devices, such as printing and faxing capabilities.

Our revenue totaled $14.4 million in 1997, $24.6 million in 1998 and $18.5
million for the six months ended June 30, 1999. We generated net income of $3.8
million in 1997, $2.3 million in 1998 and $866,000 for the six months ended June
30, 1999.

We began operations in July 1994, generated our first revenue in October
1994 and shipped our first product in November 1996. Through late 1997, we
provided software services directly to semiconductor vendors. In late 1997,
Microsoft decided to contract with us to provide our services to the
semiconductor customers with whom we had previously contracted directly. As a
result, we began to experience a shift from providing services directly to
semiconductor vendors to contracting directly with Microsoft for the benefit of
these companies. This shift was completed in the second quarter of 1998.

In 1997 we began research and development activities in connection with our
software applications. These activities produced software applications such as
our CE Xpress Adaptation kits, part of our intelligent computing device
integration tool kits, for use by original equipment manufacturers to integrate
Windows CE into their intelligent computing devices. These activities also
produced software applications such as bFAX and bPRINT for use by consumers on
their handheld devices. We also hired personnel to build our human resource,
finance, legal and administrative infrastructure. In early 1998, we accelerated
our investments in research and development, marketing and domestic and
international sales channels. Since March 1998, we have:

- hired more than 165 employees;

- provided software products and services for the development of more than
30 different intelligent computing devices;

- established direct sales offices in Germany and Japan; and

- released more than 20 localized versions of our products in German,
Spanish, French, Italian, Japanese, Portugese and International English.

Beginning in early 1999, we expanded our marketing and sales force to
penetrate the growing market for our products and services. These investments
have significantly increased our operating expenses, contributing to reduced
profitability compared to 1997. We anticipate that our operating expenses will
increase substantially for the foreseeable future as we expand our product
development, sales and marketing and professional services staff. If we fail to
increase our revenue to keep pace with these increased expenses, we may
experience quarterly losses.

To date, we have derived substantially all of our revenue from the
provision of services to Microsoft, semiconductor vendors and original equipment
manufacturers. We also generate product revenue from software sales and royalty
licenses. We perform our services under both time-and-materials contracts and
fixed-fee contracts. We also receive a small portion of service revenue from the
provision of contract support

21
<PAGE> 25

services upon the purchase of our software products. We sell our packaged
software products through standard retail channels, our direct sales force and
through indirect channels, such as resellers. In addition, we receive royalty
payments from original equipment manufacturers related to the bundling of our
software on their intelligent computing devices and, more recently, from the
license to them of software products contained in our intelligent computing
device integration tool kits.

We recognize revenue on the following bases:

- Time-and-materials consulting contracts. We recognize service revenue
performed under time-and-materials consulting contracts as the services
are rendered. Under our master agreement with Microsoft, we bill
Microsoft on a time-and-materials basis, although each project work plan
has a maximum dollar cap. We recognize the revenue generated under this
master agreement as the services are rendered.

- Fixed-fee consulting contracts. Service revenue from fixed-fee contracts
is recognized on the percentage-of-completion method, measured by the
ratio of the cost incurred to date to the estimated total cost for the
contract. This method is used because we consider expended costs to be
the best available measure of contract performance. Contract costs
include all direct labor, material and any other costs related to
contract performance. Selling, general and administrative costs are
expensed as incurred. Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are determined.
Changes in job performance, job conditions and estimated profitability
may result in revisions in the estimate of total costs. Any required
adjustments due to these changes are recognized in the period in which
such revisions are determined.

- Product revenue. Product revenue, including advanced production royalty
payments, is generally recognized when a customer license agreement has
been executed, the software has been shipped, remaining obligations are
insignificant and collection of the resulting account receivable is
probable. We recognize license royalty income as reported by the reseller
when it ships its product to distributors.

MICROSOFT MASTER DEVELOPMENT AND LICENSE AGREEMENT

In 1997 and 1998 and for the six months ended June 30, 1999, 39%, 79% and
87% of our revenue, respectively, was generated under our master development and
license agreement with Microsoft. The master agreement, the current renewable
term of which concludes in July 2000, includes a number of project-specific work
plans. As described above, we bill Microsoft on a time-and-materials basis,
although each project has a maximum dollar cap, and recognize revenue generated
under the master agreement as the services are rendered. The master agreement
and each of the individual work plans may be modified or terminated by Microsoft
at any time. The average budget of our current work plans under the master
agreement is approximately $1,650,000. While we anticipate that our relationship
with Microsoft will remain strong, we are unable to predict the magnitude and
number of future projects for Microsoft.

In addition, under a non-competition provision contained in the master
agreement, we must obtain written permission from Microsoft in order to design
or develop products, or provide services in connection with products, which
compete with Windows CE or related products in existence as of October 1, 1998
or which Microsoft is developing or intends to develop or acquire.

PRELIMINARY THIRD QUARTER RESULTS

Total revenue increased 53% from $6.6 million for the three months ended
September 30, 1998 to $10.0 million for the three months ended September 30,
1999 and increased 64% from $17.4 million for the nine months ended September
30, 1998 to $28.6 million for the nine months ended September 30, 1999. Net
income decreased 67% to $262,000 for the three months ended September 30, 1999
from $802,000 for the three months ended September 30, 1998. For the nine months
ended September 30, 1999, net income decreased 44% to $1.1 million from $2.0
million for the same period in 1998. The decrease in net income in both of the
1999 periods over the 1998 periods was due primarily to operating expenses,
including payroll and

22
<PAGE> 26

facilities costs, associated with our international offices. These offices were
opened in the fourth quarter of 1998 and, accordingly, there were no expenses
associated with our international operations during the first nine months of
1998. To a lesser extent, the decrease in net income in both periods was due to
an increased investment in research and development activities, including the
upgrading and development of our software application products, and the
expansion of our sales and marketing efforts. We have hired 28 additional
product engineers and 11 additional sales and marketing employees since
September 30, 1998.

HISTORICAL RESULTS OF OPERATIONS

The following table presents certain financial data as a percentage of
total revenue for the years ended December 31, 1996, 1997 and 1998 and for the
six months ended June 30, 1998 and 1999. Our historical operating results are
not necessarily indicative of the results for any future period.

<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUE
-----------------------------------------
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
----------------------- --------------
1996 1997 1998 1998 1999
----- ----- ----- ----- -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenue:
Service....................................... 100% 97% 95% 94% 96%
Product....................................... -- 3 5 6 4
----- ----- ----- ----- -----
Total revenue............................ 100 100 100 100 100
----- ----- ----- ----- -----
Cost of revenue:
Service....................................... 34 39 46 46 47
Product....................................... -- -- -- 1 1
----- ----- ----- ----- -----
Total cost of revenue.................... 34 39 46 47 48
----- ----- ----- ----- -----
Gross margin..................................... 66 61 54 53 52
Operating expenses:
Research and development...................... 5 10 15 13 16
Selling, general and administrative........... 14 20 26 24 28
----- ----- ----- ----- -----
Total operating expenses................. 19 30 41 37 44
----- ----- ----- ----- -----
Income from operations........................... 47 31 13 16 8
Interest income, net............................. -- -- 1 1 1
----- ----- ----- ----- -----
Income before income taxes....................... 47 31 14 17 9
Provision for income taxes....................... -- 5 5 6 4
----- ----- ----- ----- -----
Net income....................................... 47% 26% 9% 11% 5%
===== ===== ===== ===== =====
</TABLE>

COMPARISON OF SIX MONTHS ENDED JUNE 30, 1998 AND 1999

Revenue

Revenue consists of service and product revenue, which includes software
license fees and royalties. Total revenue increased 72% from $10.8 million for
the six months ended June 30, 1998 to $18.5 million for the six months ended
June 30, 1999. Microsoft accounted for 73% and 87% of total revenue for the six
months ended June 30, 1998 and 1999, respectively. This increase was the result
of the completion of the shift from providing services directly to semiconductor
vendors to providing such services to Microsoft for the benefit of such vendors.
We anticipate that we will continue to receive a substantial portion of our
revenue from the provision of services to Microsoft. Revenue outside of the U.S.
totaled $545,000 for the six months ended June 30, 1998 and $271,000 for the six
months ended June 30, 1999. The decrease in international revenue resulted
primarily from the shift from working directly with international semiconductor
vendors to working directly with Microsoft on behalf of those customers.

23
<PAGE> 27

Service revenue. Service revenue increased by 75% from $10.2 million for
the six months ended June 30, 1998 to $17.8 million for the six months ended
June 30, 1999. This increase was due to an increase in the number and size of
consulting service projects. As a percentage of total revenue, service revenue
did not increase materially.

Product revenue. Product revenue increased 12% from $621,000 for the six
months ended June 30, 1998 to $695,000 for the six months ended June 30, 1999.
This increase resulted primarily from an increase in sales of pre-packaged
application products including the newly introduced CEValidator quality
assurance test suite. As a percentage of total revenue, product revenue did not
change materially.

Cost of Revenue

Cost of service revenue. Cost of service revenue consists primarily of
salaries and benefits for software developers and quality assurance personnel,
plus an allocation of facilities and depreciation costs. Cost of service revenue
increased 79% from $4.9 million for the six months ended June 30, 1998 to $8.8
million for the six months ended June 30, 1999. The increase in absolute dollars
resulted primarily from the hiring and training of additional employees to
support an increased number of projects. At June 30, 1998 and 1999, we had 135
and 212 employees, respectively, engaged in engineering consulting. Cost of
service revenue as a percentage of related service revenue was 48% for the six
months ended June 30, 1998 and 49% for the six months ended June 30, 1999. The
increase in cost of service revenue as a percentage of the related service
revenue in the first half of 1999 was primarily the result of an increase in
software engineering salaries due to competitive employee recruiting and
retention pressures in the greater-Seattle area.

Cost of product revenue. Cost of product revenue consists of license fees
and royalties for third-party software, product media, product duplication and
manuals. Cost of product revenue decreased from $121,000 for the six months
ended June 30, 1998 to $108,000 for the six months ended June 30, 1999.

Operating Expenses

Research and development. Research and development expenses consist
primarily of salaries and benefits for software developers, quality assurance
personnel, program managers and an allocation of our facilities and depreciation
costs. Research and development expenses increased 104% from $1.5 million for
the six months ended June 30, 1998 to $3.0 million for the six months ended June
30, 1999. This increase resulted from an increase in the number of software
developers and quality assurance personnel to expand our product offerings and
to support development and testing activities. Research and development expenses
represented 13% of our total revenue for the six months ended June 30, 1998 and
16% for the six months ended June 30, 1999. The increase in research and
development expenses as a percentage of total revenue primarily reflects the
more rapid increase of our investment in product development activities as
compared to the growth in revenue during this period. We anticipate that
research and development expenses will continue to increase in absolute dollars
in future periods.

Selling, general and administrative. Selling expenses are comprised of
salaries and benefits earned by sales and marketing personnel, travel expenses,
corporate advertising and promotional expenses, plus an allocation of facilities
and depreciation costs. General and administrative expenses consist primarily of
salaries, benefits and related costs for our executive, finance, legal,
administrative and information services personnel and professional service fees.

Selling expenses increased 68% from $967,000 for the six months ended June
30, 1998 to $1.6 million for the six months ended June 30, 1999. This increase
resulted primarily from our continued investment in sales and marketing
infrastructure, both domestically and internationally, which included
significant personnel-related expenses, travel expenses and related facility and
equipment costs, as well as increased marketing activities, including trade
shows, public relations and other promotional expenses. Selling expenses
represented 9% of our total revenue for the six months ended June 30, 1998 and
June 30, 1999. We anticipate that sales and marketing expenses will increase in
absolute dollars in future periods as we expand our sales and marketing staff
both domestically and internationally.

24
<PAGE> 28

General and administrative expenses increased 119% from $1.7 million for
the six months ended June 30, 1998 to $3.6 million for the six months ended June
30, 1999. General and administrative expenses represented 15% of our total
revenue for the six months ended June 30, 1998 and 19% for the six months ended
June 30, 1999. This increase in absolute dollars and as a percentage of total
revenue resulted primarily from the addition of executive, finance and
administrative personnel to support the growth of our business as well as
personnel and facility costs associated with our international offices. Our
general and administrative expenses have increased and we anticipate they will
continue to increase in absolute dollars as we expand our administrative staff
and incur expenses associated with becoming a public company.

Interest income (expense), net. Interest income (expense), net consists of
earnings on our cash, cash equivalents and short-term investment balances offset
by interest expense associated with debt obligations. Interest income (expense),
net was $179,000 for the six months ended June 30, 1998 and $130,000 for the six
months ended June 30, 1999. The decrease resulted from an increase in interest
expense on our long-term obligations.

Income taxes. Our provision for federal, state and international income
taxes was $666,000 for the six months ended June 30, 1998 as compared to
$712,000 for the six months ended June 30, 1999, yielding effective rates of
35.4% in 1998 and 45.1% in 1999. The increase in the effective rate was due to
the effect of the non-deductibility of losses from our international operations.

COMPARISON OF YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998

Revenue

Total revenue increased 245% from $4.2 million in 1996 to $14.4 million in
1997, and an additional 71% to $24.6 million in 1998. Microsoft accounted for
5%, 39% and 79% of total revenue in 1996, 1997 and 1998, respectively. Revenue
outside of North America totaled $1.8 million in 1996, $4.3 million in 1997 and
$954,000 in 1998. The decreases in international revenue from 1996 to 1998 and
the increases in Microsoft revenue resulted from the shift from working directly
with semiconductor vendors to working with Microsoft for the benefit of those
customers during this period.

Service revenue. Service revenue increased 236% from $4.2 million in 1996
to $14.0 million in 1997, and an additional 67% to $23.4 million in 1998. The
increases in service revenue for all periods were due to the increasing number
and size of service projects and related hiring of engineering personnel to
fulfill project requirements.

Product revenue. Product revenue increased from zero in 1996 to $384,000 in
1997, and an additional 217% to $1.2 million in 1998. The increases in product
revenue from 1996 to 1997 resulted primarily from an increase in the volume of
our software applications bundled on handheld PCs. The increases in product
revenue from 1997 to 1998 resulted from the expansion of product offerings from
software applications for handheld PCs to intelligent computing device
integration tool kits.

Cost of Revenue

Cost of service revenue. Cost of service revenue increased 298% from $1.4
million in 1996 to $5.6 million in 1997, and an additional 100% to $11.1 million
in 1998. These increases resulted from the hiring and training of additional
employees to support our growing customer base. At December 31, 1996, 1997 and
1998, we had 28, 87 and 152 employees, respectively, engaged in engineering
consulting. Cost of service revenue as a percentage of related service revenue
was 34% in 1996, 40% in 1997 and 48% in 1998. The increases in cost of service
revenue as a percentage of related service revenue reflect higher personnel
costs related to the personnel pressures in the greater-Seattle area, as well as
higher facilities and depreciation costs associated with expansion.

Cost of product revenue. Cost of product revenue increased from zero in
1996 to $78,000 in 1997, and an additional 113% to $166,000 in 1998. Cost of
product revenue as a percentage of related product revenue was zero in 1996, 20%
in 1997 and 14% in 1998.

25
<PAGE> 29

Operating Expenses

Research and development. Research and development expenses increased 579%
from $205,000 in 1996 to $1.4 million in 1997, and an additional 164% to $3.7
million in 1998. These increases primarily related to the increase in the number
of software developers and quality assurance personnel hired to expand our
product offerings and to support our product development and testing activities.
Research and development expenses represented 5% of our total revenue in 1996,
10% in 1997 and 15% in 1998. The increases in research and development expenses
as a percentage of total revenue primarily reflect the more rapid investment in
our research and development activities compared to the growth of our revenue
during these periods.

Selling, general and administrative. Selling expenses increased 451% from
$152,000 in 1996 to $837,000 in 1997, and an additional 172% to $2.3 million in
1998. These increases resulted primarily from our investment in sales and
marketing infrastructure, both domestically and internationally, which included
significant personnel-related expenses, travel expenses and related facility and
equipment costs, as well as increased marketing activities, including trade
shows, public relations and other promotional expenses. Selling expenses
represented 4% of our total revenue in 1996, 6% in 1997 and 9% in 1998. The
increases in selling expenses as a percentage of total revenue primarily
reflects the more rapid investment in our sales and marketing infrastructure
compared to the growth of our revenue during these periods.

General and administrative expenses increased 334% from $454,000 in 1996 to
$2.0 million in 1997, and an additional 113% to $4.2 million in 1998. The
increases from 1996 to 1998 primarily resulted from the addition of finance,
executive and administrative personnel to support the growth of our business
during these periods. General and administrative costs represented 11%, 14% and
17% of our total revenue in 1996, 1997 and 1998, respectively.

Interest income (expense), net. Interest income (expense), net was $7,000
in 1996, ($12,000) in 1997 and $319,000 in 1998. The increase in interest income
in 1998 over prior periods resulted from higher average cash and cash equivalent
and short-term investment balances in that year.

Income taxes. Our provision for federal, state and international income
taxes was zero for 1996, $746,000 for 1997 and $1.2 million for 1998, yielding
effective rates of 0.0%, 16.4% and 34.1% in 1996, 1997 and 1998, respectively.
We were taxed as a subchapter S corporation until October 15, 1997, when our
shareholders elected to convert to a C corporation. Accordingly, taxes on our
income were the responsibility of the shareholders until the conversion.

26
<PAGE> 30

QUARTERLY RESULTS OF OPERATIONS

The following table presents our unaudited quarterly results of operations
for 1998 and the six months ended June 30, 1999. You should read the following
table in conjunction with our consolidated financial statements and related
notes included elsewhere in this prospectus. We have prepared this unaudited
information on the same basis as our audited consolidated financial statements.
This table includes all adjustments, consisting only of normal recurring
adjustments, that we consider necessary for a fair presentation of our financial
position and operating results for the quarters presented. You should not draw
any conclusions about our future results from the results of operations for any
quarter.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30,
1998 1998 1998 1998 1999 1999
--------- -------- --------- -------- --------- --------
(IN THOUSANDS, EXCEPT AS A PERCENTAGE OF TOTAL REVENUE)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenue:
Service............................... $5,159 $5,022 $6,334 $6,878 $8,461 $9,387
Product............................... 333 288 245 353 348 347
------ ------ ------ ------ ------ ------
Total revenue.................... 5,492 5,310 6,579 7,231 8,809 9,734
------ ------ ------ ------ ------ ------
Cost of revenue:
Service............................... 2,360 2,547 2,978 3,250 4,150 4,641
Product............................... 68 53 9 36 58 50
------ ------ ------ ------ ------ ------
Total cost of revenue............ 2,428 2,600 2,987 3,286 4,208 4,691
------ ------ ------ ------ ------ ------
Gross profit............................. 3,064 2,710 3,592 3,945 4,601 5,043
Operating expenses:
Research and development.............. 575 877 1,023 1,196 1,474 1,486
Selling, general and administrative... 1,201 1,417 1,373 2,479 2,405 2,831
------ ------ ------ ------ ------ ------
Total operating expenses......... 1,776 2,294 2,396 3,675 3,879 4,317
------ ------ ------ ------ ------ ------
Income from operations................... 1,288 416 1,196 270 722 726
Interest income, net..................... 33 146 58 82 53 77
------ ------ ------ ------ ------ ------
Income before income taxes............... 1,321 562 1,254 352 775 803
Provision for income taxes............... 465 201 452 71 343 369
------ ------ ------ ------ ------ ------
Net income............................... $ 856 $ 361 $ 802 $ 281 $ 432 $ 434
====== ====== ====== ====== ====== ======
AS PERCENTAGE OF TOTAL REVENUE
Revenue:
Service............................... 94% 95% 96% 95% 96% 96%
Product............................... 6 5 4 5 4 4
------ ------ ------ ------ ------ ------
Total revenue.................... 100 100 100 100 100 100
------ ------ ------ ------ ------ ------
Cost of revenue:
Service............................... 43 48 45 45 47 48
Product............................... 1 1 -- -- 1 --
------ ------ ------ ------ ------ ------
Total cost of revenue............ 44 49 45 45 48 48
------ ------ ------ ------ ------ ------
Gross margin............................. 56 51 55 55 52 52
Operating expenses:
Research and development.............. 10 16 16 17 17 15
Selling, general and administrative... 22 27 21 34 27 29
------ ------ ------ ------ ------ ------
Total operating expenses......... 32 43 37 51 44 44
------ ------ ------ ------ ------ ------
Income from operations................... 24 8 18 4 8 8
Interest income, net..................... -- 3 1 1 1 1
------ ------ ------ ------ ------ ------
Income before income taxes............... 24 11 19 5 9 9
Provision for income taxes............... 8 4 7 1 4 4
------ ------ ------ ------ ------ ------
Net income............................... 16% 7% 12% 4% 5% 5%
====== ====== ====== ====== ====== ======
</TABLE>

27
<PAGE> 31

The trends discussed in the annual comparisons of operating results from
1996 through 1998 and for the six months ended June 30, 1998 and 1999 generally
apply to the comparison of results of operations for these six quarters. Revenue
decreased during the three months ended June 30, 1998 due to the shift from
working directly with semiconductor vendors on a fixed-fee basis to working with
Microsoft on a time-and-materials basis. Research and development expenses
increased significantly as a percentage of total revenue during the three months
ended June 30, 1998 due to substantial investments related to the development of
integration tool kits and end-user applications. Selling, general and
administrative expenses increased during the three months ended December 31,
1998 due to the increased personnel and facility costs associated with opening
sales offices in Germany and Japan as well as expenses related to seasonal trade
show activities. Our quarterly operating results have varied widely in the past,
and we expect that they will continue to fluctuate in the future as a result of
a number of factors, many of which are outside our control.

