<PAGE>

================================================================================

                                  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, 2001

                                       OR

[_]  Transition Report under Section 13 or 15(d) of the Securities Exchange Act
     of 1934

                           Commission File No.: 1-5270

                              SOFTNET SYSTEMS, INC.
                              ---------------------
             (Exact name of registrant as specified in its charter)

           Delaware                                   11-1817252
           --------                                   ----------
(State or other jurisdiction of           (I.R.S. Employer Identification No.)
 incorporation or organization)

650 Townsend Street, Suite 225, San Francisco, California            94103
---------------------------------------------------------            -----
       (Address of principal executive offices)                   (Zip Code)

       Registrant's telephone number, including area code: (415) 354-3900
                                                           --------------

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

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

              Class                   Outstanding at December 31, 2001
              -----                   --------------------------------
   Common stock, $0.01 par value                  25,171,275

================================================================================

<PAGE>

                     SoftNet Systems, Inc. and Subsidiaries
                                      Index

<TABLE>
<CAPTION>
                                                                                                                   Page
                                                                                                                   ----
<S>                                                                                                                <C>
PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

         Condensed Consolidated Balance Sheets as of December 31, 2001, and September 30, 2001 ..................   2

         Condensed Consolidated Statements of Operations for the three months ended December 31, 2001 and
           2000 .................................................................................................   3

         Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2001 and
           2000 .................................................................................................   4

         Notes to Condensed Consolidated Financial Statements ...................................................   5

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations ..................   9

Item 3   Quantitative and Qualitative Disclosures About Market Risk .............................................  13

PART II- OTHER INFORMATION

Item 1   Legal Proceedings ......................................................................................  14

Item 2   Changes in Securities ..................................................................................  14

Item 3   Defaults Upon Senior Securities ........................................................................  14

Item 4   Submission of Matters to a Vote of Security Holders ....................................................  14

Item 5   Other Information ......................................................................................  15

Item 6   Exhibits and Reports on Form 8-K .......................................................................  23
</TABLE>

                                       -1-

<PAGE>

PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements

                     SoftNet Systems, Inc. and Subsidiaries
                      Condensed Consolidated Balance Sheets
                        (In thousands, except share data)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                         December 31,           September 30,
                                                                             2001                   2001
                                                                             ----                   ----
<S>                                                                      <C>                    <C>
                                       ASSETS

Current assets:
   Cash and cash equivalents .........................................    $  25,411              $  14,960
   Short-term investments, available-for-sale ........................       46,332                 60,494
   Accounts receivable, net of allowance for doubtful
     accounts of $99 and $123, respectively ..........................        2,158                  2,060
   Inventory, net ....................................................          463                    537
   Other current assets ..............................................          966                  1,364
                                                                          ---------              ---------

Total current assets .................................................       75,330                 79,415

Restricted cash ......................................................        2,492                  2,492
Property and equipment, net of accumulated depreciation
  of $1,334 and $1,281, respectively .................................        2,067                  2,335
Accounts receivable, non current portion .............................        1,093                  1,583
Long-term equity investments .........................................        1,484                  1,484
Other assets .........................................................          187                    217
                                                                          ---------              ---------

                                                                          $  82,653              $  87,526
                                                                          =========              =========

                         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable ..................................................    $     475              $     696
   Net liabilities associated with discontinued operations ...........        3,554                  4,159
   Restructuring accrual .............................................        1,364                  1,752
   Other accrued expenses ............................................        1,784                  3,029
   Current portion of long-term debt .................................        1,444                  1,444
                                                                          ---------              ---------

Total current liabilities ............................................        8,621                 11,080
                                                                          ---------              ---------

Commitments and contingencies

Stockholders' equity:
   Preferred stock, $0.10 par value, 3,970,000 shares
     designated, no shares issued and outstanding ....................            -                      -
   Common stock, $0.01 par value, 100,000,000 shares
     authorized; 27,461,775 and 27,461,775 shares issued;
     25,171,275 and 25,171,275 shares outstanding,
     respectively ....................................................          275                    275
   Additional-paid-in capital ........................................      477,680                477,680
   Deferred stock compensation .......................................       (1,222)                (1,645)
   Accumulated other comprehensive loss ..............................         (537)                  (480)
   Accumulated deficit ...............................................     (393,027)              (390,247)
   Treasury stock, at cost, 2,290,500 and 2,290,500 shares,
     respectively ....................................................       (9,137)                (9,137)
                                                                          ---------              ---------

Total stockholders' equity ...........................................       74,032                 76,446
                                                                          ---------              ---------

                                                                          $  82,653              $  87,526
                                                                          =========              =========
</TABLE>

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

                                       -2-

<PAGE>

                     SoftNet Systems, Inc. and Subsidiaries
                 Condensed Consolidated Statements of Operations
                      (In thousands, except per share data)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                      Three Months Ended December 31,
                                                                                      -------------------------------
                                                                                        2001                   2000
                                                                                        ----                   ----
<S>                                                                                   <C>                   <C>
Net sales .........................................................................   $    851               $  1,395
Cost of sales .....................................................................        757                  1,346
                                                                                      --------               --------

   Gross profit ...................................................................         94                     49
                                                                                      --------               --------

Operating expenses:
   Selling and marketing ..........................................................        130                  1,175
   Engineering, exclusive of non-cash compensation expense of $18 and $44,
     respectively .................................................................        441                  1,726
   General and administrative, exclusive of non-cash compensation expense
     (benefit) of $405 and $(333), respectively ...................................      1,680                  3,518
   Depreciation ...................................................................        196                    385
   Amortization ...................................................................          -                    575
   Non-cash compensation expense (benefit) related to stock options ...............        423                   (289)
   Restructuring expense ..........................................................          -                  3,900
                                                                                      --------               --------

Total operating expenses ..........................................................      2,870                 10,990
                                                                                      --------               --------

Loss from continuing operations before other income (expense), income taxes and
   discontinued operations ........................................................     (2,776)               (10,941)

Other income (expense):
   Interest income ................................................................        618                  2,649
   Interest expense ...............................................................        (28)                   (48)
   Equity in net losses of investee companies .....................................          -                   (374)
   Miscellaneous expense, net .....................................................         (4)                  (340)
                                                                                      --------               --------

Loss from continuing operations before income taxes and discontinued operations ...     (2,190)                (9,054)

Provision for income taxes ........................................................          -                      -
                                                                                      --------               --------

Loss from continuing operations before discontinued operations ....................     (2,190)                (9,054)

Discontinued Operations:
   Loss on disposition ............................................................       (590)                     -
                                                                                      --------               --------

Net loss ..........................................................................   $ (2,780)              $ (9,054)
                                                                                      ========               ========

Basic and diluted loss per common share:
   Loss from continuing operations applicable to common shares ....................   $  (0.09)              $  (0.36)
   Discontinued operations ........................................................      (0.02)                     -
                                                                                      --------               --------
   Net loss applicable to common shares ...........................................   $  (0.11)              $  (0.36)
                                                                                      ========               ========

Shares used to compute basic and diluted loss per common share ....................     25,171                 24,997
                                                                                      ========               ========
</TABLE>

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

                                       -3-

<PAGE>

                     SoftNet Systems, Inc. and Subsidiaries
                 Condensed Consolidated Statements of Cash Flows
                                 (In thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                      Three Months Ended December 31,
                                                                                      -------------------------------
                                                                                        2001                   2000
                                                                                        ----                   ----
<S>                                                                                   <C>                    <C>
Cash flows from operating activities:
   Net loss .......................................................................   $ (2,780)              $ (9,054)
   Adjustments to reconcile net loss to net cash used in operating activities:
     Loss on disposition of discontinued operations ...............................        590                      -
     Provision for restructuring costs ............................................          -                  3,900
     Depreciation and amortization ................................................        196                    960
     Amortization of deferred stock compensation expense (benefit) ................        423                   (289)
     Amortization of deferred debt issuance costs .................................          -                      7
     Provision for (reversal of) doubtful accounts ................................        (24)                    51
     Provision for inventory losses ...............................................          -                     87
     Loss on disposition of property and equipment ................................         72                      -
     Equity in net losses of investee companies ...................................          -                    374
     Loss on disposition of equity investment, net ................................          -                     18
     (Gain) loss on disposition of other short-term investment ....................         (6)                     1
     Changes in operating assets and liabilities (net of effect of acquisitions
       and discontinued operations):
       Decrease in accounts receivable, net .......................................        416                    353
       Decrease (increase) in inventory ...........................................         74                 (2,030)
       Decrease in other current assets ...........................................        398                    540
       Decrease in other assets ...................................................         30                      7
       Decrease in accounts payable and accrued expenses ..........................     (1,854)                  (447)
                                                                                      --------               --------

