<PAGE>
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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION


                             WASHINGTON, D.C. 20549

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

                                    FORM 10-Q

       /X/       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

       / /       FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1998

                                       OR

       / /       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE TRANSITION PERIOD FROM_____ TO _____

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

                        Commission File Number 000-23597


                          EXTENDED SYSTEMS INCORPORATED
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)


                  DELAWARE                               82-0399670
      -------------------------------               --------------------
      (State or other jurisdiction of                (I.R.S. Employer
       incorporation or organization)               Identification No.)


                  5777 NORTH MEEKER AVENUE, BOISE, ID      83713
               ---------------------------------------   ---------
               (Address of principal executive office)   (Zip Code)     


       Registrant's telephone number, including area code:  (208) 322-7575

Indicate by check mark whether the registrant (1) has filed all reports 
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 
1934 during the preceding 12 months (or for such shorter period that the 
registrant was required to file such reports), and (2) has been subject to 
such filing requirements for the past 90 days.     Yes  /X/     No  / /


The number of shares outstanding of the registrant's common stock as of 
December 31, 1998 was 8,465,609.

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<PAGE>


                           EXTENDED SYSTEMS INCORPORATED
                                          
                                     FORM 10-Q
                                          
                FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 1998
                                          
                                       INDEX

<TABLE>
<CAPTION>
                                                                                     PAGE
                                                                                     ----
<S>                                                                                   <C>
PART I.    FINANCIAL INFORMATION                                            

Item 1.    Financial Statements

           Consolidated Statement of Operations
           for the Three and Six Months Ended December 31, 1998 and 1997.........       1

           Consolidated Balance Sheet
           as of December 31, 1998 and June 30, 1998 ............................       2


           Consolidated Condensed Statement of Cash Flows
           for the Six Months Ended December 31, 1998 and 1997...................       3

           Notes to Consolidated Financial Statements............................       4

Item 2.    Management's Discussion and Analysis of Financial Condition
           and Results of Operations.............................................       7

Item 3.    Quantitative and Qualitative Disclosures about Market Risk............      17


PART II.   OTHER INFORMATION

Item 6.    Exhibits and Reports on Form 8-K......................................      17


SIGNATURE  ......................................................................      19
</TABLE>



<PAGE>

                           PART I.  FINANCIAL INFORMATION
                                          
ITEM 1.  FINANCIAL STATEMENTS

EXTENDED SYSTEMS INCORPORATED

CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

<TABLE>
<CAPTION>
                                               Three Months Ended           Six Months Ended
                                                  DECEMBER 31,                 DECEMBER 31,
                                             ----------------------      ----------------------
                                               1998          1997          1998          1997
                                             --------      --------      --------      --------
<S>                                          <C>           <C>           <C>           <C>

Net revenue..............................    $  9,259      $ 12,131      $ 22,802      $ 23,283
Cost of net revenue......................       5,698         4,963        11,517         9,392
                                             --------      --------      --------      --------
Gross profit.............................       3,561         7,168        11,285        13,891
Operating expenses:
  Research and development...............       1,764         1,562         3,299         3,096
  Acquired research and development......         758          --             758          --
  Marketing and sales....................       4,117         3,424         7,720         6,647
  General and administrative.............         832           752         1,721         1,507
                                             --------      --------      --------      --------
    Income (loss) from operations........      (3,910)        1,430        (2,213)        2,641
Other income (expense), net..............           6           (84)          113          (137)
Interest expense.........................        (183)         (178)         (370)         (345)
                                             --------      --------      --------      --------
Income (loss) before income taxes........      (4,087)        1,168        (2,470)        2,159
Provision (benefit) for income taxes.....      (1,146)          415          (579)          765
                                             --------      --------      --------      --------
    Net (loss) income....................    $ (2,941)     $    753      $ (1,891)     $  1,394
                                             --------      --------      --------      --------
                                             --------      --------      --------      --------

Earnings (loss) per share:
    Basic................................    $  (0.35)     $   0.11      $  (0.23)     $   0.20
    Diluted..............................    $  (0.35)     $   0.10      $  (0.23)     $   0.19
Number of shares used in earnings (loss) 
  per share calculation:
    Basic................................       8,360         6,863         8,305         6,864
    Diluted..............................       8,360         7,281         8,305         7,156
</TABLE>

The accompanying notes are an integral part of the financial statements

                                       1


<PAGE>

EXTENDED SYSTEMS INCORPORATED

CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>

                                                            December 31,    June 30,
                                                               1998          1998
                                                            -----------     --------
<S>                                                         <C>             <C>
ASSETS
Current:
  Cash and cash equivalents...........................       $  7,573       $ 15,006
  Short term investments..............................          3,750           --
  Accounts receivable, net............................          8,747          8,776
  Other receivables...................................          1,506            419
  Inventories: 
    Purchased parts...................................          1,742          1,906
    Finished goods....................................          3,963          4,076
  Income taxes receivable.............................            956            --
  Prepaids and other..................................            847            318
                                                             --------       --------
    Total current assets..............................         29,084         30,501
Property and equipment, net...........................          8,701          8,586
Other assets..........................................          1,818          1,060
                                                             --------       --------
        Total assets..................................       $ 39,603       $ 40,147
                                                             --------       --------
                                                             --------       --------

LIABILITIES AND SHAREHOLDERS' EQUITY                       
Current:                                                   
  Accounts payable and accrued expenses...............       $  3,916       $  3,586  
  Accrued payroll and related benefits................            835          1,478
  Income taxes payable................................             24            505
  Current portion of long-term debt...................          7,737            235
                                                             --------       --------
    Total current liabilities.........................         12,512          5,804
Long-term debt........................................            321          7,617
Deferred income taxes.................................            175            134
                                                             --------       --------
    Total liabilities.................................         13,008         13,555
                                                             --------       --------

Shareholders' equity:                                      

  Common stock........................................              8              8
  Additional paid-in capital..........................         12,015         10,847
  Retained earnings...................................         15,096         16,987
  Deferred compensation...............................           (702)        (1,074)
  Accumulated other comprehensive income..............            178           (176)
                                                             --------       --------
    Total shareholders' equity........................         26,595         26,592
                                                             --------       --------
    Total liabilities and shareholders' equity.........      $ 39,603       $ 40,147
                                                             --------       --------
                                                             --------       --------
</TABLE>

The accompanying notes are an integral part of the financial statements

                                       2


<PAGE>

EXTENDED SYSTEMS INCORPORATED

CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>

                                                                    Six Months Ended December 31,
                                                                      1998                  1997
                                                                    --------             --------
<S>                                                                 <C>                   <C>
Net cash provided (used) by operating activities............        $ (2,555)            $  1,317
                                                                    --------             --------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of property and equipment........................            (622)              (1,710)
  Purchase of short-term investments........................          (3,750)                --
  Acquisitions:
     Rand Software Corporation, net of cash acquired........            (647)                --
     Parallax Research Pte, net of cash acquired............            (333)                --
  Other investing activities................................            (141)                   8
                                                                    --------             --------
       Net cash used by investing activities................          (5,493)              (1,702)
                                                                    --------             --------

CASH FLOWS FROM FINANCING ACTIVITIES:

  Proceeds from the issuance of common stock................             564                 --
  Payments on long-term debt................................            (132)                 (66)
  Other financing activities................................              23                  195
                                                                    --------             --------
      Net cash provided by financing activities.............             455                  129

  Effect of currency exchange rate changes on cash..........             160                  (64)
                                                                    --------             --------
  Net decrease in cash and cash equivalents ................          (7,433)                (320)

CASH AND CASH EQUIVALENTS:
  Beginning of year.........................................          15,006                6,621
                                                                    --------             --------

  End of year...............................................        $  7,573             $  6,301
                                                                    --------             --------
                                                                    --------             --------

Supplemental disclosures of cash flow information:
  Income taxes paid, net of refunds.........................        $    779             $    799
  Issuance of common stock in acquisition...................             735                 --
  Deferred compensation.....................................             202                  991
  Interest paid.............................................              69                   58
</TABLE>

The accompanying notes are an integral part of the financial statements

                                       3


<PAGE>

EXTENDED SYSTEMS INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

     
     Extended Systems Incorporated provides distributed and mobile computing
solutions that address the needs of the virtual enterprise. 
     
