FOCUS ENHANCEMENTS INC, 10KSB40, 2000-04-14

FOCUS ENHANCEMENTS INC
10KSB40, 2000-04-14
COMPUTER COMMUNICATIONS EQUIPMENT

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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-KSB

|X| ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934

For the fiscal year ended December 31, 1999, or

|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number 1-11860
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FOCUS Enhancements, Inc.
(Name of Small Business Issuer in its Charter)

Delaware 04-3186320
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

600 RESEARCH DRIVE
Wilmington, Massachusetts 01887
(Address of Principal Executive Offices)

(978) 988-5888
(Issuer's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of Act:

NAME OF EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
Common Stock, $.01 par value NASDAQ

Securities registered pursuant to Section 12(g) of the Act: None

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

Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such other 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. [X] Yes [ ] No

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB [X]

Issuer's revenues for the fiscal year ended December 31, 1999 were $17,182,985.
The aggregate market value of voting Common Stock held by non-affiliates of the
Registrant was approximately $51,348,421 based on the closing bid price of the
Registrant's Common Stock on April 12, 2000 as reported by NASDAQ ($2.0625 per
share).

As of April 15, 2000, there were 24,896,204 shares of Common Stock outstanding.

Document Incorporated by Reference: Portions of the Definitive Proxy Statement
for the Annual Meeting of Stockholders for the fiscal year ended December 31,
1999, to be filed pursuant to Regulations 14A (the "Proxy Statement"), are
incorporated by reference in Part III of this Form 10-KSB.
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TABLE OF CONTENTS
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PART I
Item 1. Business 3
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11

PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 12
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 7. Financial Statements 23
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 24

PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons,
Compliance with Section 16(a) of the Exchange Act 25
Item 10. Executive Compensation 25
Item 11. Security Ownership of Certain Beneficial Owners
and Management 25
Item 12. Certain Relationships and Related Transactions 25
Item 13. Exhibits and Reports on Form 8-K 25
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PART I

ITEM 1. BUSINESS

Business of the Company

FOCUS Enhancements, Inc., (`the Company' or `FOCUS'), internally develops
proprietary technology for the conversion and enhancement of PC and Macintosh
output for display on televisions and large-screen monitors, and markets and
sells, worldwide, a line of video conversion products using this technology.
These video conversion products range from custom-designed video co-processor
chips, used by leading Original Equipment Manufacturers (OEMs), to computer
peripherals marketed to consumers directly and through a global network of
value-added resellers (VARs), distributors and retailers. In a 1997
independent survey by Frost & Sullivan, FOCUS was recognized as an industry
leader in the development and marketing of PC-to-TV video conversion products
that make personal computers "TV ready" and televisions "PC ready". In 1999,
FOCUS continued to solidify this leadership position through:

1. Increased research and development investment, resulting in additional
patents being awarded to the Company, and in industry-wide recognition of the
superior video quality of its products,

2. Significant new licensing agreements with OEMs for use of FOCUS' proprietary
TV video conversion ASIC chips in current and future product designs, and

3. New strategic alliances with major OEMs, resellers and national retail
chains.

In our 1998 Annual Report the Company stated that it was in discussions with
other PC manufacturers, television manufacturers, VGA chip and VGA card
developers. In 1999 many of these discussions came to fruition.

The Company was founded in December 1991, as a Massachusetts corporation and
was reincorporated in Delaware in April 1993. In December 1993, the Company
acquired Lapis Technologies, Inc. (`Lapis'), a developer of high-quality, low-
cost Macintosh PC-to-TV video graphics products. Effective September 30, 1996,
the Company consummated the acquisition of Tview, Inc., a developer of PC-to-TV
video conversion ASIC technology. This acquisition has played a significant
strategic role in allowing FOCUS to gain a major technological position in the
video scan conversion category, and has positioned FOCUS as a leader in PC-to-TV
video conversion technology. On September 30, 1997, the Company sold its line
of computer connectivity products. On March 31, 1998, the Company acquired
selected assets of Digital Vision, Inc., a manufacturer of both PC-to-TV and TV-
to-PC products. On July 29, 1998, the Company acquired the net assets of PC
Video Conversion, Inc., a manufacturer of professional high-end video conversion
products. In December 1998, the Company restructured this entity into a
Professional Products Research & Development group and began to consolidate its
operating activities to the Company's corporate headquarters.

The Company's executive offices are located at 600 Research Drive, Wilmington,
Massachusetts 01887. Its Research and Development center is located at 9275 SW
Nimbus Avenue, Beaverton,

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Oregon. The Company's Professional A/V Conversion team is located at 16120
Caputo Drive, Suite A, Morgan Hill, CA 95037. The Company's general telephone
number is (978) 988-5888, and its Worldwide Web address is
http:www.focusinfo.com.

BUSINESS STRATEGY

In 1999 the Company continued to concentrate its resources on the growing PC-
to-TV scan conversion technology market, which has been projected by independent
industry sources to grow, within the United States alone, at an annual compound
growth rate of approximately 24%, achieving sales of over 200 million dollars by
the year 2003, see Frost & Sullivan 1997 report. Following key strategic
acquisitions over the past six years, and the discontinuance of any lines not
directly in line with the Company's strategic direction, the Company continues
to focus on internal research and development of cutting-edge video enhancement
technology and products. Also, while continuing to service and expand its global
marketing network targeting Professional Consumers and Home Consumers, the
Company has long recognized that the greatest growth potential for its
technology is through sales to, and licensing agreements with, leading OEMs.
Because the patented design of FOCUS' FS400 family of ASICs has allowed the
Company to dramatically improve video quality while reducing cost, leading
manufacturers in the Internet Appliance (IA), PC Reference Design, and
Television markets signed agreements with FOCUS in 1999.

PRODUCT STRATEGY

The company continues on its course of concentrating on developing low-cost,
high-quality video conversion technology. For the year ended December 31, 1999
research and development expenditures were $1,400,732. Approximately 77% of
this expenditure was directed toward new product activities.

MARKETING AND SALES STRATEGY

. The Company vigorously pursued the OEM market for its technology in 1999,
resulting in numerous Licensing Integration agreements with some of the most
significant names in the United States and global TV, PC and Internet
Appliance markets. In 2000 the Company will continue to concentrate its
marketing efforts toward those OEMs which dominate their respective markets,
and which have the manufacturing, sales and distribution networks in place to
capitalize on the huge growth forecast for the PC-to-TV and TV-to-PC
conversion products over the next decade. Also, the redesigned Company web
site, launched in March 1999, features a new OEM Custom Integration section
to showcase FOCUS' line of proprietary video conversion ASICs and OEM
solutions.

. The Professional Consumer market continues to be a growing segment, and the
Company made significant inroads into that market in 1999. In September the
Company unveiled its new Tview QuadScan Pro, a cost-effective, high-
resolution line quadrupler/video scaler at the CEDIA Expo '99. The QuadScan
is being marketed for professional AV applications, as well as for home
theater use. FOCUS continued to expand its presence in the

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Videoconferencing and Education markets through new strategic alliances
consummated in 1999. Additionally, the Company added a new Professional
Consumer Products section to its redesigned World Wide Web site.

. While the Company has determined that the OEM market offers the best
potential for future growth, it also continues to recognize its consumer
channel, through its reseller distribution network as a substantial, revenue-
generating market. One of the potentially most significant new distributor
agreements was signed with The Douglas Stewart Company, the nation's largest
marketer of computer products, electronics and student supplies to the
education market. The Company also continues to offer cooperative
advertising incentives to resellers on a percentage-of-product-purchases
basis. Funded programs include sales incentives, special pricing programs,
and targeted advertising campaigns.

. Direct Marketing to business, education and end-user consumers continues to
be a viable and profitable segment for the Company. Arrangements with
independent, third-party mail order companies such as MicroWarehouse, CDW,
Global Computer Supplies, MultiZones and PC Connections have proven to be a
cost-effective method for achieving direct sales.

The Company's web site contains an interactive list of resellers and outlets for
its products contributing to the goal of direct access to end users and building
relationships. The Company also offers the ability to buy direct on-line through
various computer resellers including MicroWarehouse and Multiple Zones
International. In March 1999, the Company went live with its new Web site that
allows for direct product purchasing from FOCUS.

The Company also utilizes a sophisticated 24-hour fax-on-demand system. Each
product specification fax requested by the customer is cross-marketed for
synergistic products.

. Cross-Marketing. The Company ships over 10,000 products per month, and a FOCUS
PC-to-TV product guide is provided in all shipped packages. This strategy is
designed to increase customer awareness of other FOCUS products, and aids the
Company's brand-recognition marketing goals.

. Display Advertising. The Company utilizes target advertising in popular
computer and consumer journals for the development of lead generation and
product brand recognition. The Company has advertised in magazines such as
Selling Power, Advanced Imaging, Mobile Computing, Laptop Buyer's Guide, Inc.
Magazine, Technology & Learning, and Presentations.

. Global Distribution. The Company has made significant investments over the
last several years in creating a global reseller/VAR channel. In 1995, the
Company had approximately 250 resellers globally. As of December 1999, the
Company's products are marketed in over 2,200 store fronts globally.

In the United States and Canada, the Company markets and sells its products
through national resellers such as CompUSA, Micro Center, Midwest Micro, Fry's
Electronics, and J&R Music World. The Company markets and sells its products
through national distributors such as Ingram Micro, D&H Distributing and
Academic Distributing. The Company also markets and sells its products through
third-party mail order resellers such as MicroWarehouse, Multiple Zones, PC
Connection and CDW.

In the rest of the world, the Company's products are sold to resellers,
independent mail order companies and distributors in Latin America, France, the
United Kingdom, Scandinavia, Germany, Switzerland, Italy, the Czech Republic,
Russia, Australia, Japan, China, Singapore, and the Republic of Korea.

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. Telemarketing and Telesales. The Company is receiving and placing over 50,000
sales calls per year. The Company utilizes telemarketing and telesales programs.

Telemarketing. The Company gathers valuable marketing data from callers. This
data allows the Company to continuously analyze its market data such as customer
type, media response and product interest. The Company also receives
registration cards that provide the Company with marketing information such as
product quality, service quality and sales representative product knowledge.
Additionally, in 1999 the Company established a new rebate program which
required the completion of an information card in order to receive the rebate.

Reactive Telesales. The Company receives calls and product orders from its lead
generation marketing efforts such as advertising, targeted business reply cards
and product guides (catalog) mailings.

PRODUCTS AND APPLICATIONS

FOCUS develops internally all of its PC-to-TV video conversion products, both
external boxes and ASICs, thereby allowing the Company to market and sell a
proprietary group of products to the PC-to-TV video conversion marketplace. The
Company's products are compatible with both Windows and Mac OS personal
computers. FOCUS' products allow PC owners to utilize any television as a large
screen computer display for use in presentations, training, education, video
conferencing, Internet viewing and home gaming.

The Company's primary focus within the video/graphics category is in the
conversion of standard PC video output (VGA) into television video input (NTSC
or PAL). FOCUS' broad line of PC-to-TV products easily allows the user to
display Windows or Mac OS video output directly to a standard television or to
videotape. These products are currently available as either a board-level
product or an external set-top device. FOCUS currently sells its PC-to-TV video
conversion products under the TView(R) brand. These products have a variety of
features geared toward the needs of business, education and consumer customer
groups. The Company has developed various proprietary enhancements for its PC-
to-TV products including image stabilization, which eliminates all flicker, and
TrueScale(R) video compression technology which ensures proper aspect ratios on
the television screen even when a computer image is compressed to fit on a
television.

CONSUMER PC-TO-TV VIDEO SCAN CONVERSION PRODUCTS

1. External Set-Top Boxes. The Company currently offers four models of external
set-top boxes under the TView brand. The Company sells the TView Micro, Micro
XGA, the TView Silver and the TView Gold, all of which are compatible with both
Windows- and Mac OS-based personal computers. All the external set-top boxes
weigh less than 7 ounces, and are easily connected to the VGA video port of the
computer and a television through the cables provided.

2. PCMCIA Card. The Company also offers a PCMCIA card under the TView brand
that provides PC-to-TV conversion capabilities to laptop computer users. Sold as
the TView Gold Card, this PCMCIA card fits into any laptop computer with a type
II or type III PC card slot. The TView Gold Card permits the user to make large
screen presentations without the size and weight associated with presentation
monitors and portable projection devices.

3. Internal Card. The Company also offers a PCI card under the TView brand that
provides PC-to-TV conversion capabilities to desktop computer users. Sold as the
TView Gold PCI Card, this card fits into any computer with a PCI card slot. The
TView Gold PCI Card permits the user to make presentations on any television.

All FOCUS products are shipped with the Company's proprietary Electronic
Marker(TM) software which turns the computer screen cursor into a drawing tool,
allowing the user to highlight or annotate text and graphics directly on the
screen.

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Commercial PC-to-TV Video Scan Conversion Products

Internal Board Level Products for PCs and TVs. For those environments where
portability is less important, such as classrooms or home entertainment systems,
the Company offers board level products that can be installed directly into a
personal computer or television. The Company currently offers board level
products for OEM televisions.

Professional PC-to-TV Video Scan Conversion Products

The Company's TView Pro AV products are high-end video conversion devices that
address the high-quality standards of the professional broadcast and
presentation markets. The Company offers each of its professional products in
desktop, rackmount, and board-level forms. The TView Pro AV products are the
most advanced broadcast-quality conversion products in the marketplace. These
products allow the user to take any high-resolution computer image and project
it onto any compatible NTSC/PAL display or VCR or over a videoconference link.
The QuadScan is a line Quadrupler/Scaler that eliminates visible scan lines and
flicker from standard video for the home theater/professional video markets.

Video Scan Conversion Integrated-Circuit Products (ASICs)

Integrated Circuits. The Company currently offers three families of integrated
circuits. The FS300 family of ASICs was developed for both consumer and
commercial applications. The FS300 was the Company's third generation PC-to-TV
video encoder designed to increase the video conversion capabilities of FOCUS'
products while reducing the cost of manufacturing the Company's products. The
FS300 supports resolutions of up to 10x4 x 768 and features patented "video
scaling" technology whereby the image on the television is scaled both
horizontally and vertically to perfectly fit the entire contents of the computer
screen on the TV.

During 1998-1999, the Company developed a fourth generation scan converter to
advance the technology to optimize the image quality on a TV, the FS400 family.
Four major areas of advancement in the FS400 family are total compatibility with
all computer systems up to very high resolution 2560 x 2048 displays,
significantly improved TV image quality including an advanced sharpness-enhanced
2D flicker filter (patent pending), auto-sensing, sizing, and scaling for hands
off TV operation, and advanced digital and progressive TV output modes. A
version of the FS400 also supports the new DVD copy protection schemes with
Macrovision encoding for DVD movie capable systems. The FS400 delivers all these
features with lower power, lower cost, and a smaller package. The FS400 will
replace the FS310 over Y2000.

The Company also announced its FS450 iNet TV ASIC in July 1999. The FS450 family
of ASICs was specifically designed for the exploding internet set top box
market, information appliances, and TV enabled PCs. It utilizes the high quality
output characteristics of the FS400 family with a low cost digital interface to
most graphic ICs found in low cost PCs, set top boxes, and 3D graphic cards. It
is in this area where the Company intends to focus its research and development
efforts, furthering its core competency in this type of technology and expanding
the application and use of video scan conversion to address digital television
including HDTV, interactive television, information appliances, LCD panels and
plasma display markets.

In December of 1999, the Company announced sale of its FS400 digital video
coprocessor. The FS400 supports high-resolution, faster speed, progressive scan
displays, and Macrovision for DVD. It also delivers such features with lower
power consumption, a smaller footprint and does so at half the cost of the
FS300. The Company plans to launch additional ASICs in 2000.

TV/Camcorder-to-PC Conversion Consumer Products

InVideo capture cards allow computers to capture and manipulate images and
videos originally displayed on a television, camcorder, or other conventional
video device. This technology is driving the burgeoning market for video
conferencing products. FOCUS' InVideo TV tuner cards allow for the cost-
effective conversion of analog television signals to digital video signals for
output on a computer monitor.