Net cash used in operating activities of continuing operations ....................     (2,465)                (5,522)
Net cash used in operating activities of discontinued operations ..................     (1,119)               (22,734)
                                                                                      --------               --------

Net cash used in operating activities .............................................     (3,584)               (28,256)
                                                                                      --------               --------

Cash flows from investing activities:

   Proceeds from maturities and sales of short-term investments, net ..............     14,095                 17,194
   Proceeds from sale of property and equipment ...................................          4                      -
   Payments for purchase of equity investments ....................................          -                   (783)
   Payment for purchase of property and equipment .................................         (4)                  (715)
                                                                                      --------               --------

Net cash provided by investing activities of continuing operations ................     14,095                 15,696
Net cash used in investing activities of discontinued operations ..................          -                 (2,806)
                                                                                      --------               --------

Net cash provided by investing activities .........................................     14,095                 12,890
                                                                                      --------               --------

Cash flows from financing activities:
   Payment for purchase of treasury stock .........................................          -                 (6,858)
   Principal payments of long-term debt ...........................................          -                   (660)
                                                                                      --------               --------

Net cash used in financing activities of continuing operations ....................          -                 (7,518)
Net cash used in financing activities of discontinued operations ..................        (60)                (1,678)
                                                                                      --------               --------

Net cash used in financing activities .............................................        (60)                (9,196)
Foreign exchange effect on cash and cash equivalents ..............................          -                     28
                                                                                      --------               --------

Net increase (decrease) in cash and cash equivalents ..............................     10,451                (24,534)
Cash and cash equivalents, beginning of period ....................................     14,960                 44,731
                                                                                      --------               --------

Cash and cash equivalents, end of period ..........................................   $ 25,411               $ 20,197
                                                                                      ========               ========
</TABLE>

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

                                       -4-

<PAGE>

                     SoftNet Systems, Inc. and Subsidiaries
              Notes to Condensed Consolidated Financial Statements

1. Basis of Presentation

   The financial information included herein is unaudited; however, such
   information reflects all adjustments (consisting solely of normal recurring
   adjustments, except as otherwise noted) which are, in the opinion of
   management, necessary for a fair presentation of the condensed consolidated
   statements of financial position, results of operations, and cash flows as of
   and for the interim periods ended December 31, 2001 and 2000.

   SoftNet Systems, Inc.'s annual report on Form 10-K for the year ended
   September 30, 2001, as amended and filed with the Securities and Exchange
   Commission, should be read in conjunction with the accompanying condensed
   consolidated financial statements. The condensed consolidated balance sheet
   as of September 30, 2001 was derived from SoftNet Systems, Inc. and
   subsidiaries (the "Company") audited consolidated financial statements.

   The results of operations for the three months ended December 31, 2001 are
   based in part on estimates that may be subject to year-end adjustments and
   are not necessarily indicative of the results to be expected for the full
   year.

2. Discontinued Operations

   Discontinued Operations of Aerzone Corporation ("Aerzone")

   On December 19, 2000, the Company decided to discontinue the Aerzone business
   in light of significant long-term capital needs and the difficulty of
   securing the necessary financing because of the current state of the
   financial markets. The loss from discontinued operations includes
   management's estimates of the remaining costs to wind down the business and
   costs to settle its outstanding liabilities. As of December 31, 2001, Aerzone
   had substantially wound down its activities. The assets and liabilities of
   such operations are reflected as net liabilities associated with discontinued
   operations of Aerzone in the accompanying condensed consolidated balance
   sheets as of December 31, 2001, and September 30, 2001.

   Net liabilities associated with discontinued operations of Aerzone as of
   December 31, 2001, and September 30, 2001, are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                        December 31,    September 30,
                                                                            2001             2001
                                                                            ----             ----
        <S>                                                            <C>              <C>
        Current assets:
           Other current assets .....................................  $             -  $           22
                                                                       ---------------  --------------
        Total current assets ........................................                -              22

        Other assets ................................................                -               2
                                                                       ---------------  --------------
        Total assets ................................................  $             -  $           24
                                                                       ===============  ==============

        Current liabilities:
           Estimated closure costs ..................................  $         1,663  $        2,039
           Accrued expenses .........................................               48              54
           Laptop Lane Limited acquisition reserve ..................               27              27
                                                                       ---------------  --------------
        Total liabilities ...........................................  $         1,738  $        2,120
                                                                       ===============  ==============
        Net liabilities associated with discontinued operations .....  $         1,738  $        2,096
                                                                       ===============  ==============
</TABLE>

   Discontinued Operations of ISP Channel, Inc. ("ISP Channel")

   On December 7, 2000, the Company's Board of Directors approved a plan to
   discontinue providing cable-based Internet services through its ISP Channel
   subsidiary by December 31, 2000, because of (1) consolidation in the cable
   television industry made it difficult for ISP Channel to achieve the
   economies of scale necessary to provide such services profitably, and (2) the
   Company was no longer able to bear the costs of maintaining the ISP Channel.
   The loss from discontinued operations includes management's estimates of the
   remaining costs to wind down the business, costs to settle its outstanding
   liabilities, and the proceeds from the sale of assets. As of December 31,
   2001, ISP Channel had substantially wound down its activities. The assets and
   liabilities of such operations are reflected as net liabilities associated
   with discontinued operations of ISP Channel in the accompanying condensed

                                       -5-

<PAGE>

   consolidated balance sheets as of December 31, 2001, and September 30, 2001.

   Net liabilities associated with discontinued operations of ISP Channel as of
   December 31, 2001, and September 30, 2001, are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                        December 31,    September 30,
                                                                            2001             2001
                                                                            ----             ----
        <S>                                                            <C>              <C>
        Current assets:
           Short-term investments, available-for-sale ...............  $            20  $           20
           Other current assets .....................................                1               2
                                                                       ---------------  --------------
        Total assets ................................................  $            21  $           22
                                                                       ===============  ==============

        Current liabilities:
           Accrued expenses .........................................  $           398  $          422
           Estimated closure costs ..................................              849           1,663
                                                                       ---------------  --------------
        Total liabilities ...........................................  $         1,247  $        2,085
                                                                       ===============  ==============
        Net liabilities associated with discontinued operations .....  $         1,226  $        2,063
                                                                       ===============  ==============
</TABLE>

   Discontinued Operations of Micrographic Technology Corporation ("MTC")

   As a result of a preliminary arbitration decision related to a dispute with
   Applications Informatiques Multimedia and a dispute related to the sale of
   MTC to Global Information Distribution GmbH ("GID"), the Company recorded the
   $590,000 estimated loss on disposal reserve of MTC for the three months ended
   December 31, 2001. MTC was previously owned by the Company, and was sold to
   GID on September 30, 1999. The estimated loss on disposal reserve of MTC is
   reflected in net liabilities associated with discontinued operations of the
   condensed consolidated balance sheet as of December 31, 2001, and the
   corresponding charge is reflected in loss on disposal of discontinued
   operations on the condensed consolidated statement of operations for the
   three months ended December 31, 2001.

3. Restructuring Charge

   On December 28, 2000, the Company's Board of Directors approved a plan to
   reduce its corporate headquarters staff in conjunction with discontinuing the
   Aerzone and ISP Channel businesses. As a result of this plan, the Company
   established a $3,900,000 restructuring reserve, which consists primarily of
   severance costs for affected employees, and is reflected in restructuring
   accrual on the condensed consolidated balance sheet as of December 31, 2001,
   and September 30, 2001. Through December 31, 2001, $2,880,000 of severance
   payments has been applied to this reserve. The remainder of $1,020,000 will
   be utilized for severance for identified employees and lease termination
   costs associated with Company headquarters.

