UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-QSB

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

                For the quarterly period ended September 30, 1998

(   )      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 0-16055

                               PHOTOMATRIX, INC.

        (Exact name of small business issuer as specified in its charter)

          California                                     95-3267788
(State or other jurisdiction of              (IRS Employer Identification No.)
 incorporation or organization)  


1958 Kellogg Avenue, Carlsbad, California                              92008
(Address of principal executive offices)                            (Zip Code)


                                 (760) 431-4999
                (Issuer's telephone number, including area code)



Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days.

                                    Yes X No

-------------------------------------------------------------------------------
At September 30, 1998, 9,931,000 shares of the Common Stock of Photomatrix, Inc.
were outstanding.
-------------------------------------------------------------------------------


                 Transitional Small Business Disclosure Format.

                                    Yes No X








<PAGE>

                                      INDEX

                                PHOTOMATRIX, INC.


                                                                          Page
PART I - FINANCIAL INFORMATION

ITEM 1:    FINANCIAL STATEMENTS

           Consolidated   balance   sheets  as  of  September   30,  1998
           unaudited) and March 31, 1998                                     2

           Unaudited consolidated  statements of operations for the three
           months and six months ended  September  30, 1998 and September
           30, 1997                                                          3

           Unaudited  consolidated  statements  of cash flows for the six
           months ended September 30, 1998 and September 30, 1997            4

           Unaudited notes to consolidated financial statements              5


ITEM 2:    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
           CONDITION AND RESULTS OF OPERATIONS                               9


PART II - OTHER INFORMATION

ITEM 4:   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS               14

ITEM 5:  OTHER INFORMATION                                                  14

ITEM 6:  EXHIBITS AND REPORTS ON FORM 8-K                                   14

SIGNATURES                                                                  15







<PAGE>


                       PHOTOMATRIX, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                   AS OF SEPTEMBER 30, 1998 AND MARCH 31, 1998



<TABLE>
                                                           September 30, 1998
                                                               (Unaudited)          March 31, 1998
                                                        ------------------------ --------------------
<S>                                                      <C>                      <C>   
ASSETS

Current assets:
  Cash and cash equivalents                                             $251,000           $1,342,000
  Accounts receivable, net of allowance
       of $165,000 and $142,000                                        2,207,000            1,625,000
  Inventories                                                          3,159,000            2,171,000
  Prepaid expenses and other                                             241,000               98,000
                                                          ---------------------- --------------------
       Total current assets                                            5,858,000            5,236,000

Property and equipment, net                                            3,948,000              547,000
Intangible assets, net                                                 2,336,000            1,287,000
Other assets                                                              78,000              125,000
Advances to officers                                                       8,000                   --
                                                         ----------------------- --------------------
                                                                     $12,228,000           $7,195,000
                                                         ======================= ====================

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                                   $1,446,000             $502,000
   Accrued liabilities and other                                         542,000              746,000
   Customer deposits                                                     255,000              409,000
   Line of credit                                                        842,000                   --
   Current maturities of notes payable                                   374,000              162,000
   Net current liabilities of discontinued operation                     898,000            1,113,000
                                                            -------------------- --------------------
       Total current liabilities                                       4,357,000            2,932,000

Notes payable to related parties, long term                              123,000              213,000

Long term debt and other                                               2,399,000               26,000

Commitments and contingencies

Shareholders' equity:

   Preferred Stock, no par value; 3,173,000 shares
      authorized, no shares issued and outstanding                           --                   --
   Common stock, no par value; 30 million shares
       authorized, 9,931,000 and 5,083,000 shares
       issued and outstanding, respectively                           21,290,000           19,351,000
   Additional paid-in capital                                             30,000                   --
   Accumulated deficit                                               (16,129,000)         (15,480,000)
   Accumulated other comprehensive income                                158,000              153,000
                                                         ----------------------- --------------------
       Total shareholders' equity                                      5,349,000            4,024,000
                                                         ----------------------- --------------------
                                                                     $12,228,000           $7,195,000
                                                         ======================= ====================
</TABLE>


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


                                        2

<PAGE>



                       PHOTOMATRIX, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
      FOR THE THREE MONTHS AND SIX MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
                                   (Unaudited)


<TABLE>
                                                   Three Months Ended                Six Months Ended
                                                      September 30,                    September 30,
                                                  1998             1997            1998            1997
                                             --------------  ---------------- --------------- ---------------
<S>                                          <C>              <C>              <C>             <C>   
REVENUES                                         $3,071,000       $2,288,000      $4,363,000      $4,559,000

COST OF REVENUES                                  1,896,000        1,448,000       2,838,000       2,966,000
                                             --------------  ---------------- --------------- ---------------
GROSS PROFIT                                      1,175,000          840,000       1,525,000       1,593,000
                                             --------------  ---------------- --------------- ---------------