     BASIS OF PRESENTATION. The unaudited consolidated financial statements
include Extended Systems Incorporated, a Delaware corporation, and its
subsidiaries (the "Company"). All significant intercompany accounts and
transactions have been eliminated. In the opinion of management, the
accompanying unaudited consolidated financial statements contain all adjustments
(consisting solely of normal recurring adjustments) necessary to present fairly
the consolidated financial position of the Company, and their consolidated
results of operations and cash flows. Certain reclassifications have been made
to the prior year consolidated financial statements to conform to the 1999
presentation. Tabular amounts are in thousands, except per share amounts.

     The information included in this Form 10-Q should be read in conjunction
with Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Financial Statements and Notes thereto included in the
Company's 1998 Annual Report on Form 10-K.

     CURRENCY TRANSLATION. The Company translates the accounts of its
international subsidiaries using the local currency as the functional currency.
The assets and liabilities of international subsidiaries are translated into
U.S. dollars using exchange rates in effect at the balance sheet date. Gains and
losses from this translation process are reflected as a component of
comprehensive income. Revenue and expenses are translated into U.S. dollars
using the average exchange rate for the period. The Company recognized a net
currency exchange gain (loss) of $90,000 and ($55,000) for the six months ended
December 31, 1998 and 1997, respectively.

     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 and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expense during
the reporting periods. Actual results could differ from those estimates. 

     SHORT-TERM INVESTMENTS are categorized as available-for-sale securities, as
defined by Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." Such
securities are reported at fair value which approximates cost. 
     
     INVENTORIES of purchased parts and finished goods are valued at the lower
of cost (principally standard cost, which approximates actual cost on a 
first-in, first-out basis) or market. The cost of net revenue for the three 
and six months ended December 31, 1998, includes a provision for write-down of 
port replicator inventory of $1.1 million and $1.4 million, respectively.
     
     REVENUE on hardware products is recognized when products are shipped to
customers, including when products are shipped to distributors and resellers,
net of an allowance for estimated product returns. As a result of the announced
exit from the port replicator business in December 1998, net revenue for the
three and six months ended December 31, 1998, includes a provision for port
replicator returns of $1.0 million.
     
     Revenue earned under software license agreements is recognized when there
is persuasive evidence of a contract, software has been delivered to the
customer and accepted, payment is due within 12 months, collectibility is
probable and there are no significant obligations remaining. The Company does
not provide any material post contract customer support. 

                                       4


<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

     EARNINGS (LOSS) PER SHARE is calculated pursuant to SFAS No. 128, "Earnings
Per Share." Basic earnings (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding increased by
the additional common shares that would be outstanding if the potential dilutive
common shares had been issued. Diluted earnings (loss) per share computations
exclude stock options and potential shares for convertible debt to the extent
their effect would have been antidilutive.

<TABLE>
<CAPTION>

                                                           THREE MONTHS ENDED          SIX MONTHS ENDED
                                                              DECEMBER 31,                DECEMBER 31,
                                                         ---------------------     ---------------------
                                                           1998         1997         1998          1997
                                                         --------     --------     --------     --------
                                                             (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                      <C>          <C>          <C>          <C>
BASIC                                                                   
  Net income (loss)...........................           $ (2,941)    $    753     $ (1,891)    $  1,394
  Weighted average shares outstanding.........              8,360        6,863        8,305        6,864
                                                         --------     --------     --------     --------
  Basic earnings (loss) per share.............           $  (0.35)    $   0.11     $  (0.23)    $   0.20
                                                         --------     --------     --------     --------
                                                         --------     --------     --------     --------

DILUTED
  Net income (loss)...........................           $ (2,941)    $    753     $ (1,891)    $  1,394
                                                         --------     --------     --------     --------
  Weighted average shares outstanding.........              8,360        6,863        8,305        6,864
  Net effect of dilutive stock options........               --            418         --            292
                                                         --------     --------     --------     --------
    Total shares and dilutive options.........              8,360        7,281        8,305        7,156
                                                         --------     --------     --------     --------
  Diluted earnings (loss) per share...........            $ (0.35)      $ 0.10     $  (0.23)    $   0.19
                                                         --------     --------     --------     --------
                                                         --------     --------     --------     --------
</TABLE>

     BUSINESS COMBINATIONS. In October 1998, the Company acquired all of the
outstanding stock of Rand Software Corporation ("Rand") for $710,000 in cash and
104,998 shares of Common Stock valued at $735,000. In November 1998, the Company
acquired a controlling interest in Parallax Research, Pte. ("Parallax") for
$347,000 in cash and by assuming $379,000 in debt. Both transactions were
accounted for by the purchase method of accounting in accordance with Accounting
Principles Board Opinion No. 16, "Business Combinations" ("APB 16"), and,
accordingly, the results of operations of both companies have been included in
the consolidated statement of operations since the acquisition dates. Pro forma
results of operations have not been presented since the effects of these
acquisitions were not material for the periods presented. 
     
     A summary of the net assets acquired at the date of the acquisitions, as
determined in accordance with APB 16 is as follows (in thousands):

<TABLE>
<S>                                                        <C>
          Net working capital........................      $ (147)
          Property and equipment.....................         135 
          Developed technology, goodwill
            and other intangibles....................       1,424
          Acquired research and development..........         758
                                                           ------
                                                          $ 2,170
                                                           ------
                                                           ------
</TABLE>

     Valuation of the intangible assets acquired from Rand and Parallax,
including acquired research and development, developed technology and goodwill
were determined by independent appraisers. Such appraisers determined the value
assigned to acquired research and development by projecting net cash flows
related to future products expected to result from commercialization of the
acquired research and development, adjusting the net cash flows for the stage of
completion of the projects and discounting the adjusted cash flows to their
present values based on risk adjusted discount rates of 25% to 35%. The net cash
flows from such projects were based on estimates made by the Company's
management and excluded amounts expected to result from existing products and
technologies. Management, based upon such independent appraisals, estimated
that, in aggregate, the fair value of acquired research and development that had
not yet reached technological feasibility and has no alternative future use is
$758,000. The amount allocated to acquired research and development was expensed
as a non-recurring, non-tax deductible charge to operations for the three and
six months ended December 31, 1998. 

