Prepared by MERRILL CORPORATION

California (State or other jurisdiction of incorporation or organization)		94-2566313 (I.R.S. Employer Identification No.)
46832 Lakeview Blvd. Fremont, California (Address of principal executive offices)		94538-6543 (Zip Code)

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 such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

The number of shares of the Registrant's Common Stock outstanding as of June 30, 2001 was 30,387,257.

FORTEL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
($000's)

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

FORTEL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands except per share data)

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

FORTEL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($000's)
(unaudited)

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

FORTEL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(Amounts in thousands except per share data)

FORTEL Inc. (the "Company" or "FORTEL") is an information technology company specializing in computer and systems optimization, data correlation and search technology. FORTEL develops and markets enterprise intranet and eBusiness performance management solutions through its product offerings which include: multi-platform performance analysis and correlation software used to optimize performance in eBusiness and enterprise backoffice infrastructure systems, professional services to enhance its offerings to existing and new customers, and software-based Internet tools.

The accompanying consolidated financial statements include the accounts of FORTEL Inc. and all wholly-owned domestic and foreign subsidiaries. All material intercompany balances and transactions have been eliminated. The interim statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and should be read in conjunction with the audited financial statements contained in the Company's annual report on Form 10-K for the fiscal year ended September 30, 2000. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted although the Company believes the disclosures which are made are adequate to make the information presented not misleading. Further, the condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary to present fairly the financial position and results of operations as of and for the periods indicated.

The results of operations for the period ended June 30, 2001 are not necessarily indicative of the results expected for the full year. The balance sheet as of September 30, 2000 is derived from the audited financial statements as of and for the year then ended but does not include all notes and disclosures required by accounting principles generally accepted in the United States of America.

The Company's consolidated financial statements have been prepared using generally accepted accounting principles applicable to a going concern, which contemplates the realization of assets and liquidations of liabilities in the normal course of business. The Company has incurred significant losses from operations for at least the past two fiscal years. The Company continues to experience negative cash flows from operations and has been dependent on credit facilities to sustain its activities. There is no assurance that such credit facilities will be available in the future. These factors raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. We believe that the adoption of SFAS 141 will not have a significant impact on our consolidated financial statements.

In July 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets", which is effective for fiscal years beginning after March 15, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. We are currently assessing but have not yet determined the impact of SFAS 142 on our consolidated financial position and results of operations.

On October 1, 2000, the Company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities", as amended. SFAS 133 establishes accounting and reporting standards for derivative instruments and requires that all derivatives be recognized on the balance sheet at their fair value. The adoption of SFAS 133 had no effect on the accompanying consolidated financial statements.

Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financials filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The Company is required to adopt SAB 101 in the fourth quarter of fiscal 2001. We believe that the implementation of SAB 101 will not have a material effect on the consolidated financial position or results of operations of the Company.

Included in other assets is goodwill and purchased technology, which are being amortized on a straight-line basis over five years. The Company periodically assesses the recoverability of these other assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. The amount of impairment, if any, is measured based on a projected discounted future operating cash flows and is recognized as a write down of the asset to its estimated net realizable value. As part of the the Company's review of its third quarter financial results, an impairment assessment of these other assets was performed. The assessment was performed primarily due to the significant decline in the Company's common stock price, the fact that the Company's common stock has been delisted from the Nasdaq SmallCap Market, and the overall decline in industry growth rates. As a result, the Company recorded a $945,000 impairment charge to adjust the goodwill associated with the acquisition of the three software companies to $0, which approximated its fair value. Other assets consist of the following (in thousands) as of:

The Company has a $3 million accounts receivable revolving line of credit. Borrowings are based on 80% of certain eligible receivables which are aged 90 days or less. The interest rate approximates 18% per annum calculated on the average daily balance outstanding. Additionally, there is an administrative fee of ¹/2 of one percent of each amount factored. The credit facility has no maturity; however, either party may terminate at any time. During the nine months ended June 30, 2001, the Company had borrowed approximately $4.0 million and repaid approximately $3.2 million. At June 30, 2001, approximately $0.8 million was outstanding against the line of credit.