OPERATING EXPENSES
   Selling, general and administrative              936,000          741,000       1,751,000       1,666,000
   Research and development                         161,000          173,000         376,000         354,000
   Facility consolidation and relocation            (42,000)              --         181,000              --
                                             --------------- ---------------- --------------- ---------------
TOTAL OPERATING EXPENSES                          1,055,000          914,000       2,308,000       2,020,000
OPERATING INCOME (LOSS)                             120,000          (74,000)       (783,000)       (427,000)
                                             --------------- ---------------- --------------- ---------------
OTHER INCOME (EXPENSE), NET                         (66,000)          89,000        (117,000)         97,000
                                             --------------- ---------------- --------------- ---------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS                                           54,000           15,000        (900,000)       (330,000)

INCOME FROM DISCONTINUED
OPERATIONS                                          251,000               --         251,000              --
                                             --------------  ---------------- --------------- ---------------
NET INCOME (LOSS)                                $  305,000       $   15,000      $ (649,000)     $ (330,000)
                                             ==============  ================ =============== ===============
BASIC EPS:
CONTINUING OPERATIONS                            $     0.01       $       --      $    (0.11)     $    (0.06)
                                             --------------  ---------------- --------------- ---------------
DISCONTINUED OPERATIONS                          $     0.02       $       --      $     0.03      $       --
                                             --------------  ---------------- --------------- ---------------
NET INCOME (LOSS)                                $     0.03       $       --      $    (0.08)     $    (0.06)
                                             --------------  ---------------- --------------- ---------------
Weighted average number of common and
common stock equivalent shares outstanding        9,931,000        5,083,000       8,209,000       5,083,000
                                             --------------  ---------------- --------------- ---------------
DILUTED EPS:
CONTINUING OPERATIONS                            $     0.01       $      --       $    (0.11)     $    (0.06)
                                             --------------- ---------------- --------------- ---------------
DISCONTINUED OPERATIONS                          $     0.02       $      --       $     0.03      $       --
                                             --------------  ---------------- --------------- ---------------
NET INCOME (LOSS)                                $     0.03       $      --       $    (0.08)     $    (0.06)
                                             --------------  ---------------- --------------- ---------------
                                                                                                  $       --
                                                                                              ---------------
Weighted average number of common and
common stock equivalent shares outstanding       10,659,000        5,083,000       8,209,000       5,083,000
                                             --------------  ---------------- --------------- ---------------
</TABLE>


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





                                        3

<PAGE>



                       PHOTOMATRIX, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
                                   (Unaudited)



<TABLE>
                                                                         1998                1997
                                                                    ---------------     --------------
<S>                                                                 <C>              <C>
CASH FLOWS FROM OPERATIONS
   Net loss from continuing operations:                                  $(900,000)         $(330,000)
   Adjustments:
      Depreciation and amortization                                        395,000            473,000
      Loss on disposal of property and equipment                            13,000                 --
      Stock options granted to third party                                  30,000                 --
      Changes in assets and liabilities, excluding effects of 
       acquisition:
          Accounts receivable                                              356,000            143,000
          Inventories                                                           --           (237,000)
          Prepaid expenses and other                                       (56,000)           (35,000)
          Accounts payable                                                  39,000            (93,000)
          Accrued liabilities and other                                   (445,000)           128,000
          Customer deposits                                               (154,000)          (274,000)
                                                                    ---------------     --------------
    Cash used in continuing operations                                    (722,000)          (255,000)
    Cash provided by discontinued operations                                36,000            628,000
                                                                    ---------------     -------------- 
Cash provided by (used in) operations                                     (686,000)           403,000
                                                                    ---------------     --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Cost of acquisition, net of cash received                                35,000                 --
   Capital expenditures                                                   (528,000)                --
   Proceeds from disposal of capital assets                                 20,000             23,000
   Decrease  in other assets                                                34,000                 --
                                                                    ---------------     --------------  
Cash provided by (used in) investing activities                           (439,000)            23,000
                                                                    ---------------     --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
    Proceeds from line of credit, net of repayments                        159,000                 --
    Repayments on notes payable                                            (22,000)                --
    Increase (decrease) in long term debt and other                       (108,000)            49,000
                                                                    ---------------     --------------
Cash provided by  financing activities                                      29,000             49,000
                                                                    ---------------     --------------
EFFECTS OF EXCHANGE RATES ON CASH                                            5,000            (13,000)
                                                                    ---------------     --------------
NET INCREASE (DECREASE) TO CASH AND CASH
    EQUIVALENTS                                                         (1,091,000)           462,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                           1,342,000            812,000
                                                                    ---------------     --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD                            $      251,000      $   1,274,000
                                                                    ===============     ==============
</TABLE>




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




                                        4

<PAGE>



                       PHOTOMATRIX, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 AS OF SEPTEMBER 30, 1998 AND MARCH 31, 1998 AND
         FOR THE THREE AND SIX MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
                                   (Unaudited)


  1.       GENERAL

  Basis of Presentation

  The  accompanying  unaudited  consolidated  financial  statements  reflect the
  accounts of Photomatrix, Inc. (the "Company"), together with its subsidiaries.
  On June 5, 1998 the shareholders of the Company approved the merger ("Merger")
  between the Company.  and I-PAC  Manufacturing,  Inc.  ("I-PAC").  The Company
  issued 4,848,000  shares of Photomatrix  common stock to shareholders of I-PAC
  in  exchange  for the  8,500  outstanding  shares of the  common  stock of the
  privately-held company. This transaction resulted in an increase in the number
  of outstanding shares of Photomatrix common stock from 5,083,000 to 9,931,000.
  All significant intercompany transactions and balances have been eliminated.