                                       5


<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)

     COMPREHENSIVE INCOME (LOSS). The Company adopted SFAS No. 130, "Reporting
Comprehensive Income" during the first quarter of 1999. This statement requires
the Company to disclose accumulative other comprehensive income (excluding net
income) as a separate component of shareholders' equity. Comprehensive income
(loss) was as follows: 

<TABLE>

                                             THREE MONTHS ENDED        SIX MONTHS ENDED
                                                 DECEMBER 31,             DECEMBER 31,
                                            --------------------     --------------------
                                              1998        1997        1998         1997
                                            --------     -------     --------     -------
                                              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                         <C>          <C>         <C>          <C>

Net income (loss).......................    $ (2,941)    $   753     $ (1,891)    $ 1,394
Change in currency translation..........         (12)       (101)         354        (141)
                                            --------     -------     --------     -------
Comprehensive income (loss).............    $ (2,953)    $   652     $ (1,537)    $ 1,253
                                            --------     -------     --------     -------
                                            --------     -------     --------     -------
</TABLE>

     RECENTLY ISSUED ACCOUNTING STANDARDS. In June 1997, the FASB issued SFAS
No. 131, "Disclosure about Segments of an Enterprise and Related Information,"
which establishes standards for publicly traded business enterprises to report
information about operating segments in annual financial statements and requires
those enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. This statement requires that a publicly traded business enterprise
report financial and descriptive information about its reportable operating
segments on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments. This statement
is effective for financial statements for periods beginning after December 15,
1997, and need not be applied to interim financial statements in the initial
year of its application, but comparative information for interim periods in the
initial year of application is to be reported in financial statements for
interim periods in the second year of application. Management is currently
evaluating the effects of adopting SFAS No. 131.
     
     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. The
statement requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. Under current operations, adoption of SFAS No. 133 is not
expected to have a material impact on the Company's results of operations and
financial position. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999.
 
     In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 requires companies to
capitalize certain costs of computer software developed or obtained for internal
use. Adoption is not expected to have a material effect on the Company's results
of operations or financial position. SOP 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998.

                                       6


<PAGE>

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

FORWARD-LOOKING STATEMENTS

     IN ADDITION TO HISTORICAL INFORMATION, THIS FORM 10-Q CONTAINS FORWARD-
LOOKING STATEMENTS. IN THIS FORM 10-Q, THE WORDS "EXPECTS," "ANTICIPATES,"
"BELIEVES," "INTENDS," "WILL" AND SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING
STATEMENTS, WHICH ARE BASED UPON INFORMATION CURRENTLY AVAILABLE TO THE COMPANY,
SPEAK ONLY AS OF THE DATE HEREOF AND ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES. THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING
STATEMENTS. THE COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS
DISCUSSED IN SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT MAY CAUSE SUCH A
DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THIS SECTION
ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS--FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE
OF STOCK." READERS SHOULD CAREFULLY REVIEW THE RISK FACTORS DESCRIBED IN OTHER
DOCUMENTS THAT THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND
EXCHANGE COMMISSION (THE "COMMISSION"), INCLUDING THE 1998 ANNUAL REPORT ON FORM
10-K AND THE QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE COMPANY IN FISCAL
1999. ALL PERIOD REFERENCES ARE TO THE COMPANY'S FISCAL YEARS ENDED JUNE 30,
1999, 1998 AND 1997, UNLESS OTHERWISE INDICATED. ALL TABULAR DOLLAR AMOUNTS ARE
PRESENTED IN THOUSANDS.
     
RESULTS OF OPERATIONS

     In December 1998, the Company announced its decision to exit the mechanical
port replicator business. The Company's decision was based on two primary
factors. The Company saw a decrease in demand for third-party port replicator
products as laptop vendors became more successful in providing similar products
in a more timely manner. In addition, the Company was experiencing quality-
related problems with its supplier and, consequently, faced a lack of a reliable
source for port replicators to support future releases of laptop PC models in
the increasingly competitive environment. 

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
Net revenue.................     $ 9,259         -23.7%           $ 12,131    $ 22,802         -2.1%           $ 23,283
</TABLE>

     The decrease in net revenue for the three months ended December 31, 1998
from the same period last year was principally due to decreased unit sales of
port replicator products, along with an increase in the allowance for port
replicator sales returns from the Company's North American distribution
partners, and decreased unit sales of printer sharing products. The decrease in
net revenue was offset, in part, by an increase in the average selling price of
Internet products due to a shift in product mix and increased unit sales of
Advantage Database Server products. The Company's revenue from ExtendNet print
server products remained relatively consistent for the three months ended
December 31, 1998 with the level of revenue in the same period last year,
however, the Company experienced an increase in unit sales of ExtendNet print
server products, which was offset by a decrease in average selling price of
print server products as a result of a shift in product mix to lower-priced
products. 
     
     The decrease in net revenue for the six months ended December 31, 1998 from
the same period last year was principally due to decreased net unit sales of
port replicator products, decreased unit sales of printer sharing products
coupled with a decrease in average selling price of printer sharing products due
to a change in product mix and an increase in the allowance for port replicator
returns from the Company's North American distribution partners. The decrease in
net revenue was offset, in part, by increased unit sales of OEM print servers,
an increase in the average selling price of Internet products due to a shift in
product mix, increased non-recurring engineering ("NRE") and royalty revenue,
and increased unit sales of Advantage Database Server products. The Company also
experienced an increase in unit sales of ExtendNet print server products, which
was partially offset by a decrease in average selling price of print server
products as a result of a shift in product mix to lower priced products. 
     
     In the first six months of 1999 and in fiscal 1998, 59.3% and 53.8%,
respectively, of the Company's net revenue was derived from sales of ExtendNet
print servers. The Company believes that net revenue from this product line will
continue to grow but will decline as a percentage of the Company's net revenue
as the Company's other products for distributed and mobile connectivity achieve
market acceptance. While the Company believes that sales of ExtendNet print
servers will continue to account for a significant portion of the Company's net
revenue and gross profit, the Company's future results of operations will be
highly dependent upon the success of its more recently introduced products. 

                                       7


<PAGE>

     The Company derives a substantial portion of its net revenue from
international sales, principally through its international sales subsidiaries
and a limited number of distributors. In the first six months of 1999 and in
fiscal 1998, international sales represented 54% and 44% of net revenue,
respectively. The Company expects that international sales will continue to
represent a substantial portion of its net revenue for the foreseeable future.
International sales are subject to a number of risks, including changes in
government regulations, export license requirements, tariffs and taxes, other
trade barriers, fluctuation in currency exchange rates, difficulty in collecting
accounts receivable, difficulty in staffing and managing international
operations and political and economic instability.
     
     The Company markets and sells a majority of its products through multiple
indirect channels, primarily distributors and resellers. Certain of the
Company's products, in particular its ExtendNet print servers, JetEye IrDA
products, infrared software, and data synchronization software are sold to OEMs,
and the Company intends to increase sales to OEMs in the future. The Company
supports its indirect channels with its own sales and marketing organization.
The Company's key distributors include Ingram Micro, Inc. ("Ingram Micro") and
Tech Data Corporation ("Tech Data"). In the first six months of 1999 and in
fiscal 1998, sales to Ingram Micro accounted for 20% and 23% of the Company's
net revenue, respectively. Sales to Tech Data accounted for 11% of the Company's
net revenue in fiscal 1998. The loss of, or reduction in sales to, any of the
Company's key customers could have a material adverse affect on the Company's
business, results of operations and cash flows. The Company provides price
protection rights and limited product return rights for stock rotation to most
of its distributors and resellers. 
 
