<PAGE>
 
                    U.S. SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                ______________
                                        
                                 FORM  10-QSB


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

                 For the quarterly period ended June 30, 1998

                        Commission file number 0-20462

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

                  CALIFORNIA                       95-3746596
            (State or other jurisdiction of        (I.R.S. Employer
           incorporation or organization)         Identification No.)

         9600 TOPANGA CANYON BOULEVARD, CHATSWORTH, CALIFORNIA  91311
                   (Address of principal executive offices)

                                 818/709-1778
                          (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 
    ---       ---   

     As of August 18, 1998, there were 12,854,981 shares of the issuer's common
stock issued and outstanding.

Transitional Small Business Disclosure Format:  Yes        No  X
                                                    ---       ---



 
                                  PAGE 1 OF 17
<PAGE>
 
                                 CHATCOM, INC.


                         PART I  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
BALANCE SHEETS                                                               (IN THOUSANDS)
---------------------------------------------------------------------------------------------------------
                                                                              (UNAUDITED)
                                                                               JUNE 30,         MARCH 31,
ASSETS                                                             NOTES         1998             1998
                                                                   -----       ---------        ---------
<S>                                                                <C>         <C>              <C>
CURRENT ASSETS:
  Cash                                                                          $    127        $    381
  Accounts receivable, net of allowances of $56,000
    (June 30, 1998) and $50,000 (March 31, 1998)                                     383             849
  Inventories                                                          2           2,283           2,636
  Prepaid expenses and other current assets                                           76              92
                                                                                --------        --------
                                                        
    Total current assets                                                           2,869           3,958
 
EQUIPMENT AND FIXTURES, Net                                            3             324             388
 
DEPOSITS                                                                              23              22
                                                                                --------        --------
TOTAL                                                                           $  3,216        $  4,368
                                                                                ========        ======== 
 
LIABILITIES AND SHAREHOLDERS' DEFICIT
 
CURRENT LIABILITIES:
  Accounts payable                                                     5        $  3,108        $  3,314
  Accrued expenses                                                                   995           1,074
  Note payable                                                         5             100
  Convertible subordinated debt                                        5             890             890
  Current portion of capital lease obligations                                        15              15
                                                                                --------        --------
    Total current liabilities                                                      5,108           5,293
                                                                                --------        --------
 
CAPITAL LEASE OBLIGATIONS - less current portion                                      14              22
                                                                                --------        --------
 
REDEEMABLE PREFERRED STOCK:
  Series E Convertible Redeemable Preferred Stock,
    $1,100,000 redemption value net of $163,000
     of offering costs, authorized 2,000 shares;
     issued and outstanding 1,100 shares                               6                             937
                                                                                --------        --------
 
SHAREHOLDERS' DEFICIT:
  Preferred stock, no par value;
    authorized 1,000,000 shares;
    Series D Convertible Preferred Stock, $1,000
      stated value per share, authorized 5,000 shares;
      issued and outstanding 2,496 shares                              5           1,407           1,407
    Series E Convertible Preferred Stock, $1,000
      stated value per share, authorized 2,000 shares,
      issued and outstanding 1,100 shares                              6             937
    Series F Convertible Preferred Stock, $1,000
      stated value per share, authorized 2,000 shares,
      issued and outstanding 945 shares                                5             945             945
    Series G Convertible Preferred Stock, $1,000
      stated value per share, authorized 500 shares,
      issued and outstanding 400 shares                                5             400             400
  Common stock, no par value; authorized
      25,000,000 shares; issued and outstanding
      11,931,925 shares at June 30, 1998 and
      11,591,215 shares at March 31, 1998                                         11,195          11,025
  Additional paid-in capital                                                       2,839           2,839
  Accumulated deficit                                                            (19,629)        (18,500)
                                                                                --------        --------
      Total shareholders' deficit                                                 (1,906)         (1,884)
                                                                                --------        --------
TOTAL                                                                           $  3,216        $  4,368
                                                                                ========        ======== 
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                 Page 2 of 17
<PAGE>
 
                                 CHATCOM, INC.
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS (UNAUDITED)                       (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
---------------------------------------------------------------------------------------------------------- 
                                                                         THREE MONTHS ENDED
                                                                               JUNE 30,
                                                                  1998                           1997
                                                              -----------                     ---------- 
<S>                                                           <C>                             <C>
NET SALES:
   Gross sales                                                $       967                     $    4,611
   Returns                                                            (52)                          (152)
                                                              -----------                     ---------- 
   Net sales                                                          915                          4,459
                                                              -----------                     ---------- 
 
COST OF GOODS SOLD                                                    911                          2,856
                                                              -----------                     ---------- 
GROSS PROFIT                                                            4                          1,603
                                                              -----------                     ---------- 
 
OPERATING EXPENSES:
  Selling                                                             280                          1,069
  General and administrative                                          446                            463
  Research and development                                            246                            599
                                                              -----------                     ---------- 
    Total operating expenses                                          972                          2,131
                                                              -----------                     ---------- 
 
LOSS FROM OPERATIONS                                                 (968)                          (528)
 
INTEREST INCOME                                                                                        7
INTEREST EXPENSE                                                      (44)                            (1)
                                                              -----------                     ---------- 
 
LOSS BEFORE INCOME TAXES                                           (1,012)                          (522)
 
PROVISION FOR INCOME TAXES                                             (1)                            (1)
                                                              -----------                     ---------- 

NET LOSS                                                           (1,013)                          (523)