  Certain  information and  disclosures  normally  included in annual  financial
  statements   prepared  in  accordance  with  generally   accepted   accounting
  principles  ("GAAP") have been condensed or omitted pursuant to GAAP, although
  the Company  believes  that the  disclosures  made are adequate to prevent the
  information  from being  misleading.  These unaudited  consolidated  financial
  statements  reflect,  in the opinion of  management,  all  adjustments  (which
  include only normal recurring  adjustments) necessary to present the Company's
  results  of  operations  and  financial  position  as of the dates and for the
  periods presented. These unaudited consolidated financial statements should be
  read in conjunction  with the audited  financial  statements and related notes
  included in the Company's  Report on Form 10-KSB filed with the Securities and
  Exchange  Commission  for the year ended March 31,  1998.  The results for the
  interim  periods  presented  are not  necessarily  indicative of results to be
  expected for a full year.

  Certain  prior  year  amounts  have  been   reclassified  to  conform  to  the
  current-year presentation.


  2.  CREDIT FACILITIES

  As of September 30, 1998,  the Company was  obligated  under a series of notes
  payable  totaling  $3,738,000.  This debt  included  a new  $2,100,000  credit
  facility  with its bank  that  included  a  $1,500,000  line of  credit  and a
  $600,000 term loan which matures in September, 2002. The aggregate outstanding
  balance under these loans as of September 30, 1998 was $1,316,000. The Company
  used  some  of  the  proceeds  from  the  term  loan  to  acquire   additional
  state-of-the-art  equipment which will significantly broaden its surface mount
  technology ("SMT") printed circuit board manufacturing capacity.

  The new line of credit  accrues  interest  on  outstanding  borrowings  at the
  bank's prime rate plus 1 % per annum.  The  Company's  previous line of credit
  accrued  interest at prime plus 2%. All other terms of the new line of credit,
  except for various covenants,  essentially  remained the same. Under the terms
  of the new  agreement,  total  borrowings  under  the line of  credit  will be
  limited to the lesser of $1,500,000 or 75% of eligible accounts receivable (as
  defined  under the  agreement).  The  Company is  required  to continue to (1)
  maintain a minimum  tangible net worth of $2,600,000 as of September 30, 1998,
  $3,200,000 as of December 31, 1998, and  $3,500,000  thereafter (2) maintain a
  ratio of total  liabilities  to tangible net worth of not greater than 2.75 to
  1.0, and (3) maintain a minimum debt service  coverage of no less than 1.25 to
  1.0. The new line of credit expires in July, 1999.

  The Company has issued two notes in the aggregate amount of $2,038,000,  which
  are  collateralized  by trust deeds of the Company's real property  located in
  Carlsbad,  California.  The  repayment of these notes is guaranteed by certain
  major shareholders of the Company and the Small Business Administration. These
  notes are payable in aggregate monthly installments of approximately  $19,000,
  including interest ranging from 7.5 to 9.5%.



                                        5

<PAGE>



  3.  DISCONTINUATION OF LEXIA SYSTEMS, INC.

  In December,  1996 the Board of Directors  approved a plan to discontinue  the
  operations of Lexia Systems, Inc. ("Lexia").  Lexia's operational results have
  been  reclassified  as  discontinued   operations  for  the  respective  years
  presented  herein.  Lexia's balance sheets have similarly been reclassified as
  net current  liabilities of  discontinued  operations as of September 30, 1998
  and March 31, 1998.

  Photomatrix  shut  down  the  operations  of  Lexia  on  September  30,  1998.
  Approximately  $110,000 of reserves for discontinued operating losses were not
  required, contributing to income from discontinued operations for the quarter.
  In addition,  Lexia has entered into a settlement with Fujitsu  Computers Ltd.
  ("Fujitsu")  regarding its disagreements  over outstanding  claims.  Lexia had
  carried  on its books  accounts  payable  claims by  Fujitsu  in the amount of
  $341,000.  Lexia has  disputed  these  liabilities.  Lexia  has  agreed to pay
  Fujitsu  $200,000  over  an  eight  month  period  as  payment  in full of all
  outstanding  claims  against  Lexia,  resulting in an  additional  $141,000 of
  income from discontinued operations for the quarter. Lexia also carries on its
  books  accounts  payable and unpaid  rent  claims by ICL, a sister  company of
  Fujitsu, in the amount of $457,000.  Lexia disputes any liability with respect
  to ICL in  light  of its own  offsetting  claims  and  defenses.  There  is no
  assurance  that Lexia will be  successful  in  prevailing in its position with
  regard to outstanding claims previously made by ICL.