During the quarter ended June 30, 2000, the Company's two outstanding legal proceedings were settled, resulting in a net gain of approximately $1.0 million, which was recorded in other income. In the first, the Company's suit against a vendor was settled on May 15, 2000. The Company received $2.5 million in cash ($1.8 million after attorney fees) which was recorded in other income as a gain from settlement of a vendor lawsuit. In the second, a complaint for Breach of Contract, Declaratory Relief and Specific Performance, against the Company, was settled on May 31, 2000. The Company issued 387,500 shares of the Company's common stock, resulting in a charge of $787 thousand to other expense as a loss from settlement of litigation.

Common stock activity for the period from October 1, 2000 through June 30, 2001 (in thousands) is as follows:

	Common Stock Shares	Common Stock Amount
Balance at September 30, 2000	26,780	$	74,471
Reclassification of redeemable common stock and warrants to common stock	2,192		5,000
Issuance of common stock under repricing warrants agreement	1,267		—
Common stock issued under employee stock purchase plan	148		63
Stock-based compensation	—		13

Balance at June 30, 2001	30,387	$	79,547

On July 18, 2000, the Company, through a private placement, issued 2,191,781 shares of common stock to two institutional investors (the "Investors") in exchange for $5,000,000. This private placement was pursuant to the Securities Purchase Agreement, Registration Rights Agreement and Repricing Warrants (collectively the "Agreements"). Due to a redemption feature contained within the Agreements, the transaction was recorded in temporary equity on the balance sheet at September 30, 2000.

On November 8, 2000, the Company entered into a letter agreement with the Investors to modify the Agreements to replace the redemption feature with specified liquidated damages as a remedy for certain breaches of and defaults under the Agreements. As a result of the modification of these terms, the transaction was reclassified from temporary equity into shareholders' equity at December 31, 2000.

A reconciliation of the numerator and denominator of basic and diluted EPS is provided as follows (in thousands, except per share amounts) for the three and nine months ended June 30, 2000 and 2001:

For the quarter and nine-month period ended June 30, 2001, options to purchase 1 thousand and 82 thousand shares of common stock, respectively, were not included in the computation of diluted EPS because of the anti-dilutive effect of including these shares in the calculation for both periods. Additionally, warrants to purchase 1,882 thousand shares of common stock were not included in the computation of EPS for the quarter and nine-month period ended June 30, 2001. For the quarter and nine-month period ended June 30, 2000, options to purchase 633 thousand and 559 thousand shares of common stock, respectively, were not included in the computation of diluted ESP because of the anti-dilutive effect of including those shares in the calculation for both periods.

For the quarters and nine-month periods ended June 30, 2000 and 2001, the Company had two reportable segments—Software and Year 2000 Services. The Software business segment develops and markets E-business performance management software solutions. The Year 2000 segment provided service to review software code and identify areas within the code where Year 2000 problems might occur. Following completion of the remaining contract outstanding at September 30, 1999, the Company ceased providing these Year 2000 services in October 1999.

The following table presents certain segment financial information (in thousands) for the three- and nine-month periods ended June 30:

The table below presents net sales (in thousands) by geographic area for the three- and nine-month periods ended June 30:

The table below presents long-lived asset information (in thousands) by geographic area:

	June 30, 2001		September 30, 2000
Long-lived assets:
U.S.	$	1,626	$	3,693
Europe		273		500

Total	$	1,899	$	4,193

Comprehensive loss includes all changes in equity during a period except those resulting from investments by and distributions to shareholders. There were no material differences between comprehensive loss and net loss as reported for each of the periods presented in these condensed financial statements.

During the quarter ended June 30, 2001, certain directors and officers of the Company made loans to the Company. These loans bear interest at 18% per annum and are payable 90 days from receipt of the funds. These loans were recorded as short-term debt. At June 30, 2001,included in short-term debt is $150,000 in loans received from such directors and officers.

On July 25, 2001 the Company received demand letters from its investors Deephaven Private Placement Ltd. and Harp Investors LLC demanding liquidated damages upon a default under the Securities Purchase Agreement, the Repricing Warrants and the Registration Rights Agreement all dated July 18, 2000 and as subsequently amended on November 6, 2000 in the aggregate amount of $1,400,000 due to the Company's delisting from The Nasdaq SmallCap Market effective May 16, 2001 and its failure to register additional securities. Pursuant to the Securities Purchase Agreement, such liquidated damages begin to accrue upon receipt by the Company of a written notice from these investors. The Company does not currently have the capabilities to satisfy these demands. Should the Company fail to negotiate a significant reduction or waiver of such demands the Company will not be able to satisfy its obligations and might therefore cease to continue as a going concern.