LIQUIDITY AND CAPITAL RESOURCES

Since our inception, we have financed our operations primarily through cash
flow from operations. As of June 30, 1999, we had $9.3 million of cash and cash
equivalents. This represents an increase of $2.4 million over December 31, 1998.
In January 1998, we issued mandatorily redeemable convertible preferred stock
from which we received net proceeds of approximately $14.3 million. Concurrent
with this transaction, we repurchased 3,333,333 shares of our common stock for
an aggregate of $6.0 million. To a lesser extent, we have financed software
system purchases through traditional financing arrangements. Our working capital
at June 30, 1999 was $10.7 million compared to $10.3 million at December 31,
1998.

We have a working capital revolving line of credit with Imperial Bank that
is secured by our accounts receivable. This facility allows us to borrow up to
the lesser of 80% of our eligible accounts receivable or $5.0 million and bears
interest at the bank's prime rate, which was 8.25% at August 31, 1999. The
facility expires in July 2000. The agreement under which the line of credit was
established contains certain covenants, including a provision requiring us to
maintain specified financial ratios. We were in compliance with these covenants
at June 30, 1999, and at that time there were no borrowings outstanding under
this credit facility. We also maintain with Imperial Bank a $1.5 million term
loan for equipment purchases, which bears interest at the bank's prime rate plus
0.25%, and a $4.0 million term loan for leasehold improvement purchases, which
bears interest at the bank's prime rate plus 0.50%. These facilities operate as
a revolver through June 2000, after which time any outstanding balances must be
paid over 36-month and 60-month terms, respectively. These loans also require us
to comply with certain financial covenants, including a requirement that we
maintain certain financial ratios. We were in compliance with these covenants at
June 30, 1999 and, at that time, there was approximately $367,000 outstanding
under the equipment term loan.

Our operating activities resulted in net cash inflows of $1.6 million in
1996, $4.3 million in 1997, $188,000 in 1998 and $3.6 million for the six months
ended June 30, 1999. The sources of cash in 1996, 1997, 1998 and for the six
months ended June 30, 1999 were primarily income from operations, and increases
in accounts payable and accrued liabilities, partially offset by increases in
accounts receivable. Investing activities used cash of $248,000 in 1996, $1.4
million in 1997 and $3.7 million in 1998, primarily for the purchase of capital
equipment and short-term investments. Investing activities provided cash of
$512,000 during the six months ended June 30, 1999, primarily due to proceeds
from the maturity of investments offset by cash used for purchases of capital
equipment. Financing activities used cash of $1.3 million in 1996, $775,000 in
1997 and $98,000 for the six months ended June 30, 1999, primarily for
shareholder draws and repayment of long-term obligations. Financing activities
generated $6.5 million in 1998, primarily through the issuance of mandatorily
convertible preferred stock, partially offset by repayment of shareholder loans
and the $6.0 million repurchase of shares of common stock.

In addition, in September 1999, we sold 1,518,378 shares of our common
stock to Vulcan Ventures for approximately $18.7 million.

We currently anticipate that we will continue to experience significant
increases in our operating expenses for the foreseeable future as we enter new
markets for our products and services, increase research and development
activities and sales and marketing activities, develop new distribution channels
and broaden our

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<PAGE> 32

professional service capabilities. Our operating expenses will consume a
material amount of our cash resources, including a portion of the net proceeds
of this offering. We believe that the net proceeds of this offering, together
with our existing cash and cash equivalents and available bank borrowings, will
be sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months. Although we believe that we will
be able to meet our anticipated cash needs after that time from cash generated
from operations and do not currently anticipate the need to raise additional
capital, if we do seek to raise additional capital, there can be no assurance
that additional financing will be available on acceptable terms, if at all. We
currently intend to use the net proceeds of this offering for general corporate
purposes. We may use a portion of the net proceeds to acquire additional
businesses, products and technologies or to establish joint ventures that we
believe will complement our current or future business. However, we have no
specific plans, agreements or commitments to do so, and are not currently
engaged in any negotiations for any such acquisition or joint venture. Pending
such uses, we will invest the net proceeds of this offering in government
securities and other short-term, investment grade, interest-bearing instruments.

YEAR 2000 COMPLIANCE

Based on our assessment to date, we believe our software products are "Year
2000 compliant." However, we may learn that our software does not contain all
the necessary routines and codes necessary for the accurate calculation,
display, storage and manipulation of data involving dates.

We are reviewing our internal management information and other systems to
identify any products, services or systems that are not Year 2000 compliant and
to take corrective action. To date, we have not encountered any material Year
2000 problems with our computer systems or any other equipment that might be
subject to such problems. We plan to verify compliance by external vendors that
supply us with software and information systems and to communicate with
significant suppliers to determine the status of third parties' remediation of
their own Year 2000 issues. As part of our assessment, we are evaluating the
level of validation we will require of third parties to ensure their Year 2000
compliance.

We will be relocating our principal offices in October 1999 to a new office
location currently under construction. Before the relocation, we will complete
our evaluation of whether the infrastructure and building systems associated
with our new facility, such as security and sprinkler systems, and all
information technology systems, such as telephony and computer network systems,
are Year 2000 compliant.

We do not expect the total cost of these Year 2000 compliance activities to
be material to our business, financial condition and operating results. To date,
we have spent less than $100,000 for Year 2000 compliance and do not expect to
expend more than $100,000 in the aggregate. These costs and the timing of our
plans to complete our Year 2000 modifications and testing processes are based on
our management's estimates.

We have not developed a contingency plan for addressing Year 2000 problems
that are not detected and corrected prior to their occurrence. Upon completion
of testing and implementation activities, we will be able to assess areas
requiring contingency planning, and we expect to conduct appropriate contingency
planning at that time. Any failure to address any Year 2000 issue could harm our
business.

RECENT ACCOUNTING PRONOUNCEMENTS

In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which establishes
guidelines for the accounting for the costs of all computer software developed
or obtained for internal use. We were required to adopt SOP 98-1 for the fiscal
year beginning January 1, 1999. Our adoption of SOP 98-1 did not have a material
impact on our financial statements.

In April 1998, the American Institute of Public Accountants issued
Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of Start-up
Activities." SOP 98-5, which is effective for fiscal years beginning after
December 15, 1998, provides guidance on the financial reporting of start-up
costs and organization costs. It requires costs of start-up activities and
organization costs to be expensed as incurred. The implementation of SOP 98-5
did not have a material impact on our financial position or results of
operations.
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<PAGE> 33

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as a part
of a hedge transaction and, if it is, the type of hedge transaction. This
statement is effective for all fiscal quarters of all fiscal years beginning
after June 15, 2000. We do not use derivative instruments, therefore the
adoption of this statement will not have any effect on our results of operations
or financial position.

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<PAGE> 34

BUSINESS

OVERVIEW

We provide a broad range of software products and services that both
facilitate the integration of the Microsoft Windows CE operating system into a
variety of devices we call intelligent computing devices and enhance the
functionality of those devices. Original equipment manufacturers, semiconductor
vendors and Windows CE software developers rely on our products and services to
help bring customized intelligent computing devices and intelligent computing
device applications to market in a timely fashion. We have been providing
Windows CE-based software services since before the commercial release of
Windows CE in September 1996, and therefore we believe that we offer a greater
breadth and depth of Windows CE expertise than any of our current competitors.

Intelligent computing devices are an emerging class of products with
sophisticated processing power that are designed for specific computing and
communications applications. Examples of intelligent computing devices include
television "set-top boxes," which sit on top of television sets and provide
users with advanced cable TV access services, sophisticated video gaming
features and Internet access; handheld and palm-size PCs; gaming systems;
handheld industrial data collectors; consumer "Internet appliances" such as
kiosk terminals and navigational devices in cars and trucks; and Windows-based
terminals. Compared to traditional computers, intelligent computing devices are
often less expensive and more adaptable in terms of their size, weight and
shape, while still providing sophisticated computing and communications
capabilities, including Internet connectivity. Increasingly, intelligent
computing devices are able to connect directly to the Internet, either through
wired or wireless telecommunications systems. As businesses and consumers
increasingly use the Internet to transact business and as demand for smaller and
more mobile devices grows, original equipment manufacturers are developing new
intelligent computing devices to better meet the needs of end users. Because of
space constraints and other design and resource limitations inherent in the
intelligent computing device environment, original equipment manufacturers
require a computer operating system that is both scaleable and highly
customizable, with lower system requirements than traditional PC operating
systems. While there are several different operating systems that can be used in
intelligent computing devices, Windows CE, a versatile and highly adaptable
operating system modeled after Microsoft Windows, is gaining market acceptance
among original equipment manufacturers as an operating system that meets these
requirements. As increased use of the Internet by consumers and businesses helps
fuel the growth of the intelligent computing device market, we believe that the
market for Windows CE will in turn benefit.

We develop products and provide services that facilitate the development of
Windows CE-based intelligent computing devices. We generate revenue in three
distinct ways. First, we provide software code-writing and related engineering
services to Microsoft and semiconductor vendors to adapt Windows CE to different
microprocessors and to enhance Windows CE's user-specific features and
functions. Second, we offer a comprehensive set of software products and
services that help enable original equipment manufacturers to cost-effectively
integrate Windows CE into their intelligent computing devices. These offerings
include original equipment manufacturer adaptation kits, software products and
test programs, along with engineering and quality assurance services, all
designed to ensure that Windows CE works properly with the original equipment
manufacturer's computer boards, which are the internal hardware constituting the
core of their intelligent computing devices. Third, we license a wide range of
Windows CE-based software applications to both original equipment manufacturers
and intelligent computing device consumers to provide additional functions to
Windows CE-based intelligent computing devices, such as printing and faxing
capabilities.

INDUSTRY BACKGROUND

The increasingly widespread use of electronic communications, including the
Internet, is enabling networks of businesses and consumers to collaborate,
access information and conduct business and personal interactions more
effectively. As the number of Internet users grows, so does the diversity of
content, services and applications available via the Internet. While the
Internet is already having a significant and highly visible impact on
business-to-consumer and consumer-to-consumer relationships, the market for
business-to-business Internet transactions is expected to expand at a greater
rate. According to a November 1998 report
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<PAGE> 35

by Forrester Research entitled "Re-sizing On-line Business Trade," U.S.-based
Internet commerce between businesses is expected to grow from $43 billion in
1998 to $1.3 trillion in 2003.

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

- businesses that use mobile computing devices to permit their employees to
access server-based network applications and the Internet from remote
sites;

- retail businesses that use handheld point-of-sale terminals to provide
real-time inventory tracking, automate their procurement processes and
publish information instantly to both internal and external users via the
Internet;

- healthcare professionals who use mobile computing devices to record and
access patient information that can then be shared via the Internet among
a broader group of professionals responsible for providing medical care;
and

- consumers who use Internet-enabled television set-top boxes, smart
cellular phones, gaming systems and other devices to access Internet
content, communicate and conduct transactions online.

The increasing need for connectivity among both business and consumer users
is driving demand for easy-to-use, cost-effective and customizable methods of
electronic communication. Although the PC has been the traditional means of
electronically connecting suppliers, partners and customers, a class of
computing devices, including Internet-enabled television "set-top boxes,"
handheld and palm-size PCs, gaming systems, handheld industrial data collectors,
and consumer "Internet appliances" such as kiosk terminals and vehicle
navigational devices, among others, is emerging. These intelligent computing
devices are particularly attractive to business and consumer users because they
are often less expensive than traditional computers; have adaptable
configurations, including size, weight and shape; and are able to support a
variety of customized applications and user interfaces that can be designed for
particular tasks. In addition, these devices are typically compatible with
existing business information systems. According to information we received in
August 1999 from International Data Corporation, a provider of information
technology data and industry analysis, the market for consumer information
appliances, a subset of the overall intelligent computing device market, is
expected to grow from $2.2 billion in 1998 to $18.7 billion in 2003.

Because intelligent computing devices can be used for a number of purposes,
from consumer information to industrial automation, and can be designed for a
range of unique applications, the intelligent computing device industry is
characterized by a wide variety of hardware configurations, and end-user
applications, each often designed for a specific market. To accommodate these
diverse characteristics in a cost-effective manner, semiconductor vendors and
original equipment manufacturers require an operating system that can be
integrated with a number of different intelligent computing devices and support
an expanding range of industry-specific content and applications. The Microsoft
Windows CE operating system helps satisfy these requirements because it
leverages the existing industry-wide base of Microsoft Windows developers and
technology standards; can be customized to operate across a variety of
intelligent computing devices and integrate with existing information systems;
offers Internet connectivity; and reduces systems requirements compared to
traditional PC operating systems. Because of these characteristics, we believe
Windows CE is emerging as an operating system of choice for many hardware and
software applications vendors. Venture Development Corporation estimates in a
December 1998 report entitled "Windows CE and the Future of Embedded Systems
Development" that the number of intelligent computing devices utilizing Windows
CE will increase from just under one million units in 1999 to more than 14
million units by 2003.

To take advantage of the multiple benefits of the Windows CE operating
system, many original equipment manufacturers and semiconductor vendors require
the services of a software product and service provider with the breadth of
experience and depth of capabilities to fully support the Windows CE operating
system and related applications across different semiconductors and intelligent
computing devices. These products and services should encompass the full cycle
of the intelligent computing device development process, including hardware
support, software development products and services, system validation and end-
user software applications. In addition, these products and services should use
existing Microsoft and other

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<PAGE> 36

industry technologies and standards to promote rapid and low-cost development,
reduced time-to-market and integration with existing enterprise software
applications. These products and services should also be designed to accommodate
the varying industry-specific needs of semiconductor, equipment and software
developers without compromising functionality and performance.

OUR BUSINESS

We provide a variety of software products and services that facilitate the
integration of the Microsoft Windows CE operating system into a wide range of
intelligent computing devices and enhance the functionality of those devices.
Original equipment manufacturers, semiconductor vendors and Windows CE software
developers rely on our products and services to help bring customized
intelligent computing devices and intelligent computing device applications to
market in a timely fashion. Key elements of our solution include:

A BROAD SET OF END-TO-END WINDOWS CE DEVELOPMENT PRODUCTS AND SERVICES TO
SUPPORT A DIVERSE RANGE OF INTELLIGENT COMPUTING DEVICE HARDWARE, SYSTEMS AND
APPLICATIONS DEVELOPMENT REQUIREMENTS:

- Software development. We provide software development, testing and
program management services to Microsoft in connection with its ongoing
development and modification of the Windows CE operating system, and to
both Microsoft and semiconductor vendors to assist with the creation of
software development tools sold in conjunction with Windows CE and the
integration of Windows CE with various microprocessors. Software
development tools are software packages that help engineers develop new
software applications. By using our services, Microsoft can draw on our
extensive expertise and experience with Windows CE and can devote its
internal resources to other projects.

- Hardware support. We provide software products and services to original
equipment manufacturers that support a variety of microprocessors and
other intelligent computing device computer hardware. For example, our CE
Xpress Kits provide pre-configured software packages that enable original
equipment manufacturers to integrate Windows CE into their intelligent
computing devices.

- System validation. We provide software products and services to assist
original equipment manufacturers in the validation and verification of
their hardware and software executing Windows CE, including services
designed to help original equipment manufacturers develop testing
programs to validate the performance and reliability of their intelligent
computing devices.

- Applications software. We provide software packages that facilitate the
third-party development of Windows CE-based intelligent computing device
user interfaces. We also license software applications to both original
equipment manufacturers and intelligent computing device end users that
enhance the functionality of their intelligent computing devices.

PRODUCTS AND SERVICES THAT USE EXISTING MICROSOFT TECHNOLOGIES AND
STANDARDS. Our Windows CE-based products and services use existing Microsoft
technologies and standards to enable semiconductor vendors and original
equipment manufacturers to deliver highly customizable and cost-efficient
intelligent computing devices to their end users. These technologies enable
original equipment manufacturers to efficiently utilize the existing pool of
programmers familiar with the Windows operating system to develop
differentiating applications for intelligent computing devices based upon
Windows CE. Our use of common programming standards also allows intelligent
computing devices designed with our development products and services to
integrate with existing information systems as well as with other Microsoft
technologies and applications. By enabling original equipment manufacturers to
standardize on a given software platform, our products and services help
original equipment manufacturers more rapidly deploy new hardware technologies
without having to re-implement their software investments across multiple
platforms.

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CAPITALIZING ON OUR DEPTH OF EXPERIENCE IN DEVELOPING WINDOWS CE-BASED
SOFTWARE PRODUCTS AND SERVICES AND OUR VARIETY OF STRATEGIC RELATIONSHIPS TO
DELIVER TANGIBLE BENEFITS TO WINDOWS CE-BASED INTELLIGENT COMPUTING DEVICE
DEVELOPERS. We have been providing Windows CE-based services for the
development, integration and deployment of the Windows CE operating system and
industry-specific applications since prior to the commercial release of Windows
CE in September 1996. In addition, we have developed strategic relationships
with Microsoft, including under both our master development and license
agreement and our distributor agreement with Microsoft, and through other
arrangements. Specifically, we are a provider of software services to Microsoft
under our master agreement, a Microsoft-sanctioned Windows CE systems integrator
as indicated on Microsoft's website, a licensed distributor of Windows CE under
our distribution agreement and a developer of Windows CE-based software
applications. Moreover, we have worked with several semiconductor vendors to
integrate Windows CE with their proprietary microprocessors. This depth and
breadth of experience enable us to bring tangible benefits to Microsoft and to a
variety of original equipment manufacturers, semiconductor vendors and software
developers. Such benefits include:

- Reduced time-to-market. By using our software services and pre-configured
software components, our customers can take advantage of our experience
with the Windows CE platform to help bring quality intelligent computing
devices to market faster than if they had chosen to develop their
hardware, operating systems and software applications internally.

- Lower development costs and reduced risks. By using our extensive library
of software tools for developing Windows CE-based intelligent computing
devices instead of developing these tools internally, our customers can
reduce the implementation and training time required for their engineers
and lower their intelligent computing device development costs. Our
software components are thoroughly tested for performance and
reliability, reducing the risk of project failure.

- Rapidly customizable graphical user interfaces. A graphical user
interface is the set of visual images through which the user interacts
with the intelligent computing device. Our software development solutions
help enable our customers to more rapidly design user- and
industry-specific graphical user interfaces to meet the specific needs of
intelligent computing device users across a variety of markets.

- Enhanced intelligent computing device functionality. Our pre-developed
software components help enable original equipment manufacturer customers
to quickly add new and differentiating application features to their
existing intelligent computing device hardware components, which can help
extend product life cycles.

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STRATEGY

Our strategy is to become one of the primary providers of software products
and services for facilitating the integration of operating systems into
intelligent computing devices. Key elements of our strategy include:

Continue to enhance our position as a provider of Windows CE integration
services. We intend to enhance our leadership position in the development and
provision of Windows CE integration services to support a wide variety of
intelligent computing devices. Because we have been providing Windows CE-based
software services since prior to the commercial release of Windows CE in
September 1996, we believe that we offer a greater breadth and depth of Windows
CE expertise than our current competitors. We intend to continue to utilize this
expertise by maintaining strong, quality-focused engineering groups, developing
market-focused products and services, and undertaking sales and marketing
activities that highlight key design wins, product awards and other third-party
endorsements.

