<PAGE>

Interactive Objects, Inc. Form 10-QSB
Quarter Ended September 30, 2001

                     U.S. Securities and Exchange Commission
                             Washington, D.C. 20549

                                   FORM 10-QSB

(Mark One)
[X]  Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange
     Act of 1934 for the quarterly period ended September 30, 2001.

[ ]  Transition report pursuant to section 13 or 15(d) of the Securities
     Exchange Act of 1934 for the transition period from __________ to _________


                            INTERACTIVE OBJECTS, INC.
        (Exact name of small business issuer as specified in its charter)


                         Commission file number: 0-25373


           WASHINGTON                                     87-0434226
 (State or other jurisdiction                  (IRS Employer Identification No.)
of incorporation or organization)


                         12600 SE 38th Street, Suite 150
                               Bellevue, WA 98006
                    (Address of principal executive offices)


                                 (425) 653-5505
                           (Issuer's telephone number)


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


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

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of November 12, 2001, the
Registrant had 14,952,602 shares of Common Stock outstanding.

TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (check one): Yes [ ]  No [X]

<PAGE>

                            INTERACTIVE OBJECTS, INC.
                         QUARTERLY REPORT ON FORM 10-QSB
                                Table of Contents

                                                                           Page
                                                                          Number

Part I    Financial Information

Item 1.   Financial Statements (Unaudited)

          Condensed Consolidated Balance Sheets - September 30, 2001
          and December 31, 2000                                             3

          Condensed Consolidated Statements of Operations - Three
          and nine months ended September 30, 2001 and 2000                 4

          Condensed Consolidated Statements of Cash Flows -
          Nine months ended September 30, 2001 and 2000                     5

          Notes to Condensed Consolidated Financial Statements              6

Item 2.   Management's Discussion and Analysis of Financial
          Condition and Results of Operations                               8

Part II   Other information

Item 1.   Legal Proceedings                                                 11

Signature                                                                   11



                                       2

<PAGE>

PART I--FINANCIAL INFORMATION

Item 1.   Financial Statements (Unaudited)


                            INTERACTIVE OBJECTS, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEETS


                                      September 30, 2001    December 31, 2000
                                      ------------------    -----------------
                         ASSETS

Current Assets

 Cash and cash equivalents                   $ 1,541,924          $   351,501
 Certificate of deposit                          119,251              115,401
 Accounts receivable                             733,091              245,214
 Prepaid expenses                                159,191               98,088
                                         ---------------    -----------------

    Total current assets                       2,553,457              810,204

Furniture and Equipment, at cost,
 less accumulated depreciation
 of $261,117 and $190,962                        293,022              241,032

Other assets                                      37,161               17,161
                                         ---------------    -----------------

Total assets                                 $ 2,883,640          $ 1,068,397
                                         ---------------    -----------------

           LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities

  Accounts payable                           $   557,733          $   393,898
  Accrued expenses                                96,524               90,119
  Unearned revenue                                50,000               21,831
                                         ---------------    -----------------

   Total current liabilities                     704,257              505,848

Redeemable preferred stock                     2,271,302                    -

Stockholders' Equity (Deficit)
  Common stock                                   149,526              149,526
  Additional paid-in capital                   8,792,543            8,607,752
  Accumulated deficit                         (9,033,988)          (8,194,729)
                                         ---------------    -----------------

   Total stockholders' equity (deficit)          (91,919)             562,549
                                         ---------------    -----------------

Total liabilities, redeemable
 preferred stock and stockholders'
 equity (deficit)                            $ 2,883,640          $ 1,068,397
                                         ===============    =================



See accompanying notes to condensed consolidated financial statements.