   In an effort to bring Intelligent Communications, Inc. ("Intellicom") to
   profitability, the Company initiated an overall cost cutting program and
   organizational restructuring during May 2001. As a result of the
   organizational restructuring, the Company established a $1,290,000
   retructuring reserve, which consists of severance costs for affected
   employees and shut down costs for certain offices, and is reflected in
   restructuring accrual on the condensed consolidated balance sheet as of
   December 31, 2001. Through December 31, 2001, $946,000 of severance payments,
   and write offs of leasehold improvements and office furniture related to the
   various offices have been applied to this reserve. The remainder of $344,000
   will be utilized for severance for identified employees and lease termination
   obligations related to the various offices.

4. Cash, Cash Equivalents and Short-Term Investments, Available-for-Sale

   Cash equivalents consist of securities with maturities of three months or
   less at date of purchase. Short-term investments, available-for-sale are
   carried at fair value based on quoted market prices. Net unrealized holding
   losses amounted to $537,000 , which is based on market value as of December
   31, 2001, and is reflected in accumulated other comprehensive loss on the
   condensed consolidated balance sheet as of December 31, 2001.

                                       -6-

<PAGE>

   Short-term investments, available-for-sale as of December 31, 2001, consist
   of $46,281,000 of debt securities that mature between one to five years, and
   $51,000 of common stock. Cash, cash equivalents and short-term investments,
   available-for-sale consisted of the following as of December 31, 2001 (in
   thousands):

<TABLE>
<CAPTION>
                                                                           Unrealized      Unrealized
                                                               Cost            Gain           Loss           Market
                                                               ----            ----           ----           ------
        <S>                                                <C>            <C>             <C>            <C>
        Cash and cash equivalents:
           Cash .........................................  $       1,240  $            -  $           -  $        1,240
           Money market funds ...........................         24,171               -              -          24,171
                                                           -------------  --------------  -------------  --------------
                                                           $      25,411  $            -  $           -  $       25,411
                                                           =============  ==============  =============  ==============

        Short-term investments, available-for-sale:
           Market auction securities ....................  $      45,501  $            -  $          (1) $       45,500
           Corporate debt securities ....................          1,100               -           (319)            781
           Common stock .................................            268               -           (217)             51
                                                           -------------  --------------  -------------  --------------
                                                           $      46,869  $            -  $        (537) $       46,332
                                                           =============  ==============  =============  ==============
</TABLE>

5. Commitments and Contingencies

   Legal Proceedings

   On September 26, 2001, Lucent Technologies Inc. ("Lucent") brought an action
   in San Francisco Superior Court against the Company, alleging that the
   Company breached a contract by failing to purchase Lucent's shares in
   Freewire Networks, Inc. ("Freewire") and claiming damages of approximately
   $3.5 million, which may be subject to increase over time. On December 31,
   2001, the San Francisco Superior Court issued an order to deny Lucent's
   application for writ of attachment, finding that Lucent had not shown a
   substantial probability that it will prevail on its claim. The Company
   continues to believe that Lucent's claims are without merit and will contest
   these claims vigorously.

   On November 9, 2001, Nokia, Inc. ("Nokia") commenced an action in San
   Francisco Superior Court against the Company and Aerzone, alleging breach of
   contract arising out of the Aerzone's proposed operations in certain
   airports. Nokia seeks approximately $2.1 million in damages. The Company
   believes that Nokia's claims are without merit and intends to contest these
   claims vigorously.

   The Company is also involved in other legal proceedings and claims, which
   arise in the ordinary course of its continuing and discontinued businesses.
   The Company believes the results of the above noted legal proceedings, other
   pending legal proceedings and claims are not expected to have a material
   adverse effect on its results of operations, financial condition or cash
   flows.

6. Comprehensive Loss

   The components of comprehensive loss for the three months ended December 31,
   2001 and 2000, are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                       Three Months Ended December 31,
                                                                       -------------------------------
                                                                            2001            2000
                                                                            ----            ----
        <S>                                                            <C>             <C>
        Net loss                                                       $       (2,780) $       (9,054)
        Unrealized loss on securities                                             (73)         (1,995)
        Foreign currency translation adjustments                                   16              28
                                                                       --------------  --------------
        Comprehensive loss                                             $       (2,837) $      (11,021)
                                                                       ==============  ==============
</TABLE>

                                       -7-

<PAGE>

7. Supplemental Cash Flow Information

   The supplemental cash flow information for the three months ended December
   31, 2001 and 2000, is as follows (in thousands):

<TABLE>
<CAPTION>
                                                                                            Three Months Ended December 31,
                                                                                            -------------------------------
                                                                                                 2001            2000
                                                                                                 ----            ----
   <S>                                                                                      <C>             <C>
   Cash paid :
      Interest ..........................................................................   $           82  $            17
      Income taxes ......................................................................                -                -

   Non-cash investing and financing activities:

      Decrease in additional-paid-in capital associated with termination of common
        stock options ...................................................................                -           (4,265)
      Unrealized loss on short-term investments .........................................              (73)          (1,995)
</TABLE>

8. Segment Information

   The Company currently operates one business segment that provides
   satellite-based Internet services through its wholly owned subsidiary,
   Intellicom. Accordingly, no additional segment information is disclosed in
   the accompanying notes to consolidated financial statements.

                                       -8-

<PAGE>

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

This Form 10-Q contains forward-looking statements that involve risks and
uncertainties. The actual results of the Company could differ significantly from
those set forth herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Factors
Affecting the Company's Operating Results" as set forth in the Company's annual
report on Form 10-K for the year ended September 30, 2001, as filed with the
Securities and Exchange Commission, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" as well as those discussed
elsewhere in this quarterly report. Statements contained herein that are not
historical facts are forward-looking statements that are subject to the safe
harbor created by the Private Securities Litigation Reform Act of 1995. Words
such as "believes", "anticipates", "expects", "intends", "estimates",
"likelihood", "unlikelihood", "assessment", and "foreseeable" and other similar
expressions are intended to identify forward-looking statements, but are not the
exclusive means of identifying such statements. A number of important factors
could cause our actual results for the year ending September 30, 2002, and
beyond to differ materially from past results and those expressed or implied in
any forward-looking statements made by us, or on our behalf. We undertake no
obligation to release publicly the results of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.

The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with, and is qualified in its entirety
by reference to, the Consolidated Financial Statements of the Company and the
related Notes thereto appearing in our annual report on Form 10-K for the year
ended September 30, 2001, as filed with the Securities and Exchange Commission
and our Condensed Consolidated Financial Statements and related Notes thereto
appearing elsewhere in this quarterly report.

Overview

On December 7, 2000, the Company's Board of Directors approved a plan to
discontinue its ISP Channel operations because of (1) the consolidation in the
cable industry made it difficult for ISP Channel to achieve the economies of
scale necessary to provide such services profitably, and (2) the Company was no
longer able to bear the costs of maintaining the ISP Channel. Subsequently on
December 19, 2000, the Company's Board of Directors approved a plan to
discontinue its Aerzone business in light of, among other things, significant
long-term capital needs and the difficulty of securing the necessary financing
because of the financial markets. In conjunction with discontinuing the ISP
Channel and Aerzone businesses, the Company's Board of Directors on December 28,
2000, approved a plan to reduce its corporate headquarters staff.

As a result of the Company's Board of Directors decisions, the Company wound
down the ISP Channel and Aerzone businesses, and reduced its corporate
headquarters staff. As of December 31, 2001, the ISP Channel and Aerzone
businesses, including Laptop Lane Limited, were substantially wound down.
Additionally, the Company has retained Bear, Stearns & Co., Inc. to assist in
exploring the Company's strategic options. On November 26, 2001, the Company
announced that the exploration was expanding to include transactions that would
focus on the Company's cash resources and status as a publicly traded company on
the NASDAQ National Market in addition to potential partners expecting to use
the Company's net operating losses in the near term. The Company has received
numerous inquiries in responsse to its November 26, 2001, press release
announcing the expansion of its scope in exploration of strategic partners. The
Company continues to expect to make a decision by March 31, 2002.