     The markets for the Company's products are characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions and short product life cycles. The Company's future success will
depend to a substantial degree upon its ability to enhance its existing products
and to develop and introduce, on a timely and cost-effective basis, new products
and features that meet changing customer requirements and emerging and evolving
industry standards. The introduction of new or enhanced products also requires
the Company to manage the transition from older products in order to minimize
disruption in customer ordering patterns, to avoid excessive levels of older
product inventories and to ensure that adequate supplies of new products can be
delivered to meet customer demand. There can be no assurance that the Company
will successfully develop, introduce or manage the transition to new products. 

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
Gross profit.................    $ 3,561         -50.3%           $ 7,168     $ 11,285         -18.8%          $ 13,891
Gross margin.................      38.5%                            59.1%        49.5%                            59.7%
</TABLE>

     The decrease in gross margin for the three months ended December 31, 1998
from the same period last year was principally due to the impact of the increase
in the inventory valuation allowance for port replicator inventory and an
increase in the allowance for port replicator returns from the Company's North
American distribution partners recorded as a result of the Company's exit from
the port replicator business. Absent the impact of these non-recurring charges,
gross margin was 55.1% in the three months ended December 31, 1998. The decrease
from the prior year was due to a shift in the Company's product mix to lower
gross margin products, including lower-priced print server products with
corresponding lower margins, offset in part by strong royalty, license and NRE
revenue. 
     
     The decrease in gross margin for the six months ended December 31, 1998
from the same period last year was principally due to the impact of the increase
in the inventory valuation allowance for port replicator inventory and a shift
in product mix from higher margin ExtendNet print server and printer sharing
products to lower margin ExtendNet print server products. The decrease in gross
margin was partially offset by increased NRE and royalty revenue as well as
increased Advantage Database Server and Internet sales. 
     
     The Company's cost of net revenue consists primarily of costs associated
with components, outsourced manufacturing of certain subassemblies, and in-house
labor associated with assembly, testing, shipping and quality assurance. The
Company's gross margin is affected by a number of factors, including product
mix, competitive product pricing pressures, manufacturing costs, component costs
and provisions for obsolete inventory. The Company anticipates that its gross
margin may continue to decline in the future as a result of shifts in the
Company's product mix and competitive pricing pressure. In particular, the
Company expects that its gross margin will decline as a result of a continued
shift in product mix toward lower priced print servers. The Company seeks to
mitigate the effects of declining prices by improving product design and
reducing costs, primarily manufacturing and component costs. 

                                       8


<PAGE>

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
Research and development.....    $ 1,764         12.9%            $ 1,562     $ 3,299         6.6%             $ 3,096
  as a % of net revenue......      19.1%                            12.9%       14.5%                            13.3%
</TABLE>

     The increase in research and development expense for the three months and
six months ended December 31, 1998 from the same periods last year was due
primarily to increased personnel costs as a result of the Company's acquisition
of Rand Software Corporation ("Rand") in October 1998 and Parallax Research,
Pte. ("Parallax") in November 1998. The increase was partially offset by
decreased employee stock option compensation expense.

     The Company expects research and development expenses to increase in the
future, although such expenses may vary as a percentage of net revenue
     
     Of the aggregate purchase price for the Rand and Parallax acquisitions,
$758,000 has been allocated to acquired research and development. For the three
months and six months ended December 31, 1998, acquired research and development
was 8.2% and 3.3% of net revenue, respectively. 

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
Marketing and sales.........     $ 4,117         20.2%            $ 3,424     $ 7,720         16.1%            $ 6,647
  as a % of net revenue.....       44.5%                            28.2%       33.9%                            28.5%  
</TABLE>

     The increase in marketing and sales expense for the three months and six
months ended December 31, 1998 from the same periods last year was principally
due to increased sales activities at the European subsidiaries and in the North
American sales group. The increase in sales and marketing expense was offset, in
part, by decreased promotional activities associated with ExtendNet print server
products in North America. 
     
     The Company expects marketing and sales expenses to increase in the future,
although such expenses may vary as a percentage of net revenue.

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
General and administrative.....  $   832         10.6%            $    752     $ 1,721         14.2%            $ 1,507
  as a % of net revenue........     9.0%                              6.2%        7.5%                             6.5%
</TABLE>

     The increase in general and administrative expense for the three months and
six months ended December 31, 1998 from the same periods last year was primarily
attributable to increased professional services expense, primarily as a result
of being a publicly traded company and increased administrative expenses
associated with the Company's acquisition of Parallax. 
     
     The Company expects general and administrative expenses to increase in the
future, although such expenses may vary as a percentage of net revenue.

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
Other income (expense), net..... $   6           107.1%           $ (84)      $ 113           -182.5%          $ (137)
  as a % of net revenue.........  0.1%                             -0.7%       0.5%                              -0.6%
</TABLE>

     The change in other income (expense) for the three months and six months
ended December 31, 1998 from the same periods last year was principally due to
increased interest income and a reduction in foreign exchange losses, offset in
part by an increase in the allowance for doubtful accounts and amortization of
goodwill related to the Rand and Parallax acquisitions. 

                                       9


<PAGE>

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
Interest expense............     $ (183)         2.8%             $ (178)     $ (370)         7.2%             $ (345)
  as a % of net revenue.....       -2.0%                            -1.5%       -1.6%                            -1.5%
</TABLE>

     The increase in interest expense for the three months and six months ended
December 31, 1998 from the same periods last year was principally due to an
increase in the balance of the Company's debt.

<TABLE>
<CAPTION>

                                      THREE MONTHS ENDED DECEMBER 31,                SIX MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------    -----------------------------------------
                                  1998           % CHANGE           1997       1998           % CHANGE           1997  
                                 -----------------------------------------    -----------------------------------------
<S>                              <C>             <C>              <C>         <C>             <C>              <C>
Income taxes..................   $ (1,146)       -376.1%          $ 415       $ (579)         -175.7%          $ 765
  as a % of income 
  before taxes................       28.0%                         35.5%         23.4%                         35.4%
</TABLE>

     The decrease in income taxes for the three months and six month ended
December 31, 1998 from the same periods last year was primarily due to a net
loss before taxes. The change in the effective tax rate is the result of non-
deductible expenses associated with the Rand and Parallax acquisitions,
primarily acquired research and development expenses and amortization of
intangibles. 

LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION

     Historically, the Company has funded its operations primarily through cash
generated from operations. The net cash used in operations was primarily a
result of decreased payables and increased inventory and prepaid and other
assets.

<TABLE>
<CAPTION>
                                                                               SIX MONTHS ENDED DECEMBER 31,
                                                                           -------------------------------------
                                                                              1998        % CHANGE         1997
                                                                           ----------     ---------     --------
<S>                                                                         <C>           <C>           <C>
Net cash provided by (used by) operating activities...................      $ (2,555)       -294.0%      $ 1,317
</TABLE>
     
     Accounts receivable was $8.7 million at December 31, 1998, below the $8.8
million recorded at June 30, 1998. Calculated based on pattern of business
within the quarter, days sales outstanding ("DSO") were 83 days at December 31,
1998 compared to 53 at June 30, 1998. The increase in DSO is reflective of lower
levels of revenue compared to the quarter ended June 30, 1998, an increase in
the amount of sales with credit terms and sales with extended credit terms
typically given to international and OEM customers. The Company also experienced
slower than expected payments from its North American distributors as a result
of excessive levels of port replicator inventory in the North American
distribution channel. The Company expects that accounts receivable will increase
as revenue increases and as revenue from international and OEM customers
represent a higher percentage of the Company's total revenue. 