DIVIDENDS ON PREFERRED STOCK                                         (116)                           (62)
                                                              -----------                     ---------- 
NET LOSS AVAILABLE TO
COMMON SHAREHOLDERS                                           $    (1,129)                    $     (585)
                                                              ===========                     ========== 

BASIC NET LOSS PER COMMON SHARE                                    $(0.10)                        $(0.06)
                                                              ===========                     ========== 
 
Weighted average number of Common Shares                       11,814,914                      9,862,242
</TABLE>

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                 PAGE 3 OF 17
<PAGE>
 
                                 CHATCOM, INC.
<TABLE>
<CAPTION>
STATEMENTS OF CASH FLOWS (UNAUDITED)                                                      (IN THOUSANDS)
--------------------------------------------------------------------------------------------------------------------
                                                                                        THREE MONTHS ENDED
                                                                                              JUNE 30,
                                                                                 1998                          1997
                                                                               -------                       -------
<S>                                                                            <C>                           <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss                                                                       $(1,013)                      $  (523)
Adjustments to reconcile net loss to
   net cash used in operating activities:
   Depreciation and amortization                                                    64                            86
   Provision for losses on accounts receivable                                       6                            30
   Provision for inventory obsolescence                                             60                          (106)
   Changes in operating assets and liabilities:
      Accounts receivable                                                          460                        (2,065)
      Inventories                                                                  293                          (507)
      Prepaid expenses and other current assets                                     16                           (10)
      Deposits                                                                      (1)
      Accounts payable                                                            (206)                        2,064
      Accrued expenses                                                             (25)                         (129)
                                                                               -------                       -------
 
 
   Net cash used in operating activities                                          (346)                       (1,160)
                                                                               -------                       -------
 
CASH FLOWS FROM INVESTING
ACTIVITIES:
   Capital expenditures                                                                                         (151)
                                                                               -------                       -------
 
CASH FLOWS FROM FINANCING
ACTIVITIES:
   Principal payments on capital leases                                             (8)                           (8)
   Issuance of note payable                                                        100
   Issuance of convertible subordinated debt                                                                     350
                                                                               -------                       -------
   Net cash provided by
      financing activities                                                          92                           342
                                                                               -------                       -------
 
NET DECREASE IN CASH                                                              (254)                         (969)
 
CASH, BEGINNING OF PERIOD                                                          381                         1,169
                                                                               -------                       -------
 
CASH, END OF PERIOD                                                            $   127                       $   200
                                                                               =======                       ======= 
                                                                                                          (CONTINUED)
</TABLE>

                                 PAGE 4 OF 17
<PAGE>
 
                                 CHATCOM, INC.

STATEMENTS OF CASH FLOWS (UNAUDITED)                                   CONTINUED

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

  During the three months ended June 30, 1998 and 1997, the Company paid
  interest of $0 and $1,000, respectively, and taxes of $1,000 and $1,000,
  respectively.

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

  During the three months ended June 30, 1998, the Company accrued dividends
  related to the Series D Convertible Preferred Stock of $62,000 and paid
  previously accrued dividends of $125,000 through the issuance of 242,001
  shares of Common Stock which resulted in an increase in Common Stock of
  $125,000 and a decrease in accrued expenses of $125,000.

  During the three months ended June 30, 1998, the Company accrued dividends
  related to the Series E Convertible Redeemable Preferred Stock of $22,000 and
  paid previously accrued dividends of $45,000 through the issuance of 98,709
  shares of Common Stock which resulted in an increase in Common Stock of
  $45,000 and a decrease in accrued expenses of $45,000.

  During the three months ended June 30, 1998, the Company accrued dividends
  related to the Series F Convertible Preferred Stock and Series G Convertible
  Preferred Stock of $22,000 and $10,000, respectively.

  During the three months ended June 30, 1997, the Company accrued dividends
  related to the Series D Convertible Preferred Stock of $62,000 and paid
  dividends of $125,000 through the issuance of 69,932 shares of Common Stock
  which resulted in an increase in Common Stock of $125,000 and a decrease in
  accrued expenses of $125,000.



                                                         (CONCLUDED)
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.


                                 PAGE 5 OF 17
<PAGE>
 
                                 CHATCOM, INC.


                         NOTES TO FINANCIAL STATEMENTS
                                 JUNE 30, 1998
                                        

1.  ACCOUNTING POLICIES

     The accompanying unaudited financial statements of ChatCom, Inc. (the
     "Company") have been prepared in accordance with instructions to Form 10-
     QSB and, in the opinion of management, include all material adjustments
     (consisting only of normal recurring accruals) which are necessary for the
     fair presentation of results of operations for the interim periods.  These
     unaudited financial statements should be read in conjunction with the
     financial statements and notes thereto included in the Company's Annual
     Report on form 10-KSB, as amended, for the fiscal year ended March 31,
     1998.  The results of operations for the three month period ended June 30,
     1998 are not necessarily indicative of the results to be expected for the
     full fiscal year ending March 31, 1999.

     Certain prior year amounts have been reclassified to conform with current
     year classifications.