While the Company is exploring strategic options, the Company currently conducts
its continuing operations through its wholly owned subsidiary, Intellicom, which
provides two-way broadband satellite connectivity utilizing very small aperture
terminal ("VSAT") technology to a wide variety of business customers. Although
Intellicom has grown in the Latin American marketplace, Intellicom has sustained
losses since its acquisition on February 9, 1999. In an effort to reduce
Intellicom losses, the Company initiated an overall cost cutting program and
organizational restructuring during May 2001, which includes the elimination of
certain departments and closure of selected offices.

Revenue for Intellicom consists primarily of (i) monthly service fees paid by
customers for satellite service on a per VSAT basis, (ii) VSAT-related equipment
sales, and (iii) from time to time, contract termination fees from customers.

Cost of sales for Intellicom consists primarily of connectivity cost and costs
of VSAT equipment sold. Intellicom's

                                       -9-

<PAGE>

connectivity cost consists primarily of satellite transponder fees. Currently,
Intellicom has transponder space on one satellite, Satelites Mexicanos, S.A. DE
C.V. ("SatMex") 5, which provides coverage over the continental United States
and Latin America.

The Company reports operating expenses in several categories: (i) selling and
marketing includes, in addition to the costs of selling and marketing the
Company's services to end users, customer care and content production; (ii)
engineering, which includes the costs of maintaining and manning the network
operations center, field engineering and information technology; and (iii)
general and administrative costs. Also included in operating expenses is
depreciation, amortization and compensation expense related to stock options.
Amortization expense includes the periodic write off of developed technology
acquired. Compensation related to stock options relates primarily to the
amortization of deferred stock compensation resulting from below market value
stock options granted between October 1998 and March 1999.

Results of Continuing Operations for the Three Months Ended December 31, 2001,
Compared to the Three Months Ended December 31, 2000

Net Sales. Consolidated net sales decreased $544,000, or 39%, to $851,000 for
---------
the three months ended December 31, 2001, compared to $1,395,000 for the three
months ended December 31, 2000. Net sales from Intellicom's core business of
satellite-based Internet services decreased $107,000, or 16%, to $553,000 for
the three months ended December 31, 2001, as compared to $660,000 for the three
months ended December 31, 2000, primarily as a result of a reduction in the
number of customers. Equipment sales decreased $282,000, or 56%, to $224,000 for
the three months ended December 31, 2001, compared to $506,000 for the three
months ended December 31, 2000, primarily as a result of decreased VSAT
equipment sales. Other sources of sales decreased $155,000 to $74,000 for the
three months ended December 31, 2001, compared to $229,000 for the three months
ended December 31, 2000, primarily as a result of collocation revenue for the
three months ended December 31, 2000, offset by transponder sublease income for
the three months ended December 31, 2001.

Cost of Sales. Consolidated cost of sales decreased $589,000, or 44%, to
-------------
$757,000 for the three months ended December 31, 2001, compared to $1,346,000
for the three months ended December 31, 2000. The largest component of
Intellicom's cost of sales is transponder fees, which decreased to $639,000 for
the three months ended December 31, 2001, compared to $885,000 for the three
months ended December 31, 2000, primarily due to the termination of the GE
Americom transponder space lease on June 15, 2001. Intellicom's equipment costs
decreased $307,000 to $86,000 for the three months ended December 31, 2001,
compared to $393,000, primarily as a result of decreased VSAT equipment sales
and reduction of the write down of inventory to market value.

Selling and Marketing. Consolidated selling and marketing expenses decreased
---------------------
$1,045,000, or 89%, to $130,000 for the three months ended December 31, 2001,
compared to $1,175,000 for the three months ended December 31, 2000.

Intellicom's selling and marketing expenses decreased $948,000, or 88%, to
$130,000 for the three months ended December 31, 2001, compared to $1,078,000
for the three months ended December 31, 2000, primarily due to reduced expenses
resulting from staff reductions associated with the May 2001 organizational
restructuring.

Corporate incurred no selling and marketing expenses for the three months ended
December 31, 2001, compared to $97,000 for the three months ended December 31,
2000, as a result of eliminating the public relations department associated with
the December 28, 2000, corporate restructuring plan.

Engineering. Consolidated engineering expenses decreased $1,285,000, or 74%, to
-----------
$441,000 for the three months ended December 31, 2001, as compared to $1,726,000
for the three months ended December 31, 2000.

Intellicom's engineering expenses decreased $977,000, or 69%, to $441,000 for
the three months ended December 31, 2001, compared to $1,418,000 for the three
months ended December 31, 2000, primarily due to reduced expenses resulting from
staff reductions associated with the May 2001 organizational restructuring.

Corporate incurred no engineering expenses for the three months ended December
31, 2001, compared to $308,000 for the three months ended December 31, 2000, as
a result of eliminating the corporate technology department associated with the
December 28, 2000, corporate restructuring plan.

General and Administrative. Consolidated general and administrative expenses
--------------------------
decreased $1,838,000, or 52%, to $1,680,000 for the three months ended December
31, 2001, compared to $3,518,000 for the three months ended December 31, 2000.

                                      -10-

<PAGE>

Intellicom's general and administrative expenses decreased $638,000, or 72%, to
$253,000 for the three months ended December 31, 2001, compared to $891,000 for
the three months ended December 31, 2000, primarily due to reduced expenses
resulting from staff reductions associated with the May 2001 organizational
restructuring.

Corporate general and administrative expenses decreased $1,200,000, or 46%, to
$1,427,000 for the three months ended December 31, 2001, compared to $2,627,000
for the three months ended December 31, 2000, primarily due to reduced expenses
resulting from staff reductions associated with the December 28, 2000, corporate
restructuring plan.

Depreciation and Amortization. Consolidated depreciation and amortization
-----------------------------
expenses decreased $764,000, or 80%, to $196,000 for the three months ended
December 31, 2001, compared to $960,000 for the three months ended December 31,
2000.

Intellicom's depreciation and amortization expense decreased $730,000, or 85%,
to $131,000 for the three months ended December 31, 2001, compared to $861,000
for the three months ended December 31, 2000, primarily due to no amortization
expense since March 31, 2001, as a result of the write off of the intangible
asset associated with the developed technology from the acquisition of
Intellicom, and reduced depreciation expense resulting from the write off of
abandoned and disposed property.

Corporate depreciation and amortization expense decreased $34,000, or 35%, to
$65,000 for the three months ended December 31, 2001, compared to $99,000 for
the three months ended December 31, 2000, primarily due to reduced depreciation
expense resulting from sales of property and write off of disposed property.

Non-Cash Compensation Expense/Benefit Related to Stock Options. The Company
--------------------------------------------------------------
recognized a non-cash compensation expense related to stock options of $423,000
for the three months ended December 31, 2001, compared to non-cash compensation
benefit related to stock options of $289,000 for the three months ended December
31, 2000. For the three months ended December 31, 2001 and 2000, non-cash
compensation expense/benefit related to stock options issued to employees.

Non-cash compensation benefits are recognized following the reversal of
previously accrued expenses in respect to stock option terminations as result of
corporate restructuring. Non-cash compensation expense related to stock options
should continue to decrease or generate a benefit, as the Company continues to
reduce its staff due to its discontinued operations and corporate restructuring.

Restructuring Expense. The Company recognized a restructuring expense of
---------------------
$3,900,000 for the three months ended December 31, 2000, related to a plan to
downsize its corporate headquarters staff. At December 31, 2001, restructuring
accruals of $1,020,000 and $344,000 remain outstanding for corporate and
Intellicom, respectively.

Interest Income. Consolidated interest income decreased $2,031,000, or 77%, to
---------------
$618,000 for the three months ended December 31, 2001, compared to $2,649,000
for the three months ended December 31, 2000, as a result of lower interest
rates, and decrease in cash, cash equivalents, and short-term investments,
available-for-sale.