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

This report contains forward-looking statements that are not historical facts but rather are based on current expectations, estimates, projections, beliefs and assumptions about our industry, our Company, our business and prospects. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates" and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include those described in "Risks Associated With FORTEL's Business and Future Operating Results", "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management's view only as of the date of this report. We undertake no obligation to update these statements or publicly release the results of any revisions to the forward-looking statements that we may make to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

References in this document to "FORTEL", "we", "our", and "us" refer to FORTEL Inc., a California corporation, its predecessors, and each of its subsidiaries.

FORTEL and SightLine are trademarks of FORTEL Inc. Zitel, Datametrics and ViewPoint are registered trademarks of FORTEL Inc. All other service marks, trademarks and registered trademarks are the property of their respective holders.

The Company recorded a net loss of $2,591,000 ($0.09 per share) for the quarter ended June 30, 2001 compared with a net income of $57,000 ($0.00 per share) for the same quarter of the prior year. Diluted weighted average shares outstanding for the current quarter were 30,226,000 compared to 27,019,000 for the same quarter of the prior year. For the nine months ended June 30, 2001, the net loss was $6,213,000 ($0.21 per share) compared with a net loss of $3,931,000 ($0.15 per share) for the same period a year

earlier. Year-to-date weighted average shares were 29,791,000 versus 25,760,000 in the prior year.

Total net sales for the current quarter were $3,453,000 versus total net sales of $7,791,000 for the same quarter of the prior year, a decrease of $4,338,000. For the nine months ended June 30, 2001, total net sales were $11,970,000 versus total net sales of $17,402,000 for the same period a year earlier, a decrease of $5,432,000. The decrease in net sales in both periods is primarily attributable to a decrease in net license sales. Additionally, net sales also decreased as a result of the closing of the hardware business and disposition of non-related training and consulting business.

Gross margin for the quarter ended June 30, 2001 was 74% of net sales compared to 69% of net sales for the same quarter of the prior year. For the nine months ended June 30, 2001, gross margin was 74% of net sales compared to 67% of net sales for the same period a year earlier. The improvement in gross margin percentage is a result of product mix. The Company does not believe that the gross margins reported for the current quarter just ended are necessarily indicative of the gross margins to be expected. Gross margins may be affected by several factors, including the volume and mix of products sold and price competition.

Research and development expenses for the quarter ended June 30, 2001 were 24% of net sales compared to 15% for the same quarter of the prior year. For the nine months ended June 30, 2001, research and development expenses were 24% of net sales compared to 15% of net sales for the same period a year earlier. Actual spending decreased $344,000 for the quarter and increased $340,000 for the nine-month period ended June 30, 2001.

Selling, general and administrative ("SG&A") expenses for the quarter ended June 30, 2001 were 96% of net sales versus 66% of net sales for the same period a year earlier. Actual spending decreased $1,829,000. Included in SG&A in the June 30, 2001 quarter was a $220,000 charge related to a reduction in force. Included in SG&A in the June 30, 2000 quarter were expenses related to the re-launch of the Company ($520,000), a loss incurred in the sublease of the Company's facility in Fremont (CA) ($371,000) and higher legal costs related to a lawsuit settled during the June 30, 2000 quarter ($175,000).

For the nine months ended June 30, 2001, SG&A expenses were 93% of net sales compared to 80% of net sales for the same period a year earlier. Actual spending decreased $2,810,000.

The decreased spending in both periods is primarily attributable to a reduction in marketing and sales personnel and a reduction in other general operating expenses.

During the quarter ended June 30, 2001, as part of the Company's review of its third quarter financial results, an impairment assessment of the goodwill associated with the acquisition of the three software companies was performed. As a result, the Company recorded a $945,000 impairment charge to adjust the goodwill to $0, which approximated it estimated net realizable value.

Other expense was $36,000 for the quarter just ended versus other income of $1,009,000 in the same quarter of the prior year. For the quarter ended June 30, 2001, other expense was primarily due to the interest expense incurred on the factoring of accounts receivable. Other income for the quarter ended June 30, 2000 was primarily due to the settlement of lawsuits.

For the nine months ended June 30, 2001, other expense was $129,000 versus other income of $869,000 for the same period a year earlier. For the current nine-month period, other expense consisted primarily of interest expense incurred on the factoring of accounts receivable. For the comparable period of the prior year, other income was primarily due to the settlement of lawsuits.