In March 1999, the Company announced the new InVideo(TM) USB Capture. The
InVideo(TM) USB Capture allows users to access video from any NTSC/PAL video
source and save it directly to any computer. Moreover, FOCUS' InVideo(TM) USB
Capture combines MMX-enhanced software with powerful video capture hardware and
can be connected to a camcorder, VCR, DVD video player, or any device that
outputs NTSC or PAL video for full motion/full-color video capture. InVideo USB
Capture offers plug and play installation for hardware platforms that support
the Windows 98 operating systems.

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PC-to-TV Video Scan Conversion Applications

Television Display Device. The large-screen area of a TV monitor makes it an
inexpensive way to present computer graphics and text to a large audience or
classroom environment. The Company's products can be used with a TV monitor for
presentations, education, training, video teleconferencing, Internet viewing,
and video gaming applications.

. Presentations. TView products are ideal for sales and business presentations.
In particular, because of the lightweight and small size of the products, they
have been embraced by mobile presenters and sales forces as a cost-effective and
space effective tool.

. Education and Training. In education, teachers and corporate trainers see the
benefit of using computers in the classroom to create an interactive learning
environment. Because TView products allow the use of one computer for multiple
students, teachers and curriculum developers no longer need to be constrained in
their use of computers for instructional purposes.

. Internet Viewing. TView products also take advantage of the rise in popularity
of the Internet and the advent of Internet-related products for television. By
allowing current PC owners to adapt their existing technology to display on a
television, TView products bridge the gap between current and future Internet
usage by offering the full functionality of a PC on a television.

. Video Gaming. TView products make the PC gaming experience larger than life by
allowing users to play PC games on a television. By connecting a PC's sound and
video ports to a television, the gaming enthusiast can share in the gaming
experience with a group or simply play along with the impact of a big screen
television.

. Print to Video. The TView systems will output the computer images directly to
a VCR allowing for an inexpensive way to print anything created on a Windows or
Mac OS personal computer to video tape.

. Mirroring Mode. The Company's proprietary technology allows the presenter to
use the small computer screen as a mirroring console to the same images
displayed on the larger TV monitor. Training of applications can be performed
from the Windows or Mac OS personal computer while the audience observes the
images on the TV monitor.

TV-to-PC Video Conversion Applications

The InVideo line of products allow television or camcorder images to be imported
into any computer with fully scalable, full-motion, full-color graphics for use
in desktop publishing, video-conferencing and video e-mail. This product is
used by businesses, web designers and distance learning customers who want to
stream video clips, create CD multimedia presentations and send video e-mail.

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Customer Support

Management believes that its future success will depend, in part, upon the
continued strength of customer relationships. To ensure customer satisfaction,
the Company provides customer service and technical support through a five-days-
per-week "hot line" telephone service. The Company uses 800 telephone numbers
for customer service and a local telephone number for technical support (the
customer pays for the phone charge on technical support). The customer service
and support lines are currently staffed by technicians who provide advice free
of charge to ensure customer satisfaction and obtain valuable feedback on new
product concepts. In order to educate its own telephone support personnel, the
Company also periodically conducts in-house training programs and seminars on
new products and technology advances in the industry.

The Company offers this same level of support for its entire domestic market
including its direct market customers who purchase the Company's products
through computer superstores or system integrators. The Company also provides
technical support to its international resellers and distributors. The Company's
international resellers and distributors also provide local support to the
customers for their respective markets.

The Company provides customers with a one- to three-year warranty on all
products. The Company repairs or replaces a defective product which is still
under warranty coverage, and substantially all the components which the Company
purchases are also covered by vendor warranties of comparable duration. Returned
products with defective components are returned by the Company to the component
vendors for repair or replacement. Product returns, exclusive of reseller stock
balancing, averaged approximately 36% and 17% of total product revenue during
the years ended December 31, 1998 and 1999, respectively. In 1999, product
returns were the result of normal customer returns in the Company's retail,
distribution and mail order channels. The decrease in product returns was
principally the result of the consolidation of one of the Company's distribution
channels effective in Q498.

Competition

The Company currently competes with other developers of PC-to-TV conversion
products, TV-to-PC conversion products and with developers of videographic
integrated circuits. Although the Company believes that it is a leader in the
PC-to-TV conversion product marketplace, the videographic integrated circuit
market is intensely competitive and characterized by rapid technological
innovations. This has resulted in new product introductions over relatively
short time periods with frequent advances in price/performance ratios.
Competitive factors in these markets include product performance, functionality,
product quality and reliability, as well as volume pricing discounts, customer
service, customer support, marketing capability, corporate reputation, brand
recognition and increases in relative price/performance ratios for products
serving these markets. In the PC-to-TV conversion product market, the Company
competes with companies such as AI Tech and AVerMedia. In the TV-to-PC market,
the Company competes with other video-in and digital frame capture manufacturers
such as Hauppauge and A.T.I. In the videographic integrated circuits market, the
Company competes with Averlogic and Fairchild Semiconductor.

Certain of the Company's competitors have greater technical and capital
resources, more marketing experience, and larger research and development staffs
than the Company. Management believes that it competes favorably on the basis of
product quality and technical benefits and features. The Company also believes
it provides competitive pricing, extended warranty coverage, and strong customer
relationships, including selling, servicing and after-market support. However,
there can be no assurance that the Company will be able to compete successfully
in the future against existing companies or new entrants to the marketplace.

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Manufacturing

In the manufacture of its products, the Company relies primarily on turnkey
subcontractors who utilize components purchased or specified by the Company. The
"turnkey" house is responsible for component procurement, board level assembly,
product assembly, quality control testing, and in some cases, final pack-out and
direct shipment. All subcontracted turnkey houses currently used by the Company
are ISO 9002 certified. During 1999, the Company relied on two turnkey
manufacturers for approximately 90% of the Company's product manufacturing.
Effective in Q499, the Company relied on a new Far East turnkey manufacturer for
approximately 90% of the Company's manufacturing. The Company has since begun
using an additional Far East Manufacturer as a 2nd source of turnkey products.

Upon receipt of a customer's order, the Company's telemarketing representative
enters the order into the Company's computerized order entry and inventory
management system. Once the customer's credit has been verified and approved by
the finance department, the orders are electronically dispatched to operations
for order fulfillment and shipment. The Company then performs final packaging
and fulfillment of product orders with most customer orders being shipped in
less than three business days from the date they are placed into the system. For
certain commercial PC-to-TV video conversion products, the Company's turnkey
manufacturers ship directly to the OEM customer and forward-shipping information
to the Company for billing purposes.

Quality control is maintained through standardized ISO 9002 quality assurance
practices at the build site and random testing of finished products as they
arrive at the Company's fulfillment center. Management believes that the turnkey
model helps it to lower inventory and staff requirements, maintain better
quality control and product flexibility and achieve quicker product turns and
better cash flow.

All customer returns are processed by the Company in its fulfillment center.
Upon receipt of a returned product, a trained testing technician at the Company
tests the product to diagnose the problem. If a product is found to be defective
the unit is either returned to the turnkey subcontractor for rework and repair
or is repaired by the Company and returned to the customer. The majority of the
Company's defective returns are repaired or replaced and returned to customers
within five business days. In 1999, product returns that are determined to be
defective represented approximately 0.5% of the total product revenues.

Intellectual Property and Proprietary Rights

The Company currently has five patents pending and five patents issued, six of
which relate to its PC-to-TV video conversion chips, and anticipates filing
another patent application in the third quarter of 2000. Patent applications
have also been filed to secure intellectual property rights in foreign
jurisdictions. The Company has also filed applications to register eight
trademarks to add to its two currently registered trademarks. Historically, the
Company has relied principally upon a combination of copyrights, common law
trademarks and trade secret laws to protect the rights to its products that it
markets under the FOCUS and TView brand names.

Upon joining the Company, employees and consultants are required to execute
agreements providing for the non-disclosure of confidential information and the
assignment of proprietary know-how and inventions developed on behalf of the
Company. In addition, the Company seeks to protect its trade secrets and know-
how through contractual restrictions with vendors and certain large customers.
There can be no assurance that these measures will adequately protect the
confidentiality of the Company's proprietary information or that others will not
independently develop products or technology that are equivalent or superior to
those of the Company.

Additionally, in connection with OEM and VAR agreements, the Company often seeks
to require manufacturers to display the Company's logo conspicuously on their
product. Management expects that this should increase name recognition and
further the association of the Company's name with the associated goods.

Because of the rapid pace of technological innovation in the Company's markets,
management believes that in addition to the patents filed and issued, the
Company's success relies upon the creative skills and experience of its
employees, the frequency of Company product offerings and enhancements, product
pricing and performance features, its diversified marketing strategy, and the
quality and reliability of its support services

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Personnel

As of December 31, 1999, the Company employed 54 people on a full-time basis, of
which 16 are in research and development, 9 in marketing and sales, 7 in
customer support, 10 in operations, and 12 in finance and administration.

Backlog

At December 31, 1999, the Company had a backlog of approximately $911,000 for
products ordered by customers as compared to a backlog of $282,000 at December
31, 1998, an increase of $629,000 or 223%. The Company expects to fill these
orders in 2000. The increase in backlog in 1999 as compared to 1998 is primarily
due to development delays on the FS400 ASIC combined with production delays on
Professional AV products in the fourth quarter of 1999. Generally, management
does not believe backlog for products ordered by customers is a meaningful
indicator of sales that can be expected for a particular time period.

ITEM 2. PROPERTIES

As of December 31, 1999, the Company leased approximately 40,000 square feet of
space at four locations. The Company leased approximately 22,000 square feet of
space at $16,380 per month in Wilmington, Massachusetts, which was used for
administration, sales, marketing, customer service, limited assembly, quality
control, packaging and shipping. This lease is scheduled to expire in February
2004. The company leases additional space in the following locations: Orinda,
California, Morgan Hill, California, and Beaverton, Oregon. The Orinda
facility is mainly used for research and development with approximately 500
square feet at $950 per month. The Morgan Hill facility is mainly used for
high-end video conversion development and final production, with approximately
11,640 square feet at $4,320 per month, expiration being May 2000. The Beaverton
facility is mainly used for research and development, with approximately 4,700
square feet at $3,631 per month, expiration being June 30, 2000. The Company is
currently in negotiations for new space in Beaverton, Oregon. The Company
believes that its existing facilities are adequate to meet current requirements
and that it can readily obtain appropriate additional space as may be required
on comparable terms.

ITEM 3. LEGAL PROCEEDINGS

The Company has been named as a defendant in a lawsuit filed in United
States District Court for the District of Massachusetts, on or about November 9,
1999, on behalf of Frank E. Ridel and other currently-unnamed person(s) who are
alleged to have purchased shares of our common stock from July 17, 1997 to
February 19, 1999. In March of 2000, 15 additional actions were filed which
made claims on behalf of shareholders who purchased stock from the previous
class period through March 1, 2000. The actions are in the process of being
consolidated. The complaints allege that the company, its chief executive
officer and its chief financial officers, violated federal securities laws in
connection with a number of allegedly false or misleading statements and seeks
certification as a class action and certain unquantified damages. We intend to
contest this case vigorously.

From time to time, the Company is party to certain other claims and legal
proceedings that arise in the ordinary course of business of which, in the
opinion of management, do not have a material adverse effect on the Company's
financial position or results of operation.

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

No matters were submitted during the fourth quarter of the year ended December
31, 1999 to a vote of security holders of the Company, whether through
solicitation of proxies or otherwise.

11
<PAGE>

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Trading in the Company's Common Stock and public warrants (the "Warrants")
commenced on May 25, 1993, when the Company completed its initial public
offering, and since that time the Company's Common Stock and Warrants
traded principally on the NASDAQ SmallCap Market under the symbol "FCSE" and
"FCSEW", respectively. The Company's Common Stock and Warrants were also traded
on the Boston Stock Exchange under the symbols "FCS" and "FCSW", respectively,
during the period May 26, 1993 through March 7, 1997. On May 27, 1998, the
Company's Warrants expired. The following table sets forth the range of
quarterly high and low bid quotations for the Company's Common Stock and
Warrants as reported by NASDAQ. The quotations represent inter-dealer quotations
without adjustment for retail markups, markdowns or commissions, and may not
necessarily represent actual transactions. The closing bid price of the
Company's Common Stock on the NASDAQ SmallCap Market on March 31, 2000 was
$3.125 per share.
<TABLE>
<CAPTION>
WARRANTS COMMON STOCK
HIGH BID LOW BID HIGH BID LOW BID
<S> <C> <C> <C> <C>
CALENDAR 1999 QUOTATIONS
First Quarter Expired Expired $1.81 $ .91
Second Quarter Expired Expired $1.75 $1.00
Third Quarter Expired Expired $2.00 $ .94
Fourth Quarter Expired Expired $9.13 $1.00

CALENDAR 1998 QUOTATIONS
First Quarter $1.25 $0.50 $4.25 $2.50
Second Quarter $1.17 $0.03 $4.75 $2.38
Third Quarter Expired Expired $3.47 $1.19
Fourth Quarter Expired Expired $1.28 $1.19
</TABLE>

As of March 8, 2000, there were 226 holders of record of the Company's
24,881,204 shares of Common Stock outstanding on that date. As of March 9, 2000
the Company estimates that approximately 11,500 shareholders hold securities in
street name. The Company does not know the actual number of beneficial owners
who may be the underlying holders of such shares.

The Company has not declared nor paid any cash dividends on its Common Stock
since its inception. The Company intends to retain future earnings, if any, for
use in its business.

12
<PAGE>

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

INTRODUCTION
- ------------

On March 31, 1998, the Company acquired selected assets of Digital Vision, Inc.,
a manufacturer of both PC-to-TV and TV-to-PC products. The Company marketed two
new products as a result of the acquisition, identified as its InVideo product
line. Sales of this product line in 1999 totaled approximately $465,000 as
compared with $500,000 for 1998. Gross profits for these products were
approximately $145,000 as compared to $200,000 in 1998. Sales related expenses
totaled $90,000 in 1999 compared to $200,000 in 1998. This acquisition resulted
in no additional personnel being added to the Company.

On July 29, 1998, the Company acquired the net assets of PC Video Conversion,
Inc. ("PC Video"), a manufacturer of Professional A/V products. In 1999,
revenues from products resulting from this acquisition totaled approximately
$2,100,000 compared to approximately $700,000 in 1998. Gross margin on sales of
professional A/V products was approximately $1,300,000 in 1999 compared to
approximately $500,000 in 1998. Operating expenses totaled approximately
$850,000 in 1999 versus approximately $600,000 in 1998.

In connection with the Company's sale of its line of computer connectivity
products in 1997, the Company acquired 189,701 shares of the common stock of
Advanced Electronic Support Products, Inc. ("AESP"). Due to a prolonged decline
in the per share market price of the AESP stock investment, the Company adjusted
this investment to its estimated net realizable value. This resulted in a charge
to earnings of approximately $346,000 in 1998. In June 1999, the Company sold
approximately 189,701 shares of AESP stock yielding gross proceeds of
approximately $324,000 and recognizing a gain of approximately $80,000.

RESULTS OF OPERATIONS
- ---------------------

Year ended December 31, 1999 as compared to Year Ended December 31, 1998

The following table sets forth, for the periods indicated, income and expense
items included in the Consolidated Statements of Operations, expressed as a
percentage of net sales:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
Net sales 98 % 100 %
Licensing fees 2 --
-------- --------
Total revenues 100 100
Cost of goods sold 61 84
-------- --------
Gross profit 39 16
-------- --------
Operating expenses:
Sales, marketing and support 23 37
General and administrative 11 12
Research and development 8 9
Depreciation and amortization 4 8
Impairment of goodwill -- 17
-------- --------
Total operating expenses 46 83
-------- --------
Loss from operations (7) (67)

Interest expense, net (3) (1)
Other income 1 1
Gain (loss) on securities available for sale -- (2)
Income (loss) before income taxes (9) (69)
Income tax expense -- --
-------- --------
Net loss (9%) (69%)
======== ========

</TABLE>

13
<PAGE>

NET SALES

Net sales for the year ended December 31, 1999 were $17,183,000 as compared with
$18,440,000 for the year ended December 31, 1998, a decrease of $1,257,000, or
7%. During the year ended December 31, 1999, the Company had net sales increases
to Professional AV customers (205%) and Internet customers (100%), while it had
decreases in net sales to US Resellers (9%), to International customers (10%),
to OEM customers (37%), and Other sales (79%).