  4.  BASIC AND DILUTED LOSS PER SHARE

  In December 1997, the Company adopted the provisions of Statement of Financial
  Accounting  Standards  ('SFAS")  No. 128,  "Earnings  per Share." SFAS No. 128
  supersedes APB No. 15 and replaces  "primary" and "fully diluted" earnings per
  share ("EPS") under  Accounting  Principles  Board ("APB") Opinion No. 15 with
  "basic" and "diluted" EPS. Unlike primary EPS, basic EPS excludes the dilutive
  effects of options,  warrants and other convertible  securities.  The weighted
  average number of common shares  outstanding  used in computing  basic EPS was
  9,931,000 and 5,083,000, in the second quarters of fiscal years 1999 and 1998,
  respectively,  and  8,209,000  and  5,083,000,  in the six month periods ended
  September 30, 1998 and 1997, respectively.  Diluted EPS reflects the potential
  dilution  attributable  to securities  that could share in the earnings of the
  Company,  similar  to fully  diluted  EPS.  Incremental  shares  from  assumed
  conversions of options and warrants representing  approximately 728,000 shares
  were used in computations  of diluted  earnings per share for the three months
  ended September 30, 1998. For the three month period ended September 30, 1998,
  outstanding  options for the purchase of approximately  28,000 shares were not
  used in  computations  of diluted  earnings per share because they were priced
  above  market  value  as of  September  30,  1998.  For the six  months  ended
  September 30, 1998, options and warrants to purchase  approximately  1,286,000
  shares were not used in  computations  of diluted  earnings per share  because
  their  effect was  anti-dilutive.  The adoption of SFAS No. 128 did not have a
  material effect on the Company's net income/loss per common share.


  5. ACQUISITION OF I-PAC MANUFACTURING, INC.

  On March 16, 1998,  the Company  entered into an Agreement  and Plan of Merger
  and Reorganization with I-PAC  Manufacturing,  Inc. The Agreement was approved
  by the shareholders of the Company on June 5, 1998, and the transaction closed
  on June 11, 1998. As a result of the Merger,  the 8,500 outstanding  shares of
  I-PAC Common Stock were exchanged for 4,848,000  shares of Photomatrix  Common
  Stock and possibly an additional  4,652,000 shares of Photomatrix Common Stock
  in the event that  I-PAC  achieves  certain  performance  milestones  during a
  twelve  month  period  commencing  on July 1, 1998 or  outstanding  options to
  purchase Photomatrix Common Stock are exercised.

  The  Merger  was  accounted  for as a  purchase  of I-PAC by the  Company  for
  accounting  and financial  reporting  purposes.  Under the purchase  method of
  accounting,  upon closing of the Merger,  I-PAC's  results of operations  were
  combined with those of the Company,  and I-PAC's assets and  liabilities  were
  recorded on the Company's books at their respective fair values.  The purchase
  price,  amounting to $2,191,000,  was comprised of the value of the stock plus
  acquisition  costs  and  was  allocated  among  the  assets  acquired  and the
  liabilities  assumed.  The  issuance  of  additional  shares  awarded to I-PAC
  shareholders under the earn-out formula and/or in connection with


                                        6

<PAGE>



  the exercise of Photomatrix  outstanding  options and warrants will be treated
  in accordance  with  generally  accepted  accounting  principles,  in that any
  additional  shares  will  be  treated  as  additional  costs  of the  acquired
  enterprise and amortized  accordingly over the benefit period.  The $1,179,000
  excess of the purchase price over the fair value of I-PAC's net assets will be
  amortized over a twenty year period.

  If the I-PAC  transaction had been consummated at the beginning of fiscal year
  1997, the Company's  consolidated  revenues,  net income (loss) and net income
  (loss) per share for the quarter and six months ended  September  30, 1998 and
  1997 would have been:

<TABLE>
                                          Quarter Ended September 30,            Six Months Ended September 30,
                                            1998                1997               1998                1997
<S>                                      <C>                 <C>               <C>                  <C>   

  Revenues                               $3,071,000          $3,396,000        $ 4,900,000          $ 7,111,000
  Net Income (Loss)                      $  305,000          $   99,000        $  (918,000)         $  (169,000)
  Basic and Diluted EPS                  $     0.03          $     0.01        $    ( 0.09)         $    ( 0.02)
</TABLE>

  6.  COMPREHENSIVE INCOME

  As of April 1, 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive
  Income." SFAS No. 130  establishes  standards for the reporting and display of
  comprehensive income and its components.  SFAS No. 130 requires the cumulative
  translation  adjustment to be included as a component of comprehensive  income
  (loss) in  addition  to net  income  (loss) for the  period.  During the three
  months ended  September 30, 1998 and 1997 total  comprehensive  income totaled
  $316,000 and $2,000,  respectively,  and during the six months ended September
  30, 1998 and 1997,  total  comprehensive  loss totaled  $644,000 and $348,000,
  respectively.


  7.  ACQUISITION OF MGM TECHREP, INC.

  On July 1, 1998, the Company  acquired the assets and business of MGM Techrep,
  Inc.  ("MGM").  MGM, a private entity that is primarily  owned by the officers
  and former owners of I-PAC,  is a  manufacturer's  sales  representative  firm
  headquartered in Santa Ana, California.  Established in 1994, MGM has been the
  primary   sales  rep  firm  in  the   Southern   California   area  for  I-PAC
  Manufacturing,  Inc.  ("I-PAC").  MGM also represents  approximately  15 other
  companies  engaged  in the  manufacture  and  distribution  of a wide range of
  industrial products used in the manufacture and sale of electronic and related
  products.