Expand our strategic relationships with hardware and software vendors. We
intend to continue to strengthen and extend our relationships with third-party
hardware and software vendors that are designing products based on Windows CE.
We provide software products and services that enable manufacturers of
microprocessors, computer boards and other components to develop hardware
designs compatible with Windows CE. We have also entered into licensing
arrangements with software developers to provide connectivity technologies for
products that interface with Windows CE. We believe that the use of our products
and services by a broad group of industry leaders is important in increasing
market awareness and generating new business opportunities.

Continue to build on our relationship with Microsoft. We have developed a
close working relationship with Microsoft and under the terms of our master
agreement are a "preferred Microsoft vendor" for the development of the Windows
CE operating system and accompanying tools. Currently, we provide software
code-writing and related engineering services to Microsoft for a number of
different Windows CE projects and we intend to continue this relationship in the
future. We believe that our success is related to the overall adoption of
Windows CE as an operating platform, and therefore we intend to continue to work
with Microsoft to promote Windows CE, as well as other Microsoft operating
systems.

Utilize our extensive Windows CE expertise to develop additional software
applications. We believe that as Windows CE is widely adopted in the
marketplace, there will be an increasing demand for complete, end-user software
applications that enhance the capabilities of Windows CE-based intelligent
computing devices. We intend to use our Windows CE expertise, our alliances with
original equipment manufacturers and our relationship with Microsoft to develop
a leading position in the market for Windows CE-based software applications. We
currently offer a variety of personal productivity software applications,
including calendar, address book and task-list functions, as well as utility and
communications software for Windows CE-based intelligent computing devices. We
intend to continue to make use of our Windows CE expertise to develop additional
applications to address the evolving requirements of this market.

Expand our international presence. We intend to continue to expand
internationally in order to enhance our profile and market reach. We believe
that Windows CE is gaining acceptance in the Asian and European markets. These
markets are attractive to us because of their high concentration of OEM
customers focusing on the development of intelligent computing devices. We have
recently established sales offices in Tokyo, Japan and Munich, Germany.

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SOFTWARE SERVICES AND PRODUCTS

We develop, market and support a wide variety of Windows CE software
products and services for the development and integration of the Windows CE
operating system across a diverse selection of intelligent computing devices.

Operating system development and accompanying tools

We provide software code-writing and related engineering services to
Microsoft and numerous semiconductor vendors to support and enhance the
following:

- the continued development of the Windows CE operating system;

- the utility of the Microsoft Visual Tools series, a set of software
development tools for use with the Windows CE operating system; and

- the integration of Windows CE with multiple microprocessors.

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

The following table summarizes the key features and benefits of the
services we offer to Microsoft and semiconductor vendors:

Integration of Windows CE with intelligent computing devices

We offer software products and services that are used by original equipment
manufacturers to integrate the Windows CE operating system with intelligent
computing devices. In order to customize the functionality of Windows CE and
integrate it with a particular intelligent computing device, original equipment
manufacturers must develop or purchase software to be used in conjunction with
the Visual Tools series and Windows CE Platform Builder products provided by
Microsoft. We offer a comprehensive set of software products and services that
enable original equipment manufacturers to cost-effectively integrate Windows CE
with intelligent computing devices, with reduced time-to-market and decreased
risk of project failure.

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Products -- The following table summarizes the key features and benefits of
the products we offer to original equipment manufacturers for the integration of
Windows CE with intelligent computing devices, from which we generated 4% of our
total revenue for the six months ended June 30, 1999:

<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
BSQUARE PRODUCT DESCRIPTION BENEFIT
<S> <C> <C>
- --------------------------------------------------------------------------------------------------------------
CE Xpress Adaptation - A set of pre-developed and tested code - Designed to save original equipment
Kits for low-level support of hardware in a manufacturers time developing
Windows CE-based device low-level software support,
reducing time-to-market
- Available for a broad range of chip
sets including those manufactured by AMD, - Pre-tested components increase
Cyrix, Hitachi, Intel and Motorola reliability of target device
- Sold in source code format to allow
customer modifications
- --------------------------------------------------------------------------------------------------------------
CE Xpress Binary Kits - Includes same functionality as CE - Enables original equipment
Xpress Adaptation Kit without access to manufacturers to rapidly evaluate
source code Windows CE on a specific reference
board with minimal investment
- Enables original equipment
manufacturers to bring reference
board-compatible products to market
with no porting or low-level
customization
- --------------------------------------------------------------------------------------------------------------
CE Xpress Single Board - A development kit that works in - Provides a foundation for original
Computer Kits conjunction with single board computers equipment manufacturers to begin
to quickly install and run Windows CE immediate development of Windows
for the development of intelligent CE-based intelligent computing
computing devices devices
- Provides all of the infrastructure
normally needed for development of
applications and customizations based
on industry-standard expansion bus (or
"plug-in") architectures
- --------------------------------------------------------------------------------------------------------------
CE Xpress86 Kit - A development kit that allows original - Eliminates need to wait for
equipment manufacturers to run Windows hardware development before
CE on a standard PC-based platform beginning software development,
enabling faster time-to-market
- Runs Windows CE without DOS
- Reduces the cost of PC-based
Windows CE systems by eliminating
the DOS license requirement
- --------------------------------------------------------------------------------------------------------------
CE Xpress OnDemand - An online subscription service for - Enables CE Xpress Kit customers to
portable device drivers for CE Xpress Kit access the latest drivers and
customers driver updates online
- --------------------------------------------------------------------------------------------------------------
CEValidator - A quality assurance and testing - Designed to save original equipment
technology for the validation of Windows manufacturers testing costs
CE integration with intelligent
computing devices - Enables original equipment
manufacturers to test software
- A client/server-based test program of throughout the design process
more than 1,000 individual test cases for
testing compliance and reliability
- Extensible architecture for
incorporating additional and custom test
programs
- --------------------------------------------------------------------------------------------------------------
CE EmbeddedDesktop - A fully customizable desktop building - Gives original equipment
utility manufacturers the ability to create
a device-specific graphical user
- Includes a set of pre-developed interface
components for creating a custom desktop
- Helps enable original equipment
- Contains customizable security and manufacturers to rapidly and easily
interface features for commercial create design prototypes and
applications complete the implementation of
graphical user interfaces
- --------------------------------------------------------------------------------------------------------------
</TABLE>

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To augment our own Windows CE software products and services, we
occasionally enter into license and distribution agreements with third-party
software vendors to provide our customers with additional features and
functionality. Our ability to license these third-party software products to
original equipment manufacturers, in conjunction with our own software products
and services, provides our original equipment manufacturer customers with a
single source for Windows CE software products and services. We are currently a
licensed distributor of Windows CE-based software from Communications
Intelligence Corporation, Datalight, Intrinsyc and Microsoft.

Services -- We also provide integration and support services to original
equipment manufacturers developing Windows CE-based intelligent computing
devices. For example, we provide implementation services for companies
developing Internet-enabled television set-top boxes, gaming systems, handheld
industrial devices, consumer Internet appliances such as kiosk terminals and
navigational devices in cars and trucks, and Windows-based terminals. Our CE
Xpress consulting services use our existing products, such as our CE Xpress
Adaptation Kit and CE EmbeddedDesktop, to implement the hardware and software
specifications of our customers' intelligent computing device products. We often
retain a license or other proprietary rights in the resulting work product. At
times, we provide new applications or system software development on behalf of
original equipment manufacturers. We believe that original equipment
manufacturer customers in need of complex adaptations can save time and
resources by outsourcing this work to us. In addition, to support our original
equipment manufacturer customers, we often "bundle" support services with our
software products and other services. These support services help enable our
original equipment manufacturer customers to complete intelligent computing
device development and reduce time-to-market.

The following table summarizes the key features and benefits of the
services we offer to our original equipment manufacturer customers:

<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
BSQUARE SERVICE DESCRIPTION BENEFIT
<S> <C> <C>
- --------------------------------------------------------------------------------------------------------------
Systems consulting services - We provide Windows CE integration - Without our software engineering
to original equipment services to original equipment consulting services, original
manufacturers developing manufacturers developing intelligent equipment manufacturers would need
intelligent computing computing devices along with custom to increase their development costs
devices adaptations of Windows CE and extend their project schedules
to provide the training and
- We provide software engineering materials required to complete the
consulting services to write the software projects in-house
code that enables Windows CE to
integrate with intelligent computing - Allows original equipment
device hardware manufacturers to move quickly past
the traditionally time consuming
early stage of integrating Windows
CE with their existing hardware and
software
- --------------------------------------------------------------------------------------------------------------
Applications consulting - We provide software applications - Allows original equipment
services to original development according to customer manufacturers to avoid the time and
equipment manufacturers specifications cost of developing in-house
developing intelligent expertise in applications
computing devices development for Windows CE
- --------------------------------------------------------------------------------------------------------------
Quality assurance - We provide complete quality assurance - Allows early discovery of design
consulting services to services on every project to ensure the problems, a more rapid development
original equipment highest quality process and higher quality products
manufacturers developing for end users
intelligent computing
devices
- --------------------------------------------------------------------------------------------------------------
</TABLE>

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Consumer Software Applications

We provide a wide range of commercially available personal productivity,
utility and communications software to enhance the functionality and usefulness
of Windows CE-based intelligent computing devices. We market our consumer
software applications through standard retail and electronic commerce channels
and also license these products to original equipment manufacturers in formats
suitable for bundling with their own products. Our current consumer software
application product offerings include:

<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
PRODUCT DESCRIPTION BENEFIT
<S> <C> <C>
- ---------------------------------------------------------------------------------------------------------
bFAX - A product family that provides - Provides a practical and
faxing capabilities for intelligent comprehensive faxing solution for
computing devices Windows CE-based devices
- bFAX Pro provides send and
receive capability for handheld PCs
- bFAX Express provides send-only
capability for handheld and
palm-size PCs
- ---------------------------------------------------------------------------------------------------------
bMOBILE News - Provides access to Internet - Mobile users can download news
newsgroups for handheld and palm- articles for on- or off-line use
size PCs
- ---------------------------------------------------------------------------------------------------------
bPRINT - Print management software for - Users can spool jobs for batch
handheld and palm-size PCs printing
- Increases the variety of printers
compatible with Windows CE-based
devices
- ---------------------------------------------------------------------------------------------------------
bREADY - An electronic book creation and - Users can store and transport
reading system which includes a large volumes of information and
desktop component for publishing literature
books and a client viewer for
handheld or palm-size PCs - Sample applications include sales
catalogs, forms and event
materials, among others
- ---------------------------------------------------------------------------------------------------------
BSQUARE SpreadSheet - A spreadsheet application for - Provides independent
palm-size PCs functionality while maintaining
Pocket Excel compatibility
- ---------------------------------------------------------------------------------------------------------
bTASK - A navigation, status and control - Alleviates the problem of
program for applications on managing multiple open applications
palm-size PCs
- ---------------------------------------------------------------------------------------------------------
bUSEFUL Backup Plus - A full-featured backup and - Avoids critical information loss
restore application for handheld by backing up data
and palm-size PCs
- ---------------------------------------------------------------------------------------------------------
bUSEFUL Utilities Pak - Utility suite for handheld and - Provides utility applications
palm-size PCs that contains 12 which enhance the performance and
different utility applications functionality of Windows CE-based
including bTASK, bUSEFUL Backup devices
Plus and other utility
applications
- ---------------------------------------------------------------------------------------------------------
bPRODUCTIVE Essentials Pak - Six software titles, including - A single installation program
bFAX, bPRINT, bTRACK, bREADY, saves time
bMOBILE News and bTASK
- ---------------------------------------------------------------------------------------------------------
</TABLE>

39
<PAGE> 43

TECHNOLOGY

We have developed a set of technologies incorporated in the software
products described under "-- Integration of Windows CE with intelligent
computing devices -- Products" that are used by original equipment manufacturers
to integrate Windows CE with their computer boards, the internal hardware
constituting the core of their intelligent computing devices. The basic features
and functions of these technologies are described below.
LOGO

The technology contained in our CE Xpress Kits, including the Original Equipment
Manufacturer Adaptation Layer, the CE Platform Layer and the Device Driver
Library, provides the interface between Windows CE and the computer board
contained within the intelligent computing device.

Original Equipment Manufacturer Adaptation Layer Library

The Original Equipment Manufacturer Adaptation Layer provides a standard
interface between the Windows CE operating system and the core components of an
intelligent computing device's computer board. A new board-specific Original
Equipment Manufacturer Adaptation Layer must be implemented for each computer
board that will be using Windows CE.

We maintain a library of Original Equipment Manufacturer Adaptation Layers
for several of the computer boards used in Windows CE-based intelligent
computing device products. These Original Equipment Manufacturer Adaptation
Layers are distributed to our customers in our CE Xpress Kits and are also used
by our engineers when we are contracted to create custom solutions. In addition,
our Original Equipment Manufacturer Adaptation Layer library serves as a
starting point for the creation of new Original Equipment Manufacturer
Adaptation Layer implementations.

Device Driver Library

Device drivers provide the interface by which the Windows CE operating
system controls any peripheral devices, including keyboards, display screens and
computer network interface cards, that may be connected to

40
<PAGE> 44

an intelligent computing device's computer board. A separate device driver must
be implemented for each peripheral device connected to a Windows CE-enabled
computer board.

We have created a library of device drivers for inclusion in our CE Xpress
Kits and for use in the custom software products and services we provide to our
customers. The existing set of drivers also provides starting points for the
creation of new device drivers.

CE Platform Layer

A peripheral device normally requires a different device driver for each
model of computer board to which it is to be connected. A device driver for one
model of computer board will not generally work with a different model of
computer board.

Our CE Platform Layer technology allows our engineers and third-party
hardware manufacturers to develop a single driver for a peripheral device that
may then be used on many different models of computer boards. This increases the
value and flexibility of each computer board by increasing the number of readily
available peripheral devices that can be used.

Our CE Platform Layer technology is included in our CE Xpress Kits and is
used for the implementation of the majority of our device drivers.

CEValidator

Our CEValidator is a quality assurance and testing product which we
originally developed for our in-house use. We believe that it is important to
test devices early in the design process and to continue testing at a high
frequency throughout the development cycle. We have designed our CEValidator to
support such a testing pattern. CEValidator is based on two primary components:

- a broad suite of over 1,000 tests which evaluates the various subsystems
of Windows CE. These tests have been developed by our engineers in the
course of our own software development efforts. In addition, CEValidator
allows original equipment manufacturers to add their own test suites to
evaluate specific features of their intelligent computing devices.

- a test control system. This system manages the execution of the tests
suite and the recording of test results. CEValidator provides
communication features which control testing over network connections, a
graphical user interface for displaying user controls and test results,
and simultaneous testing capabilities for multiple systems.

CUSTOMERS

Microsoft is our largest customer, representing approximately 79% and 87%
of our total revenue in 1998 and for the six months ended June 30, 1999,
respectively. Our other target customers include semiconductor vendors and
original equipment manufacturers seeking to leverage the numerous benefits of
Windows CE in order to develop high quality, full-feature products that meet the
complex and evolving requirements of numerous end-markets.

Semiconductor Vendors

Through late 1997, we provided services directly to semiconductor vendors.
In late 1997, Microsoft decided to contract with us to provide services to the
semiconductor vendors with whom we had previously contracted directly. In 1996
and 1997 we provided in excess of $1.0 million of services to each of the
following semiconductor vendors:

ARM
Hitachi Semiconductor (America)
Motorola Computer Group
NEC

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<PAGE> 45

Currently, we provide software products and services to these and other
semiconductor vendors under our master agreement with Microsoft.

OEM Customers

The following is a representative list of our original equipment
manufacturer customers in the first six months of 1999:

AT&T
Boundless Technologies
Casio
Cedar Systems
Data General
Development Concepts
Ericsson
Hewlett-Packard
IGEL AG
Lexicon
LG Electronics
NEC Electronics
Philips Electronics
Philips Mobile Computing Group
Sainco
Sharp Electronics
Symbol Technologies
Takaoka Electric
Televideo
Telxon
Total Control Products
Touchstar Technologies
Two Technologies
WebTV

Due to customer confidentiality requirements, some customers are not
disclosed. For the first six months of 1999, per-customer revenue for all
customers varied from less than $5,000 to approximately $575,000.

42
<PAGE> 46

Selected Customer Projects
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
CUSTOMER PROJECT
- ----------------------------------
<S> <C>
Hitachi Semiconductor Hitachi Semiconductor (America) Inc., a wholly owned
subsidiary of Hitachi America Ltd, is a semiconductor
vendor.
When Microsoft Windows CE was first introduced, Microsoft
wanted to integrate Windows CE with a Hitachi-manufactured
microprocessor. However, at the time, Hitachi did not
possess tools that would allow Windows CE to operate on its
microprocessor.
Hitachi turned to us to help enable it to integrate the
Windows CE operating system with its microprocessor. We
worked closely with Hitachi to design software programs that
helped enable Hitachi to develop a Windows CE-supported
microprocessor architecture.
- -
Hewlett-Packard Hewlett-Packard develops handheld and palm-size PC devices.
To enhance the functionality of its handheld devices, HP was
seeking to bundle third-party software applications with its
devices to provide additional features, such as calendar and
address book functions and faxing and printing capabilities.
When HP began developing new Windows CE-based handheld
devices, it turned to us to provide a variety of utility and
personal productivity applications that would enhance the
features of its product. Rather than include these
applications on third-party CDs in its product boxes, HP now
bundles these products into the memory of HP's handheld
devices, HP Jornada 820 and HP Jornada 680, providing users
instant access to our software programs without additional
installations.
- -
Advanced Micro Devices Advanced Micro Devices is a supplier of integrated circuits
for the personal and networked computer and communications
markets. AMD needed to run Windows CE on its ElanSC400
microprocessor, but lacked the in-house resources and
knowledge of Windows CE necessary to complete the project
within its required timeframe. AMD called on us to provide
software products to help integrate Windows CE with its
intelligent computing device microprocessor. We retained
rights to the software we developed for AMD, and we are now
reselling this software, in the form of a CE Xpress Kit, to
original equipment manufacturers interested in developing
intelligent computing devices based on the AMD ElanSC400
system.
- -
</TABLE>

MICROSOFT RELATIONSHIP

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

Development partner. Under the terms of our master agreement, we are a
"preferred Microsoft vendor" for Windows CE. Approximately 200 of our software
engineers work on a number of different Windows CE-based projects for Microsoft
and on the development of Windows CE-related software tools under various work
plans. These software tools are then provided by Microsoft under the Microsoft
name to semiconductor vendors and various original equipment manufacturers
utilizing Windows CE. We bill Microsoft on a time-and-materials basis, although
each project has a maximum dollar cap. A separate work plan is generated for
each project, which can then be modified or terminated by Microsoft at any time.

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<PAGE> 47

Systems integrator. We are a Microsoft-sanctioned systems integrator for
Windows CE, as indicated on the "embedded Windows CE" portion of Microsoft's
website. In this capacity, we provide training, consulting and software
engineering services and products to original equipment manufacturers that are
building Windows CE-based intelligent computing devices. We actively participate
in the Microsoft systems integrator program, including participating with
Microsoft in "partner pavilions" at trade shows and listing our services and
posting our product announcements on the "embedded Windows CE" portion of
Microsoft's website. In addition, Microsoft has periodically utilized our
services when an original equipment manufacturer has required additional
software engineering services.

Windows CE distributor. We are a licensed distributor of the Windows CE
operating system. We sub-license Windows CE by reselling the right to bundle
this operating system in intelligent computing devices. Microsoft actively
assists and manages its distributors to secure additional licensing
opportunities for Windows CE. We are promoted on the "embedded Windows CE"
portion of Microsoft's website as a distributor, and Microsoft shares with us
leads generated from Web inquiries and tradeshows.

Windows CE independent software vendor. Microsoft actively encourages
third-party application development through its Developer Relations Group and
Windows CE logo program, which allows third-party applications to receive
Windows CE compatibility logos. We develop several software applications for a
wide variety of Windows CE-based intelligent computing devices, which we market
under our brand names, including bFAX and bPRINT. We also participate in
marketing opportunities offered by Microsoft for third-party developers to
promote our software applications. In addition, Microsoft has from time to time
demonstrated our applications in connection with demonstrations to third parties
of its Windows CE operating system.