In 1999, net sales to US Resellers (Distributors, Retailers, VAR's and Education
segments) were approximately $11,402,000 as compared to $12,498,000 in 1998, a
decrease of $1,096,000 or 9%. Net sales included sales to a major distributor
totaling approximately $4,318,000 or 25% as compared to 5,686,000 or 31% in
1998. The decrease in absolute dollars is the result of a reduction in major
retailers that were directed to this distributor in 1999 as compared to 1998.

During 1999, net sales to OEM customers were approximately $2,442,000 as
compared to $3,866,000 in 1998, a decrease of $1,424,000 or 37%. The decline in
OEM sales was primarily due to the delay in development and completion of the
Company's new FS400 mixed signal ASIC for the television, computer and internet
appliance markets. This ASIC was completed in Q499 and is in full production in
Q100.

Net sales to international customers in 1999 were approximately $758,000
compared to $605,000 in 1998, an increase of $153,000 or 25%. The increase is
principally the result of the addition of professional AV sales to the
international sector.

In 1999, net sales to Professional AV customers were approximately $2,112,000
compared to $692,000 in 1998, an increase of $1,420,000 or 205%. The increase
is primarily due to development of a distribution and reseller channel in 1999,
combined with the introduction of two new products. In addition, 1998 results
only consist of five months activity pursuant to the purchase of PC Video
Conversion, Inc. on July 30, 1998.

In 1999, net sales to customers on-line via the internet were approximately
$167,000 compared to $0 in 1998. The increase is principally the result of the
Company establishing an e-commerce site which offers products direct to
customers.

Other net sales in 1999 were approximately $165,000 as compared to $780,000 in
1998, a decrease of $615,000 or 79%. Other sales in 1998 principally consisted
of networking and other discontinued product sales. The Company sold its
networking product line in September, 1997 to AESP.

LICENSING FEES

In 1999, the Company received licensing fees of $350,000 as compared with $-0-
in 1998. Licensing fees in 1999 were comprised of single source, non-recurring
licensing revenues.

COST OF GOODS SOLD

Cost of goods sold was $10,544,000, or 61% of net sales, for the year ended
December 31, 1999, as compared

14
<PAGE>

with $15,411,000, or 84% of net sales, for the year ended December 31, 1998, a
decrease of $4,866,000 or 32%. In the fourth quarter of 1999, the Company
adjusted the carrying values of certain inventory items to their estimated net
realizable values. As a result, the Company charged approximately $164,000 in
the fourth quarter of 1999 thus increasing its inventory reserves to
approximately $399,000. In the fourth quarter of 1998, as a result of a detailed
review of its inventories the Company identified certain excess and obsolete
inventory items and also determined that the cost of certain inventory items
required adjustments to their estimated net realizable value. As a result, the
Company charged approximately $1,929,000 to expenses in the fourth quarter of
1998, thereby increasing its inventory reserves to approximately $2,168,000 at
December 31, 1998. In addition, the Company recognized an additional $240,000 in
market development costs in 1998 as a result of its expansion into the office
superstore retail market. Cost of sales as a percentage of sales in 1999 were
slightly lower compared to 1998, exclusive of the inventory adjustments and
market development expenses in 1998. This is principally the result of continued
cost reductions in manufacturing designs along with a new Far East manufacturing
relationship established in Q499 resulting in lower manufacturing costs.

During the fourth quarter of 1999, the Company reduced cost of sales by
$420,000, representing the cost of product sales returns from major customers,
including anticipated sales returns in the first quarter of 2000. The Company
also adjusted cost of sales by accruing for price protection and cooperative
advertising credit claimed on prior products sold as the Company's management
decided in the fourth quarter of 1999 to offer pricing incentives to remain
competitive in 2000. This accrual resulted in a charge of approximately
$194,000.

During the fourth quarter of 1998, the Company reduced cost of sales by
approximately $3,400,000, representing the cost of product sales returns from
major customers, including anticipated sales returns in the first quarter of
1999. The Company also adjusted cost of sales by accruing for price protection
claims on prior products sold as the Company's management decided in the fourth
quarter of 1998 to reduce its suggested retail price in 1999 to remain
competitive. This accrual resulted in a charge of approximately $645,000.

SALES, MARKETING AND SUPPORT EXPENSES.

Sales, marketing and support expenses were $3,970,000, or 23% of net revenues,
for the year ended December 31, 1999, as compared with $6,902,000, or 37% of net
revenues, for the year ended December 31, 1998, a decrease of $2,932,000 or 42%.
The decrease in sales, marketing and support expenses in absolute dollars is
primarily the result of reduced marketing and advertising expenditures resulting
from the consolidation of a segment of the Company's retail channel in Q498. In
addition, the Company postponed marketing activities pertaining to its new FS400
ASIC that encountered development delays and was not released from engineering
until Q499.

GENERAL AND ADMINISTRATIVE EXPENSES.

General and administrative expenses for the year ended December 31, 1999 were
$1,878,000 or 11% of net revenues, as compared with $2,166,000 or 12% of net
revenues for the year ended December 31, 1998, a decrease of $288,000 or 13%.
The decrease in terms of absolute dollars and as a percentage of net revenues is
primarily due to decreases in provisions for bad debts of approximately $99,000,
consulting fees of approximately $80,000, office supplies of approximately
$51,000, recruiting expenses of approximately $45,000, investor relations
expenses of approximately $41,000 and temporary help of approximately $25,000.
These reductions were offset by an increase in stock compensation charges of
approximately $65,000.

15
<PAGE>

RESEARCH AND DEVELOPMENT EXPENSES.

Research and development expenses for the year ended December 31, 1999 were
approximately $1,401,000 or 8% of net revenues, as compared with $1,699,000 or
9% of net revenues, for the year ended December 31, 1998, a decrease of $298,000
or 18%. The decrease in research and development expenses in both absolute
dollars and as a percentage of revenues is due primarily to a reduction of
period expenses in the Beaverton, OR development center resulting from
incremental increases in capitalized ASIC development costs of approximately
$605,000, offset by an increase in Professional AV products R&D of approximately
$305,000. This increase is a result of a full twelve months activity as compared
with only five months activity in 1999 pursuant to the acquisition of PC Video
Conversion, Inc. on July 30, 1998.

DEPRECIATION AND AMORTIZATION.

Depreciation and amortization expenses for the year ended December 31, 1999 were
$557,000 or 3% of net revenues, as compared with $1,500,000 or 8% of net
revenues, for the year ended December 31, 1998, a decrease of $943,000 or 63%.
In the fourth quarter of 1998, the Company performed a detailed review of its
property and equipment accounts. As a result of this review, certain assets
were written off and the estimated useful lives of certain assets were revised.
The effect of these write-offs and revisions resulted in additional depreciation
expense of approximately $766,000. In addition, in 1998 the Company recorded
additional amortization of goodwill resulting from the acquisition of Digital
Vision, Inc. and PC Video Conversion, Inc. totaling approximately $146,000.

INTEREST EXPENSE, NET.

Net interest expense for the year ended December 31, 1999 was $531,000, or 3% of
net revenues, as compared to $226,000, or 1% of net revenues, for the year ended
December 31, 1998, an increase of $305,000 or 135%. The increase in interest
expense is attributable to an increase in interest bearing obligations at
increased interest rates. On March 31, 1999, the Company was required to
restructure its line of credit with its commercial bank resulting in an increase
in interest rate combined with additional transaction fees.

IMPAIRMENT OF GOODWILL

The Company recognized a write-off of $3,054,000 in 1998 representing impaired
goodwill resulting from the acquisitions of Lapis Technologies, Inc. ("Lapis"),
Digital Vision, Inc. ("Digital Vision") and PC Video Conversion, Inc. ("PC
Video").

The Company acquired Lapis in December, 1993 and utilized its video conversion
technology in its products through 1998. In 1997, the Company began developing
its own proprietary video conversion technology and in Q198 introduced its FS300
video conversion ASIC to the market place. During 1998, the Company began
including this ASIC in its manufactured products and simultaneously began the
end-of-life cycle for Lapis based products. By the end of Q498, all remaining
inventory incorporating Lapis technology was disposed of by sale or write-off.
The Company wrote-off the balance of approximately $543,000 of impaired goodwill
on Lapis Technologies, Inc.

16
<PAGE>

The Company acquired Digital Vision on March 31, 1998 to obtain its TV-to-PC
product line. Upon evaluation of the product line, the Company deemed that only
two products warranted inclusion in its product portfolio. However, this line,
the InVideo product line was not widely accepted by the Company's customer base
due to significant competition in its category, limited product features in
comparison with the competition, and its cost structure required pricing higher
than many of the competing products. In addition, no proprietary technology was
acquired with this acquisition. The Company achieved sales, gross profit and
expenses of $500,000, $200,000 and $200,000 respectively for the InVideo product
line in 1998. As result of an impairment analysis in Q498, the Company
determined that the acquired goodwill was impaired. The remaining goodwill was
valued using a discounted cash flow model that resulted in a write-off of
approximately $1,070,000 of impaired goodwill.

On July 30, 1998 the Company purchased the net assets of PC Video. This
acquisition was intended to provide the Company with an entry into high quality,
professional audio/video scan conversion market. Upon review of the product
offerings of PC Video, the Company realized that the product quality,
manufacturing capacity, and distribution network were inadequate to provide
positive operating income from this venture on an on-going basis and
discontinued producing all products of the former PC Video. The engineering
resources pertaining to product design and technology vision were evaluated and
deemed exceptional by management. Accordingly, the Company decided to
restructure the PC Video operation into a high-end, professional A/V research
and development center in Q498 tasked to produce new high quality, professional
A/V product utilizing the Company's proprietary ASIC technology. During 1998,
sales of legacy PC Video products were approximately $700,000 yielding gross
profits of approximately $500,000 offset by operating expenses of approximately
$600,000. The Company performed an impairment analysis in Q498 utilizing a
discounted cash flow model, resulting in a write-off of impaired goodwill of
approximately $1,441,000.

OTHER INCOME.

For the year ended December 31, 1999, the Company had other income of $138,000
or 1% of net revenues as compared to other income of $100,000 or 0.5% of net
revenues for the year ended December 31, 1998, an increase of $38,000.

GAIN (LOSS) ON SECURITIES AVAILABLE FOR SALE

During June 1999, the Company sold approximately 189,701 shares of AESP stock
available for sale. This stock was acquired by the Company as a result of the
sale of a line connectivity products to AESP on September 30, 1997. The Company
received gross proceeds of approximately $324,000 and recognized a gain of
approximately $80,000 on the transaction.

On September 30, 1997, the Company sold its line of computer connectivity
products to AESP for 189,701 shares of AESP common stock. Included in the sale
were customer lists and the right to use the FOCUS networking brand name to
market the product line as well as certain of AESP's complementary products. In
connection with this transaction, the Company recorded other income in the
amount of $358,000. During 1998, the fair market value of this investment
declined 58%. At December 31, 1998, there was no indication that the fair market
value of this investment would increase substantially in the foreseeable future,
therefore the Company recognized a loss on this investment of approximately
$346,000 in the fourth quarter of 1998.

17
<PAGE>

NET LOSS.

For the year ended December 31, 1999, the Company reported a net loss of
$1,480,000, or $0.08 per share (basic), as compared to a net loss of
$12,787,000, or $0.78 per share (basic), for the year ended December 31, 1998, a
reduction in loss of $11,307,000. For the quarter ended December 31, 1999, the
Company recorded a net loss of approximately $1,779,000. This loss resulted from
certain adjustments in the fourth quarter as follows: product returns from
discontinued resellers (approximately $367,000), inventory adjustments
(approximately $527,000), accounts receivable adjustments (approximately
$383,000), accrued expense adjustment (approximately $254,000), stock
compensation and other charges (approximately $284,000).

For the quarter ended December 31, 1998, the Company recorded a net loss of
approximately $14,235,000. This loss resulted from reduced sales in the quarter
due to lower than anticipated sell through of the Company's products and higher
than expected inventory levels at certain retail customers, which resulted in
significant sales returns in the fourth quarter. In addition, the Company made
significant adjustments in the fourth quarter. The effect of the sales returns
and the significant fourth quarter adjustments are as follows: product returns
from non-performing resellers (approximately $3,455,000), impaired goodwill
(approximately $3,054,000), inventory adjustments (approximately $1,929,000),
accrued expense adjustments (approximately $2,125,000), fixed asset adjustments
(approximately $766,000), and revaluation of stock investments (approximately
$346,000).

FINANCIAL CONDITION
- -------------------

TOTAL ASSETS.

Total Assets increased $2,279,000 or 18%, from December 31, 1998 to December 31,
1999. The increase in assets is due to: increases of cash and certificates of
deposit by $2,889,000, accounts receivable by $360,000, and property and
equipment by $174,000, capitalized software development costs by $1,645,000 and
other current asset by $24,000; offset by reductions of securities available for
sale by $249,000, inventory by $2,360,000 and goodwill by $187,000 and other
assets by $17,000. Cash and certificates of deposits increased 210% principally
resulting from equity infusions in 1999 from private placements of common stock
and issuances of common stock pursuant to exercises of common stock warrants and
options. Accounts receivable increased by 14% in 1999 compared with 1998
principally due increased sales in Q499 compared to Q498. In Q498 the Company
restructured a segment of a non-performing reseller channel resulting in
significant sales returns. Property and equipment increased 22% primarily due
to investments in year 2000 compliant computer hardware and software systems.
Capitalized software development costs increased 344% resulting from increased
investments in ASIC development costs. Securities available for sale decreased
by 100% in 1999 compared with 1998 due to the sale of approximately 189,701
shares of AESP stock in June 1999. The decrease in inventory in 1999 as
compared with 1998 is the result of increased sales combined with inventory
adjustments in Q499 compared to significant product returns and inventory
adjustments in Q498. Goodwill decreased by 23% in 1999 compared with 1998
primarily due to the revaluation of impaired goodwill associated with Lapis,
Digital Vision and PC Video recorded in Q498.

TOTAL LIABILITIES.

Total liabilities decreased $4,051,000, or 41% from December 31, 1998 to
December 31, 1999. The decrease is primarily due to: decreases in accounts
payable by $2,586,000, accrued liabilities by $1,291,000, capital leases and
long term debt by $393,000 and deferred income by $84,000; offset by increases
in notes payable by $304,000. Decreases in accounts payable is principally the
result of increased payments on debt obligations and vendor payables combined
with the reclassification of certain accounts payable to notes payable
(approximately $1,006,000). Accrued liabilities decreased as a result of reduced
marketing activities in 1999 as compared to 1998. Long term debt decreased
primarily due to payments under capital leases and long-term notes payable in
accordance with contractual agreements.

18
<PAGE>

STOCKHOLDERS' EQUITY.

Stockholders' equity increased $6,329,000 from December 31, 1998 to December 31,
1999. The increase is primarily due the issuance of common stock resulting from
the exercise of common stock options and warrants, as well as a private
offerings of the Company's common stock of approximately $7,493,000 the
repayment of a note receivable for common stock of approximately $316,000 and
the liquidation of liabilities through stock issuances of approximately
$320,000. These increases were offset by a net loss incurred in fiscal year 1999
of $1,480,000.

LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------

Since inception, the Company has financed its operations primarily through the
public and private sale of common stock, operating income, short-term borrowing
from private lenders, and favorable credit arrangements with vendors and
suppliers.

Net cash used in operating activities for the years ended December 31, 1999 and
1998 was $1,447,000 and $4,591,000, respectively. In 1999, net cash used in
operating activities consisted principally of the net loss of $1,480,000, and
increases in accounts receivable of $360,000, with decreases in inventory of
$2,360,000, accounts payable of $1,257,000 and accrued liabilities of
$1,291,000. In addition, the Company issued common stock for services and debt
of $159,000 and recognized a gain on the sale of securities of $80,000 and
recognized previously deferred income of $84,000. In 1998, net cash used in
operating activities consisted primarily of the net loss of $12,787,000, and
increases in inventories of $1,587,000, accounts payable of $387,000, accrued
liabilities of $916,000 with decreases in accounts receivable of $3,325,000. In
addition, the Company had a decrease in value of marketable securities of
$346,000 and write-off of impaired goodwill of $3,054,000.