2.   INVENTORIES
     The components of inventories are as follows:
<TABLE>
<CAPTION>
                                                         June 30,                  March 31,
                                                           1998                      1998
                                                        -----------              -----------
     <S>                                                <C>                        <C>
     Raw materials                                      $   886,000              $   766,000
     Work in process                                         63,000                  469,000
     Finished goods                                       3,171,000                3,192,000
                                                        -----------              -----------
     Inventory at cost                                    4,120,000                4,417,000
     Less: Reserve for obsolescence                      (1,837,000)              (1,781,000)
                                                        -----------              -----------

                                                        $ 2,283,000              $ 2,636,000
                                                        ===========              ===========
</TABLE>



3.  EQUIPMENT AND FIXTURES, Net

     Equipment and fixtures consist of the following:

<TABLE>
<CAPTION>
                                                          June 30,                 March 31,
                                                            1998                     1998
                                                          ---------                ---------
     <S>                                                  <C>                      <C>
     Equipment                                            $ 694,000                $ 694,000
     Software                                                75,000                   75,000
     Furniture and fixtures                                  33,000                   33,000
     Leasehold improvements                                  89,000                   89,000
                                                          ---------                ---------
                                                            891,000                  891,000

     Less: accumulated depreciation                        (567,000)                (503,000)
                                                          ---------                ---------

                                                          $ 324,000                $ 388,000
                                                          =========                =========
</TABLE>

                                 PAGE 6 OF 17
<PAGE>
 
                                 CHATCOM, INC.


4.   LINE OF CREDIT

     On June 15, 1998, the Company entered into a conditional commitment letter
     with ALCO Financial Services, Inc. ("ALCO") pursuant to which ALCO has
     agreed, subject to certain conditions, to provide the Company with a
     maximum $750,000 line of credit. Under the proposed terms of the line of
     credit, which would remain in effect for a period of one year, the Company
     would be able to borrow from ALCO based on eligible U.S. accounts
     receivable and inventory, at prime plus seven percent. The line of credit
     would also include certain other fees and conditions and would grant ALCO a
     blanket lien on all assets of the Company. On July 16, 1998, ALCO withdrew
     its conditional commitment letter and cited the Company's apparent
     deterioration in financial condition as the reason for its withdrawal.
     Subsequently, ALCO has verbally notified the Company that it would provide
     the Company a maximum line of credit of $300,000 provided that the Company
     receive a cash infusion of $200,000 (in addition to the $200,000 received
     by the Company from VRPI subsequent to March 31, 1998 - See Note 5) prior
     to effecting the line of credit. As of the date of this report, the Company
     has not received funding from ALCO under a line of credit and there can be
     no assurance that any line of credit will ultimately be effected.


5.   CONVERSION OF UNSECURED DEBT, ADDITIONAL FINANCING AND PROPOSED
     SALE AGREEMENT

     As of February 1, 1998, the Company entered into a Settlement Agreement
     with Vermont Research Products, Inc. ("VRPI"), a major supplier of certain
     products (which are resold by the Company), for the conversion of a portion
     of the amount owed by the Company to VRPI (approximately $2.04 million at
     February 1, 1998) into 945 shares of the Company's Series F Convertible
     Redeemable Preferred Stock, $1,000 stated value per share, valued at
     $945,000 (the "Series F Preferred Stock") and 400 shares of the Company's
     Series G Convertible Preferred Stock, $1,000 stated value per share, valued
     at $400,000 (the "Series G Preferred Stock"). The Settlement Agreement also
     provided for payment terms with respect to  the remaining balance owed to
     VRPI (approximately $694,000 at February 1, 1998 (the "Remaining
     Balance")). As additional consideration, the Company issued to VRPI a five-
     year warrant to purchase 285,000 shares of Common Stock at an exercise
     price of $.35 per share. Dividends on the Series F Preferred Stock and
     Series G Preferred Stock are payable in cash or shares of Common Stock, at
     the election of the Company, at the rate of 9.5% per annum. The Series F
     Preferred Stock is convertible into shares of Common Stock at any time
     through January 31, 2003 at a conversion price equal to the market price at
     the time of conversion, but at a conversion price no greater than $.95 per
     share and no less than $.35 per share. The Series G Preferred Stock is
     convertible into shares of Common Stock at a conversion price of $.35 per
     share. The holder of the Series F Preferred Stock and Series G Preferred
     Stock are entitled to equal preference with holders of the Company's Series
     D and Series E Preferred Stock. As long as any amounts of Series F
     Preferred Stock or Series G Preferred Stock remain outstanding, VRPI shall
     have the right to approve any preferred stock offering by the Company which
     rank equal to or senior  to those of VRPI's, and approve any debt offering
     contemplated by the Company, except for commercial bank lines of credit or
     loans secured by the Company's U.S. accounts receivable or inventory. Of
     the remaining balance owed to VRPI after the conversion of certain amounts
     into the Series F Preferred Stock and the Series G Preferred Stock,
     $274,000 represents equipment warehoused by VRPI for the Company and is
     payable to VRPI at the time of shipment to any customer of the Company. Of
     the remaining balance owed to VRPI (approximately $420,000 together with
     interest at 9.5% effective February 1, 1998), $5,000 was payable upon
     execution of the Settlement Agreement, $5,000 was payable on March 1, 1998,
     $5,000 was payable on April 1, 1998, and $35,000 per month was payable
     commencing May 1, 1998. Additionally, the Company is required to remit 25%
     of its collections of foreign accounts receivable commencing February 1,
     1998 as well as 20% of the net proceeds to the Company of any equity
     financings 

                                 PAGE 7 OF 17
<PAGE>
 
                                 CHATCOM, INC.


     (other than commercial bank loan financing or asset based lending against
     United States accounts receivable and finished or assembled good inventory)
     effected by the Company subsequent to February 1, 1998 plus the sum of
     $50,000 upon consummation of each of the first two such financings. The
     Company also agreed to pay VRPI's expenses in connection with this
     transaction.