  The Photomatrix acquisition included all contracts with MGM's principals,  its
  customer  list,  all  physical  assets,  and the MGM trade name.  MGM retained
  existing  liabilities  and released its sales  personnel to  Photomatrix,  and
  MGM's shareholders  executed non-compete  agreements with respect to the sales
  rep  business.  The  purchase  price  of the  transaction  will be  determined
  primarily  on an earn-out  basis by a declining  percentage  (75% in the first
  year,  50% in the second year and 25% in the final year  following the closing
  date) of the  commissions  earned  over a  three-year  period  by MGM on sales
  involving its existing  principals and customers as of the time of purchase by
  Photomatrix.  During the three months ended  September  30, 1998,  the Company
  recorded approximately $43,000 of goodwill related to these earn-out accruals.
  No payments will be due to MGM for principals or customer accounts added after
  the closing date. In addition,  I-PAC forgave approximately $18,000 of amounts
  due from MGM as of the closing date.

  Consistent with the provisions of the Photomatrix-I-PAC merger agreement, this
  related party  transaction was reviewed and approved by the outside  directors
  on the Audit Committee of the Photomatrix Board of Directors.






                                        7

<PAGE>



  8.  EMPLOYEE STOCK PURCHASE PLAN

  On June 5, 1998 the Board of Directors  authorized  the  Photomatrix  Employee
  Stock  Purchase  Plan  and  authorized  the  purchase  of  up to  $250,000  of
  Photomatrix  common stock for the plan on the open market.  The purpose of the
  Purchase Plan is to serve as an incentive to and to encourage  stock ownership
  by  eligible  employees  of the  Company so that they may  acquire or increase
  their proprietary interest in the success of the Company and to encourage them
  to remain in the service of the Company.

  All  full-time  employees  of the  Company  who  have  been in the  continuous
  employment of the Company for more than six months are eligible to participate
  in the Purchase  Plan,  provided  that no employee may be granted the right to
  purchase  stock under the  Purchase  Plan if,  immediately  after the right to
  purchase such stock is granted, such employee owns stock possessing 5% or more
  of the total  combined  voting power or value of all classes of the  Company's
  stock.  The option price will be determined  by the Company,  provided that it
  will be equal to or greater than 85% of the fair value of the Company's common
  stock on the date the option is granted. Each participating employee may elect
  to contribute to the Purchase Plan up to the lesser of $8,000 or 10% of his or
  her base compensation during each calendar year.

  A total of  750,000  shares  of stock are  available  for  purchase  under the
  Purchase Plan, subject to adjustment for various changes in the capitalization
  of the Company.


  9.  EXPIRATION OF DEBT

  During the  quarter  ended  September  30,  1998,  the  Company  recorded  the
  cancellation  of a $227,000 long term  liability due a  lender/customer.  This
  long term liability was previously  assumed by the Company in connection  with
  the acquisition of I-PAC. Under terms of the agreement, the liability was only
  to be repaid if sales were to be made to the lender prior to September 5, 1998
  at a rate  of 40% of the  non-material  component  of any  such  sales.  As of
  September 5, 1998, the $227,000 liability expired and all underlying  security
  interest was released under terms of the  agreement.  The Company has recorded
  the expiration of the note as a reduction to goodwill  related to the purchase
  of I-PAC.


  10. RELATED PARTY TRANSACTIONS

  During the quarter  ended  September  30, 1998 the Company paid  approximately
  $111,000  to  Evergreen  Investments,  a company  owned by William L.  Grivas,
  Photomatrix Chairman and major shareholder,  and Patrick W. Moore, Photomatrix
  Chief Executive Officer and major shareholder.  Of this amount,  approximately
  $43,000  was  for  S  Corp  distributions   intended  to  cover  personal  tax
  liabilities  of  the  former  I-PAC   shareholders  for  calendar  year  1997,
  approximately  $34,000 was for pre-merger management fees, and another $34,000
  was for pre-acquisition  commission payments due MGM TechRep. In addition, the
  Company paid  approximately  $26,000 to Sullivan,  Hill, Lewin, Rez, Engle and
  LaBazzo,  a law firm in which James P. Hill, a director and major shareholder,
  is a partner.  The Company also  received  approximately  $1,000 from Keystone
  Gaming, a company in which Patrick Moore has a minority interest. At September
  30,  1998,  the Company had  accrued  approximately  $33,000 in amounts due to
  former  shareholders  of  I-PAC  for S Corp  distributions  intended  to cover
  personal tax  liabilities  for calendar  year 1997,  approximately  $33,000 in
  legal fees due to Sullivan,  Hill,  Lewin, Rez, Engle and LaBazzo and advances
  totaling approximately $8,000 due from William Grivas and Patrick Moore.

  As mentioned in Note 2, certain  shareholders  of the Company have  guaranteed
  approximately  $2,015,000  of the  Company's  debt at September  30, 1998.  In
  addition,  the Company has  guaranteed  approximately  $117,000 of debt of the
  same shareholders.