                                      3

<PAGE>

                            INTERACTIVE OBJECTS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                               Three Months Ended                 Nine Months Ended
                                       September 30,       September 30,    September 30,   September 30,
                                          2001                 2000             2001            2000
                                    ------------------  -----------------  --------------  --------------
<S>                                   <C>                 <C>               <C>             <C>
Revenues
 Service revenues and software
   license fees                             $ 1,049,613        $   224,691     $ 2,636,712     $   673,031
Expenses

 Labor and benefits                             577,185            395,759       1,509,925       1,261,291
 Selling, general and
  administrative                                645,045            200,330       1,998,814         782,285
                                     ------------------  -----------------  --------------  --------------
                                              1,222,230            596,089       3,508,739       2,043,576
                                     ------------------  -----------------  --------------  --------------

Loss from operations                           (172,617)          (371,398)       (872,027)     (1,370,545)

Interest income                                  15,723             11,546          32,768          47,903
                                     ------------------  -----------------  --------------  --------------

   Net loss                                 $  (156,894)       $  (359,852)    $  (839,259)    $(1,322,642)
                                     ==================  =================  ==============  ==============

Basic and diluted loss per share            $     (0.01)       $     (0.02)    $     (0.06)    $     (0.09)
                                     ==================  =================  ==============  ==============
Weighted average common shares
   outstanding                               14,952,602         14,804,778      14,952,602      14,701,875
                                     ==================  =================  ==============  ==============
</TABLE>

See accompanying notes to condensed consolidated financial statements.


                                       4

<PAGE>

                            INTERACTIVE OBJECTS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                    Nine Months Ended
                                                             September 30,   September 30,
                                                                  2001            2000
                                                             -------------   -------------
<S>                                                           <C>             <C>
Cash Flows From Operating Activities
    Net loss                                                    $ (839,259)    $(1,322,642)
    Adjustments to reconcile net loss to net
      cash used in operating activities:
   Interest earned on certificate of deposit                        (3,850)         (3,723)
   Non-cash stock compensation                                       2,291               -
   Depreciation                                                     70,155          83,451
   Changes in operating assets and liabilities
       Accounts receivable                                        (487,877)         33,929
       Prepaid expenses and other assets                           (81,103)        (59,038)
       Accounts payable and accrued expenses                       170,240         (67,177)
       Unearned revenue                                             28,169         (59,113)
                                                             -------------   -------------

       Net cash used in operating activities                    (1,141,234)     (1,394,313)

Cash Used in Investing Activities-
       purchases of furniture and equipment                       (122,145)        (64,493)

Cash Flows from Financing Activities

       Proceeds from stock option exercises                              -         352,758
       Proceeds from issuance of preferred stock
         and warrants to acquire preferred stock,
         net of issuance costs                                   2,453,802               -
       Payments on borrowings                                            -         (61,000)
                                                             -------------   -------------

       Net cash provided by financing activities                 2,453,802         291,758
                                                             -------------   -------------

       Net increase (decrease) in cash                           1,190,423      (1,167,048)
Cash and cash equivalents, beginning of period                     351,501       1,922,392
                                                             -------------   -------------

Cash and cash equivalents, end of period                        $1,541,924      $  755,344
                                                             =============   =============
</TABLE>

See accompanying notes to condensed consolidated financial statements.


                                       5

<PAGE>

                            INTERACTIVE OBJECTS, INC.
              Notes To Condensed Consolidated Financial Statements

Note 1.   Basis of Presentation.

The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions to Form 10-QSB and therefore do not include
all disclosures necessary for a fair presentation of financial position, results
of operations, and cash flows in conformity with accounting principles generally
accepted in the United States. The unaudited consolidated financial statements
include the accounts of Interactive Objects, Inc. ("Interactive Objects" or the
"Company") and its wholly-owned subsidiary Avatar Interactive, Inc. Significant
intercompany transactions have been eliminated in the accompanying unaudited
consolidated financial statements. The operating results for interim periods are
unaudited and are not necessarily an indication of the results to be expected
for the full fiscal year. In the opinion of management, the financial statements
reflect all adjustments (consisting only of normal recurring adjustments) which
are necessary for a fair presentation of operating results.

Note 2.   Per Share Information

Basic loss per share is computed by dividing net loss by the weighted average
number of common shares outstanding in the period. Diluted loss per share takes
into consideration common shares outstanding (computed under basic loss per
share) and potentially dilutive common shares. Potentially dilutive common
shares at September 30, 2001, consist of shares issuable to holders of
outstanding employee stock options, convertible preferred stock, and warrants to
purchase convertible preferred stock. Accordingly, because these shares are
antidilutive in the periods presented, basic and diluted earnings or loss per
share are the same.