     Pursuant to the Settlement Agreement, the Company has paid VRPI the sum of
     $50,000 (of which $5,000 was paid upon the execution of the Settlement
     Agreement, $5,000 paid on March 1, 1998 and April 1, 1998 and $35,000 was
     paid on May 1, 1998). Due to the Company's liquidity crisis, no further
     payments have been made to VRPI including  any amounts owed in connection
     with the Company's issuance of Common Stock in March 1998 ($110,000) and in
     connection with the Company's collection of foreign accounts receivable
     (approximately $93,000 as of June 30, 1998).

     On June 6, 1998, the Company received written notice from VRPI of VRPI's
     decision (which the Company has not agreed to) to surrender its Series F &
     Series G Preferred  Stock as a result of VRPI's contention that the Company
     failed to timely file a registration statement covering the underlying
     Common Shares.  On June 11, 1998, the Company received a $100,000 loan from
     VRPI (the "VRPI Loan").  The VRPI Loan provides for interest at the rate of
     15% per annum, is secured by the Company's foreign accounts receivable and
     is due on July 11, 1998. During the 30 day period ending July 11, 1998 (the
     "Study Period"), VRPI conducted an examination of the Company's technology
     and finances in order to  determine if an investment in the Company is
     warranted. The VRPI Loan contains certain restrictions, including, among
     others, the use of the loan proceeds for only those expenses necessary to
     continue the Company's operations during the Study Period and the Company's
     agreement not to issue stock or incur debt, except for the Company's
     proposed line of credit (described above) with any party other than VRPI
     and those persons or entities who choose to participate with VRPI in
     connection with any further financing of the Company.  VRPI has informed
     the Company that it has prepared, but not filed, a lawsuit against the
     Company and certain of its officers and directors and has agreed not to
     file the complaint during the Study Period.  On July 7, 1998 VRPI provided
     an additional $100,000 of financing to the Company.

     The Company has been conducting negotiations with VRPI and High View
     Capital in an attempt to secure additional financing in order to meet its
     current obligations and immediate needs. High View Capital (including
     certain of its affiliates) is the holder of the Company's Series D
     Convertible Preferred Stock and the Company's convertible subordinated debt
     in the aggregate principal amount of $890,000. The Company has reached an
     agreement in principle with VRPI and High View Capital ("HVC") whereby the
     Company would sell its recently announced BrightStar product technology
     (the "New Product") to VRPI and HVC (collectively, the "Purchasers") in
     exchange for $400,000 in cash ($200,000 of which was advanced to the
     Company by VRPI through July 7, 1998 and the remaining $200,000 would be
     payable to the Company at the closing), the cancellation of all outstanding
     loans and convertible notes made to the Company by the Purchasers or their
     affiliates including accrued interest (approximately $1.2 million at August
     19, 1998), the cancellation of all trade debt owing by the Company to the
     Purchasers (approximately $390,000 at August 19, 1998), the cancellation of
     a purchase order from the Company to VRPI in the amount of approximately
     $288,000 including accrued interest, the cancellation of all shares of
     preferred stock (and accrued dividends thereon) owned by the Purchasers or
     any of their affiliates (approximately $4.0 million in stated value at
     August 19, 1998) and the cancellation of all warrants held by the
     Purchasers or their affiliates to purchase shares of the Company's Common
     Stock (835,000 shares) (the "Proposed Sale"). The aggregate value of the
     consideration in connection with the Proposed Sale is approximately $5.8
     million at August 19, 1998. The Proposed Sale is subject to certain
     conditions, which include the Company's receipt of a minimum of $300,000
     from ALCO under a line of credit prior to the closing of the Proposed Sale
     and the execution of a license agreement concurrent with the

                                 PAGE 8 OF 17
<PAGE>
 
                                 CHATCOM, INC.


     closing of the Proposed Sale under which the Company would receive an
     exclusive license to the New Product (the "License Agreement"). The License
     Agreement would provide for royalty payments to be made by the Company to
     the Purchasers in the amount of 5% of the sales price of New Products sold
     by the Company. In the event of any sale or merger of the Company or the
     licensing by the Company of the New Product to a third party, the Company
     may elect to buy-back the New Product from the Purchasers for $1, provided
     the sale or merger or licensing arrangement generates at least $8 million
     in aggregate proceeds to the Company. In that event, the Company would be
     required to distribute the proceeds from such a transaction on the
     following incremental basis: up to $1 million, 75% to Purchasers, 25% to
     the Company; $1,000,000 to $5,999,999, 48.5% to Purchasers, 51.5% to the
     Company; $6,000,000 to $7,999,999, 68% to Purchasers, 32% to the Company;
     $8,000,000 to $9,999,999, 60% to Purchasers, 40% to the Company;
     $10,000,000 to $12,999,999, 21% to Purchasers, 79% to the Company;
     $13,000,000 to $16,000,000, 7.5% to Purchasers, 92.5% to the Company; over
     $16,000,000, 100% to the Company. In the event the Company enters into a
     sale, merger or licensing agreement that generates less than $8 million in
     aggregate proceeds to the Company, the license granted to the Company under
     the License Agreement would convert to a non-exclusive license. For a one-
     year period following the closing of the Proposed Sale, the Purchasers
     would have the right to rescind the Proposed Sale transaction.

     No assurances can be given that the Proposed Sale will be consummated or
     that VRPI, HVC, or any other person or entity will provide additional
     financing to the Company or that VRPI will not take legal action against
     the Company.