SALES AND MARKETING

We market our services to different semiconductor vendors through our
direct sales force. We market our software tools products and related services
that help original equipment manufacturers integrate Windows CE into their
intelligent computing devices through our direct sales force as well as through
third-party representatives and distributors. We market our Windows CE-based
software applications that are both bundled by original equipment manufacturers
onto particular intelligent computing devices and purchased directly by
consumers for their intelligent computing devices through our direct sales
force, third-party representatives and distributors, and other consumer retail
channels. We have direct sales offices in the United States, Germany and Japan.
As of August 31, 1999, we had 27 employees in our sales and marketing
department. Key elements of our sales and marketing strategy include direct
advertising, event marketing, an active public relations program, channel
marketing programs, customer and strategic alliance partner co-marketing
programs and a comprehensive website.

We are currently developing new sales channels, including value-added
resellers and systems integrators. We believe that these additional channels
will further increase the brand awareness of our software products and services
and will further promote the development of software infrastructures for Windows
CE-based intelligent computing devices.

CUSTOMER SUPPORT

We recognize the importance of offering quality service and support to our
resellers and end-user customers. Therefore, we provide a wide range of services
and support to both of these groups, including technical support for our
products, educational services and professional services for implementing and
customizing our products. Both our resellers and end-user customers can utilize
web-based, e-mail and/or telephone support 24 hours a day, seven days a week, to
access answers to questions, obtain assistance in determining the source of
defects or errors and acquire solutions to common problems.

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<PAGE> 48

RESEARCH AND DEVELOPMENT

As of August 31, 1999, we had 275 engineers engaged in research and
development. Our research and development teams are responsible for the design,
development and release of our products. Members of our research and development
staff work closely with our sales and marketing department, as well as with our
customers and potential customers, to better understand market needs and
requirements.

A substantial majority of our research and development engineers is
involved in the development of the Windows CE operating system and accompanying
tools for Microsoft. These responsibilities require significant expertise due to
the radically different nature of the microprocessors and other hardware
components used in Windows CE-based intelligent computing devices. This team has
accumulated detailed knowledge of the Windows CE environment over the past five
years, allowing us to continue to develop software products and services that
enable the expanding capability and compatibility of Windows CE-based
intelligent computing devices. To ensure that compatibility goals are met and
that a high level of product quality is achieved, quality assurance groups
within this team subject our products to tens of thousands of individual tests
in multiple test configurations before the products are released to our
customers. Due to the broad variety of hardware that hosts Windows CE, the
quality assurance groups have had to develop a special expertise in managing and
extending the test tools used to validate the tool kits for these diverse
operating environments.

The remainder of our research and development engineers develop Windows CE
software for both end-user markets and product/application developers. The
software engineers in this team are responsible for the development of
commercial applications that provide added breadth and functionality for Windows
CE-based intelligent computing devices as well as standard products used in the
development and testing of new products utilizing the Windows CE operating
system. Our engineers have significant experience in creating products for
Windows CE, which enables us to bring products to market in a timely manner.

COMPETITION

We face competition from:

- our current and potential customers' internal research and development
departments that may seek to develop their own proprietary products and
solutions;

- large professional engineering services firms, such as Cadence and EDS,
that may enter the market;

- established intelligent computing device software and tools manufacturers
such as Applied Microsystems, Spyglass, Phoenix Technologies, Mentor
Graphics and Integrated Systems;

- small- and medium-size engineering services companies such as VenturCom,
Eclipse International, BlueWater Systems and Vadem; and

- software and component distributors such as Avnet/Hamilton Hallmark,
Pioneer and Annasoft Systems.

As we develop new products, particularly products focused on specific
industries, we may begin competing with companies with whom we have not
previously competed.

We compete principally on the basis of the breadth of software products and
services offered, the experience of the providers, the quality of the software
products and services, the time-to-market and price. We believe we compete
favorably in each of these areas.

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<PAGE> 49

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

Intellectual property is critical to our success. In general, we attempt to
protect our intellectual property rights through patent, copyright, trademark
and trade secret laws and contractual arrangements. There can, however, be no
assurance that our efforts will be effective to prevent misappropriation of our
technology, or to prevent the development and design by others of products or
technologies similar to or competitive with those developed by us.

We currently have three pending U.S. patent applications. We do not have
any issued patents. BSQUARE, bFAX and BSQUARE View are our registered
trademarks. Additionally, bTRACK, bREADY, bFIND, bPRINT, bMOBILE, bUSEFUL,
bTASK, bPRODUCTIVE, bSTART and CEValidator are our trademarks. We will continue
to pursue registration of these and other marks. This prospectus also contains
trademarks and tradenames of other companies.

EMPLOYEES

As of August 31, 1999, we had 348 employees, excluding independent
contractors and other temporary employees, including 275 employees in research
and development, 27 employees in sales and marketing and 46 employees in general
and administrative services. Of these employees, 338 are located in the United
States, three are located in Germany and seven are located in Japan. In
addition, from time to time, we employ temporary employees and consultants. None
of our employees is represented by a labor union, and we consider our relations
with our employees to be good.

FACILITIES

We lease approximately 70,000 square feet of space in three buildings in
Bellevue, Washington under multiple leases with various terms, with the longest
term expiring in April 2003. In October 1999, we plan to relocate all of our
U.S. employees to a single new location in Bellevue, Washington with
approximately 126,000 square feet, pursuant to a lease that expires in 2009,
with the option to renew for up to an additional 20 years. We also lease office
space in Munich, Germany and Tokyo, Japan. We believe that our new facilities
will be adequate to meet our needs for at least the next twelve months.

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<PAGE> 50

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information regarding our executive
officers and directors:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
William T. Baxter............... 36 Chairman of the Board, President and Chief Executive
Officer
Brian V. Turner................. 39 Senior Vice President, Chief Financial Officer and
Secretary
Albert T. Dosser................ 42 Senior Vice President, Director
Peter R. Gregory................ 37 Senior Vice President
David J. Bialer................. 39 General Manager
Donald L. Whitt................. 53 General Manager
Jeffrey T. Chambers(1)(2)....... 44 Director
Scot E. Land(1)(2).............. 45 Director
William L. Larson............... 43 Director
</TABLE>

- ---------------
(1) Member of audit committee

(2) Member of compensation committee

William T. Baxter co-founded BSQUARE in July 1994 and has served as our
President, Chief Executive Officer and Chairman of the Board since our
inception. From June 1993 to October 1994, Mr. Baxter served as Principal
Engineer at Digital Equipment Corporation, a manufacturer of business and
networking computer systems. Between February 1990 and May 1993, Mr. Baxter
served as Manager of Compiler Development at Intergraph Corporation, a developer
and manufacturer of interactive computer graphics systems. Mr. Baxter holds a
B.S. and M.S. in computer science from the University of Wyoming.

Brian V. Turner has been our Senior Vice President, Chief Financial Officer
and Secretary since April 1999. From September 1995 to April 1999, Mr. Turner
was the Chief Financial Officer at RadiSys Corporation, a manufacturer and
designer of computers. Between July 1982 and September 1995, Mr. Turner was with
PricewaterhouseCoopers LLP, an accounting firm, most recently as a director in
Corporate Finance. Mr. Turner holds a B.A. in international political science
and a B.B.A. in accounting from the University of Washington.

Albert T. Dosser co-founded BSQUARE in July 1994 and has served as a Senior
Vice President and a director since our inception. From June 1992 to October
1994, Mr. Dosser served as a software engineer at Digital Equipment Corporation.
Between August 1984 and June 1992, Mr. Dosser served as a software engineer at
Telesoft, a software firm developing Ada compilers and related products, and
from July 1982 to August 1984, he served as a sales support analyst and as
assistant to the national product manager for the OEM Systems Division at NCR, a
manufacturer of business and networking computer systems. Mr. Dosser holds a
B.S. in information science, with a minor in mathematics, from East Tennessee
State University.

Peter R. Gregory co-founded BSQUARE in July 1994, has served as a Senior
Vice President since our inception and was a director from inception until
September 1999. From August 1991 to October 1994, Mr. Gregory served as Senior
Software Engineer at Digital Equipment Corporation. Between February 1990 and
August 1991, Mr. Gregory served as Senior Software Engineer at a subsidiary of
Motorola, a computer component and telecommunications equipment manufacturer.
Mr. Gregory holds a B.A. in computer science from Southern Illinois University
at Carbondale.

David J. Bialer has been a General Manager at BSQUARE since September 1998.
From January 1998 to August 1998, Mr. Bialer was the Director of Business
Development at MobileSoft, a division of Philips Electronics North America
Corporation and a Windows CE e-commerce website founded by Mr. Bialer. From
April 1996 to January 1998, Mr. Bialer served as a Senior Product Manager at
Philips Mobile Computing Group, a manufacturer of Windows CE-based devices, and
from December 1995 to February 1996, he served as a Senior Manager, Business
Development at VDOnet, a developer of video conferencing,

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<PAGE> 51

messaging and streaming software. From December 1994 to December 1995, Mr.
Bialer served as a Senior Manager at Oracle Corporation, a database company, and
from January 1993 to December 1994, he served as a Senior Product Marketing
Engineer at Intel Corporation, a manufacturer of semiconductor, computer and
networking products. Mr. Bialer holds a B.S. in computer science from Cornell
University and an M.B.A. from the University of Pennsylvania, Wharton School of
Business.

Donald L. Whitt has been a General Manager at BSQUARE since April 1998, and
from May 1997 to April 1998, Mr. Whitt held various other positions with us.
From October 1993 to May 1997, Mr. Whitt was a program manager at Secure
Computing Corporation, an Internet security company, and from May 1970 to May
1993, he served in management positions at Control Data Corporation, a computer
manufacturer. Mr. Whitt holds a B.S. in mathematics from California State
University at Fresno.

Jeffrey T. Chambers has been a director of BSQUARE since February 1998. Mr.
Chambers was elected to our board of directors in connection with the purchase
of shares of our preferred stock by affiliates of TA Associates, Inc., a venture
capital firm. Mr. Chambers has been employed by TA Associates or its predecessor
since 1980, where he currently serves as a managing director. In addition to
BSQUARE, Mr. Chambers currently serves as a director of several privately held
companies.

Scot E. Land has been a director of BSQUARE since February 1998. Mr. Land
was elected to our board of directors in connection with the purchase of shares
of our preferred stock by affiliates of Encompass Group, a venture capital firm.
Mr. Land is currently a managing director of Encompass Ventures, an affiliate of
Encompass Group, a position he has held since September 1997. Prior to joining
Encompass, Mr. Land was a Senior Technology Analyst and Strategic Planning
Consultant with Microsoft from June 1995 to September 1997, and a technology
research analyst and investment banker for First Marathon Securities, a Canadian
investment bank, from September 1993 to April 1995. From October 1988 to
February 1993, Mr. Land was the President and Chief Executive Officer of
InVision Technologies, a publicly traded company founded by Mr. Land in October,
1988 that designs and manufacturers high-speed computer-aided topography systems
for automatic explosives detection for aviation security. Prior to founding
InVision Technologies, Mr. Land served as a principal in the international
consulting practice of Ernst and Young LLP, a public accounting firm, from April
1984 to October 1988.

William L. Larson has been a director of BSQUARE since September 1998.
Since September 1993 Mr. Larson has been the Chief Executive Officer of Network
Associates, Inc., a software company, where he has also served as President and
a director since October 1993 and as Chairman of the Board since April 1995.
From August 1988 to September 1993, Mr. Larson served as a Vice President of
SunSoft, Inc., a systems software subsidiary of Sun Microsystems, where he was
responsible for worldwide sales and marketing.

BOARD OF DIRECTORS

We currently have authorized seven directors; however, two board seats are
vacant. Currently all directors hold office until the next annual meeting of
shareholders or until their successors are duly elected, and will continue to do
so following the closing of this offering. However, our amended and restated
articles of incorporation provide that as of the first annual meeting of
shareholders after the closing of this offering, our board of directors will be
divided into three classes, each with staggered three-year terms. As a result,
only one class of directors will be elected at each annual meeting of our
shareholders, with the other classes continuing for the remainder of their
respective three-year terms.

In addition, in connection with its purchase of shares of common stock,
following this offering we have agreed to use our best efforts to cause an
individual selected by Vulcan Ventures and reasonably acceptable to us to be
elected to our board of directors.

Committees

Our board of directors currently has an audit committee and a compensation
committee. The audit committee consists of Mr. Chambers and Mr. Land. The audit
committee makes recommendations to our

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<PAGE> 52

board of directors regarding the selection of independent auditors, reviews the
scope of audit and other services by our independent auditors, reviews the
accounting principles and auditing practices and procedures to be used for our
financial statements and reviews the results of our audits. The compensation
committee consists of Mr. Chambers and Mr. Land. The compensation committee
reviews and approves the compensation and benefits for our executive officers,
grants stock options under our stock option plan and makes recommendations to
our board of directors on compensation matters.

Compensation Committee Interlocks and Insider Participation

No interlocking relationship exists between any member of our board of
directors or compensation committee and any member of the board of directors or
compensation committee of any other company, nor has any such interlocking
relationship existed in the past.

In January 1998, we sold 8,333,333 shares of Series A Preferred Stock at a
per share price of $1.80. Purchasers of Series A Preferred Stock included:

- TA Associates and its affiliates, who collectively purchased 6,666,667
shares and are beneficial owners of 25.6% of our outstanding common stock
on an as-converted basis prior to this offering. One of our directors,
Jeffrey T. Chambers, is a managing director of TA Associates; and

- Encompass Ventures and its affiliates, who collectively purchased
1,666,666 shares and are beneficial owners of 6.5% of our outstanding
common stock on an as-converted basis prior to this offering. One of our
directors, Scot E. Land, is a managing director of Encompass Ventures.

Upon closing of this offering, each outstanding share of Series A Preferred
Stock will convert into one share of common stock.

In September 1998, we granted an option to purchase 125,000 shares of
common stock at an exercise price of $1.00 per share to NextGen, an affiliate of
Encompass Ventures, in exchange for consulting services.

We have also granted options to purchase common stock to Messrs. Chambers
and Land. Because of contractual obligations involving Mr. Chambers and his
affiliated investment entities, the option grant to Mr. Chambers was issued in
the name of TA Associates, Inc.

Compensation

Our directors are reimbursed for expenses incurred in connection with
attending board and committee meetings but are not otherwise compensated for
their services as board members. In August 1998, we granted to each of TA
Associates, with whom Jeffrey T. Chambers, one of our directors, is affiliated,
and Scot E. Land, one of our directors, an option to purchase 45,000 shares of
our common stock at an exercise price of $1.80 per share, vesting in three
annual installments of 15,000 shares each. Moreover, in October 1999, we granted
to Mr. Land an option to purchase 40,000 shares of our common stock at an
exercise price of $12.00 per share, vesting in four annual installments of
10,000 shares each. In July 1998, we granted to William Larson, one of our
directors, an option to purchase 120,000 shares of our common stock at an
exercise price of $1.80 per share, vesting in three annual installments of
40,000 shares each. We currently intend to make comparable option grants to
future non-employee directors.

EXECUTIVE OFFICERS

Our executive officers are elected by, and serve at the discretion of, our
board of directors. There are no family relationships among our directors and
officers.

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<PAGE> 53

EXECUTIVE COMPENSATION

The following table sets forth certain information concerning compensation
for services rendered to us in all capacities during the fiscal year ended
December 31, 1998 by our chief executive officer and our four other most highly
compensated executive officers whose salary and bonus for fiscal 1998 exceeded
$100,000.

<TABLE>
<CAPTION>
ANNUAL LONG TERM ALL OTHER
COMPENSATION COMPENSATION COMPENSATION
------------------ ------------ -------------------------------------
SECURITIES HEALTH LIFE AND
UNDERLYING INSURANCE DISABILITY MOVING
NAME AND PRINCIPAL POSITION SALARY BONUS OPTIONS (#S) PREMIUMS PREMIUMS EXPENSES
- --------------------------- -------- ------ ------------ ---------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
William T. Baxter.......... $252,625 $ -- -- $2,133 $1,060 $ --
President and Chief
Executive Officer
Albert T. Dosser........... 150,000 -- -- 1,776 1,305 --
Senior Vice President
Peter R. Gregory........... 150,000 -- -- -- 1,070 --
Senior Vice President
David J. Bialer(1)......... 37,000 1,000 100,000 699 -- 8,676
General Manager
Donald L. Whitt............ 103,265 2,452 10,000 2,192 -- --
General Manager
</TABLE>

- ---------------
(1) Mr. Bialer was hired by us on September 8, 1998. If he had been employed
during the entire fiscal year ended December 31, 1998, his annual salary
would have been $130,000.

Option Grants in Fiscal Year 1998

The following table sets forth certain information with respect to stock
options granted to each of our named executive officers during the fiscal year
ended December 31, 1998. In accordance with the rules of the Securities and
Exchange Commission, also shown below is the potential realizable value over the
term of the option, the period from the grant date to the expiration date,
giving effect to the initial public offering price of $15.00 per share and based
on assumed rates of stock appreciation of 5% and 10%, compounded annually. These
rates are mandated by the SEC and do not represent our estimate of future stock
price. Actual gains, if any, on stock option exercises will depend on the future
performance of our common stock. In the fiscal year ended December 31, 1998, we
granted options to acquire up to an aggregate of 1,108,150 shares of common
stock to employees and directors, all under our stock option plan and all at an
exercise price equal to the fair market value of our common stock on the date of
grant as determined in good faith by our board of directors.

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------------- POTENTIAL REALIZABLE VALUE
PERCENT OF AT ASSUMED ANNUAL RATES OF
TOTAL OPTIONS STOCK PRICE APPRECIATION FOR
NUMBER OF SECURITIES GRANTED TO EXERCISE OPTION TERM
UNDERLYING OPTIONS EMPLOYEES IN PRICE PER EXPIRATION -----------------------------
NAME GRANTED FISCAL 1998 SHARE DATE 5% 10%
---- -------------------- ------------- --------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
William T. Baxter....... -- -- $ -- -- $ -- $ --
Albert T. Dosser........ -- -- -- -- -- --
Peter R. Gregory........ -- -- -- -- -- --
David J. Bialer......... 100,000 9.0% 1.00 9/25/08 2,443,342 3,890,614
Donald L. Whitt......... 10,000 1.0% 1.00 7/17/08 244,334 389,061
</TABLE>

50
<PAGE> 54

Aggregate Option Exercises in Fiscal Year 1998 and Fiscal Year-End Option
Values

With respect to our named executive officers, the following table sets
forth information concerning option exercises in the fiscal year ended December
31, 1998 and exercisable and unexercisable options held as of December 31, 1998.
The "Value Realized" and the "Value of Unexercised In-the-Money Options at
December 31, 1998" are based upon the initial public offering price of $15.00
per share minus the per share exercise price multiplied by the number of shares
underlying the option.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
NUMBER OF SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED ON EXERCISE OPTIONS AT IN-THE-MONEY OPTIONS AT
----------------------- DECEMBER 31, 1998 DECEMBER 31, 1998
VALUE --------------------------- ---------------------------
NAME EXERCISED REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- --------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
William T. Baxter............ -- $ -- -- -- $ -- $ --
Albert T. Dosser............. -- -- -- -- -- --
Peter R. Gregory............. -- -- -- -- -- --
David J. Bialer.............. -- -- 100,000 -- 1,400,000 --
Donald L. Whitt.............. 5,000 -- -- 25,000 -- 364,250
</TABLE>

EMPLOYEE BENEFIT PLANS

Amended and Restated Stock Option Plan

Our board of directors adopted and our shareholders approved our amended
and restated stock option plan in May 1997. As of August 31, 1999, we had
reserved a total of 5,625,000 shares of common stock for issuance under the
stock option plan. The stock option plan provides for the granting to our
employees, including officers and directors, of incentive stock options within
the meaning of Section 422 of the Internal Revenue Code of 1986 and for the
granting to employees, consultants and non-employee directors of nonstatutory
stock options. If an optionee would have the right in any calendar year to
exercise for the first time incentive stock options for shares having an
aggregate fair market value (determined for each share as of the date the option
to purchase the shares was granted) in excess of $100,000, any such excess
options shall be treated as nonstatutory stock options. Unless terminated
earlier by our board of directors, the plan will terminate in May 2007. As of
August 31, 1999, options to purchase 3,251,542 shares of common stock were
outstanding under this plan and 303,278 shares had been issued upon exercise of
options.