Note 3.   Redeemable Preferred Stock

In April 2001, the Company sold 1,798,561 shares of Series A Preferred Stock
(Preferred Stock) at $1.39 per share to a small group of accredited investors in
a private offering. The offering includes 5-year warrants (the Warrants) to
purchase 50% of the number of shares of Preferred Stock purchased in the
offering with an exercise price of $1.67 per share. Net proceeds of $2,453,802
after deducting costs associated with the offering of $46,198 were allocated
between the Preferred Stock and the Warrants based on their relative estimated
fair value. The estimated value of the warrants of $182,500 was recorded as
additional paid-in capital.

The Preferred Stock has a par value of $0.01 per share and is convertible into
shares of the Company's common stock after one year on a one-to-one ratio and
has certain liquidation preferences. The Preferred Stock is redeemable at the
original purchase price in the event of a change of control, or at a premium if
upon the request of the Company. The investors have certain piggy back, S-3 and
demand registration rights with respect to the common stock into which the
Series A Preferred Stock converts. However, the demand registration rights are
not exercisable for one year. Furthermore, except in cases of underwritten
offerings or waiver by the Company, the investors are limited to selling not
more than 10% of such common stock in any one calendar month. The investors also
have rights of first refusal to purchase their pro rata shares of future
offerings by the Company, with certain exceptions.

The Series A Preferred Stock will not be registered under the Securities Act of
1933 and may not be offered or sold in the United States absent registration
under the Securities Act or an applicable exemption from the registration
requirements of the Securities Act.


                                       6

<PAGE>

Note 4.   Legal Proceedings

In August 2000, a lawsuit was filed against the Company, a current board member,
a former board member and the former CEO and chairman of the board. The lawsuit
was brought forth by two founders of the Company (Plaintiffs) who, in 1999,
agreed to sell the majority of their shares of Company stock back to the
Company. They are claiming that they were induced to sell through fraudulent
representations and omissions. The Plaintiffs are seeking in excess of $11
million, or in the alternative, rescission of the purchase and sale of the
Plaintiffs' shares. In August 2001, both the Company and the Plaintiffs filed
for summary judgment and the results of those filings are pending. In the event
neither party is successful in its summary judgment motion, the case is
scheduled for trial in February 2002.

The Company intends to vigorously defend this case, but, because of the nature
of the litigation process, the Company is not able to predict the outcome of
this matter. If the Company prevails, it is entitled to receive reimbursement
for all legal fees and related costs incurred by it in defense of this matter.


                                       7

<PAGE>

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


                            INTERACTIVE OBJECTS, INC.
           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                            AND RESULTS OF OPERATIONS

Statement of Forward-Looking Information

This discussion and analysis should be read together with our consolidated
financial statements and related notes appearing in Item 1, above. This report
contains both objective historical information and subjective "forward-looking
statements" that are subject to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995, and bear certain risks and
uncertainties that could cause actual results to differ materially from those
projected. Generally, forward-looking statements are prefaced by the words:
"believe," "expect," "intend," "anticipate," and similar expressions; but their
absence does not mean that a statement is not forward-looking. Numerous factors
both within and outside our control could affect our actual results, including,
but not limited to, the factors set forth in the "Risk Factors," and
"Description of Business" discussions in our Annual Report on Form 10-KSB for
the year ended December 31, 2000. These risk factors, among others, could cause
results to differ materially from those presently anticipated by us. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date of this report. We undertake no obligation to publicly
release the results of any revisions to these forward-looking statements that
may be made to reflect events or circumstances after the date of this report or
to reflect the occurrence of anticipated events.

General

Interactive Objects, Inc. was founded in 1995 by several former
Microsoft employees. Today, Interactive Objects is a leading designer of
embedded software and hardware solutions for digital audio, video and imaging
appliances.