<TABLE>
<CAPTION>
                                                                               SIX MONTHS ENDED DECEMBER 31,
                                                                           -------------------------------------
                                                                              1998        % CHANGE         1997
                                                                           ----------     ---------     --------
<S>                                                                         <C>           <C>           <C>
Net cash used by investing activities.................................      $ (5,493)      222.7%       $ (1,702)
                                                            
</TABLE>

     Net cash used by investing activities in the six months ended December 31,
1998 consisted primarily of the purchase of $3,750 of available-for-sale
securities that increased the Company's overall investment return, and the cash
investments made for the acquisitions of Rand and Parallax.
     
     The Company currently plans to incur aggregate capital expenditures of
approximately $1.0 million during 1999, primarily for software, system
improvements, personal computers, technology equipment, office furnishings and
building improvements.


<TABLE>
<CAPTION>
                                                                               SIX MONTHS ENDED DECEMBER 31,
                                                                           -------------------------------------
                                                                              1998        % CHANGE         1997
                                                                           ----------     ---------     --------
<S>                                                                         <C>           <C>           <C>
Net cash provided by financing activities.............................      $ 455         252.7%        $ 129
</TABLE>

                                      10


<PAGE>

     Net cash provided by financing activities for the six months ended December
31, 1998 consisted primarily of proceeds from the issuance of Common Stock to
employees under employee stock plans, offset by payments on the Company's debt. 
     
     The Company has a $5 million uncollateralized bank revolving line of credit
that expires on November 30, 2000. Interest on borrowings is at the lenders
prime rate. There were no borrowings under this line as of December 31, 1998,
however, the line of credit requires the Company to maintain certain financial
ratios and other covenants. Although the Company was not in compliance with one
of the covenants for the three months ended December 31, 1998, the Company
obtained an amendment to the existing agreement from the lender in the form of a
permanent waiver of the covenant requirement. 
     
     The Company issued zero coupon promissory notes to certain investors on
September 30, 1992 for $4,000,000. The notes have a maturity value in September
1999 of $7,625,000 and may be converted at any time at the option of the holder
into a total of 495,810 shares of Common Stock. If held to maturity, the notes
would yield 9.25%. In addition, the Company issued 10% promissory notes in the
principal amount of $500,000 to the same investors on September 30, 1992 that
may be converted at any time prior to maturity in September 1999 at the option
of the holders into a total of 61,977 shares of Common Stock. Interest on the
10% promissory notes is paid annually in arrears.
      
     Both the zero coupon and the 10% promissory notes (the "Notes") are
subordinated in right of payment to future senior indebtedness of the Company.
In the event of a change in control, as defined in the Notes, or the sale of
substantially all of the assets of the Company, the holders may require
redemption of the Notes at the issue price plus accrued original issue discount.
The Company has a right of first refusal to purchase the Notes or, if converted,
the shares of Common Stock issued pursuant thereto..
     
     The Company believes that its existing working capital and borrowing
capacity, coupled with the funds generated from the Company's operations, will
be sufficient to fund its anticipated working capital, capital expenditures and
debt payment requirements through 1999. In the longer term, the Company may
require additional sources of liquidity to fund future growth. Such sources of
liquidity may include additional equity offerings or debt financing. In the
normal course of business, the Company evaluates acquisitions of businesses,
products and technologies that complement the Company's business. 
     
     In addition to the Rand and Parallax acquisitions, the Company intends to
continue to pursue strategic acquisitions of, or strategic investments in,
companies with complementary products, technologies or distribution networks in
order to broaden its product lines and to provide a more complete virtual
enterprise network solution. The Company has no present commitments or
agreements with respect to any such transaction, however, the Company may
acquire businesses, products or technologies in the future. There can be no
assurance that the Company will not require additional financing in the future
or, if the Company were required to obtain additional financing in the future,
that sources of capital will be available on terms favorable to the Company, if
at all.
     
YEAR 2000 COMPLIANCE
     
     Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digit year entries to distinguish 21st century dates
from 20th century dates. To address such "Year 2000" issues, the Company
established a Year 2000 Project Team which is currently in phase four of its
five-phase plan to assess the Company's Year 2000 compliance. In prior phases,
the Company identified three key areas critical to successful Year 2000
compliance: products, financial and information systems and third-party
relationships. The Company has also successfully completed testing of current
products and does not believe there is significant risk of noncompliance. In
addition, the Company has completed initial evaluation, analysis and testing of
its core internal systems and its initial assessment of the readiness of third-
party business partners, including significant vendors and customers. The
assessment of the compliance of internal systems and third party business
partners, as well as the development of appropriate contingency plans, is on-
going and is expected to continue throughout 1999. The cost of addressing the
Company's Year 2000 issues is not expected to be material. At this time, the
Company cannot reasonably estimate the potential impact on its financial
position and results of operations if key suppliers, customers and other
business partners do not become Year 2000 compliant on a timely basis. 

                                      11


<PAGE>

     Because many companies may need to upgrade or replace computer systems and
software to comply with Year 2000 requirements, the Company believes that the
purchasing patterns of customers and potential customers may be affected by Year
2000 issues as companies expend significant resources to upgrade their current
software systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase products such as those offered by the
Company, which could have a material adverse effect on the Company's business,
results of operations and cash flows.

FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK

     IN ADDITION TO THE RISK FACTORS DISCUSSED ELSEWHERE IN THIS FORM 10-Q, THE
FOLLOWING ARE IMPORTANT FACTORS WHICH COULD CAUSE ACTUAL RESULTS OR EVENTS TO
DIFFER MATERIALLY FROM THOSE CONTAINED IN ANY FORWARD-LOOKING STATEMENTS MADE BY
OR ON BEHALF OF THE COMPANY.

     POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's operating
results have fluctuated significantly in the past and are likely to fluctuate
significantly in the future on a quarterly and an annual basis. Prior growth
rates that the Company has experienced in net revenue and net income should not
be considered indicative of future growth rates. Factors that could cause the
Company's future operating results to fluctuate include the level of demand for
the Company's products, the Company's success in developing new products, the
timing of new product introductions and product enhancements by the Company and
its competitors, market acceptance of the Company's new and enhanced products,
the emergence of new industry standards, the timing of customer orders, the mix
of products sold, discontinuation of product offerings by the Company or it
suppliers, competition, the mix of distribution channels through which the
Company's products are sold and general economic conditions. Many of such
factors are beyond the Company's control.
 
     The Company typically operates with a relatively small order backlog. As a
result, quarterly sales and operating results depend in large part on the volume
and timing of orders received within the quarter, which are difficult to
forecast. A significant portion of the Company's expense levels is fixed in
advance, based in large part on the Company's forecast of future revenue. If
revenue is below expectations in any given quarter, the adverse impact of the
shortfall on the Company's operating results may be magnified by the Company's
inability to adjust spending to compensate for the shortfall. Therefore, a
shortfall in actual revenue as compared to estimated revenue could have a
material adverse effect on the Company's business, results of operations and
cash flows.
 
     A substantial majority of the Company's net revenue results from the sale
of products to distributors and original equipment manufacturers ("OEMs"), which
sales are difficult to predict and may have lower margins than sales through
other channels. Sales through such channels may contribute to increased
fluctuations in operating results. A significant portion of the Company's
revenue in any quarter is typically derived from sales to a limited number of
distributors. Any significant deferral of purchases of the Company's products by
its distributors could have a material adverse effect on the Company's business,
results of operations and cash flows in any particular period.
 