The stock option plan may be administered by our board of directors or a
committee of our board. Our board of directors determines the terms of each
option granted under the stock option plan, including the number of shares
subject to an option, exercise price, vesting schedule and duration. The
exercise price of all incentive stock options granted under the stock option
plan cannot be less than the fair market value of the common stock on the date
of grant and, in the case of incentive stock options granted to holders of more
than 10% of our voting power, not less than 110% of the fair market value.
Generally, options granted under the stock option plan have a term of ten years,
vest annually over a four-year period and are nontransferable. Payment of the
exercise price of options may be made in cash or other consideration as
determined by our board of directors.

Our board of directors has the authority to amend or terminate the stock
option plan as long as such action does not adversely affect any outstanding
option and provided that shareholder approval for any amendments to the stock
option plan shall be obtained to the extent required by applicable law.

Employee Stock Purchase Plan

Our board of directors and shareholders adopted an employee stock purchase
plan in August 1999. We will implement the employee stock purchase plan
effective as of the date of this prospectus. The employee stock purchase plan
provides a convenient and practical means by which employees may participate in
stock ownership. Our board of directors believes that the opportunity to acquire
a proprietary interest in our success through the acquisition of shares of
common stock pursuant to the employee stock purchase plan is an important aspect
of our ability to attract and retain highly qualified and motivated employees.
The employee

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<PAGE> 55

stock purchase plan is intended to qualify as an "employee stock purchase plan"
within the meaning of Section 423 of the Internal Revenue Code. The employee
stock purchase plan may be administered by our board of directors or by a
committee appointed by our board of directors. The plan administrator has the
power to make and interpret all rules and regulations it deems necessary to
administer the employee stock purchase plan. Our board of directors has broad
authority to amend the employee stock purchase plan, subject in some instances
to shareholder approval. All of our employees who customarily work more than 20
hours per week, including our officers, are eligible to participate in the
employee stock purchase plan. Eligible employees may elect to contribute from 1%
to 10% of the compensation paid to them during each pay period towards stock
purchases under the plan. Other than the first offering, which will have a
duration of approximately 19 months, each participant may enroll in an 18-month
offering in which shares of common stock are purchased on the last day of each
six-month period during the offering. The first offering will commence on the
date of this prospectus and will terminate on May 14, 2001. Thereafter, a
separate offering will commence on November 15 and May 15 of each year. The
purchase price for shares purchased under the employee stock purchase plan will
be equal to 85% of the lower of:

- the fair market value of our common stock on the enrollment date of the
offering; or

- the fair market value on the date of purchase.

Neither payroll deductions credited to an employee's account nor any rights with
regard to the purchase of shares under the employee stock purchase plan may be
assigned, transferred, pledged or otherwise disposed of in any way by a
participant, except that a participant may designate a beneficiary in the event
of his or her death.

Upon termination of employment due to death, retirement or disability, the
payroll deductions credited to an employee's account will be used to purchase
shares on the next purchase date. Any remaining balance will be returned to the
participant or his or her beneficiary. Upon termination of employment for any
other reason, any payroll deductions credited to an employee's account will be
returned to the participant. We have authorized the issuance of up to 1,500,000
shares of common stock under the employee stock purchase plan. In the event of a
merger, consolidation or acquisition by another corporation of all or
substantially all of our assets, each outstanding right to purchase shares under
the employee stock purchase plan shall be assumed or an equivalent stock
purchase right substituted by the successor corporation. If the successor
corporation refuses to assume or substitute for the stock purchase right, the
offering period during which a participant may purchase stock will be shortened
to a specified date before the proposed merger or sale. Similarly, in the event
of our liquidation or dissolution, the offering period during which a
participant may purchase stock will be shortened to a specified date before the
date of the liquidation or dissolution.

401(k) Plan

In March 1997, our board of directors adopted a tax-qualified employee
savings and retirement plan for eligible U.S. employees. Eligible employees may
elect to defer a percentage of their eligible compensation in the 401(k) plan,
subject to the statutorily prescribed annual limit. We make matching
contributions on behalf of all participants in the 401(k) plan in the amount
equal to one-half of the first 6% of an employee's contributions. Matching
contributions are subject to a vesting schedule; all other contributions are at
all times fully vested. We intend the 401(k) plan to qualify under Sections
401(k) and 501 of the Internal Revenue Code so that contributions by employees
or us to the 401(k) plan, and income earned, if any, on plan contributions, are
not taxable to employees until withdrawn from the 401(k) plan, and so that we
will be able to deduct our contributions when made. The trustee of the 401(k)
plan, at the direction of each participant, invests the assets of the 401(k)
plan in any of a number of investment options.

EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS

We currently do not have any employment agreements with any of our named
executive officers. Our stock option plan provides that in the event a third
party acquires us through the purchase of all or substantially all of our
assets, a merger or other business combination, if so provided in applicable
stock option agreements, the unexercised portion of outstanding options will
vest and become immediately exercisable.
52
<PAGE> 56

Only two of our officers have stock option agreements that contain change of
control provisions. David Bialer has a stock option agreement which provides for
the acceleration of vesting of 50% of any unvested portion of his options in the
event a third party acquires us. In addition, Brian V. Turner has a stock option
agreement pursuant to which his options are all immediately vested but subject
to repurchase by us over a period of four years from the date of grant. Mr.
Turner's option agreement also provides for the release of 50% of any unreleased
portion of his options in the event a third party acquires us. We do not have
change of control arrangements with any of our other named executive officers.

DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY

Our amended and restated articles of incorporation limit the liability of
directors and officers to the fullest extent currently permitted by the
Washington Business Corporation Act or as it may be amended in the future.
Consequently, subject to the WBCA, no director will be personally liable to us
or our shareholders for monetary damages resulting from his conduct as our
director, except liability for:

- acts or omissions involving intentional misconduct or knowing violations
of law;

- unlawful distributions; or

- transactions from which the director personally receives a benefit in
money, property or services to which the director is not legally
entitled.

Our amended and restated articles of incorporation also provide that we
shall indemnify any individual made a party to a proceeding because that
individual is or was one of our directors or officers and shall advance or
reimburse reasonable expenses incurred by such individual in advance of the
final disposition of the proceeding to the fullest extent permitted by
applicable law. Any repeal of or modification to our amended and restated
articles of incorporation may not adversely affect any right of any of our
directors who is or was a director at the time of such repeal or modification.
To the extent the provisions of our amended and restated articles of
incorporation provide for indemnification of directors for liabilities arising
under the Securities Act, those provisions are, in the opinion of the SEC,
against public policy as expressed in the Securities Act and are therefore
unenforceable.

Our bylaws provide that we shall indemnify our directors and officers and
may indemnify our employees and agents to the fullest extent permitted by law.
In addition, we have entered into separate indemnification agreements with our
directors and certain executive officers that could require us, among other
things, to indemnify them against liabilities that arise because of their status
or service as directors or executive officers and to advance their expenses
incurred as a result of any proceeding against them as to which they could be
indemnified. Finally, we have purchased and intend to maintain a liability
insurance policy, pursuant to which our directors and officers may be
indemnified against liability they may incur for serving in their capacities as
our directors and officers. We believe that the limitation of liability
provisions in our amended and restated articles of incorporation, the
indemnification provisions in our bylaws, the indemnification agreements and the
liability insurance policy will facilitate our ability to continue to attract
and retain qualified individuals to serve as our directors and officers.

53
<PAGE> 57

RELATED-PARTY TRANSACTIONS

In connection with our conversion from a subchapter S corporation to a C
corporation in October 1997, we issued notes payable to William T. Baxter,
Albert T. Dosser and Peter R. Gregory, each in the principal amount of
$654,970.76, which were repaid in full in January 1998.

In January 1998, we sold 8,333,333 shares of Series A Preferred Stock at a
per share price of $1.80. Purchasers of Series A Preferred Stock included TA
Associates and its affiliates, who collectively purchased 6,666,667 shares and
hold more than 5% of our outstanding common stock on an as-converted basis, and
of which one of our directors, Jeffrey T. Chambers, is a partner; and Encompass
Ventures and its affiliates, who collectively purchased 1,666,666 shares and
hold more than 5% of our outstanding common stock on an as-converted basis, and
of which one of our directors, Scot E. Land, is a managing director. Messrs.
Chambers and Land were elected to our board of directors under the terms of the
stock purchase agreement pursuant to which the investors purchased the Series A
Preferred Stock. Upon closing of this offering, each outstanding share of Series
A Preferred Stock will convert into one share of common stock.

In connection with the sale of the Series A Preferred Stock, the investors
were granted registration rights, and we may therefore become obligated to
effect a registration under the Securities Act of shares of common stock held by
these investors upon the conversion of their preferred stock. In addition, in
connection with the Series A Preferred Stock offering, we redeemed 1,111,111
shares of common stock from each of Messrs. Baxter, Dosser and Gregory for
aggregate consideration of $6,000,000.

In September 1998, we entered into an agreement granting an option to
purchase 125,000 shares of common stock at an exercise price of $1.00 per share
to NextGen in exchange for consulting services. A minority interest in NextGen
was subsequently acquired by Encompass Ventures and its name was changed to
Encompass Europe, Inc. Mr. Land became a director of Encompass Europe. The
consulting agreement by its terms terminated August 1, 1999.

We granted options to purchase shares of common stock to the following
officers and directors on the date, for the number of shares and with an
exercise price indicated opposite each person's name:

<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERLYING EXERCISE
NAME GRANT DATE OPTIONS PRICE
---- ---------- ---------------- --------
<S> <C> <C> <C>
David J. Bialer............................ 9/25/98 100,000 $ 1.00
Jeffrey T. Chambers........................ 8/3/98 45,000 1.80
Scot E. Land............................... 8/3/98 45,000 1.80
10/15/99 40,000 12.00
William L. Larson.......................... 7/20/98 120,000 1.80
Brian V. Turner............................ 4/7/99 300,000 1.44
10/15/99 40,000 12.00
Donald L. Whitt............................ 6/11/97 20,000 0.05
7/17/98 10,000 1.00
7/5/99 40,000 2.50
</TABLE>

Because of contractual obligations involving Mr. Chambers and his
affiliated investment entities, the option grant to Mr. Chambers was issued in
the name of TA Associates, Inc.

In September 1999, we sold 1,518,378 shares of our common stock to Vulcan
Ventures for an aggregate purchase price of approximately $18.7 million. In
connection with its purchase of our common stock, Vulcan Ventures will receive
piggy-back registration rights, and we may therefore become obligated to
register under the Securities Act shares of common stock held by Vulcan
Ventures. In addition, pursuant to the stock purchase agreement between us and
Vulcan Ventures, following this offering we have agreed to use our best efforts
to cause an individual selected by Vulcan Ventures and reasonably acceptable to
us to be elected to our board of directors. Vulcan Ventures has the right to
require us to redeem the shares at the original issuance price if this offering
is not completed by December 15, 1999.

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<PAGE> 58

PRINCIPAL SHAREHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of our common stock as of August 31, 1999, and as adjusted to reflect
the sale of the common stock offered hereby, by:

- each shareholder known by us to own beneficially more than 5% of our
outstanding common stock;

- each of our directors;

- each of our named executive officers; and

- all current executive officers and directors as a group.

Beneficial ownership is determined in accordance with the rules of the SEC.
For purposes of calculating the number of shares beneficially owned by a
shareholder and the percentage ownership of that shareholder, shares of common
stock subject to options that are currently exercisable or exercisable within 60
days of August 31, 1999 by that shareholder are deemed outstanding. These
options are listed below under the heading "Number of Shares Underlying Options"
and are not treated as outstanding for the purpose of computing the percentage
ownership of any other shareholder. Percentage ownership is based on 28,196,656
shares of common stock outstanding on August 31, 1999, giving effect to the sale
of 1,518,378 shares of common stock to Vulcan Ventures in September 1999, and
32,196,656 shares outstanding upon completion of this offering.

If the underwriters' over-allotment option is exercised in full, eight of
our shareholders, consisting of entities affiliated with TA Associates, Albert
T. Dosser, Peter R. Gregory, William T. Baxter and Joseph Notarangelo, will sell
an aggregate of 600,000 shares of common stock to the underwriters. Information
regarding the beneficial ownership of these shareholders in the event the
underwriters' over-allotment option is exercised in full is set forth below.

Unless otherwise noted below, the address for each shareholder below is:
c/o BSQUARE Corporation, 3633 136th Place S.E., Suite 100, Bellevue, WA 98006.
Unless otherwise noted, we believe that each of the shareholders has sole
investment and voting power with respect to the common stock indicated, except
to the extent shared by spouses under applicable law.

<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
OUTSTANDING
NUMBER OF ---------------------
SHARES
NUMBER OF UNDERLYING BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES OPTIONS OFFERING OFFERING
------------------------------------ ---------- ----------- --------- ---------
<S> <C> <C> <C> <C>
Entities affiliated with TA Associates, Inc.(1)..... 7,192,130 15,000 25.5% 22.4%
High Street Tower
Suite 2500
Boston, MA 02110
Jeffrey T. Chambers(2).............................. 7,192,130 15,000 25.5 22.4
Albert T. Dosser(3)................................. 5,888,889 -- 20.9 18.3
Peter R. Gregory(4)................................. 5,875,089 -- 20.8 18.2
William T. Baxter(5)................................ 5,142,362 -- 18.2 16.0
Scot E. Land(6)..................................... 1,805,555 56,666 6.6 5.8
Entities affiliated with Encompass Ventures(7)...... 1,805,555 41,666 6.5 5.7
4040 Lake Washington Blvd. N.E.
Suite 205
Kirkland, WA 98033
</TABLE>

55
<PAGE> 59

<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
OUTSTANDING
NUMBER OF ---------------------
SHARES
NUMBER OF UNDERLYING BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES OPTIONS OFFERING OFFERING
------------------------------------ ---------- ----------- --------- ---------
<S> <C> <C> <C> <C>
Vulcan Ventures Incorporated(8)..................... 1,518,378 -- 5.4 4.7
110 110th Avenue N.E., Suite 550
Bellevue, WA 98004
Brian V. Turner..................................... -- 300,000 1.1 *
William L. Larson................................... -- 40,000 * *
David J. Bialer..................................... -- 100,000 * *
Donald L. Whitt..................................... 5,000 7,500 * *
All executive officers and directors as a group(9
persons)(9)....................................... 25,909,025 519,166 93.7% 82.1%
</TABLE>

- ---------------
* Less than 1%

(1) Includes 5,865,962 shares held by TA/Advent VIII L.P., 1,100,968 shares held
by Advent Atlantic and Pacific III, L.P., 117,318 shares held by TA
Investors L.L.C. and 107,882 shares held by TA Executives Fund L.L.C., all
of which are funds managed by TA Associates. If the underwriters'
over-allotment option is exercised in full, the entities affiliated with TA
Associates will sell 176,330 shares and own 21.8% of the shares then
outstanding.

(2) Includes 5,865,962 shares held by TA/Advent VIII L.P., 1,100,968 shares held
by Advent Atlantic and Pacific III, L.P., 117,318 shares held by TA
Investors L.L.C. and 107,882 shares held by TA Executives Fund L.L.C., all
of which are funds managed by TA Associates. Mr. Chambers is a managing
director of TA Associates. Mr. Chambers directly or indirectly shares voting
and investment power with respect to such shares but disclaims beneficial
ownership. If the underwriters' over-allotment option is exercised in full,
the entities affiliated with TA Associates will sell 176,330 shares and own
21.8% of the shares then outstanding.

(3) If the underwriters' over-allotment option is exercised in full, Mr. Dosser
will sell 144,390 shares and own 17.8% of the shares then outstanding.

(4) If the underwriters' over-allotment option is exercised in full, Mr. Gregory
will sell 144,033 shares and own 17.8% of the shares then outstanding.

(5) If the underwriters' over-allotment option is exercised in full, Mr. Baxter
will sell 126,067 shares and own 15.6% of the shares then outstanding.

(6) Includes 1,372,222 shares held by Encompass Group US Information Technology
Partners 1 LP, 277,778 shares held by TCI Club and 155,555 shares held by
Northwest Financing, L.L.C., all of which are funds managed by Encompass
Ventures. Also includes an option to purchase 41,666 shares held by
Encompass Europe, Inc., in which Encompass Ventures holds a minority
interest. Mr. Land is a managing director of Encompass Ventures and is a
director of Encompass Europe. Mr. Land directly or indirectly shares voting
and investment power with respect to such shares but disclaims beneficial
ownership.

(7) Includes 1,372,222 shares held by Encompass Group US Information Technology
Partners 1 LP, 277,778 shares held by TCI Club and 155,555 shares held by
Northwest Financing, L.L.C., all of which are funds managed by Encompass
Ventures. Also includes an option to purchase 41,666 shares held by
Encompass Europe, Inc., in which Encompass Ventures holds a minority
interest. Encompass Ventures disclaims beneficial ownership of Encompass
Europe's shares.

(8) In September 1999, we sold 1,518,378 shares of our common stock to Vulcan
Ventures Incorporated. Vulcan Ventures has the right to require us to redeem
the shares at the original issuance price if this offering is not completed
by December 15, 1999.

(9) See footnotes 2 through 7 above. If the underwriters' over-allotment is
exercised in full, all executive officers and directors as a group will sell
590,820 shares and own 79.0% of the shares then outstanding.

56
<PAGE> 60

Joseph Notarangelo, our Vice President-Strategic Business Development,
beneficially owns 375,000 shares of common stock and immediately exercisable
options to purchase an additional 64,250 shares, which together represent 1.6%
of the shares outstanding prior to this offering and 1.4% after this offering.
If the underwriters' over-allotment option is exercised in full, Mr. Notarangelo
will sell 9,180 shares and own 1.3% of the shares then outstanding.

57
<PAGE> 61

DESCRIPTION OF CAPITAL STOCK

GENERAL

Upon completion of this offering, we will be authorized to issue up to
50,000,000 shares of common stock, no par value, and 10,000,000 shares of
preferred stock, no par value. The following summary of certain provisions of
our common stock and preferred stock is not complete and may not contain all the
information you should consider before investing in the common stock. This
description is subject to and qualified in its entirety by provisions of our
amended and restated articles of incorporation and bylaws, which are included as
exhibits to the registration statement of which this prospectus is a part, and
by provisions of applicable Washington law.

COMMON STOCK

As of August 31, 1999, assuming conversion of all outstanding shares of
preferred stock and the issuance of 1,518,378 shares of common stock to Vulcan
Ventures, there were 28,196,656 shares of common stock outstanding that were
held of record by 99 shareholders. After giving effect to the sale of common
stock offered in this offering, there will be 32,196,656 shares of common stock
outstanding, assuming no exercise of outstanding options. As of August 31, 1999,
there were outstanding options to purchase a total of 3,251,542 shares of common
stock.

The holders of common stock are entitled to one vote per share on all
matters to be voted on by the shareholders. Subject to preferences that may be
granted to any outstanding shares of preferred stock, the holders of common
stock are entitled to receive ratably only those dividends our board of
directors declares out of funds legally available for the payment of dividends
as well as any other distributions to the shareholders.

If we are liquidated, dissolved or wound-up, the holders of common stock
are entitled to share pro rata all of our assets remaining after payment of our
liabilities and liquidation preferences of any then-outstanding shares of
preferred stock. Holders of common stock have no preemptive rights or rights to
convert their common stock into any other securities. There are no redemption or
sinking fund provisions applicable to the common stock. All outstanding shares
of common stock are fully paid and non-assessable, and the shares of common
stock to be issued in this offering will be fully paid and non-assessable.

PREFERRED STOCK

Upon the closing of this offering, all outstanding shares of preferred
stock will be converted into 8,333,333 shares of common stock. Thereafter,
pursuant to our amended and restated articles of incorporation, our board of
directors will have the authority, without further action by the shareholders,
to issue up to 10,000,000 shares of preferred stock in one or more series and to
fix the relative designations, powers, preferences and privileges of the
preferred stock, any or all of which may be greater than the rights of the
common stock. Our board of directors, without shareholder approval, can issue
preferred stock with voting, conversion or other rights that could adversely
affect the voting power and other rights of the holders of common stock.
Preferred stock could thus be issued quickly with terms that could delay or
prevent a change in control of us or make removal of our management more
difficult. Additionally, the issuance of preferred stock may decrease the market
price of the common stock and may adversely affect the voting and other rights
of the holders of common stock. We have no present plans to issue any preferred
stock.