Net cash used in investing activities for the years ended December 31, 1999 and
1998 was $2,110,000 and $2,042,000, respectively. In 1999, cash used in
investing activities consisted primarily of the purchase of property and
equipment and capitalized software development costs of $2,158,000, increases in
certificate of deposits of $281,000, offset by proceeds received from the sale
of securities available for sale of $329,000. In 1998, cash used in investing
activities consisted primarily of the purchase of property and equipment and
capitalized software development costs of $858,000 and cash paid in
acquisitions, net of cash received, of $931,000, and increases in certificate of
deposits of $253,000.

Net cash from financing activities for the years ended December 31, 1999 and
1998 was $6,164,000 and $7,042,000, respectively. In 1999, the Company received
$4,414,000 in net proceeds from private offerings of Common Stock and $2,596,000
from the exercise of common stock options and warrants, and repayment of a note
receivable for common stock of $316,000. The proceeds in 1999 were offset by
$1,028,000 in payments on notes payable, and payments made under capital lease
obligations of $134,000. In 1998, the Company received $2,827,000 in net
proceeds from private offerings of Common Stock and $7,004,000 from the exercise
of common stock options and warrants. The proceeds in 1998 were offset by
$1,954,000 in payments on notes payable, $700,000 in payments for treasury stock
acquired, and payments made under capital lease obligations of $135,000.

As of December 31, 1999, the Company had working capital of $5,633,000, as
compared to working capital of $1,435,000 at December 31, 1998, an increase of
$4,198,000. The Company's cash and certificates of deposit were $4,271,000 at
December 31, 1999, an increase of $1,381,000, over amounts at December 31, 1998.

On February 22, 1999, the Company issued warrants to purchase 30,000 shares of
common stock as partial compensation to an unaffiliated investor relations firm.
The warrants are exercisable until February 22, 2004 at an exercise price of
$1.063 per share. These warrants were exercised on February 23, 2000 (15,000)
and March 2, 2000 (15,000).

On February 22, 1999, the Company issued warrants to purchase 100,000 shares of
common stock as partial

19
<PAGE>

compensation to an unaffiliated investment advisor. The warrants are exercisable
until September 9, 2002 at an exercise price of $1.063 per share. These warrants
were exercised on December 10, 1999.

On June 4, 1999, the Company completed a financing of $1,200,000 in gross
proceeds from the sale of 1,350,000 shares of common stock and the issuance of a
warrant to purchase an additional 120,000 shares of common stock in a private
placement to an unaffiliated accredited investor. The warrant is exercisable
until June 30, 2004 at a per-share exercise price of $1.478125. The Company
filed a registration statement under the Securities Act of 1933 for the shares
issued in connection with this transaction and issuable upon exercise of the
warrant. The Company received proceeds from this transaction in two tranches
of $600,000, less applicable fees. The first tranche was funded on June 14,
1999 for $600,000 less fees and expenses associated with this offering of
$52,015 yielding net proceeds of $547,985. The second tranche for $600,000
less applicable fees of $42,015 yielding net proceeds of $557,985 was funded on
August 18, 1999, which was the date on which the above-referenced registration
statement became effective.

On June 30, 1999, as a result of a reconciliation with its transfer agent, the
Company determined that 3,808 shares of common stock were misclassified between
common stock and additional paid-in capital. Accordingly, on June 30, 1999 the
Company adjusted its records to properly reflect its common stock outstanding.

On September 17, 1999, the Company completed a financing of $1,500,000 in gross
proceeds from the sale of 1,583,333 shares of common stock and the issuance of a
warrant to purchase an additional 150,000 shares of common stock in a private
placement to an unaffiliated accredited investor. The warrant is exercisable
until September 17, 2004 at a per-share exercise price of $1.5375. The Company
filed a registration statement under the Securities Act of 1933 for the shares
issued in connection with this transaction and issuable upon exercise of the
warrant. The Company received proceeds from this transaction in two tranches of
$750,000, less applicable fees. The first tranche was funded on September 21,
1999 for $750,000 less fees and expenses associated with this offering of
$62,515 yielding net proceeds of $687,485. The second tranche was funded on
November 17, 1999 for $750,000 less fees and expenses associated with this
offering of $52,500 yielding net proceeds of $697,500.

On September 22, 1999, the Company received gross proceeds of $135,000 from the
issuance of 120,000 shares of common stock resulting from the exercise of common
stock warrants issued pursuant to the private placement with an unaffiliated
investor on June 3, 1999.

On November 30, 1999, the Company completed a financing of $2,000,000 in gross
proceeds from the sale of 1,250,000 shares of common stock and the issuance of a
warrant to purchase an additional 125,000 shares of common stock in a private
placement to three unaffiliated accredited investors. The warrant is
exercisable until November 30, 2004 at a per-share exercise price of $1.5375.
The shares issued in connection with this transaction and issuable upon exercise
of the warrant will be registered under the Securities Act of 1933. Fees and
expenses

20
<PAGE>

associated with this offering amounted to approximately $37,015 yielding net
proceeds of $1,962,985.

At September 30, 1999, the Company was in violation of the balloon payment
provision of a term note payable to a contract manufacturer in the amount of
$1,669,000. On December 28, 1999, the Company and the holder of the note reached
an agreement as to the settlement of the obligation. On January 5, 2000 the
Company repaid $1,000,000 of this note and on January 28, 2000, placed $669,000
in escrow to be paid to the holder in three installments on February 5, March 5,
and April 5, 2000, all of which sums have been paid.

During the year ended December 31, 1999, the Company issued at various times,
2,152,990 shares of common stock resulting from other exercises of options and
warrants, receiving cash of approximately $2,596,000. On June 1, 1998, the
Company recorded a note receivable in the amount of $316,418 in connection with
the exercise of stock options to purchase 171,000 shares of common stock by a
former director. On December 28, 1999, the Company received $353,000 in full
payment of this note, including accrued interest at 8%.

The Company maintains incentive stock option plans for all employees and
directors. Management believes that these plans provide long term incentives to
employees and directors and promote longevity of service. The Company prices
issued options at the closing of NASDAQ market price of its common stock on the
date of the option issuance. In addition, the Company maintains the right to
re-price the options under such plans to reflect devaluation in the market value
of its common stock. On September 1, 1998, the Company re-priced all employee
and director options under all plans to $1.22 per share for those options priced
in excess of this value. This price represented the closing market price of the
Company's common stock on September 1, 1998. The FASB has issued a proposed
interpretative release - Stock Compensation - Interpretation of APB No. 25,
which will have a prospective impact on the Company's stock option plans, when
adopted.

Although the Company has been successful in the past in raising sufficient
capital to fund its operations, there can be no assurance that the Company will
achieve sustained profitability or obtain sufficient financing in the future to
provide the liquidity necessary for the Company to continue operations.

EFFECTS OF INFLATION AND SEASONALITY
- ------------------------------------

The Company believes that inflation has not had a significant impact on the
Company's sales or operating results. The Company's business does not experience
substantial variations in revenues or operating income during the year due to
seasonality.

RECENT ACCOUNTING PRONOUNCEMENTS
- ---------------------------------

The FASB has issued a proposed interpretive release, Stock Compensation-
Interpretation of APB Opinion 25 ("Interpretation"). The Interpretation will
provide accounting guidance on several issues that are not specifically
addressed in Accounting Principles Board ("APB") No. 25, "Accounting for Stock
Issued to Employees. Of the many questions addressed in the Interpretation, the
most significant are a clarification of the definition of the term "employee"
for purposes of applying the opinion and the accounting for options that have
been repriced.

The Interpretation is generally effective beginning July 1, 2000. The
Interpretation applies prospectively at that date for repricings that occur
after December 15, 1998. It also applies prospectively on July 1, 2000 to new
awards granted after December 15, 1998 for purposes of applying the definition
of "employee".

In December 1999, the Securities and Exchange Commission (the "Commission")
published Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition",
which provides guidance for applying generally accepted accounting principles to
revenue recognition in financial statements filed with the Commission, including
income statement presentation and disclosure. As originally issued, SAB 101 was
to be applied no later than the first quarter of the fiscal year beginning after
December 15, 1999. However, the Commission has delayed the effective date of
the SAB for companies with fiscal years beginning between December 16, 1999 and
March 15, 2000. For such entities, the mandatory implementation date may now be
no later than the second quarter of the fiscal year beginning after December 15,
1999.

The company is in the process of reviewing and evaluating the pronouncements
detailed above to determine the potential impact on the financial statements of
the company.

21
<PAGE>

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
- ----------------------------------------------

The Company does not provide forecasts of the future financial performance of
the Company. However, from time to time, information provided by the Company or
statements made by its employees may contain "forward looking" information that
involve risks and uncertainties. In particular, statements contained in this
Form 10-KSB which are not historical facts (including, but not limited to,
statements concerning international revenues, anticipated operating expense
levels and such expense levels relative to the Company's total revenues)
constitute forward looking statements and are made under the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The
Company's actual results of operations and financial condition have varied and
may in the future vary significantly from those stated in any forward looking
statements. Factors that may cause such differences include, without limitation,
the availability of capital to fund the Company's future cash needs, reliance on
major customers, history of operating losses, limited availability of capital
under credit arrangements with lenders, market acceptance of the Company's
products, technological obsolescence, competition, component supply problems and
protection of proprietary information, as well as the accuracy of the Company's
internal estimates of revenue and operating expense levels.

22
<PAGE>

Item 7. FINANCIAL STATEMENTS

The Company's consolidated financial statements and the related report of
independent accountants are presented in pages F-1 - F-23, which are contained
in this Annual Report immediately following page 29. The consolidated financial
statements filed in this Item 7 are as follows:
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants F-1
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-2
Consolidated Statements of Operations for the Years Ended December 31, 1999 and 1998 F-3
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1999 and 1998 F-4
Consolidated Statements of Cash Flows for the Years Ended December 31, 1999 and 1998 F-5
Notes to Consolidated Financial Statements F-7
</TABLE>

23
<PAGE>

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not Applicable

24
<PAGE>

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT

OCCUPATIONS OF DIRECTORS AND EXECUTIVE OFFICERS

The information required hereunder is incorporated by reference from the
Company's Proxy Statement to be filed within 120 days of December 31, 1999 in
connection with the Company's 2000 Annual Meeting of Stockholders.

ITEM 10. EXECUTIVE COMPENSATION

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

The following exhibits, required by Item 601 of Regulation S-B, are filed as a
part of this Annual Report on Form 10-KSB or are incorporated by reference to
previous filings as indicated by the footnote immediately following the exhibit.
Exhibit numbers, where applicable, in the left column correspond to those of
Item 601 of Regulation S-B.

Exhibit Item No. Item and Description

1.4 Form of Stock Escrow Agreement (1)

2.1 Agreement of Merger, dated April 12, 1993, between FOCUS Enhancement,
Inc., a Massachusetts corporation, and the Company (1)

2.2 Certificate of Merger, as filed with the Delaware Secretary of State
on April 12, 1993 (1)

2.3 Articles of Merger, as filed with the Massachusetts Secretary of
State on April 14, 1993 (1)

2.4 Agreement and Plan of Reorganization and Merger between the Company,
FOCUS Acquisition Corporation and Lapis Technologies, Inc. dated as of
November 29, 1993 (2)

25
<PAGE>

3.1 Second Restated Certificate of Incorporation of the Company (1)

3.2 Certificate of Amendment to Second Restated Certificate of
Incorporation of the Company (3)

3.3 Restated By-laws of the Company (1)

4.1 Specimen certificate for Common Stock of the Company (1)

4.2 Specimen certificate for Redeemable Common Stock Purchase Warrant (1)

4.3 Form of Warrant Agreement between the Company, Mellon Securities
Trust Company and Thomas James Associates, Inc. (1)

4.4 Form of Warrant issued to Thomas James Associates, Inc. (1)

10.1 Amended and Restated Employment Contract between the Company and a
Corporate Officer, effective January 1, 1992 (1)

10.2 1992 Stock Option Plan, as amended (4)

10.3 Form of Incentive Stock Option Agreement, as amended, under the 1992
Stock Option Plan, as amended (1)

10.4 Form of Non-Qualified Stock Option Agreement, as amended, under the
1992 Stock Option Plan, as amended (1)

10.5 1993 Non-Employee Director Stock Option Plan (4)

10.6 Form of Non-Qualified Stock Option Agreement under the 1993 Non-
Employee Director Stock Option Plan (4)

10.7 Credit Agreement between the Company, Lapis and Silicon Valley Bank
dated January 20, 1994 (4)

10.8 Promissory Note in the principal amount of $2,000,000, dated as of
January 20, 1994, made by the Company and Lapis to the order of
Silicon Valley Bank (4)

10.9 Security Agreement, dated as of January 20, 1994, by the Company in
favor of Silicon Valley Bank (4)

10.10 Security Agreement, dated as of January 20, 1994, by Lapis in favor
of Silicon Valley Bank (4)

10.11 Pledge Agreement, dated as of January 20, 1994, by the Company in
favor of Silicon Valley Bank (4)

10.12 Purchase and Sale Agreement, dated as of May 25, 1994, between the
Company and Inline Software, Inc. (5)

10.13 Master Purchase Agreement, dated as of August 12, 1994, between the
Company and Apple Computer, Inc. (5)

10.14 Forbearance Letter, dated as of October 6, 1994, to the Company
from Silicon Valley Bank (5)

10.15 Note and Warrant Subscription Agreement, dated as of October 18,
1994, between the Company and a Private Lender (5)

26
<PAGE>

10.16 Security Agreement, dated as of October 18, 1994, between the
Company and a Private Lender (5)

10.17 Term Line of Credit Note, dated October 18, 1994, by the Company in
favor of a Private Lender (5)

10.18 Warrant W-K issued to a Private Lender, dated as of October 18,
1995 (5)

10.19 Intercreditor and Subordination Agreement, dated as of October 18,
1994, by and between the Company, a Private Lender and Silicon Valley
Bank (5)

10.20 Debt Extension Agreement, dated as of February 22, 1995, by and
between the Company and a Private Lender (5)

10.21 1995 Non-Employee Director Stock Plan (7)

10.22 Form of Non-Qualified Stock Option Agreement under the 1995 Non-
Employee Director Stock Plan (6)

10.23 Form of Settlement Agreement between the Company and Lapis
Technologies, Inc. Shareholders (7)

10.24 Manufacturing Agreement between the Company and a manufacturer (7)

10.25 Loan Document Modification Agreement dated as of April 5, 1996 by
and between the Company, Lapis Technologies, Inc. and Silicon Valley
Bank (8)

10.26 Amended and Restated Promissory Note dated as of April 5, 1996 in
favor of Silicon Valley Bank (8)

10.27 Amendment No. 2 to the Note and Warrant Subscription Agreement
dated as of June 28, 1996 between the Company and a Private Lender (8)

10.28 Amended and Restated Term Line of Credit Note dated as of June 28,
1996 in favor of a Private Lender (8)

10.29 Security Agreement dated as of June 28, 1996 between the Company
and a Private Lender (8)

10.30 Warrant W96/6, dated June 28, 1996, issued to a Private Lender (8)

10.31 Agreement dated as of June 28, 1996 between the Company and a
manufacturer (8)

10.32 Security Agreement dated as of June 28, 1996 between the Company
and a manufacturer (8)

10.33 Amendment to Master Purchase Agreement between the Company and TV
OEM. (10)

10.34 Lease Agreement between the Company and Cummings Properties for the
facility at 142 North Road, Sudbury, Massachusetts (10)

10.35 Agreement of Plan of Merger dated September 30, 1996, by and among
the Company, FOCUS Acquisition Corp., and TView, Inc. (9)

10.36 Form of Stock Subscription Agreement between the Company and
various investors in the December 95 Offering (11)

27
<PAGE>

10.37 Form of Amendment No. 1 to Stock Subscription Agreement dated April
1996 between the Company and various investors in the December 95
Offering (11)

10.38 Form of Warrant issued to various investors pursuant to Amendment
No. 1 (11)

10.39 Form of Subscription Agreement between the Company and various
investors in the March 97 Offering (11)

10.40 Form of Warrant issued to the placement agent in the March 97
Offering (11)

10.41 1997 Director Stock Option Plan (12)

10.42 Form of Director Stock Option Agreement (12)

10.43 Key Officer Non-Qualified Stock Option Agreement for a Corporate
Officer (12)

10.44 Key Officer Non-Qualified Stock Option Agreement for a Corporate
Officer (12)

10.45 Key Officer Non-Qualified Stock Option Agreement for a Corporate
Officer (12)

10.46 Subscription Agreement between the Company and Smith Barney
Fundamental Value Fund, Inc. dated September 8, 1997 (13)

10.47 Form of Warrant dated September 10, 1997 issued to designees of the
placement agent (13)

10.48 Lease by Wakefield Ready Mixed Concrete Co., Inc. to FOCUS
Enhancements, Inc. dated December 1, 1998

10.49 Common Stock and Warrants Purchase Agreement with AMRO
International, S.A.(14)

10.50 Form of Stock Purchase Warrant issued to AMRO International, S.A.
(included as Exhibit A to the Common Stock and Warrants Purchase
Agreement). (14)

10.51 Form of Registration Rights Agreement with AMRO International, S.A.
(included as Exhibit B to the Common Stock and Warrants Purchase
Agreement. (14)

10.52 Registration Rights Agreement dated as of July 29, 1998 between the
Company and PC Video Conversion, Inc. (15)

10.53 Form of Common Stock Purchase Warrant issued to Brian Swift and
Edward Price. (16)

10.54 Common Stock Purchase Warrant issued to Silicon Valley Bank. (16)

10.55 Common Stock and Warrant Purchase Agreement, as amended, with BNC
Bach International Ltd., INC (17).

10.56 Form of Stock Purchase Warrant issued to BNC Bach International,
Inc. (included as Exhibit A to the Common Stock and Warrant
Agreement (17).