Since fiscal year 1997, in addition to the working capital provided by product sales, the Company has augmented its cash needs to finance operations primarily through the issuance of convertible subordinated notes, the private sale of common stock and proceeds from borrowings against the accounts receivable revolving line of credit.

During the nine-month periods ended June 30, 2001 and 2000, working capital decreased $3,843,000 and $2,743,000, respectively. Cash flows used in operating activities were $1,243,000 for the nine months ended June 30, 2001 and cash flow utilized by operating activities were $133,000 for the same period a year earlier. For the nine months ended June 30, 2001, the utilization of cash in operating activities resulted primarily from a net loss of $6,213,000 and an increase in accounts receivable of $73,000, offset by an increase in deferred revenue of $880,000, an increase in accounts payable of $1,451,000, depreciation and amortization charges of $1,342,000 and impairment of goodwill of $945,000. For the nine-months ended June 30, 2000, cash utilized by operating activities resulted primarily from the net loss of $3,931,000 and an increase in accounts receivable of $1,215,000, offset by an increase in deferred revenue of $1,418,000, an increase in accounts payable and accrued liabilities of $1,040,000 and depreciation and amortization charges of $1,628,000.

For the nine-month period ended June 30, 2001, net cash provided by investing activities of $7,000 was comprised of disposal of fixed assets of $44,000 and acquisition of fixed assets of $37,000. During the nine-month period ended June 30, 2000, net cash used in investing activities of $1,381,000 was primarily made up of $680,000 in capitalized software development costs and $676,000 in acquisition of fixed assets.

Net cash provided by financing activities was $824,000 and $1,124,000 for the nine-month periods ended June 30, 2001 and 2000, respectively. For the nine-month period ended June 30, 2001, cash provided by financing activities was comprised of $3,996,000 from borrowings, $63,000 from the sale of stock under the Company's employee stock purchase plan offset by repayment of borrowings of $3,235,000. Net cash provided by financing activities for the same period a year earlier was comprised of $2,418,000 from borrowings, $154,000 from the sale of stock under the Company's employee stock purchase plan offset by repayment of borrowings of $1,448,000.

The Company currently plans to increase its revenues to a level that will finance expected expenditures and result in at least neutral cash flows from operations. However, until that stage is reached, the Company will continue to use its current cash on hand, working capital, and utilize the available accounts receivable line of credit.

If the Company is unable to generate sufficient cash flows from operations or should management determine it to be prudent, it may attempt to raise additional debt or equity. There can be no assurance that in the event the Company requires additional financing, that such financing will be available on terms which are favorable or at all.

In the event that the Company is unable to increase revenue levels or financing is unavailable, management has developed alternative plans which will entail the reduction of expenses to levels that could be financed by revenues generated. Such reductions in expenditures may include actions similar or greater in scope than the reduction in workforce undertaken by the Company in September 2000. There can be no assurance that the

reduction in workforce undertaken in September 2000 or any further cost cutting exercises will be successful in completely eliminating the difference between expenditures and revenues or that such actions would not have a harmful effect on the Company's business and results of operations.

Based on its current plans, management believes that the Company will meet its cash requirements for the next twelve months from cash on hand, working capital, cash flow from operations, and utilization of the available accounts receivable line of credit.

In December 1999, SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financials filed with the SEC. SAB 101 outlines the

basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The Company is required to adopt SAB 101 in the fourth quarter of fiscal 2001. We believe that the implementation of SAB 101 will not have a material effect on the consolidated financial position or results of operations of the Company.

Set forth below and elsewhere in this Quarterly Report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report.

A material portion of our revenues has been derived from large orders, as major customers deployed our products. Increases in the dollar size of some individual license transactions would also increase the risk of fluctuation in future quarterly results. Moreover, recent adverse economic conditions in the United States, particularly those related to the technology industry, may increase the likelihood that customers will unexpectedly delay or cancel orders and result in revenue shortfalls. This risk is particularly relevant with respect to large customer orders which are more likely to be cancelled or delayed and also have a greater financial impact on our operating results. A large number of technology companies, particularly software companies that, like FORTEL, sell e-commerce related software solutions, have recently announced that these conditions have adversely affected their financial results. Additionally, our operating expenses are based in part on our expectations for future revenues and are difficult to adjust in the short term. Any revenue shortfall below our expectations could have an immediate and significant adverse effect on our results of operations.