  Claudia  Fullerton,  who is the wife of  Patrick  Moore,  is  employed  by the
  Company as its  Director  of  Administration  at an annual  salary of $54,000.
  William Grivas, Jr., who is the son of William Grivas, is


                                        8

<PAGE>



  employed by the Company as an account  representative  at an annual  salary of
  $30,000.

  All  related  party  transactions  are  reviewed  and  approved  by the  Audit
  Committee of the Board of Directors.


         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                              RESULTS OF OPERATIONS


  Management's  discussion  and analysis of financial  condition  and results of
  operations  should  be read in  conjunction  with the  consolidated  financial
  statements and unaudited notes to consolidated  financial  statements included
  elsewhere herein.


  Three  months  ended  September  30, 1998  compared to the three  months ended
  September 30, 1997

  On June 5, 1998,  the Company  acquired I-PAC and on July 1, 1998, the Company
  acquired MGM. Both  acquisitions  were treated as purchases for accounting and
  financial  reporting  purposes.  Under the purchase method of accounting,  the
  results of operations of the acquired companies are combined with those of the
  Company at the date of acquisition.  Accordingly, the three month period ended
  September 30, 1998,  represents the first full quarter reflecting the combined
  operations of the Company, I-PAC and MGM.

  Consolidated  revenues  for the quarter  ended  September  30, 1998  increased
  $783,000  or  34.2%  to  $3,071,000  from  $2,288,000  for the  quarter  ended
  September 30, 1997. The increase is primarily attributable to the inclusion of
  three months of Electronic  Manufacturing  Services  ("EMS")  revenues of both
  I-PAC and MGM.  Imaging  Products  revenues in the quarter ended September 30,
  1998  decreased  by  approximately  $350,000  due  to  approximately  $100,000
  decrease in foreign  document scanner sales and $250,00 decrease in duplicator
  repair and spare parts sales.

  Consolidated  gross margin for the quarter ended  September 30, 1998 increased
  $335,000 or 69.1% to $1,175,000  from $840,000 for the quarter ended September
  30, 1997.  This increase is also  primarily  attributable  to the inclusion of
  three months of EMS gross profit of I-PAC. Likewise, gross margin as a percent
  of revenues increased 1.6% to 38.3% from 36.7% for the quarter ended September
  30,  1997.  The  increase  was  primarily  attributable  to the  cost  savings
  anticipated  with the merger,  together with the Imaging Products sales of the
  new 9600 document  scanner  systems,  which carry  increased  margins over our
  previous product offerings.

  Selling,  general and  administrative  expenses ("SG&A") for the quarter ended
  September 30, 1998 included three months of expenses of both I-PAC and MGM and
  as a result,  increased  $195,000 or 26.3% to $936,000  from  $741,000 for the
  quarter  ended  September  30, 1997.  As a percent of  revenues,  SG&A for the
  quarter ended September 30, 1998 decreased to 30.5% from 32.4% for the quarter
  ended September 30, 1997.  Offsetting the increase in costs resulting from the
  inclusion of three months of costs from I-PAC and MGM were reductions in costs
  due to the elimination of duplicated functions.

  Research and  development  expenses for the quarter  ended  September 30, 1998
  decreased  $12,000 or 6.9% to $161,000  from  $173,000  for the quarter  ended
  September 30, 1997. As a percent of revenues,  research and development  costs
  decreased  to 5.2% in the  current  quarter  from 7.6% for the  quarter  ended
  September 30, 1997. No expenditures were capitalized  during the quarter ended
  September  30,  1998 due to  continuing  emphasis  upon  scanner  development,
  including the development of a new mid-range scanner. During the quarter ended
  September 30, 1997 product development  spending was $189,000,  and $16,000 of
  expenditures were capitalized because they related to technologically feasible
  software  development  projects.  The overall reduction in product development
  spending was primarily the result of reductions in materials and rework.


                                        9

<PAGE>



  Approximately  $42,000  of the  $223,000  reserves  for  moving  and  facility
  relocation  costs  recorded  in the  quarter  ended  June  30,  1998  were not
  required, resulting in a credit of $42,000 in facility relocation costs in the
  quarter ended September 30, 1998.

  Other expense was $66,000 for the quarter ended  September 30, 1998,  compared
  to income of $89,000 for the quarter  ended  September  30, 1997.  The current
  quarter net expense is  primarily  comprised  of interest  expense  related to
  I-PAC  mortgages  and the line of credit,  compared to income of $100,000 from
  the sale of an unused  trademark  during the quarter ended September 30, 1997.
  Interest  expense  increased  $68,000,  which  reflects  the  addition  of the
  interest on the mortgage for the Carlsbad  facility for three months,  as well
  as increased borrowings related to the line of credit.

  There was no  provision  for income  taxes  booked in the three  months  ended
  September 30, 1998, the same as in the three months ended  September 30, 1997,
  because of the effects of net operating loss carry forwards.