Interest Expense. Consolidated interest expense decreased $20,000, or 42%, to
----------------
$28,000 for the three months ended December 31, 2001, compared to $48,000 for
the three months ended December 31, 2000. This decrease is primarily due to the
reduction of interest expense payment of the 8.5% promissory note to the former
Intellicom stockholders.

Equity in Net Losses of Investee Companies. The Company recognized equity in net
------------------------------------------
losses of investee companies of $374,000 for the three months ended December 31,
2000. The Company did not incur any equity in net losses of investee companies
for the three months ended December 31, 2001, as a result of the sale and write
offs of investee companies accounted for under the equity method for the year
ended September 30, 2001.

Miscellaneous Expense, Net. Consolidated miscellaneous expense decreased
--------------------------
$336,000 to $4,000 for the three months ended December 31, 2001, compared to
consolidated miscellaneous expense of $340,000 for the three months ended
December 31, 2000. This decrease is primarily due to losses incurred from the
disposal of property for the three months ended December 31, 2000.

Income Taxes. The Company made no provision for income taxes for the three
------------
months ended December 31, 2001 and 2000, as a result of the Company's continuing
losses.

Loss Attributed to Discontinued Operations. As a result of a preliminary
------------------------------------------
arbitration decision related to a dispute with Applications Informatiques
Multimedia and a dispute related to the sale of MTC to GID, the Company

                                      -11-

<PAGE>

recorded the $590,000 loss on disposal of MTC for the three months ended
December 31, 2001. MTC was previously owned by the Company, and was sold to GID
on September 30, 1999.

Net Loss. The Company had a net loss of $2,780,000, or a net loss per share of
--------
$0.11, for the three months ended December 31, 2001, compared to a net loss of
$9,054,000, or a net loss per share of $0.36, for the three months ended
December 31, 2000.

Liquidity and Capital Resources

Since September 1998, the Company has funded the significant negative cash flows
from its subsidiary operating activities and the associated capital expenditures
through a combination of public and private equity sales, convertible debt
issues and equipment leases. As of December 31, 2001, the Company had
$71,743,000 in cash, cash equivalents, and short-term investments compared with
$75,454,000 as of September 30, 2001.

Net cash used in operating activities of continuing operations for the three
months ended December 31, 2001, was $2,465,000. This results from, a net loss of
$2,190,000 from continuing operations, offset by several non-cash items
including amortization of deferred stock compensation expense of $423,000,
depreciation expense of $196,000, a net decrease in operating assets of
$1,004,000, and a net decrease in operating liabilities of $1,854,000. Net cash
used in operating activities of discontinued operations was $1,119,000.

Net cash provided by investing activities of continuing operations for the three
months ended December 31, 2001, was $14,095,000, and was primarily provided by
proceeds from maturities and sales of short-term investments, net of purchases.
No cash was provided by or used in investing activities of discontinued
operations.

No cash was provide by or used in financing activities for the three months
ended December 31, 2001. Net cash used in financing activities of discontinued
operations was $60,000.

The Company believes it has sufficient cash to meet its presently anticipated
business requirements over the next twelve months including the funding of
operating losses, discontinued operations, working capital requirements, and
capital investments. The Company expects continued reductions in cash usages
from its discontinued operating activities for the year ending September 30,
2002.

                                      -12-

<PAGE>

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

The Company's exposure to market risk for changes in interest rates relates
primarily to the increase or decrease in the amount of interest income the
Company can earn on its investment portfolio, and on the increase or decrease in
the amount of interest expense the Company must pay with respect to its various
outstanding debt instruments. The risk associated with fluctuating interest
expense is limited, however, to the exposure related to those debt instruments
and credit facilities, which are tied to market rates. The Company does not use
derivative financial instruments or engage in hedging activities in its
investment portfolio. The Company ensures the safety and preservation of its
invested principal funds by limiting default risks, market risk and reinvestment
risk. The Company mitigates default risk by investing in safe and high-credit
quality securities.

The Company had short-term investments of $46,332,000 at December 31, 2001.
Except for investments in common and preferred stock, these short-term
investments consist of highly liquid investments with original maturities at the
date of purchase of between three and twenty-three months. These investments are
subject to interest rate risk and will fall in value if market interest rates
increase. The Company believes a hypothetical increase in market interest rates
by 10% from levels at December 31, 2001, would cause the fair value of these
short-term investments to fall by an immaterial amount. Since the Company is not
required to sell these investments before maturity, it has the ability to avoid
realizing losses on these investments due to a sudden change in market interest
rates. On the other hand, declines in the interest rates over time will reduce
its interest income.

The Company had outstanding convertible debt of approximately $1,444,000 at
December 31, 2001. This instrument has a fixed interest rate of 5.0%. Because
the interest rate of this instrument is fixed, a hypothetical 10% increase in
interest rates will not have a material effect on the Company. Interest rate
increases, however, will increase interest expense associated with future
borrowings by the Company, if any. The Company does not hedge against interest
rate fluctuations.

Currency Exchange Risk

The Company has historically had very low exposure to changes in foreign
currency exchange rates, and as such, has not used derivative financial
instruments to manage foreign currency fluctuation risk. If the Company were to
expand globally, the risk of foreign currency exchange rate fluctuations would
increase. Therefore, in the future, the Company may consider utilizing
derivative instruments to mitigate such risks.

                                      -13-

<PAGE>

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

On September 26, 2001, Lucent brought an action in San Francisco Superior Court
against the Company, alleging that the Company breached a contract by failing to
purchase Lucent's shares in Freewire and claiming damages of approximately $3.5
million, which may be subject to increase over time. On December 31, 2001, the
San Francisco Superior Court issued an order to deny Lucent's application for
writ of attachment, finding that Lucent had not shown a substantial probability
that it will prevail on its claim. The Company continues to believe that
Lucent's claims are without merit and will contest these claims vigorously.

On November 9, 2001, Nokia commenced an action in San Francisco Superior Court
against the Company and Aerzone, alleging breach of contract arising out of the
Aerzone's proposed operations in certain airports. Nokia seeks approximately
$2.1 million in damages. The Company believes that Nokia's claims are without
merit and intends to contest these claims vigorously.

The Company is also involved in other legal proceedings and claims, which arise
in the ordinary course of its continuing and discontinued businesses. The
Company believes the results of the above noted legal proceedings, other pending
legal proceedings and claims are not expected to have a material adverse effect
on its results of operations, financial condition or cash flows.

Item 2. Changes in Securities

Not Applicable

Item 3. Defaults upon Senior Securities

Not Applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not Applicable

                                      -14-

<PAGE>

Item 5. Other Information

                Factors Affecting the Company's Operating Results

The risks and uncertainties described below are not the only ones that the
Company faces. Additional risks and uncertainties not presently known to the
Company or that the Company currently deems immaterial may also impair the
Company's business operations. If any of the following risks actually occur, the
Company's business, financial condition or results of operations could be
materially adversely affected. In such case, the trading price of the Company's
common stock could decline, and you may lose all or part of your investment.

                                  Company Risks

The Company Is Exploring Strategic Options and the Direction of the Company Is
Unclear

The Company has retained Bear, Stearns & Company to assist in exploring the
Company's strategic options. On November 26, 2001, the Company announced that
the exploration was expanding to include transactions, which would focus on the
Company's cash resources and status as a publicly traded company on the NASDAQ
National Market in addition to potential partners expecting to use the Company's
net operating losses in the near term. The Company has received numerous
inquiries in response to its November 26, 2001, press release announcing the
expansion of its scope in exploration of strategic partners. No assurance can be
given as to the results of this exploration or as to the future direction of the
Company.

The Company Has a Limited History of Operating Internet Businesses, which May
Make It Difficult to Evaluate the Company's Performance and Prospects

Any evaluation of the Company's businesses will be difficult because of its
limited operating history in the Internet access and services business. The
Company acquired Intellicom on February 9, 1999. Prior to 1996, the Company did
not have any experience in businesses related to the Internet or high
technology, and since the decision to terminate the operations of ISP Channel
and Aerzone in December 2000, the nature of the Company's business has changed.
As a result, the Company's historical financial information may not be
indicative of the Company's future results, and the Company's prospects are
difficult to predict and may change rapidly.