FORTEL's quarterly operating results have in the past varied and may in the future vary significantly depending on a number of factors, including:

Due to all of the foregoing factors, FORTEL believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as an indicator of future performance. It is possible that in some future quarter the Company's operating results may be below the expectations of public market analysts and investors.

The Company has not generated net sales sufficient to produce an operating profit in recent years. The Company has relied on significant financings to support its activities. Operations in prior years were also partially funded by a stream of royalty payments under an agreement with IBM. This agreement was terminated in April 1998. The Company sustained substantial operating losses and net losses in fiscal years 1997 through 2000. The Company must generate substantial additional net sales and gross margins on its products and services and must continue to successfully implement programs to manage cost and expense levels in order to remain a viable operating entity. There is no assurance that the Company can achieve these objectives.

For the first three quarters of fiscal year 2001, the Company reported a net loss of $6,213,000. The Company reported total net losses of $8,653,000, $13,103,000 and $43,205,000 for fiscal years 2000, 1999 and 1998, respectively.

The Company has taken a number of steps to attempt to return to profitability, although there is no assurance that it will be successful. A significant portion of the cumulative losses were caused by the funding of MatriDigm Corporation and operations of the Company's former storage systems business, which was sold in July 1998. MatriDigm filed Chapter 7 bankruptcy in October 1999 so there will be no additional funding. The Company has subleased its Fremont, California headquarters, and moved to substantially smaller and less costly premises.

The Company continues to consider options and take actions necessary to bring costs into line with anticipated revenues. There can be no assurance that the Company will be successful in this effort and remain a viable operating entity.

The price of FORTEL's common stock during the nine-month period of fiscal year 2001 ranged from the low closing bid price of $0.17 to the high closing bid price of $1.03125. During the fiscal year 2000, the price of the Company's common stock was volatile, ranging from the low closing bid price of $0.65625 to the high closing bid price of $6.625.

Trading restrictions and reduced liquidity may adversely affect our stock price and the ability to trade our stock

Following the delisting of our Common Stock from The Nasdaq SmallCap Market effective May 16, 2001 our Common Stock is currently traded on the OTC Bulletin Board market. Our Common Stock may be subject to regulation as a "penny stock." The SEC has adopted regulations which generally define "penny stock" to be any equity security that has a market price or exercise price less than $5.00 per share, subject to certain exceptions, including listing on the Nasdaq SmallCap Market. If no other exception applies, the Company's common stock may become subject to the SEC's Penny Stock Rules, Rule 15g-1 through Rule 15g-9 under the Exchange Act. For transactions covered by these rules, broker-dealers must make a

special suitability determination for the purchase of such securities and must have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer must also disclose the commission payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the penny stock rules may restrict the ability of broker-dealers to sell the Company's securities and may affect the ability of holders to sell these securities in the secondary market and the price at which such holders can sell any such securities. Rule 15g-9 under the Exchange Act imposes additional sales practice requirements on broker-dealers who sell such securities except in transactions exempted from such rule. Such exempt transactions include those meeting the requirements of Rule 505 or 506 of Regulation D promulgated under the Securities Act and transactions in which the purchaser is an institutional accredited investor or an established customer of the broker-dealer. As a result, holders of our Common Stock may be unable to readily sell the stock they hold or may not be able to sell it at all.

The market for system management tools in which the Company's software products business unit competes is intensely competitive. Many of the companies with which the Company competes, such as Computer Associates International, Inc., Hewlett-Packard Company, and BMC Software, Inc. have substantially larger installed bases and greater financial resources than the Company. There can be no assurance that the Company's competitors will not develop products comparable or superior to those developed by the Company or adapt more quickly than the Company to new technologies, evolving industry standards, new product introductions, or changing customer requirements.

The markets in which the Company operates are characterized by rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards. The introduction of products embodying new technologies and/or the emergence of new industry standards could render the Company's existing products and services obsolete and unmarketable. The Company's future success will depend upon its ability to develop and to introduce new products and services on a timely basis that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of its customers. There can be no assurance that the Company will be successful in developing and marketing products or services that respond to technological changes or evolving industry standards, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of new products or services, or that its new products or services will adequately meet the requirements of the marketplace and achieve market acceptance. If the Company is unable, for technological or other reasons, to develop and introduce new products or services in a timely manner in response to changing market conditions or customer requirements, the Company's business, operating results and financial condition will be materially and adversely affected.