  Photomatrix  shut down the  operations of its subsidiary  Lexia Systems,  Inc.
  ("Lexia")  on  September  30,  1998.  Approximately  $110,000 of reserves  for
  discontinued  operating losses were not required,  contributing to income from
  discontinued operations for the quarter. In addition, Lexia has entered into a
  settlement with Fujitsu Computers Ltd. ("Fujitsu") regarding its disagreements
  over  outstanding  claims.  Lexia had  carried on its books  accounts  payable
  claims by Fujitsu in the amount of approximately $341,000.  Lexia had disputed
  these  liabilities.  Lexia has agreed to pay  Fujitsu  $200,000  over an eight
  month  period as  payment in full of all  outstanding  claims  against  Lexia,
  resulting in an additional  $141,000 income from  discontinued  operations for
  the quarter.  Lexia also carries on its books accounts payable and unpaid rent
  claims by ICL, a sister company of Fujitsu,  in the amount of $445,000.  Lexia
  disputes  that any  liability  exists with  respect to ICL in light of its own
  offsetting  claims  and  defenses.  There is no  assurance  that Lexia will be
  successful in prevailing  in its position  with regard to  outstanding  claims
  previously made by ICL.

  The net effect of the increases in gross margin and other income  coupled with
  the decrease in research and development expenses, together with the increases
  in interest expense and selling, general and administrative expenses, resulted
  in net income from  continuing  operations for the quarter ended September 30,
  1998 of $54,000 or $0.01 per share.  The addition of income from  discontinued
  operations  of $251,000 or $0.02 per share  resulted in net income of $305,000
  or $0.03 per share.  This compares to net income of $15,000 or $0.00 per share
  for the quarter ended September 30, 1997.

  Six months ended September 30, 1998 compared to the six months ended September
  30, 1997

  During the quarter ended June 30, 1998, the Company  completed the move of its
  operations into I-PAC's facility located in Carlsbad, California. As expected,
  this move was disruptive and resulted in certain operating inefficiencies.

  Consolidated  revenues in the six months ended  September  30, 1998  decreased
  $196,000  or 4.3% to  $4,363,000  from  $4,559,000  in the  six  months  ended
  September 30, 1997. This decline was primarily  attributable to  disappointing
  Imaging  Product  revenues  of the first  quarter.  The  increase  in  revenue
  attributable  to the newly  acquired EMS operations was not enough to overcome
  this reduction.

  Consolidated gross margin in the six months ended September 30, 1998 decreased
  $68,000  or  4.2% to  $1,525,000  from  $1,593,000  in the  six  months  ended
  September 30, 1997.  The overall 35.0% gross margin during the six months just
  ended was slightly higher than the 34.9% gross margin  percentage for the same
  period of the prior year. Favorable gross margins of the second quarter offset
  lower  margins  due to the  low  volume  transitional  quarter  of  pre-merger
  operations for the Company.

  Selling,  general and administrative expenses ("SG&A") in the six months ended
  September 30, 1998 increased  $85,000 or 5.1% to $1,751,000 from $1,666,000 in
  the six months ended  September 30, 1997.  These  increases were primarily the
  result of the  inclusion of four months of I-PAC  expenses and three months of
  MGM expenses,  offset by the reduction of costs resulting from the elimination
  of the  duplication  of functions  as a result of the merger.  As a percent of
  revenue,  SG&A in the six months ended  September 30, 1998  increased to 40.1%
  from

                                       10

<PAGE>



  36.5% in the six months ended September 30, 1997, primarily as a result of the
  abnormally low revenues during the first quarter.

  Research and  development  expenses in the six months ended September 30, 1998
  increased by $22,000 or 6.2% to $376,000 from $354,000 in the six months ended
  September  30, 1997.  As a  percentage  of revenue,  research and  development
  expenses increased  slightly,  0.8 percentage points to 8.6% from 7.8% for the
  six months ended September 30, 1997. No expenditures  were capitalized  during
  the six months ended September 30, 1998 as an emphasis was placed upon scanner
  development,  including the development of a new mid-range scanner. During the
  previous six months ended  September  30, 1997  product  development  spending
  totaled $438,000,  and $84,000 of expenditures  were capitalized  because they
  related to technologically feasible software development projects.

  The Company  incurred  approximately  $181,000 in facility  consolidation  and
  relocation  cost as a result of moving its Sorrento  Valley  Imaging  Products
  operations into the I-PAC owned facilities in Carlsbad, California.

  Other expense was $117,000 in the six months ended September 30, 1998 compares
  to income of $97,000 in the six months ended  September 30, 1997.  This change
  reflects a $94,000  increase  in  interest  expense in the  current six months
  compared to income of  $100,000  on the sale of a trademark  in the six months
  that ended September 30, 1997.

  There  was no  provision  for  income  taxes  booked in the six  months  ended
  September  30, 1998,  the same as in the six months ended  September 30, 1997,
  because of the effects of net operating loss carry forwards.

  The net effect of the increases in SG&A and research and development costs and
  decreases in gross margin and other income resulted in an increase in the loss
  from continuing operations between years of $570,000, to $(900,000) in the six
  months ended September 30, 1998, or $(0.11) per share,  compared to $(330,000)
  or $(0.06) per share in the six months ended  September  30,  1997.  There was
  income from discontinued  operations in the current six months ended September
  30, 1998 of $251,000,  or $0.03 per share,  compared to no income or loss from
  discontinued  operations  in the six months  ended  September  30,  1997.  The
  results  were a net loss of  $(649,000)  or $(0.08) in the  current six months
  period  compared  to a loss of  $(330,000)  or $(0.06) in the prior six months
  period.