    
6.   SERIES E CONVERTIBLE REDEEMABLE PREFERRED STOCK

     The Company's Series E Convertible Redeemable Preferred Stock (the "Series
     E Preferred Stock") contains a mandatory redemption feature which provides
     that if on September 1, 1998 all of the shares of Common Stock issuable
     upon conversion of the then outstanding shares of Series E Preferred Stock
     is not at that time duly registered, the Company, at the demand of the any
     investor, shall redeem such investor's shares of Series E Preferred Stock
     for a total amount equal to the market price times the number of shares of
     Common Stock into which such shares of Series E Preferred Stock are
     convertible on the date of such demand, and shall also pay accrued
     dividends on such shares of Series E Preferred Stock, whether or not
     declared, to the redemption date. On July 15, 1998, the Company's Form S-3
     (which registered certain shares of Common Stock of the Company including
     those Common shares issuable upon conversion of the Series E Preferred
     Stock) was declared effective (the "Registration"). As a result of the
     Registration, the mandatory redemption feature of the Series E Preferred
     Stock was eliminated and the Company reclassified the Series E Preferred
     Stock to Shareholders' Deficit in the accompanying Balance Sheet as of June
     30, 1998.

     The Series E Preferred Stock Registration Rights Agreement contains a late
     registration penalty which requires the Company to pay the investors on
     January 24, 1998 and on each successive date which is 30 days after the
     previous payment (prorated for partial periods) until such registration
     statement is declared effective, payments in the amount of 3% of the
     purchase price of the outstanding Series E Preferred Stock ($1,100,000), in
     cash or shares of the Company's Common Stock at the election of the
     investor. Through the effective date of the Registration, the Company has
     incurred approximately $215,000 in late registration penalties. The
     investors have notified the Company that payment of the penalty shall be
     made by the Company in cash. As of June 30, 1998, the Company's financial
     statements reflect the accrual of $198,000 in late registration penalties.
     The Company believes that the late registration penalty was a result of the
     Company's severe cash flow constraints. Furthermore, the Company is
     presently not capable of paying the registration penalty in cash.


                                 PAGE 9 OF 17
<PAGE>
 
                                 CHATCOM, INC.


     On July 31, 1998, August 11, 1998 and August 12, 1998, holders of Series E
     Preferred Stock converted in the aggregate $125,000 in stated value of the
     Series E Preferred Stock into shares of the Company's Common Stock which
     resulted in the issuance of 923,056 shares of Common Stock.


7.   RELATED PARTIES

     One of the officers of the Company is also a shareholder of a law firm that
     provides legal consultation to the Company.  At June 30, 1998 and 1997, the
     Company owed this law firm $18,000 and $12,000, respectively.  During the
     three months ended June 30, 1998 and 1997, fees relating to services
     provided by this law firm in the amounts of $5,500 and $10,000,
     respectively, were included in general and administrative expenses in the
     accompanying statement of operations.


                                PAGE 10 OF 17
<PAGE>
 
                                 CHATCOM, INC.



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
--------------------------------------------------------------------------------

     Except for the historical information contained herein, the matters
discussed in this quarterly report are forward-looking statements, which involve
risks and uncertainties, including but not limited to economic, competitive,
governmental and technological factors affecting the Company's business
operations and financial condition and other factors as described in the
Company's various filings with the Securities and Exchange Commission, including
without limitation the Company's Form 10-KSB for the fiscal year ended March 31,
1998, as amended.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THE
THREE MONTHS ENDED JUNE 30, 1997

     Net sales during the three months ended June 30, 1998 (the "first quarter
of fiscal 1999") decreased $3.5 million or 79% compared to the three months
ended June 30, 1997 (the "first quarter of fiscal 1998"). Net sales for the
first quarter of fiscal 1999 were $296,000 or 24% lower than the $1.2 million
recorded during the fiscal quarter ended March 31, 1998. The decline in net
sales during the first quarter of fiscal 1999 compared to the first quarter of
fiscal 1998 ($3.5 million) resulted primarily from a decrease in shipments to
the Company's Singapore distributor ($2.8 million) as a result of the Asian
economic crisis in the later half of 1997 and decreased shipments to domestic
Value Added Resellers ("VAR's") ($567,000) which the Company believes is
attributable to the declining demand for remote control type remote access
solutions, and a continued decrease in selling, advertising and marketing
expenditures including marketing support for VAR's during fiscal 1999 due to the
Company's cash flow constraints.

     In December 1997, the Company and its Singapore distributor, Macon
Holdings(S) Pte. Ltd. ("Macon") entered into an agreement whereby the Company
agreed to permit Macon to return a majority of the equipment (approximately $2.7
million at sales price, approximately $1.8 million at cost) previously sold to
Macon in the quarterly periods ended June 30, 1997 ($2.8 million) and September
30, 1997 ($.5 million) due to Macon's inability to pay for this equipment. Macon
has attributed its inability to pay for such equipment primarily to the Asian
economic crisis during the later part of 1997 as well as less than anticipated
market acceptance of the equipment. Of the amount returned by Macon,
approximately $505,000 (approximately $328,000 at cost) was received by the
Company during the quarter ended December 31, 1997 (of which $285,000 at sales
price, approximately $185,000 at cost was accrued for as of September 30, 1997)
and approximately $2.2 million (approximately $1.4 million at cost) was received
during the quarter ended March 31, 1998 (of which approximately $2.1 million at
sales price and, approximately $1.3 million at cost was accrued for during the
quarter ended December 31, 1997). The equipment received from Macon is a type
that can be readily sold to other customers in the event the Company is able to
secure additional orders for these products. Through June 30, 1998,
approximately $1.2 million (approximately $761,000 at cost) of the equipment
returned from Macon had been resold by the Company to other customers.