REGISTRATION RIGHTS

Series A Convertible Preferred Stock

After this offering, the holders of 8,333,333 shares of common stock will
be entitled to rights with respect to the registration of such shares under the
Securities Act pursuant to a stock purchase and shareholders agreement among
such holders and us dated January 30, 1998. Under the terms of this agreement,
if we propose to register any of our securities under the Securities Act, either
for our own account or for the account of other security holders exercising
registration rights, such holders are entitled to notice of the registration

58
<PAGE> 62

and to include their shares of common stock in the registration at our expense.
Additionally, such holders are entitled to demand registration rights pursuant
to which they may require us to file a registration statement under the
Securities Act at our expense with respect to their shares of common stock.
Further, such holders may require us to file additional registration statements
on Form S-3 at our expense. All of these registration rights are subject to the
right of the underwriters of an offering to limit the number of shares included
in such registration. These registration rights terminate when the holder can
transfer his or her registrable shares pursuant to Rule 144. The holders of
these registration rights have entered into lock-up agreements and waived their
registration rights until 180 days following the closing of this offering.

Vulcan Ventures Incorporated

In connection with its purchase of 1,518,378 shares of our common stock,
Vulcan Ventures Incorporated is entitled to rights with respect to the
registration of such shares under the Securities Act. If we propose to register
any of our shares under the Securities Act, either for our own account or for
the account of other security holders exercising registration rights, Vulcan
Ventures is entitled to notice of the registration and to include their shares
of common stock in the registration at our expense. Vulcan Ventures'
registration rights are subject to the right of the underwriters of an offering
to limit the number of shares included in such registration. Vulcan Ventures'
registration rights terminate when Vulcan Ventures can sell its registrable
shares pursuant to Rule 144 without restriction. Vulcan Ventures has entered
into a lock-up agreement until 180 days following the closing of this offering.

ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF OUR AMENDED AND RESTATED ARTICLES
OF INCORPORATION, BYLAWS AND WASHINGTON LAW

Our board of directors, without shareholder approval, has the authority
under our amended and restated articles of incorporation to issue preferred
stock with rights superior to the rights of the holders of common stock. As a
result, preferred stock could be issued quickly and easily, could adversely
affect the rights of holders of common stock and could be issued with terms
calculated to delay or prevent a change in control of us or make removal of our
management more difficult. In addition, as of the first annual meeting of
shareholders following the closing of this offering, our board of directors will
be divided into three classes. The directors in each class will serve for
three-year terms, one class being elected each year by our shareholders, and
directors can only be removed for cause. This system of electing and removing
directors may tend to discourage a third party from making a tender offer or
otherwise attempting to obtain control of our company because it generally makes
it more difficult for shareholders to replace a majority of the directors.

Chapter 19 of the Washington Business Corporation Act generally prohibits a
"target corporation" from engaging in certain significant business transactions
with an "acquiring person," which is defined as a person or group of persons
that beneficially owns 10% or more of the voting securities of the target
corporation, for a period of five years after the acquisition, unless the
transaction or acquisition of shares is approved by a majority of the members of
the target corporation's board of directors prior to the time of acquisition.
Prohibited significant business transactions include, among other things:

- a merger or consolidation with, disposition of assets to, or issuance or
redemption of stock to or from, the acquiring person;

- termination of 5% or more of the employees of the target corporation as a
result of the acquiring person's acquisition of 10% or more of the
shares; or

- allowing the acquiring person to receive any disproportionate benefits as
a shareholder.

After the five-year period, a "significant business transaction" may occur
as long as it complies with certain "fair price" provisions of the statute. A
corporation may not "opt out" of this statute. This provision may have the
effect of delaying, deterring or preventing a change in control of our company.

In addition, our bylaws provide that shareholders may not raise new matters
or nominate directors at a meeting of shareholders unless advance notice
requirements are satisfied, which could have the effect of delaying or deterring
a change in control of us.
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<PAGE> 63

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services, L.L.C. The transfer agent's address is 520 Pike Street,
Suite 1220, Seattle, Washington 98101, and its telephone number is (206)
292-3795.

NATIONAL MARKET LISTING

We have been approved to list our common stock on The Nasdaq Stock Market's
National Market under the symbol "BSQR."

60
<PAGE> 64

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, we will have 32,196,656 shares of common
stock outstanding, assuming no exercise of options after August 31, 1999 and the
issuance of 1,518,378 shares of common stock to Vulcan Ventures. Of these
shares, the 4,000,000 shares sold in this offering will be freely tradable in
the public market without restriction under the Securities Act, unless such
shares are held by our "affiliates," as that term is defined in Rule 144 under
the Securities Act.

The remaining 28,196,656 shares of common stock that will be outstanding
after this offering will be restricted shares because they were sold in private
transactions in reliance on exemptions from registration under the Securities
Act. The following table shows the timing of when shares outstanding on August
31, 1999 may be eligible for resale in the public market after effectiveness of
this offering:

S-8 Registration Statements

As of August 31, 1999, there were a total of 3,251,542 shares of common
stock subject to outstanding options under our stock option plan, 1,100,574 of
which were vested. Immediately after effectiveness of this offering, we intend
to file registration statements on Form S-8 under the Securities Act to register
certain of the shares of common stock issued or reserved for future issuance
under our stock option plan and our employee stock purchase plan. After the
effective dates of the registration statements on Form S-8, shares purchased
upon exercise of options granted pursuant to our stock option plan and employee
stock purchase plan generally would be available for resale in the public market
without restriction. Approximately 107,885 shares underlying vested stock
options will be eligible for sale upon filing of the Form S-8 registration
statement immediately after effectiveness of this offering.

Rule 144

In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned restricted
shares for at least one year would be entitled to sell in any three-month period
up to the greater of:

- 1% of the then-outstanding shares of common stock, or approximately
322,000 shares immediately after this offering; and

- the average weekly trading volume of the common stock during the four
calendar weeks preceding the filing of a Form 144 with respect to such
sale.

Sales under Rule 144 are also subject to certain manner of sale and notice
requirements and to the availability of current public information about us.

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<PAGE> 65

Rule 701

Any of our employees, directors, officers, consultants or advisors who
purchased shares from us in connection with a written stock or option plan
before the effective date of this offering is entitled to rely on the resale
provisions of Rule 701, subject to the lock-up agreements described above. In
general, Rule 701 permits non-affiliates to sell their Rule 701 shares 90 days
after the effectiveness of a registration statement relating to a company's
initial public offering without having to comply with the public information,
holding period, volume limitation or notice provisions of Rule 144 and permits
affiliates to sell their Rule 701 shares without having to comply with the
holding period of Rule 144.

Rule 144(k)

Under Rule 144(k), a person who has not been one of our affiliates during
the preceding 90 days and who has beneficially owned the restricted shares for
at least two years is entitled to sell them without complying with the manner of
sale, public information, volume limitation or notice provisions of Rule 144.

Lock-Up Agreements

Pursuant to certain "lock-up" agreements, we and our executive officers,
directors and certain of our other shareholders have agreed not to offer, sell,
contract to sell, announce an intention to sell, pledge or otherwise dispose of,
directly or indirectly, or file with the SEC a registration statement under the
Securities Act relating to, any shares of common stock or securities convertible
into or exchangeable or exercisable for any common stock without the prior
written consent of Credit Suisse First Boston Corporation for a period of 180
days after the date of this prospectus.

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<PAGE> 66

UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting
agreement dated October 19, 1999, we have agreed to sell to the underwriters
named below, for whom Credit Suisse First Boston Corporation, Lehman Brothers
Inc., A.G. Edwards & Sons, Inc. and Wit Capital Corporation are acting as
representatives, the following respective numbers of shares of common stock:

<TABLE>
<CAPTION>
Number of Shares
Underwriter ----------------
<S> <C>
Credit Suisse First Boston Corporation...................... 1,632,000
Lehman Brothers Inc. ....................................... 1,088,000
A.G. Edwards & Sons, Inc. .................................. 340,000
Wit Capital Corporation..................................... 340,000
BancBoston Robertson Stephens Inc. ......................... 75,000
Black & Company, Inc. ...................................... 75,000
Hambrecht & Quist LLC....................................... 75,000
Invemed Associates LLC...................................... 75,000
Legg Mason Wood Walker, Incorporated........................ 75,000
Ragen MacKenzie Incorporated................................ 75,000
Charles Schwab & Co., Inc. ................................. 75,000
Volpe Brown Whelan & Company, LLC........................... 75,000
---------
Total.................................................. 4,000,000
=========
</TABLE>

The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that if an underwriter defaults, the
purchase commitments of non-defaulting underwriters may be increased or the
offering of common stock may be terminated.

Eight of our shareholders have granted to the underwriters a 30-day option
to purchase on a pro rata basis up to 600,000 additional shares at the initial
public offering price less the underwriting discounts and commissions. This
option may be exercised only to cover any over-allotments of common stock.

The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a concession of $0.63 per share. The
underwriters and selling group members may allow a discount of $0.10 per share
on sales to other broker/dealers. After the initial public offering, the public
offering price and concession and discount to broker/dealers may be changed by
the representatives. As used in this section:

- Underwriters are securities broker/dealers that are parties to the
underwriting agreement and will have a contractual commitment to purchase
shares of our common stock from us, and the representatives are the four
firms acting on behalf of the underwriters.

- Broker/dealers are firms registered under applicable securities laws to
sell securities to the public.

The following table summarizes the compensation and estimated expenses we
will pay. The compensation we will pay to the underwriters will consist solely
of the underwriting discount, which is equal to the public offering price per
share of common stock less the amount the underwriters pay to us per share of
common stock. The underwriters have not received and will not receive from us
any other item of compensation or expense in connection with this offering
considered by the National Association of Securities Dealers, Inc. to be
underwriting compensation under its rules of fair practice. The underwriting fee
was determined based on our negotiations with the underwriters at the time the
initial public offering price of our

63
<PAGE> 67

common stock was determined. The underwriting discount per share of common stock
is 7% of the initial public offering price per share of common stock.

<TABLE>
<CAPTION>
PER SHARE TOTAL
-------------------------------- --------------------------------
WITHOUT WITH WITHOUT WITH
OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting discounts and
commissions paid by us............. $1.05 $1.05 $4,200,000 $4,830,000
Expenses payable by us............... $0.25 $0.22 $1,000,000 $1,000,000
</TABLE>

The aggregate amount of offering expenses payable by us will be
approximately $1,000,000. The principal components of these offering expenses
will include the fees and expenses of our accountants and attorneys, the fees of
our registrar and transfer agent, the cost of printing this prospectus, The
Nasdaq Stock Market listing fees, and filing fees paid to the Securities and
Exchange Commission and the National Association of Securities Dealers, Inc.

The underwriters have informed us that they do not expect discretionary
sales to exceed 5% of the shares of common stock being offered.

We and our executive officers, directors and certain of our other
shareholders have agreed not to offer, sell, contract to sell, announce an
intention to sell, pledge or otherwise dispose of, directly or indirectly, or
file with the SEC a registration statement under the Securities Act relating to,
any shares of common stock or securities convertible into or exchangeable or
exercisable for any common stock without the prior written consent of Credit
Suisse First Boston Corporation for a period of 180 days after the date of this
prospectus.

The underwriters have reserved for sale, at the initial public offering
price, up to 200,000 shares of common stock for employees, directors and other
parties who have a preexisting relationship with our company, including vendors
and customers, who have expressed an interest in purchasing common stock in this
offering. The number of shares available for sale to the general public in this
offering will be reduced to the extent these persons purchase the reserved
shares. Any reserved shares not so purchased will be offered by the underwriters
to the general public on the same terms as the other shares.

We have agreed to indemnify the underwriters against liabilities under the
Securities Act, or contribute to payments which the underwriters may be required
to make in that respect.

We have been approved to list our common stock on The Nasdaq Stock Market's
National Market under the symbol "BSQR."

Prior to this offering, there has been no public market for our common
stock. The initial public offering price was determined by negotiation between
us and the underwriters and does not reflect the market price of the common
stock following the offering. The principal factors that were considered in
determining the public offering price include:

- the information in this prospectus and otherwise available to the
underwriters;

- market conditions for initial public offerings;

- the history and the prospects for the industry in which we will compete;

- the ability of our management;

- the prospects for our future earnings;

- the present state of our development and our current financial condition;

- the recent market prices of, and the demand for, publicly traded common
stock of generally comparable companies; and

- the general condition of the securities markets at the time of this
offering.

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<PAGE> 68

We can offer no assurances that the initial public offering price will
correspond to the price at which the common stock will trade in the public
market subsequent to the offering or that an active trading market for the
common stock will develop and continue after the offering.

The representatives may engage in over-allotment, stabilizing transactions,
syndicate covering transactions and penalty bids in accordance with Regulation M
under the Securities Exchange Act of 1934.

- Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.

- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.

- Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions.

- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a syndicate covering transaction to
cover syndicate short positions.

These stabilizing transactions, syndicate covering transactions and penalty bids
may cause the price of the common stock to be higher than it would otherwise be
in the absence of these transactions. These transactions may be effected on The
Nasdaq Stock Market's National Market or otherwise and, if commenced, may be
discontinued at any time.

A prospectus in electronic format is being made available on an Internet
website maintained by Wit Capital. In addition, pursuant to an e-dealer
agreement, all broker/dealers purchasing shares from Wit Capital in the offering
similarly have agreed to make a prospectus in electronic format available on
websites maintained by each of the e-dealers. E-dealers are broker/dealers who
use the Internet to distribute shares to customers who have accounts with these
broker/dealers that are accessible through the Internet.

Wit Capital, a member of the National Association of Securities Dealers,
will participate in the offering as one of the underwriters. The NASD approved
the membership of Wit Capital on September 4, 1997. During the last 12 months,
Wit Capital acted as co-manager on 48 initial public offerings and co-lead
manager on one initial public offering. Except for its participation as a
manager in this offering, Wit Capital has no relationship with us or any of our
founders or our significant shareholders.

NOTICE TO CANADIAN RESIDENTS

RESALE RESTRICTIONS

The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common stock are effected. Accordingly, any resale of the common stock
in Canada must be made in accordance with applicable securities laws which will
vary depending on the relevant jurisdiction, and which may require resales to be
made in accordance with available statutory exemptions or under a discretionary
exemption granted by the applicable Canadian securities regulatory authority.
Purchasers are advised to seek legal advice prior to any resale of the common
stock.

REPRESENTATIONS OF PURCHASERS

Each purchaser of common stock in Canada who receives a purchase
confirmation will be deemed to represent to us and the dealer from whom the
purchase confirmation is received that (1) the purchaser is entitled under
applicable provincial securities laws to purchase common stock without the
benefit of a prospectus qualified under the securities laws, (2) where required
by law, that the purchaser is purchasing as principal and not as agent, and (3)
the purchaser has reviewed the text under "Resale Restrictions."

65
<PAGE> 69

RIGHTS OF ACTION (ONTARIO PURCHASERS)

The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.

ENFORCEMENT OF LEGAL RIGHTS

All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be possible
for Canadian purchasers to effect service of process within Canada upon the
issuer and these persons. All or a substantial portion of the assets of the
issuer and these persons may be located outside of Canada and, as a result, it
may not be possible to satisfy a judgment against the issuer or these persons in
Canada or to enforce a judgment obtained in Canadian courts against the issuer
or these persons outside of Canada.

NOTICE TO BRITISH COLUMBIA RESIDENTS

A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that the purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by such purchaser in this offering. This report must be in
the form attached to British Columbia Securities Commission Blanket Order BOR
#95/17, a copy of which may be obtained from us. Only one report must be filed
in respect of common stock acquired on the same date and under the same
prospectus exemption.

TAXATION AND ELIGIBILITY FOR INVESTMENT

Canadian purchasers of common stock should consult with their own legal and
tax advisors with respect to the tax consequences of an investment in our common
stock in their particular circumstances and with respect to the eligibility of
our common stock for investment by the purchaser under relevant Canadian
legislation.

LEGAL MATTERS

The validity of the common stock offered hereby will be passed upon for
BSQUARE by Summit Law Group, PLLC, Seattle, Washington. Certain legal matters
will be passed upon for the underwriters by Morrison & Foerster LLP, Palo Alto,
California.

As of the date of this prospectus, Summit Law Group beneficially owns
34,722 shares of our common stock.

EXPERTS

Our audited consolidated financial statements and schedule of BSQUARE
Corporation and subsidiaries included in this prospectus and elsewhere in the
registration statement to the extent and for the periods indicated in their
reports have been audited by Arthur Andersen LLP, independent public
accountants, and are included herein as indicated in their reports with respect
thereto, in reliance upon the authority of said firm as experts giving said
reports.

WHERE TO FIND ADDITIONAL DOCUMENTS

We have filed with the SEC a registration statement on Form S-1. This
prospectus, which forms a part of the registration statement, does not contain
all the information included in the registration statement. Certain information
is omitted and you should refer to the registration statement and its exhibits.
With respect to references made in this prospectus to any of our contracts or
other documents, such references are not

66
<PAGE> 70

necessarily complete and you should refer to the exhibits attached to the
registration statement for copies of the actual contract or document. You may
read and copy the registration statement, including exhibits and schedules filed
with it, at the SEC's public reference facilities in Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on
the operation of the SEC's public reference facilities by calling the SEC at
1-800-SEC-0330. The SEC maintains a website (http://www.sec.gov) that contains
reports, proxy and information statements and other information regarding
registrants, such as us and Microsoft, that file electronically with the SEC.

Upon completion of this offering, we will become subject to the information
and periodic reporting requirements under the Exchange Act and, in accordance
with this law, will file periodic reports, proxy statements and other
information with the SEC. These periodic reports, proxy statements and other
information will be available for inspection and copying at the SEC's public
reference facilities and the website of the SEC referred to above.

67
<PAGE> 71

BSQUARE CORPORATION

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Income and Comprehensive
Income.................................................... F-4
Consolidated Statements of Shareholders' Equity (Deficit)... F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>

F-1
<PAGE> 72

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To BSQUARE Corporation:

We have audited the accompanying consolidated balance sheets of BSQUARE
Corporation and subsidiaries as of December 31, 1997 and 1998, and the related
consolidated statements of income and comprehensive income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1998. 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 consolidated financial statements referred to above,
present fairly, in all material respects, the financial position of BSQUARE
Corporation and subsidiaries as of December 31, 1997 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.

/s/ ARTHUR ANDERSEN LLP

Seattle, Washington,
August 13, 1999 (except for the matter discussed in
Note 13 for which the date is August 18, 1999)

F-2
<PAGE> 73

BSQUARE CORPORATION

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
PRO FORMA
SHAREHOLDERS'
DECEMBER 31, EQUITY
---------------- JUNE 30, (NOTE 1) AT
1997 1998 1999 JUNE 30, 1999
------ ------- ------------ -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $2,286 $ 5,324 $ 9,284
Short-term investments................................... -- 1,582 --
Accounts receivable, net of allowance for doubtful
accounts of $10 in 1997, $67 in 1998 and $112 in
1999................................................... 2,700 5,487 4,531
Income taxes receivable.................................. -- 134 --
Prepaid expenses and other current assets................ 89 155 236
Deferred income tax asset................................ -- 237 832
------ ------- -------
Total current assets.............................. 5,075 12,919 14,883
Furniture, equipment and leasehold improvements, net....... 1,320 3,061 3,380
Deposits and other assets.................................. 58 178 486
------ ------- -------
Total assets...................................... $6,453 $16,158 $18,749
====== ======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term obligations................. $ -- $ 157 $ 157
Accounts payable......................................... 367 676 507
Accrued compensation..................................... 732 1,331 1,333
Accrued expenses......................................... 147 308 1,509
Income taxes payable..................................... 484 -- 53
Deferred income taxes payable............................ 38 -- --
Deferred revenue......................................... 389 167 649
------ ------- -------
Total current liabilities......................... 2,157 2,639 4,208
Notes payable to shareholders.............................. 1,743 -- --
Long-term obligations, net of current portion.............. -- 289 210
Deferred income tax payable, net of current portion........ 223 111 111
------ ------- -------
Total liabilities................................. 4,123 3,039 4,529
------ ------- -------
Commitments and contingencies (Note 6)
Mandatorily redeemable convertible Series A preferred
stock, no par value: Authorized 10,000,000 shares, issued
and outstanding, no shares in 1997 and 8,333,333 shares
in 1998 and 1999, preference in liquidation of
$15,000,000.............................................. -- 14,417 14,475 --
Shareholders' equity (deficit):
Common stock, no par value: Authorized 50,000,000 shares,
issued and outstanding, 21,375,000 shares in 1997,
18,161,605 shares in 1998, and 18,225,205 in 1999...... 2,766 2,123 3,209 17,684
Deferred stock option compensation....................... (572) (401) (1,157) (1,157)
Stock subscription....................................... -- -- (29) (29)
Cumulative foreign currency translation adjustment....... -- 5 (61) (61)
Retained earnings (accumulated deficit).................. 136 (3,025) (2,217) (2,217)
------ ------- ------- -------
Total shareholders' equity (deficit).............. 2,330 (1,298) (255) $14,220
------ ------- ------- =======
Total liabilities and shareholders' equity........ $6,453 $16,158 $18,749
====== ======= =======
</TABLE>

See notes to Consolidated Financial Statements.