In addition, the Company confronts all of the challenges and uncertainties
encountered by growing, early-stage companies, particularly companies in the new
and rapidly evolving international market for Internet connectivity, access and
related services. These challenges include the Company's ability to:

     .  Increase the services purchased from the Company by its customers and
        the amount of revenue the Company receives from each of its customers;
     .  Satisfy the changing needs of the Company's existing and future
        customers;
     .  Acquire, develop and market new Internet services;
     .  Respond to the changing needs of the Internet access and content
        delivery market;
     .  Expand Intellicom's international customer base;
     .  Develop and maintain strategic and business relationships;
     .  Capitalize on the Company's early entrant status; and
     .  Recruit and retain key personnel.

The Company Has a History of Losses and Expects to Incur Losses in the Future

The Company has sustained substantial losses over the last five fiscal years and
expects to continue to report net losses for the foreseeable future. For the
three months ended December 31, 2001, the Company had a net loss of $2,780,000.
As of December 31, 2001, the Company had an accumulated deficit of $393,027,000.
The Company expects to incur additional losses and experience negative cash
flows related to capital expenditures, sales and marketing, and general and
administrative expenses as Intellicom expands its satellite-based Internet
services. These efforts may be more expensive than the Company currently
anticipates. The Company cannot guarantee it will ever achieve profitability or
reduce its accumulated deficit.

The Company May Not Generate Sufficient Cash Flows to Support Its Expenses

The Company's current expense levels are to a large extent fixed on expectations
of future revenues. In addition, the Company may be unable to adjust spending
quickly enough to compensate for any unexpected revenue shortfall. As a result,
the Company may not be able to grow its revenues quickly enough to absorb these
expenses.

                                      -15-

<PAGE>

If the Company Is Unable to Successfully Integrate Future Acquisitions into the
Company's Operations, then the Company's Results and Financial Condition May Be
Adversely Affected

The Company may acquire other businesses. The Company cannot predict if or when
any prospective acquisitions will occur or the likelihood that they will be
completed on favorable terms. Acquiring a business involves many risks,
including:

     .    Disruption of the Company's ongoing business and diversion of
          resources and management time;
     .    Dilution to existing stockholders if the Company uses equity
          securities to finance acquisitions;
     .    Incurrence of unforeseen obligations or liabilities;
     .    Inability of management to maintain uniform standards, controls,
          procedures and policies;
     .    Difficulty assimilating the acquired operations and personnel;
     .    Risks of entering markets in which the Company has little or no direct
          prior experience; and
     .    Impairment of relationships with employees or customers as a result of
          changes in management.

The Company cannot assure that it will make any acquisitions or that it will be
able to obtain additional financing for such acquisitions, if necessary. If any
acquisitions are made, the Company cannot assure that it will be able to
successfully integrate the acquired business into its operations or that the
acquired business will perform as expected.

The Company's Equity Investments in Other Companies May Not Yield Any Returns

The Company has made equity investments in Internet-related companies, including
joint ventures in other countries. In most instances, these investments are in
the form of unregistered securities of private companies. These companies
typically are in an early stage of development and may be expected to incur
substantial losses. The Company's investments in these companies may not yield
any return. Furthermore, if these companies are not successful, the Company
could incur and have incurred charges related to the write-down or write-off of
assets. The Company also records and continues to record a share of the net
losses in these companies, up to the Company's cost basis. The Company may make
additional investments in the future. Losses or charges resulting from these
investments could harm the Company's operating results.

The Company's Stock Price Is Volatile

The volatility of the Company's stock price may make it difficult for holders of
the common stock to transfer their shares at the prices they want. The market
price for the Company's common stock has been volatile in the past, and several
factors could cause the price to fluctuate substantially in the future. These
factors include:

     .    Announcements of developments related to the Company's business;
     .    Fluctuations in the Company's results of operations;
     .    Sales of substantial amounts of the Company's securities in the
          marketplace;
     .    General conditions in the Company's industries or the worldwide
          economy;
     .    An outbreak of war or hostilities;
     .    A shortfall in revenues or earnings compared to securities analysts'
          expectations;
     .    Changes in analysts' recommendations or projections;
     .    Announcements of new products or services by the Company or the
          Company's competitors; and
     .    Changes in the Company's relationships with the Company's suppliers or
          customers.

The market price of the Company's common stock may fluctuate significantly in
the future, and these fluctuations may be unrelated to the Company's
performance. General market price declines or market volatility in the future
could adversely affect the price of the Company's common stock, and thus, the
current market price may not be indicative of future market prices.

Prospective Anti-Takeover Provisions Could Negatively Impact the Company's
Stockholders

The Company is a Delaware corporation. Delaware General Corporation Law contains
certain provisions that may discourage, delay or make a change in control of the
Company more difficult or prevent the removal of incumbent directors. In
addition, the Company's certificate of incorporation and bylaws has certain
provisions that have the same effect. These provisions may have a negative
impact on the price of the Company's common stock and may discourage third-party
bidders from making a bid for the Company or may reduce any premiums paid to
stockholders for their common stock.

                                      -16-

<PAGE>

                                Intellicom Risks

Intellicom May Fail if Its Industry as a Whole Fails or Its Products and
Services Do Not Gain Commercial Acceptance

It has become feasible to offer Internet services using satellites on a broad
scale only recently. There is no proven commercial acceptance of satellite-based
Internet services. It is currently very difficult to predict whether these
companies will become viable. The failure of the broadband Internet services
industry to evolve in the manner in which it is currently contemplated could
adversely affect the Company's business, financial condition and prospects.

The success of Intellicom will depend upon the willingness of new and existing
subscribers to pay the monthly fees and installation costs associated with the
service, and to purchase or lease the equipment necessary to access the
Internet. Accordingly, the Company cannot predict whether Intellicom's pricing
models will be viable, whether demand for Intellicom's services will materialize
at the prices they expect to charge, or whether current or future pricing levels
will be sustainable. If Intellicom does not achieve or sustain such pricing
levels or if their services do not achieve or sustain broad market acceptance,
then the Company's business, financial condition, and prospects will be
materially adversely affected.

An Interruption in the Supply of Products and Services that Intellicom Obtains
From Third Parties Could Cause a Decline in Sales of Intellicom Services

In designing, developing and supporting Intellicom's Internet services,
Intellicom relies extensively on third parties. In particular, Intellicom relies
on satellite providers, satellite dish manufacturers, Internet hardware
manufacturers and systems integrators to help build its networks. These
suppliers may experience difficulty in supplying Intellicom with products and
services sufficient to meet the needs of Intellicom or they may terminate or
fail to renew contracts for supplying these products and services to Intellicom
on terms that it finds acceptable. Any significant interruption in the supply of
any of these products or services could cause a decline in sales of Intellicom's
services.

Intellicom Derives a Significant Portion of Its Revenues From Providing
Equipment and Internet Services to a Limited Number of Customers which Presents
Credit Risks and Could Cause Increased Expenses or Losses of Future Revenue

For the three months ended December 31, 2001, sales to Intellicom's largest
customer, Tricom, S.A. ("Tricom"), accounted for approximately 53% of
Intellicom's net revenue, and as of December 31, 2001, Tricom accounted for
approximately 93% of Intellicom's total accounts receivable. Intellicom expects
that a small number of customers will continue to account for a significant
portion of its revenue for the foreseeable future. If any one of Intellicom's
customers, especially Tricom, discontinues its relationship for any reason,
Intellicom may suffer a significant reduction to its future revenue and may
incur significant losses, and adversely effect its financial condition and
prospects.

Intellicom Depends on Third-Party Carriers to Maintain Its Networks and Any
Interruption of Its Operations due to the Failure to Maintain Such Networks
Would Have a Material Adverse Effect on the Company's Business, Financial
Condition and Prospects

Intellicom's success will depend upon the capacity, reliability and security of
the network used to carry data between its subscribers and the Internet. Third
parties own a portion of the network used by Intellicom, and accordingly,
Intellicom is reliant upon these third parties for its quality and maintenance.
Currently, Intellicom has transit agreements with MCIWorldCom, Pacific Bell, and
others to support the exchange of traffic between its network operations center
and the Internet. In addition, Intellicom has agreements with SatMex for
satellite transponder space. The failure of any link in the delivery chain
resulting in an interruption of Intellicom's operations would have a material
adverse effect on the Company's business, financial condition and prospects.