     The Company believes that sales may fluctuate on a quarterly basis as a
result of a number of factors, including the status of world economic
conditions, fluctuations in foreign currency exchange rates and the timing of
system shipments (the current U.S. list price of the Company's most powerful
system, for example, exceeds $300,000; thus the acceleration or delay of a small
number of shipments from one quarter to another can significantly affect the
results of operations for the quarters involved). Orders and shipments during
the first half of the September 30, 1998 fiscal quarter have been lower than
anticipated which the Company believes is the result of reduced expenditures for
advertising and marketing programs and the postponement of hiring or replacement
of certain sales personnel due to the Company's continuing and deepening cash
flow constraints, and the Company's poor financial condition to the extent that
it has caused certain customers to delay purchases from the Company or order
from other  suppliers. Additionally, as a result of the Company's poor financial
condition, the Company may 


                                 PAGE 11 OF 17
<PAGE>
 
                                 CHATCOM, INC.


not be able to effect the timely procurement of manufacturing components and
thus may need to extend the time normally required to ship finished goods and
may not be able to meet delivery requirements of certain customers.

     Cost of goods sold were $911,000 or 100% of net sales during the first
quarter of fiscal 1999 compared to $2.9 million or 64% of net sales in the first
quarter of fiscal 1998. The decrease in gross margin in fiscal 1999 (0% vs. 36%,
respectively) was primarily the result of price discounting on certain orders
due to competition and continued fixed manufacturing overhead costs which did
not decrease proportionately with the lower sales during the first quarter of
fiscal 1999. Although the cost of certain components (i.e., microprocessors and
random access memory components) during the first quarter of fiscal 1999 were
somewhat lower than the comparable prior year quarter, the Company has not been
able to achieve further reductions in component costs due to the lower
quantities purchased during fiscal 1999 as a result of the  decrease in sales
described above. Furthermore, as a result of the Company's cash flow
constraints, the Company may incur additional costs from vendors in order to
expedite the procurement of components in order to satisfy delivery requirements
of certain customers. The Company's gross margins are affected by several
factors, including, among others, sales mix and distribution channels and,
therefore, may vary in future periods from those experienced during the first
quarter of fiscal 1999.

     Selling expenses decreased $789,000 or 74% in the first quarter of fiscal
1999 compared to the first quarter of fiscal 1998, primarily as a result of
decreased salaries and related costs ($242,000) in all departments (selling,
marketing and technical support) as a result of resignations (and the subsequent
postponement of hiring replacement personnel due to cash flow constraints) and
reductions-in-force effected by the Company since November 1997, as well as
decreased advertising expenses ($179,000) and trade show expenses ($83,000) due
to certain cost reductions implemented during the second quarter of fiscal 1998.

     General and administrative ("G&A") expenses decreased by $17,000, or 4%, to
$446,000 during the first quarter of fiscal 1999 from $463,000 during the first
quarter of fiscal 1998. The decrease in G&A expenses consisted primarily of
lower bad debt expense ($25,000) as a result of the lower sales in fiscal 1998;
the elimination of certain consulting expenses ($45,000) due to the termination
during February 1998 of an employment contract with a former executive officer
of the Company; and lower investor relation expenses ($26,000). These decreases
were substantially offset by increases in legal fees ($51,000) and the accrual
of a penalty ($99,000 during the first quarter of fiscal 1999) due to the delay
in registering shares in connection with the Company's Series E Preferred Stock
(which was primarily due to the Company's liquidity problems). As a result of
the Company's current liquidity problems, a number of vendors have either sued
the Company or have forwarded their accounts to collection. The Company
anticipates that it will continue to incur substantial legal expenses in the
September 30, 1998 quarter as well as possible interruption in the receipt of
goods and services due to its liquidity problems.

     Research and development expenses during the first quarter of fiscal 1999
decreased $353,000 or 59% compared to the first quarter of fiscal 1998.  The
decrease in the first quarter of fiscal 1999 was primarily attributable to lower
payroll and related expenses ($87,000); decreased use of consultants ($209,000);
and  decreased expenditures for prototypes ($62,000); all of which were due to
cost reductions implemented by the Company as a result of its poor financial
condition and cash flow constraints.

     The Company did not earn interest income during the first quarter of fiscal
1999 compared to $7,000 earned during the first quarter of fiscal 1998 as a
result of lower investment balances due primarily to cash used for operating
activities.

     Interest expense increased to $44,000 during the first quarter of fiscal
1999 from $1,000 in the first quarter of fiscal 1998 primarily as a result of
interest associated with convertible subordinated notes of $350,000 and $540,000
issued by the Company in May 1997 and December 1997, respectively, as well as
interest related to the VRPI Loan and outstanding trade indebtedness to VRPI.


                                 PAGE 12 OF 17
<PAGE>
 
                                 CHATCOM, INC.


Liquidity and Capital Resources
-------------------------------

     The Company recorded net losses of $7.8 million and $4.6 million during
fiscal years ended March 31, 1998 and 1997, respectively, and recorded a net
loss of $1,013,000 during the first quarter of fiscal 1999.  During the first
quarter of fiscal 1999, cash decreased $254,000 primarily due to the negative
cash flow from operations of $346,000.  The negative cash flow from operations
during the first quarter of fiscal 1999 was comprised primarily of the net loss
($1.0 million) and a decrease in accounts payable ($206,000). These decreases to
cash were partially offset by a decrease in accounts receivable ($460,000) as a
result of collections; a decrease in inventories ($293,000) due primarily to
shipment of components returned from Macon; and by non cash charges primarily
related to depreciation and amortization ($64,000) and inventory obsolescence
($60,000).