The Company's agreements with its customers typically contain provisions intended to limit the Company's exposure to potential product liability claims. It is possible that the limitation of liability provisions contained in the Company's agreements may not be effective. Although the Company has not received any product liability claims to date, the sale and support of products by the Company and the incorporation of products from other companies may entail the risk of such claims. A successful product liability claim against the Company could have a material adverse effect on the Company's business and financial position, as well as operating results and cash flows.

The Company's success depends significantly upon its proprietary technology. The Company currently relies on a combination of patent, copyright and trademark laws, trade secrets, confidentiality agreements and contractual provisions to protect

its proprietary rights. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. The Company has registered its trademarks and will continue to evaluate the registration of additional trademarks as appropriate. The Company generally enters into confidentiality agreements with its employees and with key vendors and suppliers. The Company currently holds a United States patent on one of its software technologies. There can be no assurance that this patent will provide the Company with any competitive advantages or will not be challenged by third parties, or that the patents of others will not have a material adverse effect on the Company's ability to do business. The Company believes that the rapidly changing technology in the computer industry makes the Company's success depend more on the technical competence and creative skills of its personnel than on patents.

There has also been substantial litigation in the computer industry regarding intellectual property rights, and litigation may be necessary to protect the Company's proprietary technology. The Company has not received significant claims that it is infringing third parties' intellectual property rights, but there can be no assurance that third parties will not in the future claim infringement by the Company with respect to current or future products, trademarks or other proprietary rights.

The Company expects that companies in its markets will increasingly be subject to infringement claims as the number of products and competitors in the Company's target markets grows. Any such claims or litigation may be time-consuming and costly, cause product shipment delays, require the Company to redesign its products or require the Company to enter into royalty or licensing agreements, any of which could have a material adverse effect on the Company's business, operating results or financial condition. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. There can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology, duplicate the Company's products or design around patents issued to the Company or other intellectual property rights of the Company.

Sales to customers outside the United States have accounted for significant portions of the Company's net sales. The Company currently has offices in and is operating in the United Kingdom, The Netherlands, Switzerland, Germany, and France. International sales pose certain risks not faced by companies that limit themselves to domestic sales. Fluctuations in the value of foreign currencies relative to the U.S. dollar, for example, could make the Company's products less price competitive. If the Company, in the future, denominates any of its sales in foreign currencies, this could result in losses from foreign currency transactions. International sales also could be adversely affected by factors beyond the Company's control, including the imposition of government controls, export license requirements, restrictions on technology exports, changes in tariffs and taxes and general economic and political conditions. The laws of some countries do not protect the Company's intellectual property rights to the same extent as the laws of the United States. The Company does not believe these additional risks are significant in the United Kingdom, The Netherlands, Switzerland, Germany or France.

The Company's future performance depends significantly upon the continued service of its key technical and senior management personnel. The Company provides incentives such as salary, benefits and option grants (which are typically subject to vesting over four years) to attract and retain qualified employees. Recently the Company's stock price has been volatile and as such, many of the Company's employees hold options with exercise prices greater than the market price of the Company's Common Stock. As a result, the prior grants of options to the Company's employees may not be a significant incentive to retain the services of these individuals. The loss of the services of one or more of the Company's officers or other key employees could have a material adverse effect on the Company's business, operating results and financial condition.

The Company's future success depends on its continuing ability to retain highly qualified technical and management personnel. Competition for such personnel is intense, and there can be no assurance that the Company can retain its key technical and management employees or that it can attract, assimilate and retain other highly qualified key technical and management personnel in the future.

The Company believes there is significant competition for the few software development professionals with the advanced technological skills necessary to perform the services offered by the Company's business. The Company's ability to maintain or renew existing relationships and obtain new business depends, in large part, on its ability to hire and retain technical personnel. An inability to hire such additional qualified personnel could impair the ability of the business to manage and complete its existing projects and to bid for and obtain new projects.