     The Company has experienced some degree of seasonality of net revenue, and
the Company expects to continue to experience seasonality in the future. Net
revenue in the first fiscal quarter typically is lower than net revenue in the
fourth fiscal quarter, reflecting lower sales in Europe and certain other
regions in the summer months when business activities are reduced.
 
     As a result of the foregoing factors, the Company's operating results may
be subject to significant volatility. It is likely that in a future period the
Company will fail to achieve anticipated operating results. Any shortfall in net
revenue, gross profit or net income from levels expected by securities analysts
in any period could have an immediate and significant adverse effect on the
trading price of the Company's Common Stock.
 
     DEPENDENCE ON RECENTLY INTRODUCED PRODUCTS. The Company's future results of
operations will be highly dependent upon the success of recently introduced
products, including Enterprise Harmony 98 data synchronization software,
Counterpoint test tools, ExtendNet VPN, ExtendNet IAS, Advantage Database Server
Version 5.0, and certain models of ExtendNet print servers. Newly introduced
products are subject to a number of risks, including failure to achieve market
acceptance and poor product performance. The Company is unable to predict with
any degree of certainty the rate of market acceptance of these newly introduced
products. No assurance can be given that any of such products will not require
additional development work, enhancement, testing or refinement before they
achieve market 

                                      12


<PAGE>

acceptance. If such new and recently introduced products have performance, 
reliability, quality or other shortcomings, then such products could fail to 
achieve market acceptance and the Company may experience reduced orders, 
higher manufacturing costs, delays in collecting accounts receivable and 
additional warranty and service expenses, which in each case could have a 
material adverse effect on the Company's business, results of operations and 
cash flows.
 
     RISKS ASSOCIATED WITH NEW AND EVOLVING MARKETS. The markets for mobile
connectivity and distributed computing solutions are still emerging, and there
can be no assurance that they will continue to grow or that, even if the markets
grow, the Company's products that address these markets will be successful. The
Company's success in generating significant revenue in these evolving markets
will depend upon, among other things, its ability to demonstrate the benefits of
its technology to potential distributors, OEMs and end users, to maintain and
enhance its relationships with leading distributors and to expand successfully
its distribution channels. The success of the ExtendNet VPN and ExtendNet IAS
products will rely, to a large degree, on the increased use of the Internet by
businesses as replacements for, or enhancements to, their private networks.

     There can be no assurance that businesses will develop sufficient
confidence in the Internet to deploy the Company's products to a significant
degree. The inability of the Company to continue to penetrate the existing
markets for mobile connectivity and distributed computing solutions or the
failure of current markets to grow or new markets to develop or be receptive to
the Company's products could have a material adverse effect on the Company's
business, results of operations and cash flows. The emergence of markets for the
Company's products will be affected by a number of factors beyond the Company's
control. For example, the Company's products are designed to conform to certain
standard infrared and networking specifications. There can be no assurance that
these specifications will be widely adopted or that competing specifications
will not emerge which will be preferred by the Company's customers. In addition,
there can be no assurance that infrared technology itself will be adopted as the
standard or preferred technology for wireless connectivity or that manufacturers
of personal computers will elect to bundle the infrared technology in their
products. The emergence of markets for the Company's products is critically
dependent upon continued expansion of the market for mobile computing devices
and the timely introduction and successful marketing and sale of mobile
computing products such as notebook computers and personal digital assistants,
of which there can be no assurance.
 
     PRODUCT CONCENTRATION. The Company believes that the ExtendNet print server
product line will continue to account for a significant portion of the Company's
net revenue and gross profit. The Company expects that its gross margin on sales
of ExtendNet print servers will continue to decline as a result of a shift in
product mix toward lower priced print servers and competitive pricing pressures.
The Company's future operating results, particularly in the near term, are
dependent upon the continued market acceptance of ExtendNet print servers. There
can be no assurance that ExtendNet print servers will continue to meet with
market acceptance or that the Company will be successful in developing,
introducing or marketing new or enhanced products. A decline in the demand for
ExtendNet print servers, as a result of competition, technological change or
other factors, or the failure to successfully develop, introduce or market new
or enhanced products could have a material adverse effect on the Company's
business, results of operations and cash flows. The life cycle of ExtendNet
print servers is difficult to estimate because of, among other factors, the
presence of strong competitors in the market and the likelihood of future
competition.
 
     RELIANCE ON DISTRIBUTION CHANNELS. The Company sells its products,
domestically and internationally, primarily to distributors and resellers and,
to a lesser extent, to OEM customers. The Company's success depends on the
continued sales efforts of its network of distributors and resellers. The loss
of, or reduction in sales to, any of the Company's key customers could have a
material adverse affect on the Company's business, results of operations and
cash flows.
 
     The Company provides most of its distributors and resellers with limited
product return rights for stock rotation. There can be no assurance that the
Company will not experience significant returns in the future or that it will
have made adequate allowances to offset such returns. The Company also provides
most of its distributors and resellers with price protection rights. Price
protection rights require that the Company grant retroactive price adjustments
for inventories of the Company's products held by distributors or resellers if
the Company lowers its prices for such products. The short life cycles of the
Company's products and the difficulty in predicting future sales increase the
risk that new product introductions, price reductions by the Company or its
competitors or other factors affecting the markets in which the Company competes
could result in significant product returns. In addition, new product
introductions by competitors or other market factors could require the Company
to reduce prices in a manner or at a time which has a material adverse impact
upon the Company's business, results of operations and cash flows.

                                      13


<PAGE>

     The Company intends to continue to enhance and diversify its international
and domestic distribution channels. None of the Company's distributors or OEMs
is obligated to purchase the Company's products except pursuant to current
purchase orders. The Company's ability to achieve future revenue growth will
depend in large part on its success in recruiting and training sufficient sales
personnel, distributors, value added resellers ("VARs") and OEM customers. Sales
to OEMs involve a number of potential risks, including lengthy sales cycles and
potential competition from OEM customers. Certain of the Company's existing
distributors currently distribute, or may in the future distribute, the product
lines of the Company's competitors. There can be no assurance that the Company
will be able to attract, train and retain a sufficient number of its existing or
future third-party distributors or direct sales personnel, that such third-party
distributors will recommend, or continue to recommend, the Company's products or
that the Company's distributors will devote sufficient resources to market and
provide the necessary customer support for such products. The Company's OEM
customers may in the future incorporate competing products into their systems or
internally develop competing solutions. In the event that the Company's OEM
customers reduce their purchases of the Company's products, the Company's future
growth would be adversely affected. All of these factors could have a material
adverse effect on the Company's business, results of operations and cash flows.
 
     COMPETITION. The markets for the Company's products are intensely
competitive, and are characterized by frequent new product introductions,
rapidly changing technology and standards, constant price pressure and
competition for distribution channels. The principal competitive factors in the
Company's markets include product performance, reliability, price, breadth of
product line, sales and distribution capability and technical support and
service. Certain of these factors are outside the Company's control. There can
be no assurance that the Company will be able to compete successfully in the
future with respect to these or any other competitive factors or that
competition will not have a material adverse effect on the Company's business,
results of operations and cash flows.
 