10.57 Form of Registration Rights Agreement with BNC Bach International
Ltd., Inc. (included as Exhibit B to the Common Stock and Warrant
Purchase Agreement (17).

10.58 Common Stock and Warrant Purchase Agreement with The Raptor Global
Portfolio Ltd., The Altar Rock Fund L.P. and Roseworth Group, LTD
(18).

10.59 Form of Stock Purchase Warrant issued to The Raptor Global Portfolio
Ltd. (for 87,150 shares), The Altar Rock Fund L.P. (for 350 shares)
and Roseworth Group, Ltd. (for 37,500 shares) (included as Exhibit A
to the Common Stock and Warrant Purchase Agreement) (18).

10.60 Form of Registration Rights Agreement with The Raptor Global
Portfolio Ltd., The Altar Rock Fund L.P. and Roseworth Group, Ltd.
(included as Exhibit B to the Common Stock and Warrant Purchase
Agreement) (18).

10.61 Contract for services to be rendered to FOCUS Enhancements, Inc. by
R.J. Falkner & Company, INC (18).

10.62 Form of Stock Purchase Warrant issued to each of R. Jerry Falkner
and Richard W. West (18).

10.63 Agreement between Union Atlantic, L.C. and FOCUS Enhancements, Inc.
confirming agreement to issue warrant in exchange for fee reduction
(18).

10.64 Stock Purchase Warrant issued to Union Atlantic, L.C. (18).

11 Statement re Computation of Earnings [Loss] Per Share

21 Subsidiaries of the Company

23 Consent of Wolf & Company P.C., Independent Accountants

27 Financial Data Schedule for year ended December 31, 1998

28
<PAGE>

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

1 Filed as an exhibit to the Company's Registration Statement on Form SB-
2, No. 33-60248-B, and incorporated herein by reference.

2 Filed as an exhibit to the Company's Current Report on Form 8-K dated
November 29, 1993, and incorporated herein by reference.

3 Filed as an exhibit to the Company's Form 10-QSB for the period ended
September 30, 1995, and incorporated herein by reference.

4 Filed as an exhibit to the Company's Form 10-KSB for the year ended
December 31, 1993, and incorporated herein by reference.

5 Filed as an exhibit to the Company's Form 10-KSB for the year ended
December 31, 1994, and incorporated herein by reference.

6 Filed as an exhibit to the Company's Registration Statement on Form S-
8, No. 33-80651, filed with the Commission on December 19, 1995, and
incorporated herein by reference.

7 Filed as an exhibit to the Company's Registration Statement on Form SB-
2, No. 33-80033, and incorporated herein by reference.

8 Filed as an exhibit to the Company's Form 10-QSB for the period ended
June 30, 1995, and incorporated herein by reference.

9 Filed as an exhibit to the Company's Form 8-K dated November 4, 1996

10 Filed as an exhibit to the Company Form 10-KSB for the year ended
December 31, 1995 and incorporated herein by reference.

11 Filed as an exhibit to the Company's Registration Statement on Form S-
3, No. 333-26911, filed with the Commission on May 12, 1997, and
incorporated herein by reference.

12 Filed as an exhibit to the Company's Registration Statement on Form S-
8, No. 333-33243, filed with the Commission on August 8, 1997, and
incorporated herein by reference.

13 Filed as an exhibit to the Company's Form 8-K dated September 10, 1997

14 Filed as an exhibit to the Company's Registration Statement on Form
S-3, No. 333-81177, filed with the Commission on June 21, 1999, and
incorporated herein by reference.

15 Filed as an exhibit to the Company's Form 10-QSB dated August 14, 1998
and incorporated herein by reference.

16 Filed as an exhibit to the Company's Form 10-QSB dated May 17, 1999
and incorporated herein by reference.

17 Filed as an exhibit to the Company's Registration Statement on Form
S-333, No. 333-82163, filed with the Commission on July 2, 1999, and
incorporated herein by reference.

18 Filed as an exhibit to the Company's Registration Statements on From
S-333, No. 333-94621, filed with the Commission on January 13, 2000,
and incorporated herein by reference.

(b) Reports on Form 8-K

The Company filed no reports on Form 8-K during the fiscal quarter
ended December 31, 1998.

29
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
FOCUS Enhancements, Inc. Wilmington, Massachusetts

We have audited the accompanying consolidated balance sheets of FOCUS
Enhancements, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of FOCUS
Enhancements, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
consolidated results of their operations and cash flows for the years then
ended, in conformity with generally accepted accounting principles.

As indicated in Note 8, the Company has been named as a defendant in sixteen
lawsuits. The complaints allege that the Company, its Chief Executive Officer,
and its Chief Financial Officer violated federal securities laws in connection
with a number of allegedly false or misleading statements and seek certification
as a class action and certain unquantified damages. The Company intends to
contest this litigation vigorously.

/s/ WOLF & COMPANY, P.C.

WOLF & COMPANY, P.C.

Boston, Massachusetts
April 11, 2000

F-1
<PAGE>

FOCUS ENHANCEMENTS, INC.

CONSOLIDATED BALANCE SHEETS

ASSETS
<TABLE>
<CAPTION>
December 31,
1999 1998
---------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,736,517 $ 1,128,380
Certificate of deposit 534,091 253,067
Securities available for sale -- 248,983
Accounts receivable, net of allowances of $294,907 and $649,987 at December 31, 2,913,005 2,553,139
1999 and 1998, respectively
Inventories 3,588,702 5,948,624
Prepaid expenses and other current assets 240,732 217,092
----------- ------------
Total current assets 11,013,047 10,349,285
Property and equipment, net 968,594 794,716
Capitalized software development costs 2,122,450 477,761
Other assets, net 287,116 304,498
Goodwill, net 624,277 810,673
----------- ------------
Total assets $15,015,484 $ 12,736,933
=========== ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 1,006,258 $ 702,057
Current portion of long-term debt 312,556 283,180
Obligations under capital leases 129,451 119,536
Accounts payable 3,413,285 5,999,694
Accrued liabilities 518,726 1,810,025
------------ ------------
Total current liabilities 5,380,276 8,914,492
Deferred income -- 84,212
Obligations under capital leases, non-current 202,002 321,760
Long-term debt, net of current portion 226,041 538,597
------------ ------------
Total liabilities 5,808,319 9,859,061
------------ ------------

Commitments and contingencies

Stockholders' equity:
Preferred stock, $.01 par value; 3,000,000 shares authorized; none issued -- --
Common stock, $.01 par value; 30,000,000 shares authorized, 24,504,203 and 245,042 180,051
18,005,090 shares issued and outstanding at December 31, 1999 and 1998,
respectively
Additional paid-in capital 46,340,891 38,913,304
Accumulated deficit (36,678,638) (35,198,935)
Note receivable, common stock -- (316,418)
Treasury stock at cost, 450,000 shares (700,130) (700,130)
------------ ------------
Total stockholders' equity 9,207,165 2,877,872
------------ ------------
Total liabilities and stockholders' equity $ 15,015,484 $ 12,736,933
============ ============
</TABLE>

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

F-2
<PAGE>

FOCUS ENHANCEMENTS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years ended December 31,
-------------------------------------
1999 1998
-------------------------------------
<S> <C> <C>
Net sales $16,832,985 $ 18,440,226
Licensing fees 350,000 --
----------- ------------
Net revenues 17,182,985 18,440,226
Cost of goods sold 10,543,997 15,410,912
----------- ------------
Gross profit 6,638,988 3,029,314
----------- ------------
Operating expenses:
Sales, marketing and support 3,969,705 6,901,546
General and administrative 1,878,045 2,166,352
Research and development 1,400,732 1,698,977
Depreciation and amortization expense 557,303 1,499,496
Impairment of goodwill -- 3,053,880
----------- ------------
Total operating expenses 7,805,785 15,320,251
----------- ------------
Loss from operations (1,166,797) (12,290,937)
Interest expense, net (531,023) (225,802)
Other income, net 138,002 100,073
Gain/(loss) on securities available for sale 80,115 (346,017)
----------- ------------
Loss before income taxes (1,479,703) (12,762,683)
Income tax expense -- 24,641
----------- ------------
Net loss $(1,479,703) $(12,787,324)
=========== ============
Loss per common share:
Basic $(0.08) $(0.78)
=========== ============
Diluted $(0.08) $(0.78)
=========== ============
Weighted average common shares outstanding:
Basic 18,743,698 16,336,872
=========== ============
Diluted 18,743,698 16,336,872
=========== ============
</TABLE>

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

F-3
<PAGE>

FOCUS ENHANCEMENTS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>

Common Stock Note Total
---------------------- Additional Accumulated Receivable Treasury Stockholders'
Shares Amount Paid-in Capital Deficit Common Stock Stock Equity
---------------------- --------------- ----------- ------------ -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1997 14,010,186 $140,102 $27,339,892 $(22,411,611) $ -- $ -- $ 5,068,383

Issuance of common stock
upon exercise of stock 2,429,958 24,299 7,296,082 -- (316,418) -- 7,003,963
options and warrants

Issuance of common stock
from private offerings, 1,092,150 10,922 2,816,433 -- -- -- 2,827,355
net of issuance costs of
$172,645

Issuance of common stock 472,796 4,728 1,460,897 -- -- -- 1,465,625
for acquisitions of
Digital Vision, Inc. and
PC Video Conversion, Inc.
Purchase of treasury stock -- -- -- -- -- (700,130) (700,130)

Net loss -- -- -- (12,787,324) -- (12,787,324)
---------- -------- ----------- ------------ --------- --------- ------------

Balance at December 31, 18,005,090 180,051 38,913,304 (35,198,935) (316,418) (700,130) 2,877,872
1998
Issuance of common stock 2,215,780 22,158 2,573,865 -- -- -- 2,596,023
upon exercise of stock
options and warrants
Issuance of common stock 4,183,333 41,833 4,372,145 -- -- -- 4,413,978
from private offerings,
net of issuance costs of
$286,022
Common stock issued in 100,000 1,000 322,260 -- -- -- 323,260
settlement of accounts
payable
Common stock warrants
issued for services
and debt -- -- 159,317 -- -- -- 159,317
Repayment of note -- -- -- -- 316,418 -- 316,418
receivable-common stock
Net loss -- -- -- (1,479,703) -- -- (1,479,703)
---------- -------- ----------- ------------ --------- --------- ------------
Balance at December 31, 24,504,203 $245,042 $46,340,891 $(36,678,638) $ -- $(700,130) $ 9,207,165
1999 ========== ======== =========== ============ ========== ========= ============
</TABLE>

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

F-4
<PAGE>

FOCUS ENHANCEMENTS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1999 1998
------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,479,703) $(12,787,324)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 557,303 1,499,496
Amortization of discount on note payable 42,344 17,696
Common stock warrants issued for service or debt 159,317 --
Deferred income (84,212) --
Loss (gain) on securities available for sale (80,115) 346,017
Write down of impaired goodwill -- 3,053,880
Changes in operating assets and liabilities, net of the effects of acquisitions;
(Increase) decrease in accounts receivable (359,866) 3,324,750
Decrease (increase) in inventories 2,359,922 (1,587,185)
Decrease (increase) in prepaid expenses and other assets (13,458) 237,799
Increase (decrease) in accounts payable (563,149) 386,892
Increase (decrease) in accrued liabilities (1,291,299) 916,044
----------- ------------
Net cash used in operating activities (752,916) (4,591,935)
----------- ------------
Cash flows from investing activities:
Proceeds from sale of securities available for sale 329,098 --
Increase in certificate of deposit (281,024) (253,067)
Additions to property and equipment and capitalized software development costs (2,157,623) (858,011)
Cash paid in acquisitions, net of cash received -- (930,563)
----------- ------------
Net cash used in investing activities (2,109,549) (2,041,641)
----------- ------------

Cash flows from financing activities:
Payments on notes payable and long-term debt (1,721,323) (1,953,900)
Payments under capital lease obligations (134,494) (135,183)
Payments for purchase of treasury stock -- (700,130)
Repayment of note receivable-common stock 316,418 --
Net proceeds from private offerings of common stock 4,413,978 2,827,355
Net proceeds from exercise of common stock options and warrants 2,596,023 7,003,963
----------- ------------
Net cash provided by financing activities 5,470,602 7,042,105
----------- ------------
Net increase in cash and cash equivalents 2,608,137 408,529
Cash and cash equivalents at beginning of year 1,128,380 719,851
----------- ------------
Cash and cash equivalents at end of year $ 3,736,517 $ 1,128,380
=========== ============
</TABLE>

F-5
<PAGE>

<TABLE>
<CAPTION>
Supplemental Cash Flow Information:
<S> <C> <C>
Interest paid $ 441,558 $200,129
Income taxes paid -- 5,020
Equipment acquired under capital leases 24,651 400,304
Common stock issued in settlement of accounts payable 323,260 --
Note payable issued in settlement of accounts payable 1,700,000 --
</TABLE>

Supplemental schedule of non-cash investing and financing activities:
On March 31, 1998, the Company purchased certain assets and assumed certain
liabilities of Digital Vision, Inc. as follows:

<TABLE>
<S> <C>
Fair value of tangible assets acquired $ 224,957
Fair value of liabilities assumed (384,495)
-----------
Fair value of net assets (liabilities) acquired (159,538)

Common stock issued (1,115,625)
Cash paid (46,980)
-----------
Excess of cost over fair value of net assets acquired $(1,322,143)
===========
</TABLE>

On July 29, 1998, the Company purchased certain assets and assumed certain
liabilities of PC Video Conversion, Inc. as follows:

<TABLE>
<S> <C>
Fair value of tangible assets acquired $ 613,336
Fair value of liabilities assumed (80,367)
-----------
Fair value of net assets acquired 532,969

Common stock issued (350,000)
Cash paid (700,000)
Note payable (910,085)
Acquisition costs (229,781)
-----------
Excess of cost over fair value of net assets acquired $(1,656,897)
===========
</TABLE>

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

F-6
<PAGE>

FOCUS ENHANCEMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business of the Company. FOCUS Enhancements, Inc. (the "Company" or
"FOCUS") is involved in the development and marketing of proprietary PC-to-TV
convergence products for Windows(TM) and Mac(TM) OS based personal computers.
The Company's products, which are sold globally through original equipment
manufacturers (OEM's) and resellers, merge computer generated graphics and
television displays for presentations, training, education, video
teleconferencing, Internet viewing and home gaming markets. Based on a targeted
product plan and its experience in video conversion technology, FOCUS has
developed a strategy to play a major role in the PC-to-TV convergence industry.

Over 90% of the components for the Company's products are manufactured on a
turnkey basis by two vendors, Furthertech Company, Ltd, and Asemtec Corporation.
In the event that these vendors were to cease supplying the Company, management
believes that alternative turnkey manufacturers for the Company's products could
be secured. However, the Company would most likely experience short-term delays
in the shipments of its products.