We have significant operations, including our headquarters, in the state of California and are dependent on a continuous power supply. California's current energy crisis could substantially disrupt our operations and increase our expenses. California has recently implemented, and may in the future continue to implement, rolling blackouts throughout the state. If blackouts interrupt our power supply, we may be temporarily unable to continue operations at our California facilities. Any such interruption in our ability to continue operations at our facilities could delay the development and delivery of our products and services and otherwise disrupt communications with our customers or other third parties on whom we rely. Future interruptions could damage our reputation and could result in lost revenue, either of which could substantially harm our business and results of operations. Furthermore, shortages in wholesale electricity supplies have caused power prices to increase. If energy prices continue to increase, our operating expenses will likely increase which could have a negative effect on our operating results.

Certain provisions of the Company's Certificate of Incorporation, as amended and restated, and Bylaws, as amended, California law and the Company's indemnification agreements with certain officers and directors of the Company may be deemed to have an anti-takeover effect. Such provisions may delay, defer or prevent a tender offer or takeover attempt that one or more stockholders consider to be in the best interests of same, including attempts that might result in a premium over the market price for the shares held by stockholders.

The Company's Board of Directors may issue additional shares of Common Stock or establish one or more classes or series of Preferred Stock, having the number of shares, designations, relative voting rights, dividend rates, liquidation and other rights, preferences and limitations determined by the Board of Directors without stockholder approval.

The Board of Directors of the Company has approved the adoption of a Preferred Share Purchase Rights Plan (the "Rights Plan"). Terms of the Rights Plan provide for a dividend distribution of one preferred share purchase right (a "Right") for each outstanding share of common stock, no par value per share (the "Common Shares"), of the Company. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, no par value (the "Preferred Stock"), at an exercise price of $69.50 per one one-hundredth of a Preferred Share (the "Purchase Price"), subject to adjustment, and a redemption price of $.01 per Right. Each one one-hundredth of a share of Preferred Stock has designations and the powers, preferences and rights, and the qualifications, limitations and restrictions which make its value approximately equal to the value of a Common Share.

The Rights are not exercisable until the earlier to occur of (i) 10 days following a public announcement that a person, entity or group of affiliated or associated persons (an "Acquiring Person") has acquired beneficial ownership of 15% or more of the outstanding Common Shares or (ii) 10 business days (or such later date as may be determined by action of the Board of Directors prior to such time as any person(s) or entity becomes an Acquiring Person) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in the beneficial ownership by an Acquiring Person of 15% or more of such outstanding Common Shares.

The Rights have certain anti-takeover effects, as they would cause substantial dilution to a potential Acquiring Person that attempted to acquire the Company on terms not approved by the Company's Board of Directors. The Rights should not interfere with any merger or other business combination approved by the Board of Directors, since the Rights may be redeemed by the Company at $.01 per Right prior to the earliest of (i) the twentieth day following the time that an Acquiring Person has acquired beneficial ownership of 15% or more of the Common Shares (unless extended for one or more 10 day periods by the Board of Directors), (ii) a change of control, or (iii) the final expiration date of the rights.

The Company has considered the provisions of Financial Reporting Release No. 48, "Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments". The Company had no holdings of derivative financial or commodity instruments at June 30, 2001. A review of other financial instruments and risk exposures at that date revealed the Company did not have exposure to interest rate risk.

The Company sells it products worldwide. Consequently, the financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Because a major portion of the Company's revenue is currently denominated in U.S. dollars, a strengthening of the dollar could make the Company's products less competitive in foreign markets.

Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

			Page Number
PART I.		Financial Information
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets (unaudited)—June 30, 2001 and September 30, 2000	3
		Condensed Consolidated Statements of Operations (unaudited)—Three and Nine Months Ended June 30, 2001 and 2000	4
		Condensed Consolidated Statements of Cash Flows (unaudited)—Nine Months Ended June 30, 2001 and 2000	5
		Notes to Condensed Consolidated Financial Statements (unaudited)	7
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	14
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
PART II.		Other Information
	Item 1.	Legal Proceedings	29
	Item 2.	Changes in Securities	29
	Item 3.	Defaults Upon Senior Securities	29
	Item 4.	Submission of Matters to a Vote of Security Holders	29
	Item 5.	Other Information	29
	Item 6.	Exhibits and Reports on Form 8-K	29

			June 30, 2001			September 30, 2000
Assets
Current assets:
	Cash and cash equivalents		$	477		$	889
	Accounts receivable, net			3,304			3,362
	Refundable taxes			6			125
	Other current assets			947			1,138

		Total current assets		4,734			5,514
Fixed assets, net				560			854
Other assets, net				1,339			3,339