Intellicom's Services May Be Subject to Downward Pricing Pressures, which Would
Negatively Impact Its Financial Results

The market for Internet access in the United States is subject to downward
pricing pressure caused by a number of factors, including increased competition
and technological advances. Pricing pressures outside the United States, in the
markets Intellicom serves, may develop as international Internet access and
services become more available. To operate, Intellicom has certain costs, such
as its lease of satellite transmission capacity, which are relatively fixed
and generally not susceptible to downward pricing pressure. As a result,
Intellicom has little flexibility in lowering

                                      -17-

<PAGE>

the price for its services. If Intellicom is affected by downward pricing
pressure, it cannot assure that it will be able to offer Internet services at
prices that are competitive or profitable.

Intellicom Has a Lengthy and Complex Sales Cycle, which May Require It to Commit
Significant Resources Prior to Receiving Revenues

Intellicom targets large enterprises and governmental entities as ideal
customers. Because the purchase of Intellicom's products and services is a
significant investment for its customer base, Intellicom's customers generally
take a long time to evaluate Intellicom's products and services. Intellicom
expects that most of its customers will evaluate its products and services in a
process involving multiple people and departments. In addition, Intellicom's
customers may have concerns about the introduction or announcement of new
products, services and technologies, whether by Intellicom or by others, as well
as requests for product or service enhancements. Accordingly, Intellicom has and
expects to continue to expend significant resources educating prospective
customers about the uses and benefits of its services. Intellicom's limited
historical experience indicates that its sales cycle can range from three months
to nine months, although the cycle could be longer due to significant delays
over which Intellicom has little or no control, such as the budgeting and
approval process of its customers. As a result of this long sales cycle,
Intellicom may take a substantial amount of time to generate revenue from sales
efforts. In addition, any delay in selling Intellicom's products and services
could lead prospective customers to find alternatives from a competitor or to
develop an in-house solution. Further, Intellicom may spend a significant amount
of time and money on a potential customer that ultimately does not purchase its
services.

If Intellicom Is Unable to Maintain, Expand and Adapt Its Network
Infrastructure, the Demand for Its Services May Decrease

Intellicom must continue to expand and adapt its network as the number of its
international customers grows, as users place increasing demands on its network,
and as other requirements change. As Intellicom grows its customer base, it may
not be able to provide its customers with the increasing levels of data
transmission capacity that they may require for a number of reasons, such as
Intellicom's possible inability to raise the funds needed to develop the network
infrastructure to maintain adequate transmission speeds and the lack of
additional network availability from third-party suppliers of satellite and
fiber optic cable transmission capacity. Intellicom's failure to achieve or
maintain high capacity transmissions could significantly reduce demand for its
services, decreasing its revenue and harming its business and financial results.

If Intellicom Fails to Accurately Predict Its Satellite Bandwidth Requirements
and Effectively Manage Its Fixed Costs, the Company's Operating Results Will
Suffer

If Intellicom does not obtain adequate satellite bandwidth capacity on
acceptable terms and realize corresponding customer volume for this bandwidth,
it is unlikely that Intellicom will achieve profitability. Intellicom purchases
this bandwidth capacity based on its projected future needs on a fixed-price
basis in advance of the sale of its services that utilize the bandwidth.
Substantially all of this bandwidth capacity can be purchased only on a
long-term basis. Intellicom sells its services on the basis of actual usage and
total bandwidth capacity used by its customers, which changes from month to
month and is difficult to predict. If Intellicom's sales fail to match its
projections, it could be subject to periods of excess satellite capacity, which
could seriously harm its business. As a result, Intellicom must obtain enough
bandwidth to meet its projected customer needs, and Intellicom must realize
adequate volume from its customers to support and justify the bandwidth capacity
and expense. If demand from existing or potential customers exceeds Intellicom's
capacity, the quality of its service may suffer or Intellicom may be unable to
capitalize on potential business opportunities. If that happens, Intellicom may
lose existing or potential customers and its operating results would suffer.

                                      -18-

<PAGE>

Problems Associated with Operating in International Markets Could Prevent
Intellicom From Achieving or Sustaining Its Intended Growth

The majority of Intellicom's business will be derived from entities located in
foreign countries. Intellicom's failure to manage its international operations
effectively would limit the future growth of its business. Intellicom faces
certain inherent challenges in conducting international operations, such as:

     .    Changes in telecommunications regulatory requirements or trade
          barriers restricting Intellicom's ability to deliver Internet services
          to its customers;
     .    The imposition of unanticipated fees, taxes and costs by foreign
          governments, which could significantly increase Intellicom's costs;
     .    Political and economic instability disrupting the operations of
          Intellicom's customers;
     .    Protectionist laws and business practices favoring local competition
          potentially giving unequal bargaining leverage to competitors; and
     .    Currency fluctuations increasing the cost of its services to its
          international customers.

Intellicom's failure to adequately respond to any of these challenges could
seriously harm its operations and prospects.

Any Damage or Failure that Causes Interruptions in Intellicom's Operations Could
Have a Material Adverse Effect on Its Business, Financial Condition and
Prospects

Intellicom's operations are dependent upon its ability to support a highly
complex network and avoid damages from fires, earthquakes, floods, power losses,
telecommunications and satellite failures, network software flaws, transmission
cable cuts and similar events. The occurrence of any one of these events could
cause interruptions in the services Intellicom provides. In addition, the
failure of an incumbent local exchange carrier or other service provider to
provide the communications capacity Intellicom requires, as a result of a
natural disaster, operational disruption or any other reason, could cause
interruptions in the services Intellicom provides. Any damage or failure that
causes interruptions in Intellicom's operations could have a material adverse
effect on the Company's business, financial condition and prospects.

Intellicom May Be Vulnerable to Unauthorized Access, Computer Viruses and Other
Disruptive Problems, which May Result in Intellicom's Liability to Its Customers
and May Deter Others From Becoming Customers

While Intellicom has taken substantial security measures, its networks may be
vulnerable to unauthorized access, computer viruses and other disruptive
problems. Internet service providers and online service providers have
experienced in the past, and may experience in the future, interruptions in
service as a result of the accidental or intentional actions of Internet users.
Unauthorized access by current and former employees or others could also
potentially jeopardize the security of confidential information stored in
Intellicom's computer systems and those of its customers. Such events may result
in Intellicom's liability to its customers and may deter others from becoming
customers, which could have a material adverse effect on the Company's business,
financial condition and prospects.

Intellicom May Face Potential Liability for Defamatory or Indecent Content,
which May Cause It to Modify the Way It Provides Services

Any imposition of liability on Intellicom for information carried on the
Internet could have a material adverse effect on the Company's business,
financial condition and prospects. The law relating to liability of Internet
service providers and online service providers for information carried on or
disseminated through their networks is currently unsettled. A number of lawsuits
have sought to impose such liability for defamatory speech and indecent
materials. Congress has attempted to impose such liability, in some
circumstances, for transmission of obscene or indecent materials. In one case, a
court has held that an online service provider could be found liable for
defamatory matter provided through its service, on the ground that the service
provider exercised active editorial control over postings to its service.
Because of the potential liability for materials carried on or disseminated
through Intellicom's systems, the Company may have to implement measures to
reduce its exposure to such liability. Such measures may require the expenditure
of substantial resources or the discontinuation of certain products or services.

                                      -19-

<PAGE>

Intellicom May Face Potential Liability for Information Retrieved and Replicated
that May Not Be Covered by Its Insurance

Intellicom's liability insurance may not cover potential claims relating to
providing Internet services or may not be adequate to indemnify Intellicom for
all liability that may be imposed. Any liability not covered by insurance or in
excess of insurance coverage could have a material adverse effect on
Intellicom's business, financial condition and prospects. Because subscribers
download and redistribute materials that are cached or replicated by Intellicom
in connection with its Internet services, claims could be made against
Intellicom under both United States and foreign law for defamation, negligence,
copyright or trademark infringement, or other theories based on the nature and
content of such materials. These types of claims have been successfully brought
against online service providers. In particular, copyright and trademark laws
are evolving both domestically and internationally, and it is uncertain how
broadly the rights provided under these laws will be applied to online
environments. It is impossible for Intellicom to determine who the potential
rights holders may be with respect to all materials available through its
services. In addition, a number of third-party owners of patents have claimed to
hold patents that cover various forms of online transactions or online
technology. As with other online service providers, patent claims could be
asserted against Intellicom based upon its services or technologies.