The personal computer enhancements market is characterized by extensive
research and development and rapid technological change resulting in product
life cycles of twelve to eighteen months. Development by others of new or
improved products, processes or technologies may make the Company's products or
proposed products obsolete or less competitive. Management believes it necessary
to devote substantial efforts and financial resources to enhance its existing
PC-to-TV products and to develop new products. There can be no assurance that
the Company will succeed with these efforts.

Basis of Presentation. The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiariary PC Video Conversion,
Inc. The Company's other subsidiaries, Lapis Technologies, Inc., T-View, Inc and
Focus Enhancements, B.V. (Netherlands corporation) became inactive or were
merged into Focus in 1999. On March 31, 1998, the Company acquired certain
assets and assumed certain liabilities of Digital Vision, Inc. in a transaction
accounted for under the purchase method of accounting. On July 29, 1998, the
Company acquired certain assets and assumed certain liabilities of PC Video
Conversion, Inc. in a transaction accounted for under the purchase method of
accounting. All intercompany accounts and transactions have been eliminated upon
consolidation.

The results of operations of Digital Vision, Inc. have been included in the
accompanying consolidated financial statements since April 1, 1998. The results
of operations of PC Video Conversion, Inc. have been included in the
accompanying consolidated financial statements since July 29, 1998. The
following unaudited pro forma information presents a summary of the consolidated
results of operations of the Company as if the acquisitions had occurred at the
beginning of the year ended December 31, 1998.

1998
--------------------
Net sales $ 20,023,000
Loss from operations (11,753,700)
Net loss (12,254,500)
Net loss per common share
Basic $ (.73)
Diluted $ (.73)

F-7
<PAGE>

Reclassifications. Certain accounts have been reclassified in the 1998
consolidated financial statements to conform to the 1999 presentation.

Use of Estimates. The process of preparing financial statements in
conformity with generally accepted accounting principles requires the use of
estimates and assumptions regarding certain types of assets, liabilities,
revenues and expenses. Actual results may differ from estimated amounts.
Significant estimates used in preparing these financial statements related to
accounts receivable allowances, stock balancing allowances, inventory valuation,
deferred tax asset valuation, the value of equity instruments issued for
services and the recoverability of goodwill related to acquisitions. It is at
least reasonably possible that the estimates will change within the next year.

Financial Instruments. The carrying amounts reflected in the consolidated
balance sheets for cash, receivables and accounts payable approximate the
respective fair values due to the short-term maturity of these instruments.
Notes payable and long-term debt approximate the respective fair values as these
instruments bear interest at terms that would be available through similar
transactions with other third parties. The fair value of securities available
for sale are based on the quoted market prices.

Cash and Cash Equivalents. The Company considers all highly liquid
investments purchased with an original maturity of three months or less to be
cash equivalents.

Securities Available for Sale. Securities available for sale consist of
marketable equity securities carried at fair value, with unrealized gains and
losses reported as a separate component of stockholders' equity. Declines in
the fair value of securities available for sale below their cost that are deemed
to be other than temporary are reflected in operations as realized losses.

Revenue Recognition. Revenue from product sales is recognized when products
are shipped. Revenue from sales to distributors may be subject to agreements
allowing rights of return and price protection. The Company provides allowances
for potential uncollectible amounts, estimated stock balancing and future
returns, exchanges and price protection credits.

Concentration of Credit Risk. As of December 31, 1999, a major distributor
represented approximately 23% of the Company's accounts receivable, a major
retailer represented approximately 13% of the Company's accounts receivable and
a second major distributor represented approximately 12% of the Company's
accounts receivable. As of December 31, 1998, the same major distributor,
represented approximately 14% of the Company's accounts receivable, a major
retailer represented approximately 13% of the Company's accounts receivable and
a major television manufacturer customer represented approximately 20% of the
Company's accounts receivable. The Company provides credit to customers in the
normal course of business with terms generally ranging between 30 to 90 days.
The Company does not usually require collateral for trade receivables, but
attempts to limit credit risk through its customer credit evaluation process.

The company maintains its bank accounts with high quality financial
institutions to minimize credit risk, however, the company's balances may
periodically exceed federal deposit insurance limits.

Inventories. Inventories are stated at the lower of cost or market value
using the first-in, first-out method, but not in excess of net realizable value.
The Company periodically reviews its inventories for potential slow moving or
obsolete items and provides valuation allowances for specific items, as
appropriate.

Property and Equipment. Property and equipment are recorded at cost and
depreciated using the straight-line method over the estimated useful lives of
the related assets as set forth below. Equipment leased under capital leases is
stated at the present value of future lease obligations and is amortized over
estimated useful lives.

CATEGORY DEPRECIATION PERIOD
- ----------------------------- -----------------------------------------------
Equipment 3-5 years
Furniture and fixtures 5 years
Purchased software 1-3 years
Leasehold improvements Lesser of 5 years or the term of the lease

F-8
<PAGE>

Capitalized Software Development Costs. Capitalized software development
costs are stated at cost and will be amortized on a units of production method
over the estimated useful life of the asset commencing on the date the product
is released. The Company capitalized $164,468 and $477,761 of software
development costs in 1999 and 1998, respectively. No products related to
capitalized software development costs were released as of December 31, 1999.

Goodwill. Goodwill resulting from business combinations is amortized on a
straight-line basis over periods ranging from five to seven years. The Company
evaluates the net realizable value of goodwill periodically based on a number of
factors including operating results, business plans, budgets and economic
projections. The Company's evaluation also considers non-financial data such as
market trends, customer relationships, product development cycles and changes in
management's market emphasis.

Advertising and Sales Promotion Costs. Advertising and sales promotion
costs are expensed as incurred. Advertising expense was approximately $1,756,000
and $3,309,000 for the years ended December 31, 1999 and 1998, respectively.

Legal Fees. Legal fees are charged to expense in the period the legal
services are performed.

Research and Development. Research and development costs are expensed as
incurred.

Product Warranty Costs. The Company's warranty period for its products is
generally one to three years. Estimated future costs for initial product
warranties are not considered material.

Income Taxes. Deferred taxes are determined based on the differences
between the financial statement and tax basis carrying amounts of assets and
liabilities, using enacted tax rates in effect in the years in which the
differences are expected to reverse. Valuation allowances are provided if, based
upon the weight of available evidence, it is more likely than not that some or
all of the deferred tax assets will not be realized.

Foreign Currency Translation. The functional currency of the Company's
foreign subsidiary, FOCUS Enhancements, B.V., is its local currency, the Gilder.
Financial statements are translated into U.S. dollars using the exchange rates
at each balance sheet date for assets and liabilities and using a weighted
average exchange rate for each period for revenue, expenses, gains and losses.
Foreign exchange gains or losses, which are not material, are recognized in
income for the years presented. On July 1, 1999, the Company closed its foreign
subsidiary and on August 15, 1999 dissolved this entity.

Stock Compensation Plans. Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation" encourages all
entities to adopt a fair value based method of accounting for employee stock
compensation plans, whereby compensation cost is measured at the grant date
based on the fair value of the award which is recognized over the service
period, which is usually the vesting period. However, it also allows an entity
to continue to measure compensation cost for those plans using the intrinsic
value based method of accounting prescribed by Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," whereby
compensation cost is the excess, if any, of the quoted market price of the stock
at the grant date (or other measurement date) over the amount an employee must
pay to acquire the stock. Stock options issued under the Company's stock option
plans have no intrinsic value at the grant date, accordingly, under APB Opinion
No. 25, no compensation cost is recognized. The Company has elected to continue
with the accounting prescribed in APB Opinion No. 25 and, as a result, must make
pro forma disclosures of net income and earnings per share and other disclosures
as if the fair value based method of accounting had been applied.

F-9
<PAGE>

Net Income (Loss) Per Share. Basic earnings per share represents income
available to common stock divided by the weighted-average number of common
shares outstanding during the period. Diluted earnings per share reflects
additional common shares that would have been outstanding if dilutive potential
common shares had been issued, as well as any adjustment to income that would
result from the assumed conversion. Potential common shares that may be issued
by the Company relate solely to outstanding stock options and warrants, and are
determined using the treasury stock method. The assumed conversion of
outstanding dilutive stock options and warrants would increase the shares
outstanding but would not require an adjustment to income as a result of the
conversion. For the years ended December 31, 1999 and 1998, options and warrants
applicable to shares and 4,937,645 shares, respectively were anti-
dilutive and excluded from the diluted earnings per share computation.

Comprehensive Income. Accounting principles generally require that
recognized revenue, expenses, gains and losses be included in net income.
Certain Financial Accounting Standards Board ("FASB") statements, however,
require entities to report specific changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities and foreign
currency items, as a separate component of the equity section of the balance
sheet. Such items, along with net income, are components of comprehensive
income. There was no accumulated comprehensive income at December 31, 1999 and
1998.

Segment Information. SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," establishes standards for the way that
public business enterprises report information about operating segments in
annual and interim financial statements. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. Generally, financial information is required to be reported on the
basis that it is used internally for evaluating segment performance and deciding
how to allocate resources to segments. The Statement also requires descriptive
information about the way that the operating segments were determined, the
products and services provided by the operating segments, differences between
the measurements used in reporting segment information and those used by the
enterprise in its general-purpose financial statements, and changes in the
measurement of segment amounts from period to period.

Recent Accounting Pronouncements

The company is in the process of reviewing and evaluating the pronouncements
detailed above to determine the potential impact on the financial statements of
the company.

F-10
<PAGE>

2. Fourth Quarter Adjustments

In the fourth quarters of 1999 and 1998, the Company sustained net losses
of $1,779,000 and $14,235,000, respectively. A summary of the effect on net
income of sales returns and other significant year-end adjustments follows:

DESCRIPTION 1999 1998
----------- ------------
Sales returns $367,000 $3,455,000
Impairment loss goodwill -- 3,054,000
Inventory 527,000 1,929,000
Fixed asset -- 766,000
Write down of investment -- 346,000
Accounts receivable 383,000 --
Accrued expenses 254,000 2,125,000
Stock compensation and other $284,000 --

3. Inventories

Inventories at December 31, consist of the following:

1999 1998
------------------ ----------------

Raw materials $1,039,356 $ 230,364
Work in process 171,637 --
Finished goods 2,377,709 5,718,260
---------- ----------
Totals $3,588,702 $5,948,624
========== ==========

The Company periodically reviews its inventories for obsolescence and adjusts
carrying costs to estimated net realizable values when they are determined to be
less than cost. In the fourth quarter of 1999, the Company identified certain
excess and obsolete inventory and charged approximately $527,000 to expenses,
writing off certain inventory and increasing inventory reserves to $399,000 at
December 31, 1999. In the fourth quarter of 1998, as a result of a detailed
review, the Company identified certain excess and obsolete inventory items and
also determined that the cost of certain inventory items required adjustments to
their estimated net realizable value. As a result of this inventory review, the
Company charged approximately $1,929,000 to expenses in the fourth quarter of
1998, thereby increasing its inventory reserves to approximately $2,168,000 at
December 31, 1998.

4. Property and Equipment

Property and equipment consist of the following at:

December 31,
------------------------------
1999 1998
---------- ----------
Equipment $1,062,443 $ 893,116
Furniture and fixtures 107,530 132,522
Leasehold and improvements 295,249 134,599
Purchased software 246,980 29,100
---------- ----------
1,712,202 1,189,337
Less accumulated depreciation and
amortization 743,608 394,621
---------- ----------
Net book value $ 968,594 $ 794,716
========== ==========

F-11
<PAGE>

Depreciation and amortization expense related to property and equipment for
the years ended December 31, 1999 and 1998 totaled $363,707 and $1,135,259,
respectively.

In the fourth quarter of 1998, the Company performed a detailed review of
its property and equipment accounts. As a result of this review, certain assets
were written off and the estimated useful lives of certain assets were revised.
The effect of these revisions and write-offs resulted in additional depreciation
expense of approximately $766,000.

5. Other Assets

NOTES RECEIVABLE.
- ----------------

The Company has $140,000 in notes receivable bearing interest at 8.0% per annum
due from an officer of the Company at December 31, 1999 and 1998. At December
31, 1999, interest receivable of $28,467 is included in accounts receivable.
Interest income recognized on the notes receivables for the years ended December
31, 1999 and 1998 amounted to $11,200 and $6,067, respectively.

RESTRICTED ASSETS.
- -----------------

As part of the Company's acquisition of TView, Inc. in September 1996, the
Company assumed a $125,000 irrevocable stand-by letter of credit with a bank to
secure office space in Beaverton, Oregon. During 1997, the Company placed
$125,000 in an interest bearing account at the Company's bank to secure the
letter of credit. During 1999, the Company requested and received $83,334 from
the interest bearing account, thus reducing the stand-by letter of credit. The
amount recorded as an other asset as of December 31, 1999 is $41,666 as compared
to $125,000 at December 31, 1998.

6. Notes Payable / Security Arrangements

LINE OF CREDIT, BANK.

During 1999, the Company repaid all monies owed under an accounts receivable
financing agreement with its bank, and closed its account. At December 31,
1998, the Company maintained a line of credit with the same bank. Borrowings
under the line were payable upon demand and were collateralized by all of the
assets of the Company, except as noted below. Borrowings aggregated $620,000 at
December 31, 1998, and were charged interest at the bank's prime rate plus 1%
(8.75% at December 31, 1998). Under the terms of the line of credit agreement,
the Company was required to comply with certain restrictive covenants and was in
violation of certain of these covenants. On March 31, 1999, the Company repaid
all monies owed on this line of credit with its commercial bank totaling
approximately $637,000 from proceeds received under a $2,000,000 accounts
receivable financing agreement with the same commercial bank. The agreement
allows for advances on accounts receivable not to exceed 80% of qualified
invoices. Interest is charged on the outstanding balance at a rate of the prime
lending rate plus 4.5%. Under the terms of this agreement the bank has been
issued warrants to purchase 100,000 shares of the Company's common stock at a
price of $1.70 per share.

TERM LOAN, BANK.

On March 31, 1998, the Company assumed a $329,953 bank loan resulting from the
purchase of certain assets and the assumption of certain liabilities of Digital
Vision, Inc. The borrowings bear interest at the prime rate plus 2% (9.75 % at
December 31, 1998). The outstanding balance is payable in monthly installments,
with interest, until the loan expiration date of June 30, 1999. At December 31,
1998, the outstanding amount owed on this loan was $82,057. The loan was paid in
full at December 31, 1999.

F-12
<PAGE>

TERM LOAN, VENDOR.

On April 20, 1999, the Company converted certain accounts payable due to a
contract manufacturer to a term note in the amount of $1,700,000 with interest
at a rate of 12% per annum. The balance of the Note was $1,006,258 at December
31, 1999. On December 31, 1999, the Company and the holder of the note reached
an agreement as to the settlement of the note and related accounts payable. On
January 5, 2000 the Company repaid $1,000,000 of these obligations and on
January 28, 2000, escrowed $669,000 to be paid to the holder in three equal
installments on February 5, March 5, and April 5, 2000.

LONG-TERM DEBT.

On July 29, 1998, the Company issued a $1,000,000 note payable to a related
party in conjunction with the acquisition of PC Video Conversion, Inc. providing
for the payment of principal and interest at 3.5 % over a period of 36 months.
The Company computed a discount of $89,915 on this note based on its incremental
borrowing rate. Maturities of long-term debt at December 31, 1999 are as
follows:

2000 312,556
2001 226,041
--------
Total $538,597
========

7. Other Income

SALE OF NETWORKING ASSETS.

Effective September 30, 1997, the Company sold its line of computer connectivity
products to Advanced Electronic Support Products, Inc. ("AESP") for 189,701
shares of AESP common stock. Included in the sale were customer lists and the
rights to use the FOCUS networking brand name to market the product line as well
as certain of AESP's complementary products. In connection with this
transaction, the Company recorded other income in the amount of $358,288,
securities available for sale in the amount of $595,000 (discounted 15% to
reflect temporary restrictions on the common stock), and deferred income of
$84,212. In addition, the Company sold networking inventory to AESP in the
amount of $159,000 at cost. A director of the Company is also a director of
AESP. At December 31, 1998, the fair value of the securities available for sale
was $248,983. The Company recorded a loss of $346,017 on the securities
available for sale in 1998 as the decline in value was considered to be other
than temporary. In June and July 1999, the Company sold the 189,701 shares of
AESP stock yielding gross proceeds of approximately $329,000 and recognizing a
gain of approximately $80,000.

ACCOUNTS PAYABLE.