Interactive Objects is the creator of the Dharma(TM) digital media development
platform. Interactive Objects' technology is featured in consumer products such
as Microsoft's (NASDAQ:MSFT) new TV Photo Viewer product and their Pocket PC(TM)
Media Player and Iomega's (NYSE:IOM) HipZip(TM). In addition, the Company's
technology is featured in Interactive Objects designed listening and viewing
stations (LVS) at several Trans World Entertainment Corp. (Trans World) retail
locations including its flagship FYE (For Your Entertainment) store in New York
City. Trans World is a leading specialty retailer of music and video products.
Trans World plans to roll out these LVS devices at its remaining 730 retail
locations in 2002.

Interactive Objects offers licenses of its proprietary Dharma development
platform to leading consumer electronics companies, PC manufacturers, computer
software companies, and other companies whose business involves digital media
technology. In addition, the Company provides embedded systems software
engineering, hardware design, and manufacturing services to such companies.

During the quarter ended September 30, 2001, the Company had a number of key
accomplishments:

     .    The Company began delivery of listening and viewing stations to Trans
          World in the pilot phase of an anticipated company-wide rollout at
          Trans World's 730 retail locations.

     .    The Company signed an agreement with Remote Solution, Inc., the U.S.
          marketing and sales organization for HanGo Electronics Co., Ltd.,
          Korea to make the Company's platform the basis for all new embedded
          media products sold under their PoGo! brand name.


                                       8

<PAGE>

     .    The Company completed services related to integrating its technology
          into Microsoft's new TV Photo Viewer product.

     .    The Company made significant progress in its research and development
          efforts by successfully incorporating in its technology support for
          MPEG 1 and 2 video compression, the standard format used for DVD
          playback and internet video on demand. This means that the Company can
          build products that provide both audio and video playback,
          significantly broadening the market potential of its platform
          technology.

The Company has incurred losses since inception and at September 30, 2001 had an
accumulated deficit of $9,033,988. The Company's ability to make a profit is
dependent upon various factors including many outside its control. For that
reason it is difficult to predict when and if the Company will achieve
profitability.

For more detailed information regarding the Company's products and services, its
customers and markets, its risk factors, and other aspects of its business, see
the Company's Annual Report on Form 10-KSB for the year ended December 31, 2000.

Results of Operations - Three and nine months ended September 30, 2001 compared
to the three and nine months ended September 30, 2000

     Revenues. Revenues for the three and nine months ended September 30, 2001
were $1,049,613 and $2,636,712, respectively, compared to $224,691 and $673,031
for the three and nine months ended September 30, 2000, respectively. This
represents a 367% increase in revenues for the comparative three-month periods
and a 292% increase for the comparative nine-month periods. During the three-
and nine-month periods in 2001, the Company's revenues were related entirely to
the development and licensing of digital media technology. Revenues in the three
months ended September 30, 2000 related entirely to the development and
licensing of digital audio technology while for the nine-month period ended
September 30, 2000 revenues included some consulting services. The increase in
revenues is the result of the transition from a software consulting business
model to that of a developer and licensor of digital media technology. The
Company's revenues are to a large extent dependent upon the success of its
licensees' products, or the Company's ability to enter into contracts with new
or existing customers. While the Company's customer base continues to expand, in
any particular quarter, depending on the contracts it is performing, the Company
has experienced significant concentration of revenues from one or a small number
of customers. The Company expects this trend to continue in the near term and
there can be no assurance as to future revenue levels in total or from a
particular customer.

     Labor and Benefits Expenses. Labor and benefits includes all internal labor
costs such as salaries, benefits, payroll taxes and independent contractor fees.
Labor and benefits expenses for the three and nine months ended September 30,
2001 were $577,185 and $1,509,925, respectively, compared to $395,759 and
$1,261,291 incurred in the three and nine months ended September 30, 2000,
respectively. The increase in labor and benefits expenses is directly
attributable the increased number of employees during the current year compared
to the prior year.

As of September 30, 2001, the Company had 26 employees with 20 employees working
primarily on product development, 4 employees working primarily in general and
administrative functions and 2 in sales and marketing. In addition, the Company
hires independent contractors when needed to support specific projects. The
Company expects that labor and benefits expense will continue to increase
through 2001 as it adds additional management personnel and engineering staff in
order to continue increasing its presence in the embedded systems digital media
market.