     RISKS OF INTERNATIONAL SALES AND OPERATIONS. The Company derives a
substantial portion of its net revenue from international sales, principally
through its international sales subsidiaries and a limited number of
distributors. The Company expects that international sales will continue to
represent a substantial portion of its net revenue for the foreseeable future.
If any significant international distributor were to cease purchasing products
or were to significantly reduce its orders from the Company for any reason, the
Company's business and operating results could be materially and adversely
affected. International sales are subject to a number of risks, including
changes in government regulations, export license requirements, tariffs and
taxes, other trade barriers, fluctuations in currency exchange rates, difficulty
in collecting accounts receivable, difficulty in staffing and managing
international operations and political and economic instability, including
instability caused by the European monetary union. Many of such factors are
beyond the Company's control.
 
     A substantial portion of the Company's international sales are typically
denominated in U.S. dollars. As a result, fluctuations in currency exchange
rates could cause the Company's products to become relatively more expensive to
customers in a particular country, leading to a reduction in sales or
profitability in that country. The Company operates subsidiaries in France,
Germany, Italy, the United Kingdom and Singapore. The transactions made through
these subsidiaries are primarily denominated in local currencies. Accordingly,
the Company's international operations impose a risk upon its business as a
result of currency exchange rate fluctuations. There can be no assurance that
exchange rate fluctuations will not have a material adverse effect on the
Company's business, results of operations and cash flows. Payment cycles for
international customers are typically longer than those for customers in the
United States. There can be no assurance that foreign markets will continue to
develop or that the Company will receive additional orders to supply its
products for use in foreign markets. 

     RISKS ASSOCIATED WITH NEW PRODUCT DEVELOPMENT. The markets for the
Company's products are characterized by rapidly changing technologies, evolving
industry standards, frequent new product introductions and short product life
cycles. The Company's future success will depend to a substantial degree upon
its ability to enhance its existing products and to develop and introduce, on a
timely and cost-effective basis, new products and features that meet changing
customer requirements and emerging and evolving industry standards. The Company
budgets research and development expenses based on planned product introductions
and enhancements; however, actual expenses may differ significantly from budget.
The product development process involves a number of risks. The development of
new, technologically advanced hardware and software products is a complex and
uncertain process requiring high levels of innovation, as well as the accurate
anticipation of technological and market trends. The introduction of new or
enhanced products also requires the Company to manage the transition from older
products in order to minimize disruption in customer ordering patterns, to avoid
excessive levels of older product inventories and to ensure that 

                                      14


<PAGE>

adequate supplies of new products can be delivered to meet customer demand. 
There can be no assurance that the Company will successfully develop, 
introduce or manage the transition to new products. The Company has in the 
past experienced, and is likely in the future to experience, delays in the 
introduction of new products, due to factors internal and external to the 
Company. Any future delays in the introduction or shipment of new or enhanced 
products, the inability of such products to achieve market acceptance or 
problems associated with new product transitions could adversely affect the 
Company's business, results of operations and cash flows.

     RISKS ASSOCIATED WITH THIRD-PARTY MANUFACTURERS AND SUPPLIERS. The
Company's future success will depend, in significant part, on its ability to
continue to have third parties manufacture its products successfully, cost-
effectively and in sufficient volumes to meet customer demand. The Company
maintains a limited in-house manufacturing capability for performing materials
procurement, final assembly, testing, quality assurance and shipping. The
Company relies primarily on independent subcontractors to manufacture its
products, and the Company intends to increase its reliance upon third-party
manufacturers in the future.

     Certain of the Company's products are manufactured in their entirety by
third parties. For example, the ExtendNet IAS is manufactured by Apexx
Technology, Inc. The reliance on third-party manufacturers involves a number of
risks, including the potential inability to obtain an adequate supply of
existing and new products and reduced control over delivery schedules, product
quality and product cost. In this regard, in December 1998, the Company
announced its decision to exit the pot replicator business. This decision was
based, in part, on quality problems associated with the sole supplier of this
product. The decision to exit the port replicator business was the primary cause
of the decline in the Company's net revenue in the three months ended December
31, 1998. There can be no assurance that the Company will not experience similar
problems with other suppliers in the future. In the event that the Company is
unable to maintain good relationships with its third-party manufacturers there
could be a material adverse effect on the Company's business, results of
operations and cash flows. 
     
     From time to time the Company has agreed with certain suppliers that the
Company will purchase certain components exclusively from such suppliers.
Because the manufacturing of the Company's products can involve long lead times,
in the event of unanticipated increases in demand for the Company's products,
the Company could be unable to manufacture certain products in a quantity
sufficient to meet its customers' demands. The Company also relies on third
party suppliers for components used in its products. Certain of the components
used in the Company's products, including certain semiconductor components and
infrared transmission components, are currently available from a limited number
of suppliers. Any inability to obtain adequate deliveries or other circumstances
that would require the Company to seek alternative manufacturers could affect
the Company's ability to ship its products on a timely basis, which could damage
relationships with current and prospective customers and end users and could
therefore have a material adverse affect on the Company's business, results of
operations and cash flows.
 
     DEPENDENCE ON LICENSED TECHNOLOGY. The Company licenses technology on a
non-exclusive basis from several companies for use with its products and
anticipates that it will continue to do so in the future. The inability of the
Company to continue to license this technology or to license other necessary
technology for use with its products, or substantial increases in royalty
payments pursuant to third-party licenses, could have a material adverse effect
on the Company's business, results of operations and cash flows. In addition,
the effective implementation of the Company's products depends upon the
successful operation of this licensed software in conjunction with the Company's
products, and therefore any undetected errors in products resulting from such
software may prevent the implementation or impair the functionality of the
Company's products, delay new product introductions and injure the Company's
reputation. Such problems could have a material adverse effect on the Company's
business, results of operations and cash flows.

     PRODUCT ERRORS; PRODUCT LIABILITY. Software and hardware products as
complex as those offered by the Company typically contain undetected errors when
first introduced or as new versions are released. Testing of the Company's
products is particularly challenging because it is difficult to simulate the
wide variety of computing environments in which the Company's customers may
deploy these products. Accordingly, there can be no assurance that, despite
testing by the Company and by current and potential customers, errors will not
be found after commencement of commercial shipments. Any such errors, or "bugs,"
could result in dissatisfied customers and the loss of or delay in market
acceptance of the new product, any of which could have a material adverse effect
upon the Company's business, results of operations and cash flows. Although to
date the Company has not experienced any material product liability claims,
there can be no assurance that the Company will not face material product
liability claims in the future. A successful product liability claim brought
against the Company could have a material adverse effect upon the Company's
business, results of operations and cash flows.

                                      15


<PAGE>

     MANAGEMENT OF GROWTH. Any future growth experienced by the Company is
likely to place a significant strain on the Company's administrative,
operational and financial resources and to increase demands on the Company's
systems and controls. Future growth may also result in an increase in the scope
of responsibility for management personnel. The Company anticipates that growth
and expansion will require it to recruit, hire, train and retain a substantial
number of new engineering, executive, sales and marketing personnel. As is the
case with many technology companies, in the current employment environment the
Company has experienced difficulty in recruiting qualified personnel, and
continued difficulty in this regard could limit the Company's ability to grow.
In order to manage its growth successfully, the Company will continue to expand
and improve its operational, management and financial systems and controls.
There can be no assurance that the Company will successfully implement such
systems and controls on a timely basis. If the Company's management is unable to
manage growth effectively, the Company's business, results of operations and
cash flows could be materially adversely affected.
 