During the year ended December 31, 1999, the Company recognized a total of
$71,076 of other income in connection with the release of selected obligations
and the reduction of certain accounts payable.

8. Commitments and Contingencies

LEASES.

The Company leases office facilities and certain equipment under operating
leases. Under the lease agreements, the Company is obligated to pay for
utilities, taxes, insurance and maintenance. Total rent expense for the years
ended December 31, 1999 and 1998 was approximately $400,000 and $451,000,
respectively.

F-13
<PAGE>

The Company leases certain computer and office equipment under capital leases
with three to five-year terms. The cost of assets under capital leases was
$468,525 and $443,874 at December 31, 1999 and 1998, respectively, and
accumulated amortization was $135,832 and $44,181, respectively. Capitalized
leased assets are included in property and equipment.

Minimum lease commitments at December 31, 1999 are as follows:

Capital Leases Operating Leases
----------------- --------------------
2000 $165,988 $ 322,357
2001 121,289 263,477
2002 69,075 240,080
2003 47,143 208,617
2004 1,118 69,312
-------- ----------
Total minimum lease payments 404,613 1,103,843
==========

Less amounts representing interest 73,160
--------
Present value of minimum obligations 331,453
Less current portion 129,451
--------
Non-current portion $202,002
========

EMPLOYMENT AGREEMENTS.

The Company has employment agreements with certain corporate officers. The
agreements are generally one to three years in length and provide for minimum
salary levels. These agreements include severance payments of approximately one
to three times each officer's annual compensation.

LETTERS OF CREDIT.

In September 1999, the Company entered into an agreement with a new
subcontractor. As part of the agreement the Company was required to obtain from
its bank an irrevocable sight letter of credit to secure payment of each order
placed with this vendor. The Company was required to secure these letters of
credit by depositing cash in an interest bearing account with the bank. At
December 31, 1999, the Company maintained an interest bearing account
collateralizing sight letters of credit in the amount of $534,091. This amount
is recorded in current assets.

In July, 1998, the Company entered into an agreement with another subcontractor.
As part of the agreement the Company's bank issued a $250,000 irrevocable stand-
by letter of credit to secure payment of the vendor's invoices. The Company
placed $250,000 in an interest bearing account at the Company's bank to secure
the letter of credit. This amount is recorded in current assets as of December
31, 1998. This agreement was terminated during 1999.

PURCHASE COMMITMENT.

The Company has agreed to purchase a minimum of $2,500,000 of cables and other
products from Advanced Electronic Support Products, Inc. ("AESP") by March 29,
2001. In return, the Company has received certain pricing commitments over the
term of the master purchase agreement. For the period October 1, 1997 through
December 31, 1999, the Company purchased approximately $995,000 of products from
AESP. In the event that the Company does not purchase at least $2,500,000 of
cables and other products during the term of the master purchase agreement, the
Company must pay AESP an amount equal to 20% of the difference between
$2,500,000 and the aggregate amount of purchases.

F-14
<PAGE>

LITIGATION.

SPECIAL INVESTIGATION

The Company's independent auditors, Wolf & Company, P.C., brought to the
attention of the Board certain matters relating to the Company's financial
controls. The board of directors thereafter formed a special committee to
investigate. The special committee engaged the law firm of Foley, Hoag & Eliot
LLP, which engaged the accounting firm of Arthur Andersen LLP to aid in the
investigation. Based upon its investigation, the committee has concluded that,
despite his denials, an accounting manager in the Company's finance department
misstated the inventory records of the Company's Pro AV series for purposes of
presentation to the Company's outside auditors in connection with the audit for
the year ended December 31, 1999. A revised inventory list for the Pro AV
series as of December 31, 1999 has been compiled in connection with the special
committee's review and has been subject to audit tests performed by Wolf &
Company, P.C. as part of its year end audit of the financial statements of the
Company as a whole. The accounting manager in question has been discharged. The
Board is continuing its review of the special committee's report.

As a result of the Committee's investigation, the Company Incurred significant
fees and expenses which will be charged to earnings in the quarter ended March
31, 2000. The total amount of such expenses has not been determined at this
time.

9. STOCKHOLDERS' EQUITY

COMMON STOCK.

On February 22, 1999, the Company issued warrants to purchase 30,000 shares of
common stock as partial compensation to an unaffiliated investor relations firm.
The warrants are exercisable until February 22, 2004 at an exercise price of
$1.063 per share. The Company recorded $15,033 in expense for the year ended
December 31, 1999 based on the fair value of the warrants. These warrants were
exercised on February 23, 2000 (15,000) and March 2, 2000 (15,000).

On February 22, 1999, the Company issued warrants to purchase 100,000 shares of
common stock as partial compensation to an unaffiliated investment advisor. The
warrants are exercisable until September 9, 2002 at an exercise price of $1.063
per share. These warrants were exercised on December 10, 1999. The Company
recorded charges of $50,111 for the year ended December 31, 1999 based on the
fair value of the warrants.

On February 22, 1999, the Company issued warrants to purchase 50,000 shares of
common stock pursuant to a debt financing arrangement with an unrelated
individual. The warrants are exercisable until February 22, 2004 at an exercise
price of $1.063 per share. These warrants were exercised on December 3, 1999.
The Company recorded charges of $25,055 for the year ended December 31, 1999
based on the fair value of the warrants.

On March 22, 1999, the Company issued warrants to purchase 100,000 shares of
common stock representing partial fees pursuant to a debt financing arrangement
with an unaffiliated commercial bank. The warrants are exercisable until March
22, 2006 at an exercise price of $1.70 per share. These warrants were exercised
on November 23, 1999 under a net exercise provision resulting in the issuance of
38,181 shares. The Company recorded charges of $69,118 for the year ended
December 31, 1999 based on the fair value of the warrants.

On June 4, 1999, the Company entered into a financing agreement resulting in
$1,200,000 in gross proceeds from the sale of 1,350,000 shares of common stock
and the issuance of a warrant to purchase an additional 120,000 shares of common
stock in a private placement to an unaffiliated accredited investor. The
warrant is exercisable until June 30, 2004 at a per-share exercise price of
$1.478125. The Company also issued a warrant to purchase 25,000 shares of common
stock at $1.478125 per share exercisable through June 4, 2004 to Union Atlantic,
L.C. in connection with the placement. The Company filed a registration
statement under the Securities Act of 1933 for the shares issued in connection
with this transaction and issuable upon exercise of the warrant . The Company
received proceeds from this transaction in two tranches of $600,000. The first
tranche was funded on June 14, 1999 for $600,000 less expenses associated with
this offering of $60,897 yielding net proceeds of $539,103. The second tranche
for $600,000 less expenses of $58,222 yielding net proceeds of $541,778 was
funded on August 18, 1999.
F-15
<PAGE>

On September 17, 1999, the Company entered into a financing agreement resulting
in $1,500,000 in gross proceeds from the sale of 1,583,333 shares of common
stock and the issuance of a warrant to purchase an additional 150,000 shares of
common stock in a private placement to an unaffiliated accredited investor. The
warrant is exercisable until September 17, 2002 at a per-share exercise price of
$1.5375. The shares issued in connection with this transaction and issuable
upon exercise of the warrant will be registered under the Securities Act of
1933. The Company received proceeds from this transaction in two tranches of
$750,000 . The first tranche was funded on September 21, 1999 for $750,000 less
expenses of $64,903 yielding net proceeds of $685,097. The second tranche was
funded in October 1999 for $750,000 less fees and expenses associated with this
offering of $60,000 yielding net proceeds of $690,000.

On November 19, 1999, the Company agreed to issue 100,000 shares of common stock
to a subcontractor in settlement of $323,260 of accounts payable. The Company
agreed to register the shares under the Securities Act of 1933. The Company
also agreed to issue up to an additional 100,000 shares of common stock if the
average market price for the five trading days preceding the effective date of
the registration statement is less than $3.23 per share. The Company was not
required to issue any of the additional shares.

In November, 1999, the Company completed a financing of $2,000,000 in gross
proceeds from the sale of 1,250,000 shares of common stock and the issuance of
three warrants to purchase an aggregate of 125,000 shares of common stock in a
private placement to three unaffiliated accredited investors. The warrants are
exercisable until December 1, 2004 at a per-share exercise price of $3.1969. The
shares issued in connection with this transaction and issuable upon exercise of
the warrant will be registered under the Securities Act of 1933. Expenses
associated with this offering amounted to approximately $42,000 yielding net
proceeds of $1,958,000.

During the year ended December 31, 1999, the Company issued at various times,
2,095,780 shares of common stock resulting from other exercises of options and
warrants, receiving cash of approximately $2,461,023.

On January 18, 2000, the Company received gross proceeds of $990,000 from the
issuance of 330,000 shares of common stock resulting from the exercise of common
stock warrants issued pursuant to a private placement with an unaffiliated
investor on September 10, 1997. During the period from January 1, 2000 to March
31, 2000 the Company issued 62001 shares on the exercise of other options and
warrants.

On March 3, 1998, the Company received approximately $3,000,000 in gross
proceeds from the sale of 1,092,150 shares of Common Stock and warrants to
purchase 327,645 shares of common stock in a private placement to an
unaffiliated accredited investor. The shares issued in connection with this
transaction and issuable upon exercise of the warrants were registered under the
Securities Act of 1933 on April 22, 1998. Fees and expenses associated with
this offering amounted to approximately $172,600 yielding net proceeds of
$2,827,400. In connection with this transaction, the Board of Directors
authorized the grant of warrants to the placement agent to purchase 21,429
shares of the Company's common stock at a price of $4.2118 per share exercisable
for a period of five years. During December 1998, the investor exercised its
warrants to acquire 327,645 shares for approximately $399,000.

The Company received gross proceeds of $6,146,888 as a result of the exercise of
910,650 of the Company's redeemable common stock purchase warrants (the
"Warrants") issued in connection with the Company's initial public offering in
May 1993. The Company issued 1,649,202 shares of common stock as a result of
the exercise. In accordance with the anti-dilution provisions of the Warrants,
the holder was entitled to receive 1.811 shares of common stock for each Warrant
exercised. The Warrants were exercisable at a price of $6.75 per Warrant until
expiration on May 27, 1998.

F-16
<PAGE>

During the year ended December 31, 1998, the Company issued at various times,
453,111 shares of common stock resulting from other exercises of options and
warrants, receiving cash and notes receivable of approximately $774,000. On June
1, 1998, the Company recorded a note receivable in the amount of $316,418 in
connection with the exercise of stock options to purchase 171,000 shares of
common stock by a former director. The note is due on demand and bears interest
at 8% due quarterly. At December 31, 1998, the note receivable has been recorded
as an offset to stockholders' equity. In December 1999, the Company received
approximately $352,000 in full payment of this note, including accrued interest.

COMMON STOCK PURCHASE WARRANTS.

Common stock warrant activity is summarized as follows:

<TABLE>
<CAPTION>
1999 1998
------------------------------------- ----------------------------------------
Grant Price Grant Price
Shares Range Shares Range
------------------ ---------------- --------------------- -----------------
<S> <C> <C> <C> <C>
Warrants outstanding at 1,018,329 $0.90 - $9.11 3,715,507 $0.90 - $9.11
beginning of year

Anti-dilution adjustment - 61,237
Warrants granted 700,000 $ 1.06-$3.20 682,074 $ 2.75-$4.21
Warrants exercised (370,000) $ 1.06-$1.70 (2,035,180) $ 1.22-$3.73
Warrants canceled (25,000) $ 1.48 (1,405,309) $ 3.25-$3.81
---------- -----------
Warrants outstanding at 1,323,329 $1.06 - $9.11 1,018,329 $0.90 - $9.11
end of year ========== ============= =========== =============
Warrants exercisable at 1,323,329 $1.06 - $9.11 1,018,329 $0.90 - $9.11
end of year ========== ============= =========== =============
Weighted average fair $ .68 $1.25
value of warrants
granted during the year
</TABLE>

1992 STOCK OPTION PLAN.

The Company's 1992 Stock Option Plan (the "Plan"), provides for the granting of
incentive and non-qualified options to purchase up to approximately 1,800,000
shares of common stock. Incentive stock options may be granted to employees of
the Company. Non-qualified options may be granted to employees, directors or
consultants of the Company. Incentive stock options may not be granted at a
price less than 100% (110% in certain cases) of the fair-market value of common
stock at date of grant. Non-qualified options may not be granted at a price less
than 85% of fair-market value of common stock at date of grant. As of December
31, 1999, all options granted under the plan were issued at market value at the
date of grant. Options generally vest annually over a three-year period and are
exercisable over a five-year period from date of grant. The term of each option
under the Plan is for a period not exceeding ten years from date of grant.
During 1998, the Board of Directors authorized reductions in the exercise price
of certain options granted under the plan to prices reflecting the market value
on the re-pricing date. As of December 31, 1999, options under the Plan to
purchase 1,123,648 shares of the Company's common stock were outstanding with
exercise prices of $1.22 to $1.34 per share.

1995 KEY OFFICER NON QUALIFIED STOCK OPTIONS.

In 1995, the Board of Directors authorized the issuance to two officers warrants
to purchase an aggregate of 500,000 shares of common stock at $1.10 per share.
The options expire in April 2002. As of December 31, 1999, options to purchase
150,000 shares of the Company's common stock were outstanding with an exercise
price of $1.10 per share.

F-17
<PAGE>

1997 DIRECTOR STOCK OPTION PLAN.

In March 1997, the Board of Directors adopted the 1997 Director Stock Option
Plan (the "1997 Director Plan"), subject to stockholder approval which was
received on July 25, 1997. The 1997 Director Plan authorized the grant of
options to purchase up to an aggregate of 1,000,000 shares of common stock. Each
non-employee director who was in office on March 19, 1997 received an automatic
grant of an option to purchase shares of common stock ranging between 100,000
and 200,000 shares based on time of service. The exercise price per share of
options granted under the 1997 Director Plan is 100% of the market value of the
common stock of the Company on the date of grant. Options granted under the 1997
Director Plan are exercisable over a five-year period with vesting determined at
varying amounts over a three year period. As of December 31, 1999, options under
the 1997 Director Plan to purchase 250,000 shares of the Company's common stock
were outstanding with an exercise price between $ 1.22 and $1.88 per share.

1997 KEY OFFICER NON QUALIFIED STOCK OPTIONS.

In March 1997, the Board of Directors authorized the grant of non-qualified
stock options to certain key officers of the Company (the "1997 Key Officer
Agreements"). The 1997 Key Officer Agreements related to the grant of options to
purchase up to an aggregate of 920,000 shares of common stock. The exercise
price per share of options granted under the 1997 Key Officer Agreements equaled
100% of the market value of the common stock of the Company on the date of
grant. Options granted under the 1997 Key Officer Agreements are exercisable in
installments over a three-year period. As of December 31, 1999, options under
the 1997 Key Officer Agreements to purchase 232,672 shares of the Company's
common stock were outstanding with exercise prices of $1.22 per share.

1998 DIRECTOR STOCK OPTION PLAN.

On September 1, 1998, the Board of Directors adopted, subject to stockholder
approval, the 1998 Non-qualified Stock Option Plan (the "1998 NQSO Plan"). The
1998 NQSO Plan authorized the grant of options to purchase up to an aggregate of
1,250,000 shares of common stock. Each non-employee director who was in office
on September 1, 1998 received an automatic grant of an option, subject to
stockholder approval, to purchase 75,000 shares of common stock. Employee
officers and directors received a grant of an option to purchase shares of
common stock ranging from 10,000 to 200,000 shares based upon time of service.
The exercise price per share of options granted under the 1998 NQSO Plan is 100%
of the market value of the common stock of the Company on the date of grant.
Options granted under the 1998 NQSO Plan are exercisable over a five-year period
with vesting determined at varying amounts over a three year period. As of
December 31, 1999, options under the 1998 NQSO Plan to purchase 1,161,006 shares
of the Company's common stock were outstanding with an exercise price between
$1.06 and $1.40.