     Selling, General and Administrative Expenses. Selling, general and
administrative(SG&A)expenses represent all costs other than labor and benefits.
For the three and nine months ended September 30, 2001 SG&A expenses were
$645,045 and $1,998,814, respectively, compared to $200,330 and $782,285 during
the same respective periods in 2000. The increase in selling, general and
administrative expenses was primarily a result of research and development
expenditures associated with the Company's line of digital media


                                       9

<PAGE>

products as well as expenditures associated with contract engineering,
design and manufacturing.

The Company believes that selling, general and administrative expenses will
continue to increase as it expands its presence in the embedded systems digital
media market and continues developing its digital media product line.

     Interest Income, Net. Interest income, net for the three and nine months
ended September 30, 2001 was $15,723 and $32,768, respectively, compared to
$11,546 and $47,903 for the respective three and nine months ended September 30,
2000. The increase during the comparable three-month periods is the result of
higher invested cash balances in 2001. The decrease during the comparable
nine-month periods is due to lower invested cash and cash equivalent balances
during the first quarter of 2001 compared to the first quarter of 2000 which
more than offsets the impact of the higher invested balance during the third
quarter of 2001.

     Net Loss. The Company had net losses of $156,894 and $839,259,
respectively, for the three and nine months ended September 30, 2001 compared to
a net losses of $359,852 and $1,322,642, respectively, for the same periods in
2000. The decrease in net losses during 2001 is primarily the result of
increased revenues offset by increases in labor and benefits and SG&A expenses,
as described above.

Liquidity and Capital Resources.

At September 30, 2001, the Company had cash and cash equivalents of $1,541,924.

Cash used in operating activities was $1,141,234 during the nine months ended
September 30, 2001, compared to cash used in operating activities of $1,394,313
in the first nine months of 2000. The decrease is primarily due to lower net
loss during the first nine months of 2001 than in the same period in 2000,
offset by an increase in accounts receivable.

During the first nine months of 2001 and 2000, investing activities used net
cash of $122,145 and $64,493, respectively, entirely for purchases of furniture
and equipment.

Cash provided by financing activities of $2,453,802 in the first nine months of
2001 resulted from net proceeds from the sale of Series A Preferred Stock (see
note 3 to condensed consolidated financial statements) and related warrants.
During the first nine months of 2000, net cash provided by financing activities
was $291,758 primarily from stock option exercises.

If the Company cannot become profitable in the near term, it will require
additional capital financing. However, it cannot guarantee that any additional
financing will be available when needed, or on commercially reasonable terms.


                                       10

<PAGE>

PART II--OTHER INFORMATION

Item 1.   Legal Proceedings.

In August 2000, a lawsuit was filed in King County Superior Court against the
Company, a current board member, a former board member and the former CEO and
chairman of the board. The lawsuit was brought forth by two founders of the
Company (Plaintiffs) who, in 1999, agreed to sell the majority of their shares
of Company stock back to the Company. They are claiming that they were induced
to sell through fraudulent representations and omissions. The Plaintiffs are
seeking in excess of $11 million, or in the alternative, rescission of the
purchase and sale of the Plaintiffs' shares. In August 2001, both the Company
and the Plaintiffs filed for summary judgment and the results of those filings
are pending. In the event neither party is successful in its summary judgment
motion, the case is scheduled for trial in February 2002.

The Company intends to vigorously defend this case, but, because of the nature
of the litigation process, the Company is not able to predict the outcome of
this matter. If the Company prevails, it is entitled to reimbursement for all
legal fees and related costs incurred by it in defense of this matter.

The Company has a suit against Kayleen Arafiles, and a related counter-suit,
pending in King County Superior Court which is discussed in the Company's 10QSB
dated August 14, 2001 for the period end June 30, 2001.

                                    SIGNATURE

     In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                   INTERACTIVE OBJECTS, INC.


Dated:  November 13, 2001              By:   /s/ Richard P. Barber
                                          ---------------------------------
                                   Richard P. Barber
                                   Chief Financial Officer, Treasurer and
                                   Secretary


                                       11