     RISKS ASSOCIATED WITH ACQUISITIONS BY THE COMPANY. As part of its growth
strategy, the Company intends to continue to pursue the acquisition of companies
that either complement or expand its existing business, as the Company did with
its acquisitions of Rand and Parallax. The Company is continually evaluating
potential acquisition opportunities, which may be material in size and scope.
Acquisitions involve a number of risks and difficulties, including the expansion
into new markets and business areas, the diversion of management's attention to
the assimilation of the operations and personnel of the acquired companies, the
integration of the acquired companies' management information systems with those
of the Company, potential adverse short-term effects on the Company's operating
results, the amortization of acquired intangible assets and the need to present
a unified corporate image. In addition, acquisitions could result in the need to
expend substantial amounts of cash. While the Company believes that it has
sufficient funds to finance its operations for at least the next 12 months, to
the extent that such funds are insufficient to fund the Company's activities,
including any potential acquisitions, the Company may need to raise additional
funds through public or private equity or debt financing or from other sources.
The sale of additional equity or convertible debt may result in additional
dilution to the Company's shareholders and such securities may have rights,
preferences or privileges senior to those of the Company's Common Stock. There
can be no assurance that additional equity or debt financing will be available
or that, if available, it can be obtained on terms favorable to the Company or
its shareholders.
 
     There can be no assurance that the Company will be successful in
identifying acquisition candidates, that the Company will have adequate
resources to consummate any acquisition, that any acquisition by the Company
will or will not occur, that if any acquisition does occur it will not have a
material adverse effect on the Company's business, results of operations and
cash flows or that any such acquisition will be successful in enhancing the
Company's business.
     
     PROPRIETARY RIGHTS AND RISKS OF INFRINGEMENT. There can be no assurance
that any patent, trademark or copyright owned by the Company will not be
invalidated, circumvented or challenged, that the rights granted thereunder will
provide competitive advantages to the Company or that any of the Company's
pending or future patent applications will be issued with the scope of the
claims sought by the Company, if at all. Further, there can be no assurance that
others will not develop technologies that are similar or superior to the
Company's technology, duplicate the Company's technology or design around the
patents owned by the Company. Effective intellectual property protection may be
unavailable or limited in certain foreign countries. There can be no assurance
that the steps taken by the Company will prevent misappropriation of its
technology by foreign companies.
 
     If the Company were found to be infringing on the intellectual property
rights of any third party, the Company could be subject to liabilities for such
infringement, which could be material. As a result, the Company could be
required to seek licenses from other companies or to refrain from using,
manufacturing or selling certain products or using certain processes. Although
holders of patents and other intellectual property rights often offer licenses
to their patent or other intellectual property rights, no assurance can be given
that licenses would be offered, that the terms of any offered license would be
acceptable to the Company or that the failure to obtain a license would not
adversely affect the Company's business, results of operations and cash flows.
 
     In order to protect its proprietary rights, the Company may in the future
initiate proceedings against third parties. Any litigation, whether brought by
or against the Company, could result in the incurrence of significant expenses
by the Company. In addition, any such litigation could result in a diversion of
management's time and efforts. A claim by the Company against a third party
could prompt a counterclaim by the third party against the Company, 

                                      16


<PAGE>

which could have an adverse effect on the Company's intellectual property 
rights. Any of the foregoing could result in a material adverse effect on the 
Company's business, results of operations and cash flows.
 
     DEPENDENCE ON KEY PERSONNEL. The Company's future success will depend to a
significant degree upon the continuing contributions of its key management,
engineering, sales and marketing personnel. The Company does not maintain any
key person life insurance policies. The loss of key management or technical
personnel could adversely affect the Company. The Company believes that its
future success will depend in large part upon its ability to attract and retain
highly skilled management, engineering, sales and marketing personnel. In
particular, the Company is currently attempting to recruit new engineering
personnel; however, there can be no assurance that the Company will be
successful at hiring or retaining these personnel. Failure to recruit, hire,
train and retain key personnel would limit future growth and could have a
material adverse effect on the Company's business, results of operations and
cash flows. 
 
     STOCK PRICE VOLATILITY. The trading price of the Company's Common Stock
could be subject to wide fluctuations in response to quarter-to-quarter
variations in operating results, announcements of technological innovations or
new products by the Company or its competitors, general conditions in the
computer industry, changes in earnings estimates or recommendations by analysts,
or other events or factors. In addition, the public stock markets have
experienced extreme price and trading volume volatility in recent months. This
volatility has significantly affected the market prices of securities of many
technology companies for reasons that may be unrelated to the operating
performance of the specific companies. These broad market fluctuations may
adversely affect the market price of the Company's Common Stock. 
 
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     All of the Company's long-term debt is at fixed interest rates and,
therefore, the fair value of these instruments is affected by changes in market
interest rates. The Company believes that the market risk arising from its
holdings of financial instruments is minimal. 

     The Company derives a substantial portion of its revenue from international
sales, principally through its international subsidiaries in Germany, France,
Italy, the United Kingdom and Singapore and through a limited number of
independent distributors. Sales made by the Company's international subsidiaries
are generally denominated in the country's local currency with the exception of
Singapore whose functional currency is U.S. dollars. Fluctuations in exchange
rates between the U.S. dollar and other currencies could materially affect the
Company's financial condition, results of operations and cash flows. To the
extent that the Company implements hedging activities in the future with respect
to currency transactions, there can be no assurance that the Company will be
successful in such hedging activities. 


PART II.  OTHER INFORMATION

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

     The Company's 1998 Annual Meeting of Shareholders was held on November 5,
1998. At the meeting, the following matters were submitted to a vote of the
shareholders:

(a)  The following nominees for Class III Directors were elected. Each person
     elected as a Class III Director will serve for a three-year term that
     expires upon the 2001 Annual Meeting of Shareholders or until their
     successors are duly elected and qualified.

<TABLE>
<CAPTION>
                                                       VOTES WITH
     NAME OF NOMINEE             VOTES FOR         AUTHORITY WITHHELD
     ---------------             ---------         ------------------
<S>                              <C>               <C>
     Raymond A. Smelek           5,781,278             116,427
     S. Scott Wald               5,782,344             115,361
</TABLE>

                                      17


<PAGE>

(a)  The ratification and appointment of PricewaterhouseCoopers LLP as 
     independent public accountants of the Company for the year ended 
     June 30, 1999 was approved:  5,892,430 votes in favor; 1,599 votes 
     against; 3,677 abstentions; and no broker non-votes.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  EXHIBITS
     
     10.23     Employment Agreement between the Company and Thomas C. White, as
               amended November 25, 1998
     10.24     Employment Agreement between the Company and Holmes T. Lundt, as
               amended November 25, 1998
     10.25     Employment Agreement between the Company and Scott J. Ritchie, as
               amended November 25, 1998
     27.1      Financial Data Schedule
     
(b)  REPORTS ON FORM 8-K

     The Company filed no reports on Form 8-K during the three months ended
December 31, 1998.
     
     
ITEMS 1, 2, 3, AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.

                                      18


<PAGE>
                                     SIGNATURE
                                          
Pursuant to the requirements of the Securities Exchange Act of 1923, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                       Extended Systems Incorporated



                                       By:   /s/ Karla K. Rosa
                                             -------------------------
                                             Karla K. Rosa
                                             Vice President, Finance
                                             Chief Financial Officer

                                             (Principal Financial and 
                                             Accounting Officer
                                             and Duly Authorized Officer)

                                     19