     Net cash provided by financing activities during first quarter of fiscal
1999 ($92,000) was primarily the result of the VRPI Loan in June 1998 (see
below).

     As of June 30, 1998 and March 31, 1998, the Company had negative working
capital of $2.2 million and $1.3 million, respectively. The Company must
immediately provide additional liquidity to meet its current obligations and
maintain its operations and is actively seeking additional financing to meet its
immediate needs. There can be no assurance that the Company will be able to
obtain any commitments for sufficient financing and the Company will be forced
to significantly reduce or suspend its operations or seek protection under
bankruptcy laws in the immediate future if it is unable to do so.

     On June 6, 1998, the Company received written notice from Vermont Research
Products, Inc. ("VRPI"), the holder of the Company's Series F and Series G
Preferred Stock and the Company's single largest creditor, of VRPI's decision
(which has not been agreed to by the Company) to surrender its Series F & Series
G Preferred   Stock as a result of VRPI's contention that the Company failed to
timely file a registration statement covering the underlying Common Shares.  On
June 11, 1998, the Company received a $100,000 loan from VRPI (the "VRPI Loan").
The VRPI Loan provides for interest at the rate of 15% per annum, is secured by
the Company's foreign accounts receivable and was due on July 11, 1998. During
the 30 day period ending July 11, 1998 (the "Study Period"), VRPI conducted an
examination of the Company's technology and finances in order to  determine if
an investment in the Company is warranted. The VRPI Loan contains certain
restrictions, including, among others, the use of the loan proceeds for only
those expenses necessary to continue the Company's operations during the Study
Period and the Company's agreement not to issue stock or incur debt, except for
the Company's proposed line of credit (described below) with any party other
than VRPI and those persons or entities who choose to participate with VRPI in
connection with any further financing of the Company.  VRPI has informed the
Company  that it has prepared, but not filed, a lawsuit against the Company and
certain of its officers and directors and has agreed not to file the complaint
during the Study Period.  On July 7, 1998 VRPI provided an additional $100,000
of financing to the Company.

     On June 15, 1998, the Company entered into a conditional commitment letter
with ALCO Financial Services, Inc. ("ALCO") pursuant to which ALCO agreed,
subject to certain conditions, to provide the  Company with a maximum $750,000
line of credit. Under the proposed terms of the line of credit, which would
remain in effect for a period of one year, the Company would be able to borrow
from ALCO based on eligible U.S. accounts receivable and inventory, at prime
plus seven percent. The line of credit would also include certain other fees and
conditions and would grant ALCO a blanket lien on all assets of the Company. On
July 16, 1998, ALCO withdrew its conditional commitment letter and cited the
Company's apparent deterioration in financial condition as the reason for its
withdrawal.  Subsequently, ALCO has verbally notified the Company that it would
provide the Company a maximum line of credit of $300,000 provided that the
Company receive a cash infusion of $200,000 (in addition to


                                 PAGE 13 OF 17
<PAGE>
 
                                 CHATCOM, INC.


the $200,000 received by the Company from VRPI subsequent to March 31, 1998)
prior to effecting the line of credit. As of the date of this report, the
Company has not received funding from ALCO under a line of credit and there can
be no assurance that any line of credit will ultimately be effected.

     The Company has been conducting negotiations with VRPI and High View
Capital in an attempt to secure additional financing in order to meet its
current obligations and immediate needs. High View Capital (including certain of
its affiliates) is the holder of the Company's Series D Convertible Preferred
Stock and the Company's convertible subordinated debt in the aggregate principal
amount of $890,000. The Company has reached an agreement in principle with VRPI
and High View Capital ("HVC") whereby the Company would sell its recently
announced BrightStar product technology (the "New Product") to VRPI and HVC
(collectively the "Purchasers") in exchange for $400,000 in cash ($200,000 of
which was advanced to the Company by VRPI through July 7, 1998 and the remaining
$200,000 would be payable to the Company at the closing), the cancellation of
all outstanding loans and convertible notes made to the Company by the
Purchasers or their affiliates including accrued interest (approximately $1.2
million at August 19, 1998), the cancellation of all trade debt owing by the
Company to the Purchasers (approximately $390,000 at August 19, 1998), the
cancellation of a purchase order from the Company to VRPI in the amount of
approximately $288,000 including accrued interest, the cancellation of all
shares of preferred stock (and accrued dividends thereon) owned by the
Purchasers or any of their affiliates (approximately $4.0 million in stated
value at August 19, 1998) and the cancellation of all warrants held by the
Purchasers or their affiliates to purchase shares of the Company's Common Stock
(835,000 shares) (the "Proposed Sale"). The aggregate value of the consideration
in connection with the Proposed Sale is approximately $5.8 million at August 19,
1998. The Proposed Sale is subject to certain conditions, which include the
Company's receipt of a minimum of $300,000 from ALCO under a line of credit
prior to the closing of the Proposed Sale and the execution of a license
agreement concurrent with the closing of the Proposed Sale under which the
Company would receive an exclusive license to the New Product (the "License
Agreement"). The License Agreement would provide for royalty payments to be made
by the Company to the Purchasers in the amount of 5% of the sales price of New
Products sold by the Company. In the event of any sale or merger of the Company
or the licensing by the Company of the New Product to a third party, the Company
may elect to buy-back the New Product from the Purchasers for $1, provided the
sale or merger or licensing arrangement generates at least $8 million in
aggregate proceeds to the Company. In that event, the Company would be required
to distribute the proceeds from such a transaction on the following incremental
basis: up to $1 million, 75% to Purchasers, 25% to the Company; $1,000,000 to
$5,999,999, 48.5% to Purchasers, 51.5% to the Company; $6,000,000 to $7,999,999,
68% to Purchasers, 32% to the Company; $8,000,000 to $9,999,999, 60% to
Purchasers, 40% to the Company; $10,000,000 to $12,999,999, 21% to Purchasers,
79% to the Company; $13,000,000 to $16,000,000, 7.5% to Purchasers, 92.5% to the
Company; over $16,000,000, 100% to the Company. In the event the Company enters
into a sale, merger or licensing agreement that generates less than $8 million
in aggregate proceeds to the Company, the license granted to the Company under
the License Agreement would convert to a non-exclusive license. For a one-year
period following the closing of the Proposed Sale, the Purchasers would have the
right to rescind the Proposed Sale transaction. No assurances can be given that
the Proposed Sale will be consummated or that VRPI, HVC, or any other person or
entity will provide additional financing to the Company or that VRPI will not
take legal action against the Company.