A summary of the status of the Company's outstanding stock options as of
December 31, 1999 and 1998, and the changes during the years then ended, is
presented below:

<TABLE>
<CAPTION>
1999 1998
------------------------------------- ---------------------------------------
Weighted Average Weighted Average
Shares Exercise Price Shares Exercise Price
----------------- ------------------ ------------------ -------------------
<S> <C> <C> <C> <C>
Options outstanding 3,919,396 $ 1.22 2,966,396 $1.81
at beginning of year
Options granted 1,229,386 $ 1.44 3,873,680 $1.42
Options exercised (1,816,125) $ 1.24 (394,778) $1.90
Options canceled (415,331) $ 1.19 (2,525,982) $1.96
---------- ----------

Options outstanding 2,917,326 $ 1.21 3,919,316 $1.22
at end of year ========== ==========

Options exercisable 393,391 $ 1.21 1,289,536 $1.20
at end of year ========== ==========

Weighted average fair value .57 $ .92
of options granted during
the year
</TABLE>

F-18
<PAGE>

Information pertaining to options outstanding at December 31, 1999 is as
follows:

<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------- --------------------------------------
<S> <C> <C> <C> <C> <C>
Weighted Weighted Weighted
Average Average Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices 12/31/99 Life Price 12/31/99 Price
- ---------------------- ---------------- ----------------- ---------------- ----------------- ------------------
$0.91-1.82 2,867,326 2.2 yrs 1.10 381,148 1.10
$1.82-2.73 50,000 4.90 yrs 1.88 12,243 1.88
--------- --------
Outstanding at 2,774,580 3.6 yrs 1.21 393,391 1.21
December 31, 1999 ========= ========

</TABLE>

STOCK-BASED COMPENSATION.

At December 31, 1999, the Company has stock option plans and non-plan stock
options that are described above. The Company applies APB Opinion No. 25 and
related interpretations in accounting for stock option. Accordingly, no
compensation cost has been recognized for stock option plans issued to
employees. Had compensation cost for the Company's stock-based compensation
plans and non-plan stock options outstanding been determined based on the fair
value at the grant dates for awards under those plans consistent with the method
prescribed by SFAS No. 123, the Company's net loss and loss per share would have
been adjusted to the pro forma amounts indicated below:

F-19
<PAGE>

<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------------
1999 1998
------------------- ------------------
<S> <C> <C> <C>
Net loss As reported $(1,479,703) $(12,787,324)
Pro forma $(2,587,558) $(14,483,121)
Basic loss per share As reported $ (.08) $ (.78)
Pro forma $ (.14) $ (.89)
Diluted loss per share As reported $ (.08) $ (.78)
Pro forma $ (.14) $ (.89)
</TABLE>

Common stock equivalents have been excluded from all calculations of loss per
share and pro forma loss per share in 1999 and 1998 because the effect of
including them would be anti-dilutive.

The fair value of each grant is estimated on the date of the grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1999 and 1998, respectively; dividend yield of
0.0 percent; expected volatility of 50% and 75%, risk-free interest rates of
6.0% and 6.0% and expected lives of 5.0 and 5.0 years.

In addition, the Company maintains the right to re-price the options under such
plans to reflect devaluation in the market value of its common stock. On
September 1, 1998, the Company re-priced all employee and director options under
all plans to $1.22 per share for those options priced in excess of this value.
This price represented the closing market price of the Company's common stock on
September 1, 1998. The FASB has issued a proposed interpretative release - Stock
Compensation - Interpretation of APB No. 25, which will have a prospective
impact on the Company's stock option plans, if adopted.

10. Income Taxes

The Company and its subsidiaries file a consolidated federal income tax return.
Allocation of the provision for income taxes between federal and state income
taxes is as follows:

<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1999 1998
-------------- -------------
<S> <C> <C> <C>
Current:
Federal income taxes $ -- $ --
-- 24,641
State income taxes -------------- -------

-- 24,641
Deferred federal and state income
taxes -- --
-------------- -------
$ -- $24,641
============== =======
</TABLE>

F-20
<PAGE>

The differences between the provisions for income taxes from the benefits
computed by applying the statutory Federal income tax rate are as follows:

<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------
1999 1998
--------------------- --------------------
<S> <C> <C>
Benefit computed at statutory rate (34%) $ (503,000) $(4,339,000)
State income tax benefit, net of federal tax (92,000) ( 766,000)
Increase in valuation allowance on deferred tax 546,000 5,029,000
asset
Other, net 49,000 100,641
------------ ------------
$ __ $ 24,641
============ ============
</TABLE>

The net deferred tax asset consists of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1999 1998
--------------------- --------------------
<S> <C> <C>
Deferred tax asset $ 15,611,000 $ 15,065,000
Deferred tax liability -- --
Valuation allowance on deferred tax asset (15,611,000) (15,065,000)
------------ ------------
Net deferred tax asset $ -- $ --
============ ============
</TABLE>

The tax effects of each type of income and expense item that give rise to
deferred taxes are as follows:

<TABLE>
<CAPTION>
December 31,
--------------------------------------------
1999 1998
----------------------- -------------------
<S> <C> <C>
Net operating loss carry forward $ 11,526,000 $ 9,909,000
Income tax credit carry forward 185,000 185,000
Tax basis in excess of book basis of fixed assets 157,000 157,000
Book inventory cost less than tax basis 160,000 867,000
Reserve for bad debts not deductible for income taxes 118,000 260,000
Tax basis in excess of book basis of other assets 466,000 466,000
Tax basis in subsidiaries in excess of book value 2,999,000 3,221,000
------------ ------------
15,611,000 15,065,000
Valuation allowance on deferred tax asset (15,611,000) (15,065,000)
------------ ------------
Net deferred tax asset $ -- $ --
============ ============
</TABLE>

A summary of the change in the valuation allowance on deferred tax assets is as
follows:

<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1999 1998
---------------- -----------------
<S> <C> <C>
Balance at beginning of year $15,065,000 $10,036,000

Addition to the allowance for the benefit of net
5,029,000
operating loss carry forwards not recognized 546,000 -----------
-----------
Balance at end of year $15,611,000 $15,065,000
=========== ===========
</TABLE>

F-21
<PAGE>

At December 31, 1999, the Company has the following carry forwards available for
income tax purposes:

Federal net operating loss carry forwards expiring in
various amounts through 2020
$28,815,000
===========

State net operating loss carry forwards expiring in
various amounts through 2005 $19,485,000
===========
Credit for research activities $ 185,000
===========

Due to the uncertainty surrounding the realization of these favorable tax
attributes, the Company has placed a valuation allowance against its otherwise
recognizable net deferred tax assets. The net operating loss carry-forwards are
subject to annual limitations based on ownership changes in the Company's
common stock as provided in Section 382 of the Internal Revenue Code.

11. Business Combinations

Lapis Technologies, Inc. On December 16, 1993, FOCUS issued 500,000 shares of
its common stock, subject to adjustment based on the value of the common stock,
in exchange for all of the outstanding common stock of Lapis Technologies, Inc.
("Lapis"). The business combination was accounted for using the purchase method
of accounting. From May to August 1995, the Company settled substantially all
claims by the former Lapis shareholders arising from the Company's acquisition
of Lapis by issuing 123,879 shares of common stock to the former Lapis
shareholders. This stock issuance was accounted for as an adjustment to the
purchase price. Negotiations are ongoing to settle the claims of two remaining
Lapis shareholders but the outcome is not expected to be material to the
Company's financial position.

In the fourth quarter of 1998, as a result of its evaluation of the impairment
of intangible assets related to this acquisition, the Company wrote-off the
balance of the goodwill in the amount of approximately $543,000. The evaluation
considered the Company's recent acquisitions, the declining Macintosh
marketplace, shifting of the market to PC-based products and technological
advances, and projected future sales of Lapis products.

TView, Inc. Effective September 30, 1996, FOCUS acquired all of the capital
stock of TView, Inc. ("TView"). The business combination has been accounted for
using the purchase method of accounting. Accordingly, the purchase price was
allocated to the assets acquired based on their estimated fair value. This
accounting treatment resulted in approximately $716,000 of goodwill that will be
amortized over its estimated benefit period of seven years. At December 31,
1998 and 1997, the balance of the goodwill was $366,267 and $488,355, net of
accumulated amortization of $349,757 and $227,669, respectively.

On March 31, 1998, the Company issued 350,000 shares of common stock valued at
approximately $1,115,600 in conjunction with the acquisition of certain assets
of Digital Vision, Inc. ("Digital Vision"). Shares issued as part of this
transaction have been registered under the Securities Act of 1933. In addition,
the Company agreed to pay approximately $47,000 in cash for net liabilities with
a fair value of approximately ($160,000), consisting of accounts receivable
($164,400), inventory ($60,600) offset by the assumption of notes payable
($330,000) and accounts payable ($55,000). At March 31, 1998, the Company
recorded goodwill of approximately $1,322,000 as a result of this acquisition.

F-22
<PAGE>

In the fourth quarter of 1998, as a result of its evaluation of the impairment
of intangible assets related to this acquisition, the Company wrote-off a
portion of the goodwill in the amount of approximately $1,070,000. Upon
evaluation of the product line, the Company deemed that only two products
warranted inclusion in its family of products. However, this In-Video product
line was not widely accepted by the Company's customer base due to significant
competition in its category, limited product features in comparison with the
competition, and its cost structure required pricing higher then many of the
competing products. In addition, no proprietary technology was acquired with
this acquisition. As a result of a discounted cash flow analysis in December
1998, the Company determined goodwill recorded on the acquisition of Digital
Vision should be written down to approximately $127,000. At December 31, 1999,
the balance of the goodwill was $95,245. The operations of Digital Vision have
been included in the financial statements of the Company since April 1, 1998.

On July 29, 1998, the Company acquired certain assets and assumed certain
liabilities of PC Video Conversion, Inc. ("PC Video"). At the closing, the
Company paid PC Video $700,000 in cash and delivered a promissory note in the
principal amount of $1,000,000 providing payment of principal and interest at
3.5% over a period of 36 months. The Company computed a discount of $89,915 on
the note based on its incremental borrowing rate. In addition, the Company
issued 122,796 shares of common stock as a result of the acquisition, which were
valued at $350,000 and the Company agreed to register the shares under the
Securities Act of 1933. The Company also assumed $80,367 of liabilities in
connection with this acquisition. The acquisition was accounted for as a
purchase and resulted in goodwill of approximately $1,657,000.

The Company paid Union Atlantic, LC $155,652 for marketing consulting services
rendered, agency services and standard business expenses in connection with the
purchase of PC Video. A Director of the Company is a partner of Union Atlantic,
LC.

In December 1998, as a result of its evaluation of the impairment of
intangible assets related to this acquisition, the Company wrote-off a portion
of the goodwill in the amount of approximately $1,441,000 resulting in a
December 31, 1998 balance of approximately $195,000. The evaluation considered a
limited distribution network, limited product features in comparison with the
competition, and the lack of proprietary technology. At December 31, 1999, the
balance of goodwill was $162,765. However, after an evaluation of the technical
engineering resources and product vision, management of the Company restructured
the PC Video business into a professional products research and development
center and began to consolidate its remaining operating activities into its
corporate office. This restructuring resulted in approximately $70,000 in one-
time charges in 1998.

12. Segment Information

The Company operates in one business segment: the development, manufacturing,
marketing and sale of computer enhancement devices for personal computers and
televisions. Sales to major television manufacturer in 1998 totaled
approximately $2,646,000 or 14% of the Company's revenues. Sales to a major
distributor in 1999 represented approximately $5,686,000, or 31% of the
Company's revenues as compared to approximately $5,686,000, or 31% of revenues
for 1998. Sales outside North America for the year ended December 31, 1999 were
approximately $951,000, principally to Europe ($604,000) and Asia ($347,000).
Sales outside North America for the year ended December 31, 1998 were
approximately $951,000, principally to Europe ($604,000) and Asia ($347,000).

Sales outside North America for the year ended December 31, 1999 were
approximately $704,000, principally to Europe ($396,000) and Asia ($308,000).
Sales outside North America for the year ended December 31, 1998 were
approximately $951,000, principally to Europe ($604,000) and Asia ($347,000).

13. Employee Benefit Plan

Effective July 1, 1998, the Company has implemented a Section 401(k) Profit
Sharing Plan (the "401(k) Plan") for all eligible employees. The Company may
make discretionary contributions to the 401(k) Plan. Employees are permitted to
make elective deferrals of up to 15% of employee compensation and employee
contributions to the 401(k) Plan are fully vested at all times. Company
contributions become vested over a period of five years. The Company has made
no contributions to the 401(k) Plan as of December 31, 1999.

14. Related Party Transactions

In connection with the Company's private placement transactions (see Note 9),
the Company paid placement fees of $66,000 to Union Atlantic, LC. In addition,
the Company paid consulting fees and expenses to Union Atlantic, LC amounting to
$46,226 in 1999. A Director of the Company is a partner in Union Atlantic, LC.

F-23
<PAGE>

SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report on Form 10-KSB to be signed on its
behalf by the undersigned, thereunto duly authorized.

FOCUS ENHANCEMENTS, INC.

By: /s/ William Coldrick
--------------------------
William Coldrick
Vice Chairman of the Board

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.

<TABLE>
<CAPTION>
Signature Title Date
- -------------------------------------- ---------------------------------------------- -------------------------
<S> <C> <C>

/s/ Thomas L. Massie Chairman of the Board April 14, 2000
- --------------------------------------
Thomas L. Massie

/s/ Gary M. Cebula Vice President of Finance & Administration April 14, 2000
- -------------------------------------- (Principal Accounting Officer)
Gary M. Cebula

/s/ John C. Cavalier
- --------------------------------------
John C. Cavalier Director April 14, 2000

/s/ William B. Coldrick
- --------------------------------------
William B. Coldrick Director April 14, 2000

- --------------------------------------
Timothy E. Mahoney Director April 14, 2000

/s/ Robert C. Eimers
- --------------------------------------
Robert C. Eimers Director April 14, 2000

/s/ William Dambrackas
- --------------------------------------
William Dambrackas Director April 14, 2000
</TABLE>

<PAGE>

EXHIBIT 11

FOCUS ENHANCEMENTS, INC.

STATEMENT OF COMPUTATION OF LOSS PER SHARE
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1999 1998
--------------------- --------------------
<S> <C> <C>
Net loss $(1,479,703) $(12,787,324)
============ ============

Basic:
Weighted average number of common shares outstanding 18,743,698 16,336,872
============ ============

Diluted:
Weighted average number of common shares outstanding 18,743,698 16,336,872
Weighted average common equivalent shares -- --
------------ ------------

Weighted average number of common
Shares outstanding used to calculate per share data 18,743,698 16,336,872
============ ============

Loss per share
Basic $ (.08) $ (.78)
Diluted $ (.08) $ (.78)
</TABLE>

<PAGE>

EXHIBIT 21

SUBSIDIARIES

The following is a list of subsidiaries of Focus Enhancements, Inc.

Name State of Incorporation
- ---- ----------------------

PC Video Conversion, Inc. Delaware

<PAGE>

EXHIBIT 23

CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the incorporation by reference in the registration statements of
FOCUS Enhancements, Inc. on Form S-8 (Nos. 33-80498, 33-80651 and 333-33243) and
on Form S-3 (Nos. 33-80033, 333-26911, 333-43285, 333-49467, and 333-57923,
333-81177, 333-82163, 333-94621) of our report, dated April 11, 2000 on the
consolidated financial statements of FOCUS Enhancements, Inc. as of December 31,
1999 and 1998 and for the years then ended, which report is included in this
Annual Report on Form 10-KSB.

/s/ WOLF & COMPANY, P.C.

WOLF & COMPANY, P.C.
Boston, Massachusetts
April 11, 2000

<PAGE>

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 3,736,517
<SECURITIES> 0
<RECEIVABLES> 3,207,912
<ALLOWANCES> 294,907
<INVENTORY> 3,588,702
<CURRENT-ASSETS> 11,013,047
<PP&E> 1,712,202
<DEPRECIATION> (743,608)
<TOTAL-ASSETS> 15,015,484
<CURRENT-LIABILITIES> 5,380,276
<BONDS> 428,043
0
0
<COMMON> 245,042
<OTHER-SE> 8,962,123
<TOTAL-LIABILITY-AND-EQUITY> 15,015,484
<SALES> 17,182,985
<TOTAL-REVENUES> 17,182,985
<CGS> 10,543,997
<TOTAL-COSTS> 7,805,785
<OTHER-EXPENSES> (218,117)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 531,023
<INCOME-PRETAX> (1,479,703)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,479,703)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,479,703)
<EPS-BASIC> (0.08)
<EPS-DILUTED> (0.08)

</TABLE>