		Total assets	$	6,633		$	9,707

Liabilities, Redeemable Common Stock and Warrants, and Shareholders' Deficit
Current liabilities:
	Accounts payable		$	3,818		$	2,367
	Accrued liabilities			1,047			1,076
	Short-term debt			761			—
	Deferred revenue			3,769			2,889

		Total current liabilities		9,395			6,332

Redeemable common stock and warrants				—			5,301

Shareholders' deficit:
	Common stock			79,547			74,471
	Accumulated deficit			(82,309	)		(76,397	)

		Total shareholders' deficit		(2,762	)		(1,926	)

	Total liabilities, redeemable common stock and warrants, and shareholders' deficit		$	6,633		$	9,707

		Three Months Ended June 30,						Nine Months Ended June 30,
		2001			2000			2001			2000
Net product sales		$	1,631		$	5,123		$	5,907		$	10,156
Services and other			1,822			2,668			6,063			7,246

	Net sales		3,453			7,791			11,970			17,402
Costs and expenses:
	Cost of products sold		125			976			437			1,638
	Cost of services and other		789			1,445			2,711			4,133
	Research and development expenses		840			1,184			2,876			2,536
	Selling, general & administrative expenses		3,309			5,138			11,085			13,895
	Impairment of goodwill		945			—			945			—

	Operating loss		(2,555	)		(952	)		(6,084	)		(4,800	)
Other (income) expense			36			(1,009	)		129			(869	)

Net income (loss)		$	(2,591	)	$	57		$	(6,213	)	$	(3,931	)

Basic income (loss) per share		$	(.09	)	$	.00		$	(.21	)	$	(.15	)

Number of shares used in basic income (loss) per share calculations			30,226			26,386			29,791			25,760

Diluted income (loss) per share		$	(.09	)	$	(.00	)	$	(.21	)	$	(.15	)

Shares used in diluted income (loss) per share calculation			30,226			27,019			29,791			25,760

			Nine Months Ended June 30,
			2001			2000
Cash flows used in operating activities:
	Net loss		$	(6,213	)	$	(3,931	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Impairment of goodwill		945			—
		Issuance of common stock in settlement of lawsuit		—			787
		Depreciation and amortization		1,342			1,628
		Provision for doubtful accounts		131			217
		Stock-based compensation to consultants		13			—
		Change in operating assets and liabilities:
		Increase in accounts receivable		(73	)		(1,215	)
		Decrease in refundable income taxes		119			1
		Decrease (increase) in other current assets		191			(78	)
		Increase in accounts payable		1,451			840
		Increase (decrease) in accrued liabilities		(29	)		200
		Increase in deferred revenue		880			1,418

	Net cash used in operating activities			(1,243	)		(133	)

Cash flows provided by (used in) investing activities:
		Acquisition of fixed assets		(37	)		(676	)
		Proceeds from disposal of fixed assets		44			—
		Capitalized software development costs		—			(680	)
		Purchase of other assets		—			(25	)

Net cash provided by (used in) investing activities				7			(1,381	)

Cash flows provided by financing activities:
		Proceeds from borrowings under factor line of credit		3,996			2,418
		Repayment of borrowings		(3,235	)		(1,448	)
		Issuance of common stock		63			154

	Net cash provided by financing activities			824			1,124

	Net decrease in cash and cash equivalents			(412	)		(390	)
Cash and cash equivalents, beginning of year				889			1,670

Cash and cash equivalents, end of period			$	477		$	1,280

Supplemental cash flow information:
	Interest paid		$	125		$	114
Supplemental non-cash investing and financing activities:
		Conversion of preferred stock	$	—		$	2,000

	June 30, 2001			September 30, 2000
Goodwill	$	—		$	2,768
Purchased technology		2,588			2,588
Deferred software implementation costs		351			351
Purchased software		550			550
Capitalized development projects		1,403			1,454
Other assets		144			144
Less: accumulated amortization		(3,697	)		(4,516	)

	$	1,339		$	3,339

(a)	Exhibits
	None
(b)	Reports on Form 8-K
	During the period from April 1, 2001 through June 30, 2001, the Company filed the following current report on Form 8-K:
	Date of Report—	Item(s) Reported:
	May 18, 2001	Delisting of the Company's common stock from Nasdaq SmallCap Market.

		FORTEL INC.
Date: August 14, 2001		By		/s/ ROMEO R. DIZON Romeo R. Dizon Chief Financial Officer