     As a result of the Company's continuing liquidity problems, the Company has
been sued for non-payment by several suppliers of products and services. Several
other vendors have forwarded their accounts with the Company to collection
agencies. To date, the Company has been successful in settling certain of these
complaints whereby the vendors have agreed to accept a substantial discount from
the balance owed of a least 40%, allow the Company a payment moratorium
(typically two months), and to accept payment of the restated debt over an
extended period of time. The Company has also entered into agreements with
several creditors (who have not sued the Company to date) which provide for
discounts equal to at least 40% of the original debt with payments of the
restated debt extended over several months. At present, the Company is in
default of most of the agreements described above. In the event 

                                 PAGE 14 OF 17
<PAGE>
 
                                 CHATCOM, INC.



the Company is unable to renegotiate or modify the payment terms previously
agreed to, the Company may be forced by certain of these creditors to file for
bankruptcy.

     The Company is seeking additional public or private financing to meet its
longer term capital needs. If additional funds are raised through the issuance
of equity securities, it is likely that the Company will be required to sell
such securities at a substantial discount to the current market price for the
Common Stock, the percentage ownership of the then current shareholders of the
Company will be reduced, and such equity securities may have rights, preferences
or privileges senior to those of the holders of the Company's Common Stock. No
assurance can be given that additional financing will be available or that, if
available, it will be available on terms favorable to the Company or its
shareholders.

     The Company has incurred operating losses in each of its last three fiscal
years, and has experienced operating losses for the past seven consecutive
fiscal quarters and is continuing to incur operating losses subsequent to June
30, 1998. Any increase in the outstanding number of shares of the Common Stock
or other securities convertible or exercisable for Common Stock may have an
adverse effect on the market price of the Common Stock and may hinder efforts to
arrange future financing. Even if the Company successfully completes any debt or
equity financings it is currently attempting to consummate, if the Company
continues to experience operating losses in the future that result in a
significant utilization of its liquid resources, the Company's liquidity and its
ability over the long-term to continue operations could be materially adversely
affected.

      The Company's Common Stock is currently quoted on the Nasdaq SmallCap
Market and, as a result, the Company is subject to the continued listing
requirements of the Nasdaq SmallCap Market ("Nasdaq"). Since the Company does
not currently satisfy Nasdaq's continued listing requirements and is unlikely to
satisfy these requirements in the foreseeable future, its securities are likely
to be delisted from Nasdaq. In the event the Company's Common Stock is no longer
quoted on Nasdaq, the Company anticipates that its Common Stock would trade on
the OTC Bulletin Board. Lack of an established trading market for the Company's
Common Stock such as Nasdaq may limit Common Stock holders' ability to dispose
of their shares and may negatively affect the prevailing price of the Common
Stock, and may adversely impact the Company's ability to arrange future
financing.

          The Company had no material commitments for capital expenditures as of
June 30, 1998.

Year 2000
---------

     The Company is currently working to resolve the potential impact of the
year 2000 on the processing of date-sensitive information by the Company's
computerized information systems.  The year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define
the applicable year.  Any of the Company's programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculation or system failures.  Based on
preliminary information, costs of addressing potential problems are currently
not expected to have a material adverse impact on the Company's financial
position, results of operations or cash flows in future periods.  However, if
the Company, its customers or vendors are unable to resolve such processing
issues in a timely manner, it could result in material financial risk to the
Company.  Accordingly, the Company plans to devote the necessary resources to
resolve all significant year 2000 issues in a timely manner.


                                 PAGE 15 OF 17
<PAGE>
 
                                 CHATCOM, INC.



PART II  OTHER INFORMATION

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

     a.  Exhibits.  The following exhibits are filed with this Form 10-QSB or
               are incorporated by reference to the document described:


         27      Financial Data Schedule

     b.  Reports on Form 8-K.

         A current report on Form 8-K dated July 15, 1998, under Item 5,
         reporting that the Company's Form S-3, registering for potential resale
         shares of the Company's Common Stock, had been declared effective by
         the Securities and Exchange Commission on July 15, 1998.

No other information is required to be filed under Part II of this Form 10-QSB.


                                 PAGE 16 OF 17
<PAGE>
 
                                 CHATCOM, INC.



                                  SIGNATURES

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

                                      CHATCOM, INC.,
                                      a California corporation



Date: August 19, 1998                 By: /s/ E. Carey Walters
                                          ----------------------------
                                          E. Carey Walters, President,
                                          Chief Executive Officer and
                                          Acting Chief Financial Officer


                                 PAGE 17 OF 17