Third Parties May Claim that Intellicom's Product Infringes on Their
Intellectual Property, which Could Result in Significant Expenses for Litigation
or for Developing or Licensing New Technology

The Internet and telecommunications industries are characterized by the
existence of a large number of patents and frequent litigation based on
allegations of patent infringement or other violations of intellectual property
rights. Third parties may assert claims that Intellicom's current or future
products, networks or ways of doing business infringe on their intellectual
property. Intellicom cannot predict whether third parties will assert these
types of claims against Intellicom or against the licensors of technology
licensed to Intellicom. Intellicom cannot predict whether such assertions would
harm its business.

If Intellicom is required to defend against these types of claims, whether they
are with or without merit or whether they are resolved in favor of or against
Intellicom or its licensors, it may face costly litigation and diversion of
management's attention and resources. As a result of these disputes, Intellicom
may have to develop or otherwise obtain non-infringing technology or enter into
licensing agreements, any of which may be costly.

A Perceived or Actual Failure by Intellicom to Achieve or Maintain High Speed
Data Transmission Could Significantly Reduce Consumer Demand for Its Services
and Have a Material Adverse Effect on the Company's Business, Financial
Condition and Prospects

Because Intellicom has only been operational for a relatively short period of
time, its ability to connect and manage a substantial number of online
subscribers at high transmission speeds is unknown. Intellicom faces risks
related to its ability to scale up to expected subscriber levels while
maintaining superior performance. The actual downstream data transmission speeds
for each customer may be slower and will depend on a variety of factors,
including:

     .    Actual speed provisioned for the customer's equipment;
     .    Quality of the server used to deliver content;
     .    Overall Internet traffic congestion;
     .    The number of active customers on the network at the same time; and
     .    The service quality of the networks of its customers.

The actual data delivery speeds realized by customers may be significantly lower
than peak data transmission speeds and will vary depending on the customers'
hardware, operating system and software configurations. Intellicom cannot
provide assurances that it will be able to achieve or maintain data transmission
speeds high enough to attract and retain its planned number of subscribers,
especially as the number of subscribers to its services grows. Consequently, a
perceived or actual failure by Intellicom to achieve or maintain high speed data
transmission could significantly reduce consumer demand for its services and
have a material adverse effect on the Company's business, financial condition
and prospects.

Intellicom May Not Be Able to Keep Pace With Rapid Technological Changes or
Emerging Industry Standards that Could Make Its Services Obsolete and
Unmarketable

Intellicom's services may become less useful to its customers if it is unable to
respond to technological advances that shape the Internet, or available
alternative technologies and services. Keeping pace with technological advances
in Intellicom's industry may require substantial expenditures and lead-time. In
addition, future advances in

                                       -20-

<PAGE>

technology or fundamental changes in the way Internet access or other Internet
services can be delivered may render Intellicom's services obsolete or less
cost-competitive. Intellicom may not be able to adequately respond to or
incorporate technological advances on a cost-effective or timely basis into its
business.

The Internet Industry Operates in an Uncertain Legal Landscape and the Adoption
or Interpretation of Future or Existing Regulations Could Harm Intellicom's
Business

The Internet and the markets in which Intellicom offers its Internet services
are relatively new. Many of the laws and regulations that govern Intellicom and
the Internet have yet to be interpreted or enforced. It is likely that in the
future many new laws will take effect that will regulate the Internet and the
markets in which the Company operates. The applicability to the Internet of
existing laws governing issues such as property ownership, copyrights and other
intellectual property issues, taxation and tariffs, libel, consumer protection,
obscenity, pricing and personal privacy is uncertain. Current and future laws
and regulations may:

     .    Decrease the growth of the Internet;
     .    Regulate its customers in ways that harm its ability to sell its
          services to them;
     .    Decrease demand for its services; and
     .    Impose taxes or other costly requirements or otherwise increase the
          cost of doing business.

Thus, the adoption and interpretation of any future or existing regulations
could seriously harm Intellicom's business.

The Legal Environment in which Intellicom Operates is Uncertain and Claims
Against Intellicom and Other Legal Uncertainties Could Cause Its Business to
Suffer

Because most of Intellicom's business is conducted outside the United States,
Intellicom is susceptible to the governmental regulations and legal
uncertainties of foreign countries. In general, the laws of countries outside
the United States governing the Internet and Internet services, to the extent
they exist at all, vary widely, are unclear and in flux and have failed to keep
pace with the rapid advancements in Internet technology and the expanding range
of Internet-based services being offered. Partly because of these problems, and
Intellicom's view that local regulatory compliance is a greater issue of concern
for its ISP customers, Intellicom has not, and currently does not intend to,
determine conclusively whether it complies with the requirements of any
particular foreign country.

Any one of the countries where Intellicom conducts business, may require that
Intellicom (i) is qualified to do business in that particular country, (ii) is
liable for certain taxes or tariffs, (iii) is otherwise subject to regulation or
(iv) is prohibited from conducting its business in that foreign country. Thus,
Intellicom cannot assure that it is currently in compliance with the legal
requirements of any particular country or all of the countries outside the
United States in which it conducts business, that Intellicom will be able to
comply with any such requirements or that the requirements will not change in a
way that would render the receipt of its services in a particular country
illegal. Intellicom's failure to comply with foreign laws and regulations could
cause it to lose customers, restrict it from entering profitable markets and
seriously harm its business.

Intellicom's customers also face many of the governmental and legal
uncertainties that Intellicom faces and currently are, or in the future may
become, subject to many of the same requirements to which Intellicom may be
subject. Intellicom makes no effort to determine whether its customers comply
with applicable regulations. The failure of Intellicom's customers to comply
with applicable laws and regulations could cause it to lose customers or
otherwise seriously harm its business.

                                       -21-

<PAGE>

                                ISP Channel Risks

The Company May Face Unexpected Liabilities in Winding Down the Business of ISP
Channel

The Company has determined that it is in the best interests of the Company and
its shareholders to wind down the business of ISP Channel. While the business of
ISP Channel has been substantially wound down, there can be no assurance that
all claims and issues have been resolved. In addition, the Company may face
litigation with respect to the wind down of its activities.

                                  Aerzone Risks

The Company May Face Unexpected Liabilities in Winding Down the Business of
Aerzone

The Company has determined that it is in the best interests of the Company and
its shareholders to wind down the business of Aerzone. While the business of
Aerzone has been substantially wound down, there can be no assurance that all
claims and issues have been resolved. In addition, the Company may face
litigation with respect to the wind down of its activities.

                                       -22-

<PAGE>

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

(a)  Exhibits

     Exhibit
          No.
          ---

                             Description of Document
                             -----------------------

             3.1   Amended and Restated Certificate of Incorporation of the
                   Registrant. Incorporated by reference to the Company's
                   Quarterly Report on Form 10-Q for the quarterly period ended
                   June 30, 1999.

             3.2   By-Laws of the Company. Incorporated by reference to the
                   Company's Registration Statement on Form S-3/A dated April
                   22, 1999.

(b)  Reports on Form 8-K:

     Not Applicable

                                       -23-

<PAGE>

                                   SIGNATURES
                                   ----------

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

SOFTNET SYSTEMS, INC.



/s/ Edward A. Bennett                           Date: January 22, 2002
-------------------------------------------           ----------------
Edward A. Bennett
Acting Chairman of the Board of Directors


/s/ George L. Hernandez                         Date: January 22, 2002
--------------------------------------------          ----------------
George L. Hernandez
Acting Chief Operating Officer; Vice President,
Finance and Administration; and Secretary

                                       -24-