F-3
<PAGE> 74

BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
--------------------------- -----------------
1996 1997 1998 1998 1999
------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Service........................................ $ 4,179 $14,021 $23,393 $10,181 $17,848
Product........................................ -- 384 1,219 621 695
------- ------- ------- ------- -------
Total revenue.......................... 4,179 14,405 24,612 10,802 18,543
------- ------- ------- ------- -------
Cost of revenue:
Service........................................ 1,404 5,566 11,135 4,907 8,791
Product........................................ -- 78 166 121 108
------- ------- ------- ------- -------
Total cost of revenue.................. 1,404 5,644 11,301 5,028 8,899
------- ------- ------- ------- -------
Gross profit........................... 2,775 8,761 13,311 5,774 9,644
------- ------- ------- ------- -------
Operating expenses:
Research and development....................... 205 1,391 3,671 1,452 2,960
Selling, general and administrative............ 606 2,806 6,470 2,618 5,236
------- ------- ------- ------- -------
Total operating expenses............... 811 4,197 10,141 4,070 8,196
------- ------- ------- ------- -------
Income from operations................. 1,964 4,564 3,170 1,704 1,448
------- ------- ------- ------- -------
Other income (expense):
Interest income................................ 7 20 359 196 149
Interest expense............................... -- (32) (40) (17) (19)
------- ------- ------- ------- -------
Total other income (expense)........... -- (12) 319 179 130
------- ------- ------- ------- -------
Income before income taxes....................... 1,971 4,552 3,489 1,883 1,578
Provision for income taxes....................... -- 746 1,189 666 712
------- ------- ------- ------- -------
Net income............................. $ 1,971 $ 3,806 $ 2,300 $ 1,217 $ 866
======= ======= ======= ======= =======
Foreign currency translation adjustment.......... -- -- (5) -- 66
------- ------- ------- ------- -------
Comprehensive net income......................... $ 1,971 $ 3,806 $ 2,295 $ 1,217 $ 932
======= ======= ======= ======= =======
Basic earnings per share......................... $ 0.09 $ 0.18 $ 0.12 $ 0.06 $ 0.04
======= ======= ======= ======= =======
Weighted average shares outstanding used to
compute basic earnings per share............... 22,106 21,400 18,372 18,615 18,206
======= ======= ======= ======= =======
Diluted earnings per share....................... $ 0.09 $ 0.17 $ 0.08 $ 0.04 $ 0.03
======= ======= ======= ======= =======
Weighted average shares outstanding to compute
diluted earnings per share..................... 22,106 21,781 27,475 27,050 28,615
======= ======= ======= ======= =======
</TABLE>

See notes to Consolidated Financial Statements.

F-4
<PAGE> 75

BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
CUMULATIVE
FOREIGN RETAINED TOTAL
COMMON STOCK DEFERRED CURRENCY EARNINGS SHAREHOLDERS'
-------------------- STOCK OPTION STOCK TRANSLATION (ACCUMULATED EQUITY
SHARES AMOUNT COMPENSATION SUBSCRIPTION ADJUSTMENT DEFICIT) (DEFICIT)
---------- ------- ------------ ------------ ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995...... 21,000,000 $ 2 $ -- $ -- $ -- $ 259 $ 261
Issuance of common stock...... 1,106,000 14 -- -- -- -- 14
Shareholder draws............. -- -- -- -- -- (1,322) (1,322)
Net income.................... -- -- -- -- -- 1,971 1,971
---------- ------- ------- ---- ---- ------- -------
Balance, December 31, 1996...... 22,106,000 16 -- -- -- 908 924
Issuance of common stock for
services rendered........... 500,000 25 -- -- -- -- 25
Repurchase of common stock.... (1,231,000) (46) -- -- -- -- (46)
Shareholder note payable on S
to C Corporation
conversion.................. -- -- -- -- -- (2,000) (2,000)
Shareholder draws............. -- -- -- -- -- (460) (460)
Net income from January 1,
1997 to October 15, 1997.... 3,670 3,670
Conversion from S corporation
to C corporation............ 2,118 (2,118) --
Issuance of compensatory stock
options..................... -- 653 (653) -- -- -- --
Compensation attributable to
stock option vesting........ -- -- 81 -- -- -- 81
Net income from October 16,
1997 to December 31,
1997........................ -- -- -- -- -- 136 136
---------- ------- ------- ---- ---- ------- -------
Balance, December 31, 1997...... 21,375,000 2,766 (572) -- -- 136 2,330
Repurchase of common stock.... (3,333,333) (649) -- -- -- (5,351) (6,000)
Exercise of stock options..... 119,938 6 -- -- -- -- 6
Compensation attributable to
stock option vesting........ -- -- 171 -- -- -- 171
Foreign currency translation
adjustment.................. -- -- -- -- 5 -- 5
Accretion on mandatorily
redeemable convertible
preferred stock............. -- -- -- -- -- (110) (110)
Net income.................... -- -- -- -- -- 2,300 2,300
---------- ------- ------- ---- ---- ------- -------
Balance, December 31, 1998...... 18,161,605 2,123 (401) -- 5 (3,025) (1,298)
Exercise of stock options..... 63,600 6 -- -- -- -- 6
Note receivable from
shareholder................. -- 30 -- (30) -- -- --
Issuance of compensatory stock
options..................... -- 1,050 (1,050) -- -- -- --
Issuance of common stock upon
payment of subscription
receivable from
shareholder................. -- -- -- 1 -- -- 1
Compensation attributable to
stock option vesting........ -- -- 294 -- -- -- 294
Foreign currency translation
adjustment.................. -- -- -- -- (66) -- (66)
Accretion on mandatorily
redeemable convertible
preferred stock............. -- -- -- -- -- (58) (58)
Net income.................... -- -- -- -- -- 866 866
---------- ------- ------- ---- ---- ------- -------
Balance, June 30, 1999
(unaudited)................... 18,225,205 $ 3,209 $(1,157) $(29) $(61) $(2,217) $ (255)
========== ======= ======= ==== ==== ======= =======
</TABLE>

See notes to Consolidated Financial Statements.

F-5
<PAGE> 76

BSQUARE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------- -----------------
1996 1997 1998 1998 1999
------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income..................................... $ 1,971 $ 3,806 $ 2,300 $ 1,217 $ 866
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization............... 35 328 948 387 1,070
Deferred income taxes....................... -- 262 (387) 7 (595)
Stock and stock option compensation......... -- 106 171 83 294
Amortization of deferred financing costs.... -- -- 14 7 --
Changes in operating assets and liabilities:
Accounts receivable....................... (205) (2,109) (2,786) (1,020) 956
Prepaid expenses and other current
assets................................. (13) (66) (76) (60) (56)
Deposits and other assets................. (27) (24) (117) (4) (315)
Accounts payable and accrued expenses..... 101 1,111 960 125 703
Income taxes.............................. -- 484 (221) (562) 187
Deferred revenue.......................... (222) 389 (618) (354) 482
------- ------- ------- ------- -------
Net cash provided by (used in)
operating activities................. 1,640 4,287 188 (174) 3,592
------- ------- ------- ------- -------
Cash flows from investing activities:
Purchases of furniture equipment and leasehold
improvements................................ (248) (1,413) (2,116) (1,628) (1,070)
Maturity (purchase) of short-term investments,
net......................................... -- -- (1,582) (1,552) 1,582
------- ------- ------- ------- -------
Net cash provided by (used in)
investing activities................. (248) (1,413) (3,698) (3,180) 512
------- ------- ------- ------- -------
Cash flows from financing activities:
Repayment of shareholder notes payable......... -- (256) (1,743) (1,743) --
Payments on long-term obligations.............. -- -- (26) -- (79)
Repurchase of common stock..................... -- (46) (6,000) (6,000) --
Deferred financing costs....................... -- (13) (2) (2) (25)
Proceeds from exercise of stock options........ -- -- 5 1 6
Shareholders' draws............................ (1,322) (460) -- -- --
Net proceeds from issuance of Series A
Preferred Stock............................. -- -- 14,307 14,307 --
Proceeds from sale of common stock............. 14 -- -- -- --
------- ------- ------- ------- -------
Net cash provided by (used in)
financing activities................. (1,308) (775) 6,541 6,563 (98)
------- ------- ------- ------- -------
Effect of exchange rate changes on cash.......... -- -- 7 -- (46)
------- ------- ------- ------- -------
Net increase in cash and cash
equivalents.......................... 84 2,099 3,038 3,209 3,960
Cash and cash equivalents, beginning of period... 103 187 2,286 2,286 5,324
------- ------- ------- ------- -------
Cash and cash equivalents, end of period......... $ 187 $ 2,286 $ 5,324 $ 5,495 $ 9,284
======= ======= ======= ======= =======
</TABLE>

See notes to Consolidated Financial Statements.

F-6
<PAGE> 77

BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(INFORMATION AS OF JUNE 30, 1998 AND 1999 IS UNAUDITED)
(DOLLARS IN THOUSANDS)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

BSQUARE Corporation, a Washington corporation, and its subsidiaries
(collectively the Company) provides a variety of software products and services
that facilitate the integration of the Microsoft Windows CE operating system
with a wide variety of intelligent computing devices. The Company works with
semiconductor vendors and original equipment manufacturers to provide software
products and engineering services for the development of intelligent computing
devices, or intelligent computing devices.

The Company helps enable the rapid and low-cost deployment of intelligent
computing devices by providing a variety of software products and services for
the development, integration and deployment of the Windows CE operating system
with industry-specific applications. The Company also develops software
applications that are licensed to end users to provide intelligent computing
devices with additional functionality. The Company markets and supports its
products and provides services on a worldwide basis through a direct sales force
augmented by distributors.

CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES

The Company operates in the software industry, and accordingly, can be
affected by a variety of factors. For example, management of the Company
believes that any of the following factors could have a significant negative
effect on the Company's future financial position, results of operations and
cash flows: unanticipated fluctuations in quarterly operating results; failure
of the market for Windows CE operating system to develop fully; failure of the
market for intelligent computing devices to develop fully; adverse changes in
the Company's relationship with Microsoft; failure to secure contracts with
market-leading original equipment manufacturers; intense competition; failure to
attract and retain key personnel; failure to protect intellectual property;
risks associated with international operations; inability to manage growth; and
litigation or other claims against the Company.

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated. Accounts denominated in foreign currencies
have been re-measured into the functional currency, using the U.S. dollar as the
functional currency.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.

UNAUDITED INTERIM FINANCIAL DATA

The unaudited interim financial statements as of June 30, 1999 and for the
six months ended June 30, 1998 and 1999 have been prepared on the same basis as
the audited financial statements and, in the opinion of management, include all
adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the financial information set forth therein, in accordance with
generally accepted accounting principles. The Company believes that the results
of operations for the six months ended June 30, 1999 are not necessarily
indicative of the results to be expected for any future period.

F-7
<PAGE> 78
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

EARNINGS PER SHARE

In accordance with Statement of Financial Accounting Standards (SFAS) No.
128, "Computation of Earnings Per Share," basic earnings per share is computed
by dividing net income available to common stock (net income less accretion of
mandatorily redeemable convertible preferred stock) by the weighted average
number of shares of common stock outstanding during the period. Dilutive
earnings per share is computed by dividing net income by the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. Common equivalent shares consist of the shares of common stock issuable
upon the conversion of the mandatorily redeemable convertible preferred stock
(using the if-converted method) and shares issuable upon the exercise of stock
options and warrants (using the treasury stock method); common equivalent shares
are excluded from the calculation if their effect is antidilutive. The Company
has not had any issuances or grants for nominal consideration as defined under
Staff Accounting Bulletin 98.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents, include demand deposits, money market accounts
and all highly liquid debt instruments with an original maturity date of three
months or less.

SHORT-TERM INVESTMENTS

The Company's short-term investments consist primarily of investment-grade
marketable securities, which are classified as held to maturity and recorded at
amortized cost. Due to the short-term nature of these investments, changes in
market interest rates would not have a significant impact on the fair value of
these securities that are carried at amortized cost, which approximates fair
value.

At December 31, 1998, all short-term investments had a contractual maturity
of one year or less.

FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK

Financial instruments that potentially subject the Company to
concentrations of credit risk consist of cash and cash equivalents, short-term
investments and trade accounts receivable, accounts payable and long-term debt.
Fair values of cash and cash equivalents and short-term investments approximate
cost due to the short period of time to maturity. The fair values of financial
instruments that are short-term and/or that have little or no market risk are
considered to have a fair value equal to book value. Assets and liabilities that
are included in this category are receivables, accounts payable and accrued
liabilities.

The Company performs initial and ongoing evaluations of its customers'
financial position, and generally extends credit on open account, requiring
collateral as deemed necessary. The Company maintains allowances for potential
credit losses.

FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Furniture, equipment and leasehold improvements are stated at cost less
accumulated depreciation. Depreciation is provided on the straight-line method
over the estimated useful lives, as follows: office furniture and
equipment -- four years; computer equipment -- three years. Leasehold
improvements are amortized over the shorter of the lease term or the estimated
useful life. Maintenance and repairs are expensed as incurred. When properties
are retired or otherwise disposed, gains or losses are reflected in the income
statement. When facts and circumstances indicate that the cost of long-lived
assets may be impaired, an evaluation of recoverability is performed by
comparing the carrying value of the asset to projected future cash flows. Upon
indication that the carrying value of such assets may not be recoverable, the
Company would recognize an impairment loss by a charge against current
operations.

SOFTWARE DEVELOPMENT COSTS

Under the criteria set forth in Statement of Financial Accounting Standards
No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed," capitalization of software

F-8
<PAGE> 79
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

development costs begins upon the establishment of technological feasibility of
the product, which the Company has defined as the completion of beta testing of
a working product. The establishment of technological feasibility and the
ongoing assessment of the recoverability of these costs require considerable
judgment by management with respect to certain external factors, including, but
not limited to, anticipated future gross product revenue estimated economic life
and changes in software and hardware technology. Amounts that could have been
capitalized under this statement after consideration of the above factors were
immaterial and, therefore, no software development costs have been capitalized
by the Company to date.

RESEARCH AND DEVELOPMENT

Research and development costs are expensed as incurred and consist
primarily of salaries and materials.

INCOME TAXES

The Company was taxed as an S Corporation until October 15, 1997, when the
shareholders elected to convert to a C Corporation. Accordingly, taxes on income
to the Company were generally the responsibility of the shareholders until the
conversion.

The Company computes income taxes using the asset and liability method,
under which deferred income taxes are provided for the temporary differences
between the financial reporting basis and the tax basis of the Company's assets
and liabilities. Deferred tax assets and liabilities are measured using
currently enacted tax rates that are expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. A valuation allowance is established when necessary to reduce deferred
tax assets to the amounts expected to be realized.

FOREIGN CURRENCY TRANSLATION

The Company commenced operations in Germany and Japan during 1998. The
functional currency of foreign subsidiaries is the local currency. Accordingly,
assets and liabilities are translated at exchange rates in effect at the balance
sheet date and income and expense accounts at the average exchange rates during
the year. Resulting translation adjustments are recorded as a separate component
of shareholders' equity. The net gains and losses resulting from foreign
currency transactions are recorded in the consolidated statements of income in
the period incurred and were not significant for any of the periods presented.

REVENUE RECOGNITION

The Company's revenue recognition policy is in compliance with the
provisions of the American Institute of Certified Public Accountants' Statement
of Position 97-2, "Software Revenue Recognition." Service revenue is derived
from software porting and development contracts. Product revenue consists of
licensing fees from software application products and operating system and
software development tool products. The Company's customers consist of software
companies, original equipment manufacturers, distributors and end users.

The Company's revenue is recognized as follows:

Time and Material Consulting Contracts. The Company recognizes revenue as
services are rendered.

Fixed-Price Consulting Contracts. Service revenue from fixed-price
contracts is recognized on the percentage-of-completion method, measured by the
cost incurred to date to the estimated total cost for the contract. This method
is used as management considers expended costs to be the best available measure
of contract performance. Contract costs include all direct labor, material and
any other costs related to contract performance. Selling, general and
administrative costs are charged to expense as incurred. Provisions for
estimated losses on uncompleted contracts are made in the period in which such
losses are determined. Changes in job performance, job conditions and estimated
profitability may result in revisions in the estimate of total costs. Any
required adjustments due to these changes are recognized in the period in which
such revisions are determined.

F-9
<PAGE> 80
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Product Revenue. Product revenue consists principally of fees from the
licensing and sale of software products. Product licensing fees, including
advanced production royalty payments, are generally recognized when a customer
license agreement has been executed, the software has been shipped, remaining
obligations are insignificant and collection of the resulting account receivable
is probable. The Company recognizes license royalty income as it is reported by
the reseller when it ships its product to distributors.

ADVERTISING COSTS

The cost of advertising is expensed as incurred. During the years ending
December 31, 1996, 1997 and 1998 and for the six months ended June 30, 1998 and
1999, the Company incurred advertising expense of $159, $279 and $278, $186, and
$128, respectively.

UNAUDITED PRO FORMA SHAREHOLDERS' EQUITY

If the offering contemplated by this prospectus is consummated, all of the
mandatorily redeemable convertible preferred stock outstanding and subscribed to
as of the closing date will automatically be converted into an aggregate of
8,333,333 shares of common stock. Unaudited pro forma shareholders' equity at
June 30, 1999, as adjusted for the conversion of mandatorily redeemable
convertible preferred stock, is presented in the accompanying consolidated
balance sheet.

RECENT ACCOUNTING PRONOUNCEMENTS

In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective
for financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance over accounting for computer software developed or obtained
for internal use including the requirement to capitalize specified costs and
amortization of such costs. The implementation of SOP 98-1 did not have a
material impact on the Company's financial position or results of operations.

In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of
Start-Up Activities." SOP 98-5, which is effective for fiscal years beginning
after December 15, 1998, provides guidance on the financial reporting of
start-up costs and organization costs. It requires costs of start up activities
and organization costs to be expensed as incurred. The implementation of SOP
98-5 did not have a material impact on the Company's financial position or
results of operations.

In June 1998, the Financial Accounting Standards Board issued Statement No.
133 of Financial Accounting Standards, "Accounting for Derivative Instruments
and Hedging Activities." This statement requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as a part
of a hedge transaction and, if it is the type of hedge transaction. This
statement is effective for all fiscal quarters of all fiscal years beginning
after December 15, 1999. The Company does not use derivative instruments,
therefore the adoption of this statement will not have any effect on the
Company's results of operations or financial position.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current
year presentation.

F-10
<PAGE> 81
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Major classifications of furniture, equipment and leasehold improvements
consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------- JUNE 30,
1997 1998 1999
------ ------- --------
<S> <C> <C> <C>
Computer equipment and system software................. $1,003 $ 2,450 $ 3,158
Office furniture and equipment......................... 404 667 727
Leasehold improvements................................. 293 1,040 1,300
Construction in progress............................... -- 118 114
------ ------- -------
1,700 4,275 5,299
Less: accumulated depreciation and amortization........ (380) (1,214) (1,919)
------ ------- -------
$1,320 $ 3,061 $ 3,380
====== ======= =======
</TABLE>

3. INCOME TAXES

As discussed in Note 1 to the financial statements, the Company was a
Subchapter S Corporation for income tax purposes from inception to October 15,
1997. Effective October 16, 1997, the Company converted to a C Corporation and
was thereafter responsible for U.S. federal income taxes. A net deferred tax
liability of $445, primarily related to the required conversion for income tax
purposes from the cash basis method to the accrual basis method of accounting,
was recorded at the conversion date to reflect the Company's net taxable
temporary differences.

In addition, in accordance with Staff Accounting Bulletin Topic 4.B., the
Company has reclassified accumulated earnings generated prior to the date of
conversion to C corporation status from retained earnings to common stock and
additional paid in capital.

The provision for income taxes consisted of the following:

<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
-------------- ----------------
1997 1998 1998 1999
---- ------ ----- -------
<S> <C> <C> <C> <C>
Current
U.S. Current..................................... $484 $1,549 $655 $1,220
International.................................... -- 27 4 87
U.S. Deferred...................................... 262 (387) 7 (595)
---- ------ ---- ------
Total tax provision...................... $746 $1,189 $666 $ 712
==== ====== ==== ======
</TABLE>

The components of net deferred tax (assets) liabilities consisted of the
following at December 31:

<TABLE>
<CAPTION>
DECEMBER 31,
------------- JUNE 30,
1997 1998 1999
---- ----- --------
<S> <C> <C> <C>
Deferred income tax (asset) liabilities:
Depreciation............................................. $ -- $ (41) $(163)
Accrued compensation and benefits........................ (64) (206) (265)
Deferred revenue......................................... -- (57) (452)
Allowance for doubtful accounts.......................... (3) (23) (38)
Cash to accrual basis conversion......................... 111 111 111
Other, net............................................... (6) (21) (25)
---- ----- -----
$ 38 $(237) $(832)
==== ===== =====
Deferred income taxes payable:
Cash to accrual basis conversion......................... $223 $ 111 $ 111
---- ----- -----
$223 $ 111 $ 111
==== ===== =====
</TABLE>

F-11
<PAGE> 82
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The provision for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory federal income tax rate to
pre-tax income, as a result of the following:

<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
------------- ------------
1997 1998 1998 1999
----- ---- ---- ----
<S> <C> <C> <C> <C>
Taxes at the U.S. statutory rate....................... 34.0% 34.0% 34.0% 34.0%
Increase (decreases) in income taxes resulting from:
Conversion from an S Corporation to C Corporation.... 9.8 -- -- --
Shareholder responsibility for taxes associated with
S Corporation status.............................. (27.4) -- -- --
Research and development tax credit.................. (0.8) (6.2) (0.5) (8.4)
International operations............................. -- 4.5 -- 14.7
Other, net........................................... 0.8 1.8 1.9 4.8
----- ---- ---- ----
16.4% 34.1% 35.4% 45.1%
===== ==== ==== ====
</TABLE>

4. SHAREHOLDER NOTES PAYABLE

The Company was a Subchapter S Corporation for income tax purposes from
inception to October 15, 1997. Effective October 16, 1997, the Company converted
to a C Corporation. In connection with the conversion, the Company issued notes
payable totaling $2.0 million to the shareholders. Interest accrued at the
applicable federal long-term rate under Section 1274 of the Internal Revenue
Code of 1986, as amended. Although the notes were not due until December 2002,
or earlier if certain conditions were met, the Company paid in full the
shareholder notes payable and related accrued interest on January 30, 1998.

5. BANK LINE OF CREDIT AND NOTES PAYABLE

At December 31, 1998, the Company had available a $2.0 million secured
domestic revolving bank line of credit to support working capital, and a $500
domestic term loan to finance the purchase of software and equipment. During
1998, the Company used $473 of the domestic term loan to finance the purchase of
certain equipment. Interest accrues at the bank's prime for the line of credit
and the bank's prime plus 0.25% for the term loan. The facility fee is 0.50% per
annum or $10 for the line of credit and bank's prime plus 0.25% per annum, or $3
for the term loan. Restrictive terms of the line of credit require, among other
restrictions that the Company maintains a minimum quick ratio, tangible net
worth and debt service ratio.

Principal maturities of long-term obligations at December 31, 1998 are as
follows:

In July 1999, the Company renewed its bank line of credit, which provided
for a $5.0 million secured domestic revolving line of credit, $1.5 million term
loan for the purchase of equipment and a $4.0 term loan for leasehold
improvements. Interest accrues at the bank's prime rate for the revolving line
of credit, the bank's prime rate plus 0.25% for the equipment term loan and the
bank's prime rate plus 0.5% for the leasehold term loan. The facility fee is
$25. Restrictive terms of the lines require, among other requirements, that the
Company maintains a minimum quick ratio, tangible net worth and debt service
ratio, and limit the Company's ability to pay dividends without the lender's
consent. The line of credit is secured by substantially all of the assets of the
Company. As of July 31, the Company had $464 in standby letters of credit issued
and outstanding under the domestic revolving line of credit.

F-12
<PAGE> 83
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. COMMITMENTS AND CONTINGENCIES

The Company leases its office space under non-cancelable operating leases
that expire at various dates through 2009. During the years ending December 31,
1996, 1997, 1998 and for the six months ended June 30, 1998 and 1999, rental
expense was $370, $420, $980, $400, and $1.4 million, respectively. Minimum
rental commitments under non-cancelable operating leases at June 30, 1999 are as
follows:

<TABLE>
<S> <C>
1999 (six months)........................................... $ 2,064
2000........................................................ 4,172
2001........................................................ 4,165
2002........................................................ 3,719
2003........................................................ 3,490
Thereafter.................................................. 20,305
-------
$37,915
=======
</TABLE>

As of June 30, 1999, commitments for construction of leasehold improvements in
1999 total $4.0 million.

In January 1999, the Company signed a ten-year lease for a new corporate
headquarters in Bellevue, Washington, which is expected to commence in October
1999. The minimum lease payments associated with this lease are included in the
commitments above. The Company has the option to extend the lease for four
additional periods of five years each. The Company must provide a $500 letter of
credit as security for the lease. If certain working capital requirements are
not met on the commencement date, the Company must provide an additional $250
letter of credit. The letter of credit may be reduced annually by specified
amounts by specified amounts in the lease agreement upon the Company's achieving
certain economic goals.

7. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK

The Company has authorized 10.0 million shares of convertible preferred
stock. The Board of Directors has the authority to establish and define, in one
or more series, the price, rights, preferences and dividends of authorized but
unissued shares of preferred stock.

On January 30, 1998, the Company issued 8,333,333 shares of Series A
Convertible Preferred Stock (Preferred Stock) at $1.80 per share. Total
proceeds, net of offering costs, approximated $14.3 million. Concurrent with
this transaction, the Company repurchased 3,333,333 shares of the Company's
common stock from its founders for $6.0 million.

The rights and preferences of the preferred stock are as follows:

- In the event of any liquidation, dissolution or winding up of the
Company, the holders of Series A preferred stock would be entitled to
receive the greater of: (i) an amount in cash equal to $1.80 per share
(adjusted for stock splits, stock dividends and the like) or (ii), cash
in an amount equal to the portion of the assets of the Company remaining
for distribution to shareholders which such shareholder would have
received if each share of Series A Preferred Stock held had been
converted into the number of shares of common stock issuable upon the
conversion of a share of Series A Preferred Stock immediately prior to
any liquidation, dissolution or winding up of the Company.

- The Preferred Stock is voluntarily convertible at any time at the option
of the holder into shares of the Company's common stock at a one-for-one
conversion. The Preferred Stock is automatically convertible upon closing
of a Qualified Public Offering, as defined in the agreement.

- Any time following the fifth anniversary of the closing, holders of the
Preferred Stock have the right to cause the Company to redeem up to 50%
of the Preferred Stock at the original purchase price. Any time following
the sixth anniversary of the closing, the holders shall have the right to
cause the Company to redeem up to 100% of the Preferred Stock at the
original purchase price.

F-13
<PAGE> 84
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- The Preferred Stock converts at a one-for-one conversion rate, and is
adjusted in certain circumstances to prevent dilution of the preferred
shareholder's ownership interest.

- The Preferred shareholders have the same voting rights and voting powers
as common shareholders.

COMMON STOCK RESERVED FOR FUTURE ISSUANCES

At June 30, 1999, the Company has reserved the following shares of common
stock for future issuance:

<TABLE>
<S> <C>
Convertible mandatorily redeemable preferred stock.......... 8,333,333
Stock Option Plan........................................... 3,441,462
----------
11,774,795
==========
</TABLE>

8. EMPLOYEE BENEFIT PLANS

STOCK OPTIONS

In May 1997, the Company adopted the Amended and Restated Stock Option Plan
(the Plan). Under the Plan, the Board of Directors may grant nonqualified stock
options at a price determined by the Board, not to be less than 85% of the fair
market value of the common stock. Options have a term of up to 10 years and vest
over a schedule determined by the Board of Directors, generally four years.
Incentive stock options granted under this program may only be granted to
employees of the Company, have a term of up to 10 years, and shall be granted at
a price equal to the fair market value of the Company's stock. A summary of
stock option activity follows:

<TABLE>
<CAPTION>
PRICE PER SHARE
--------------------------------
NUMBER OF OPTIONS AVAILABLE FOR WEIGHTED AVERAGE
OUTSTANDING ISSUANCE EXERCISE PRICE RANGE
----------------- -------------- ---------------- -------------
<S> <C> <C> <C> <C>
Balance, December 31, 1996........... -- -- --
Authorized......................... -- 2,500,000 -- --
Granted............................ 1,750,100 (1,750,100) $0.08 $0.05 - $1.00
Exercised.......................... -- -- -- --
Canceled........................... (69,300) 69,300 $0.05 $0.05 - $0.05
--------- ---------- ----- -------------
Balance, December 31, 1997........... 1,680,800 819,200 $0.08 $0.05 - $1.00
Authorized......................... -- 1,125,000 -- --
Granted............................ 1,108,150 (1,108,150) $1.15 $1.00 - $1.80
Exercised.......................... (119,938) -- $0.05 $0.05 - $0.05
Canceled........................... (128,850) 128,850 $0.34 $0.05 - $1.00
--------- ---------- ----- -------------
Balance, December 31, 1998........... 2,540,162 964,900 $0.54 $0.05 - $1.80
Granted............................ 626,400 (626,400) $1.44 $1.44 - $1.44
Exercised.......................... (63,600) -- $0.53 $0.05 - $1.00
Canceled........................... (106,400) 106,400 $0.42 $0.05 - $1.44
--------- ---------- ----- -------------
Balance, June 30, 1999............... 2,996,562 444,900 $0.73 $0.05 - $1.80
========= ========== ===== =============
</TABLE>

In July 1999, the Company authorized an additional 2.0 million shares for
grants under the plan.

F-14
<PAGE> 85
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information concerning currently outstanding
and exercisable options at June 30, 1999:

<TABLE>
<CAPTION>
OUTSTANDING
------------------------------------------ EXERCISABLE
WEIGHTED AVERAGE -------------------------------------
REMAINING CONTRACTUAL WEIGHTED AVERAGE
NUMBER OF OPTIONS LIFE (YEARS) NUMBER OF OPTIONS EXERCISE PRICE
----------------- --------------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Rate of Exercise
Price:
$0.05.............. 1,303,012 8.0 578,378 $0.05
$0.50.............. 31,650 8.3 8,100 $0.50
$1.00.............. 827,500 8.3 177,571 $1.00
$1.44.............. 624,400 9.7 300,000 $1.44
$1.80.............. 210,000 9.1 -- $1.80
--------- --- --------- -----
2,996,562 8.5 1,064,049 $0.60
========= === ========= =====
</TABLE>

Had compensation expense been recognized on stock options issued based on
the fair value of the options at the date of the grant and recognized over the
vesting period, the Company's net income would have been reduced to the pro
forma amounts presented below.

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------
1997 1998
------ ------
<S> <C> <C>
Net income, as reported..................................... $3,806 $2,300
(12) (82)
------ ------
Pro forma net income........................................ $3,794 $2,218
====== ======
Pro forma basic earnings per share.......................... $ 0.18 $ 0.12
====== ======
</TABLE>

The fair value of options granted in 1997 and 1998 of $.03 and $.25 has
been estimated at the date of grant using the Black-Scholes method with the
following weighted-average assumptions:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31
------------------
1997 1998
------- -------
<S> <C> <C>
Dividend yield.............................................. 0% 0%
Expected life............................................... 5 years 5 years
Expected volatility......................................... 0% 0%
Risk-free interest rate..................................... 6.0% 5.5%
</TABLE>

The effects on pro forma disclosures of applying SFAS No. 123 are not
likely to be representative of the effects on pro forma disclosures of future
years.

DEFERRED STOCK OPTION COMPENSATION

In connection with the grant of certain stock options to employees and
consultants during 1997 and the six months ended June 30, 1999, the Company
recorded deferred stock option compensation of $653 and $1.1 million,
respectively, representing the difference between the estimated fair value of
the common stock for accounting purposes and the option exercise price of such
options at the date of grant. Such amount is presented as a reduction of
shareholders' equity and amortized, in accordance with FASB Interpretation No.
28, on an accelerated basis over the vesting period of the applicable options
(generally four years). During the years ended December 31, 1997, 1998 and for
the six months ended June 30, 1998 and 1999, the Company expensed approximately
$106, $171, $83 and $294, respectively. The balance will be expensed over the
period the options vest. Compensation expense is decreased in the period of
forfeiture for any accrued but unvested compensation arising from the early
termination of an option holder's services.

F-15
<PAGE> 86
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Included in the expensed amounts noted above for the six months ended June
30, 1999 is $30 related to options granted to a consultant for services
rendered. As of June 30, 1999, the consultant had earned 20,833 options to
acquire common stock at $1 per share. The Company has recorded the fair value of
the options as of the date the options were earned based on a Black-Scholes
model utilizing a 50% volatility factor and an expected life of 2 years.
Subsequent to June 30, 1999, the agreement was terminated.

1999 EMPLOYEE STOCK PURCHASE PLAN

On July 21, 1999, the board of directors approved the adoption of the
Company's 1999 Employee Stock Purchase (the "1999 Purchase Plan"), subject to
shareholder approval. A total of 1.5 million shares of common stock has been
reserved for issuance under the 1999 Purchase Plan. The 1999 Purchase Plan
permits eligible employees to acquire shares of the Company's common stock
through periodic payroll deductions of up to 10% of base cash compensation. No
more than 3,334 shares may be purchased by each employee on any purchase date.
Each offering period will have a maximum duration of 6 months. The price at
which the common stock may be purchased is 85% of the lesser of the fair market
value of the Company's common stock on the first day of the applicable offering
period or on the last day of the respective purchase period. The initial
offering period will commence on the effectiveness of the initial public
offering and will end on May 14, 2001.

PROFIT SHARING AND DEFERRED COMPENSATION PLAN

The Company has a Profit Sharing and Deferred Compensation Plan (Profit
Sharing Plan) under Section 401(k) of the Internal Revenue Code of 1986, as
amended. Substantially all full-time employees are eligible to participate. The
Company, at its discretion, may elect to match the participants' contributions
to the Profit Sharing Plan. Participants will receive their share of the value
of their investments upon retirement or termination, subject to a vesting
schedule. The Company made no matching contributions to the Profit Sharing Plan
during 1998 or 1997. For the six months ended June 30, 1999, the Company made
matching contributions to the profit sharing plan of $228.

9. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------- ----------------
1996 1997 1998 1998 1999
----- ----- ------- ------ ------
<S> <C> <C> <C> <C> <C>
Issuance of notes payable for equipment............ $-- $-- $ 473 $ -- $ --
Cash paid for interest............................. -- 13 57 40 42
Cash paid for income taxes......................... -- -- 2,170 1,220 1,100
</TABLE>

All significant non-cash financing activities are listed elsewhere in the
financial statements or the notes thereto.

10. SIGNIFICANT CUSTOMERS

Sales to customers, which comprised at least 10% of revenue for the years
ended December 31 were as follows:

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------ ----------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Microsoft....................................... 5% 39% 79% 73% 87%
Hitachi......................................... 43% 18% 2% 5% --
NEC............................................. 48% 17% 3% 5% --
ARM............................................. -- 11% 1% 2% --
</TABLE>

As of December 31, 1997, and 1998, and as of June 30, 1999, Microsoft
represented 73%, 84% and 72% of total accounts receivable, respectively.
F-16
<PAGE> 87
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In February 1999, the Company signed a two-year agreement with Microsoft
Corporation to continue to provide services to Microsoft which extend the
capabilities of the Windows CE operating system.

11. GEOGRAPHIC AND SEGMENT INFORMATION

The Company follows the requirements of Statement of Financial Accounting
Standards No. 131, Disclosures About Segments of an Enterprise and Related
Information. As defined in SFAS No. 131, the Company operates in two reportable
segments, Service and Products for the Microsoft Windows CE environment. The
following table summarizes total revenue and long-lived assets attributed to
significant countries:

<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED
-------------------------- JUNE 30,
1996 1997 1998 1999
------ ------- ------- ----------
<S> <C> <C> <C> <C>
Total revenue:
United States............................... $2,357 $10,065 $23,658 $18,272
Japan....................................... 1,802 2,632 195 108
Other Foreign............................... 20 1,708 759 163
------ ------- ------- -------
Total revenue*...................... $4,179 $14,405 $24,612 $18,543
====== ======= ======= =======
Long-lived assets:
United States............................... $ 1,378 $ 2,795 $ 3,460
Japan....................................... -- 239 220
Germany..................................... -- 205 186
------- ------- -------
Total long-lived assets............. $ 1,378 $ 3,239 $ 3,866
======= ======= =======
</TABLE>

- ---------------
* Revenue is attributed to countries based on location of customer invoiced.

BSQUARE has two operating segments, Services and Products. The Services
segment includes design and development of integration tools for the
semiconductor vendors and the original equipment manufacturer market. The
Product segment derives revenue from licensing of software products to original
equipment manufactures and distributing product through resellers. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies.

The Company does not track assets or operating expenses by operating
segments. Consequently, it is not practicable to show assets or operating
expenses by operating segments.

F-17
<PAGE> 88
BSQUARE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. EARNINGS PER SHARE

The following is a reconciliation of the numerators and denominators used
in computing basic and diluted earnings per share:

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, -------------------
--------------------------- JUNE 30, JUNE 30,
1996 1997 1998 1998 1999
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Net income (numerator diluted),.............. $ 1,971 $ 3,806 $ 2,300 $ 1,217 $ 866
Less: Accretion of mandatorily redeemable
convertible preferred stock............. -- -- (110) (50) (58)
------- ------- ------- ------- -------
Net income available to common shareholders
(numerator basic).......................... $ 1,971 $ 3,806 $ 2,190 $ 1,167 $ 808
======= ======= ======= ======= =======

Shares (denominator basic):
Weighted average common shares
outstanding............................. 22,106 21,400 18,372 18,615 18,206
======= ======= ======= ======= =======
Basic earnings per share..................... $ 0.09 $ 0.18 $ 0.12 $ 0.06 $ 0.04
======= ======= ======= ======= =======
Shares (denominator diluted):

Weighted average common shares
outstanding............................. 22,106 21,400 18,372 18,615 18,206
Mandatorily redeemable convertible
preferred
stock................................... -- -- 7,648 6,951 8,333
Common stock equivalents................... -- 381 1,455 1,484 2,076
------- ------- ------- ------- -------
Shares used in computation, (denominator
diluted)................................ 22,106 21,781 27,475 27,050 28,615
======= ======= ======= ======= =======
Diluted earnings per share................... $ 0.09 $ 0.17 $ 0.08 $ 0.04 $ 0.03
======= ======= ======= ======= =======
</TABLE>

13. STOCK PURCHASE AGREEMENT

On August 18, 1999, the Company entered into a stock purchase agreement to
sell 1,518,378 shares of common stock to a new investor for approximately $18.7
million. The investor has the right to require the Company to redeem the shares
at the original issuance price if the Company's initial public offering is not
declared effective by December 15, 1999.

F-18
<PAGE> 89
Back Cover
[BSQUARE LOGO]
[Text]

BSQUARE provides software products and services that facilitate the
integration of Windows CE into intelligent computing devices.

"We came to BSQUARE because we knew they had the products and expertise to
assist us in the development of Capio[TM], our latest Window[R]-based Terminal,
within our tight timeframe. With BSQUARE's CE Xpress[TM] Kit and a custom
Ethernet driver they developed for us, we were able to shorten our development
time and deliver our product to market quickly."

MIKE OLIVA, DIRECTOR OF MARKETING, BOUNDLESS TECHNOLOGIES INC.

BSQUARE press release June 9, 1999

"BSQUARE seems to always be keying in on the most meaningful segments of the
Windows CE product market: They always know what we want as consuming people."

JARED MINIMAN, "The Future of Windows CE Utilities"

WinCELair Review Center November 1998
<PAGE> 90

[COMPANY LOGO]