                         Liquidity and Capital Resources

  Recent and Future Sources of and Demands on Liquidity and Capital Resources

  During the six months ended September 30, 1998, the Company's  primary sources
  of liquidity were from a reduction to accounts receivable ($356,000), increase
  in accounts  payable  ($39,000),  proceeds from the disposal of capital assets
  ($20,000),  decrease in other assets  ($34,000),  proceeds from line of credit
  net of repayments ($159,000),  the effects of exchange rates on cash ($5,000),
  reduction in cost of acquisition  ($35,000) and cash provided by  discontinued
  operations  ($36,000).  During the same period the primary  uses of  liquidity
  were a net  loss  net of  noncash  charges  ($462,000),  increase  to  prepaid
  expenses  and  other  assets  ($56,000),   reduction  in  accrued  liabilities
  ($445,000),   reduction  in  customer  deposits   ($154,000),   capital  asset
  expenditures ($528,000), and repayments on notes payable and other obligations
  ($130,000).  As a result of these sources and uses of liquidity during the six
  months ended  September 30, 1998 as described  above,  the Company's  cash and
  cash  equivalents  balance  decreased  $1,091,000  or 81.3%,  to $251,000 from
  $1,342,000.

  In July, 1998 the Company  entered into a new $2,100,000  credit facility with
  its bank that  includes a $1,500,000  line of credit and a $600,000 term loan.
  The  outstanding  balances  under  these  loans as of  September  30, 1998 was
  $1,316,000.  The new  line of  credit  will  accrue  interest  on  outstanding
  borrowings at the bank's prime rate plus 1 % per annum. Under the terms of the
  new agreement,  total  borrowings  under the line of credit will be limited to
  the lesser of $1,500,000 or 75% of eligible  accounts  receivable  (as defined
  under the  agreement).  The  Company  is  required  to (1)  maintain a minimum
  tangible net worth of $2,600,000  as of September  30, 1998,  $3,200,000 as of
  December 31, 1998,  and  $3,500,000  thereafter  (2) maintain a ratio of total
  liabilities to tangible net worth

                                       11

<PAGE>



  of not  greater  than 2.75 to 1.0,  and (3)  maintain a minimum  debt  service
  coverage of no less than 1.25 to 1.0. The new line of credit  expires in July,
  1999.  Based  on  September  30,  1998  financial  data,  the  Company  was in
  compliance with all of these covenants.

  The Company has issued two notes in the aggregate amount of $2,038,000,  which
  are  collateralized  by the trust deeds of the Company's real property located
  in Carlsbad, California. The repayment of these notes is guaranteed by certain
  major shareholders of the Company and the Small Business Administration. These
  notes are payable in aggregate monthly installments of approximately  $19,000,
  including interest ranging from 7.5 to 9.5%.

  The Company is obligated under a series of notes payable totaling  $294,000 as
  of September 30, 1998. These notes bear interest at a rate of 8% per annum and
  mature in April 2000. Interest and principal payments totaling $16,000 are due
  monthly. As of September 30, 1998 all payments were current.

  The  Company  also has  certain  equipment  notes in the  aggregate  amount of
  $50,000 with interest rates varying  between 11% and 26.6% with final payments
  due between 2000 and 2005. These notes are collateralized by equipment.

  During September 1998, The Company's wholly-owned  subsidiary,  Lexia Systems,
  settled its outstanding dispute with Fujitsu. As a result, the Company reduced
  its previously  recorded liability of $340,000 to Fujitsu to $200,000 and will
  begin making payments against this liability in November,  1998 with the final
  payment  due to Fujitsu in June,  1999.  Lexia also has  recorded  liabilities
  reflecting accounts payable and unpaid rent claims of ICL and related entities
  in the amount of  $457,000  at  September  30,  1998.  These  liabilities  are
  classified  under net liabilities of discontinued  operations.  Lexia disputes
  any liability  with respect to ICL in light of its own  offsetting  claims and
  defenses. There is no assurance that Lexia will be successful in prevailing in
  its position with regard to outstanding claims previously made by ICL.

  The Company's sources of future  short-term  liquidity are its cash balance of
  $251,000 as of September  30, 1998 and the $784,000  unused  amount of its new
  $2.1 million  credit  facility with its bank.  Availability  under the line of
  credit can be further  limited  based upon the  balance of  eligible  accounts
  receivable as described  above. As of September 30, 1998, the  availability of
  the line of credit was limited to  $1,135,000,  based upon  eligible  accounts
  receivable as of that date.

  The  Company  is  currently  obligated  as a  guarantor  under  an  assignment
  agreement of a lease in the amount of approximately  $20,000 per month through
  September, 2002. The Company is also obligated to pay approximately $8,000 per
  month on various other leases.  Aside from these commitments,  the Company has
  not made any material commitments.

  The Company is  concentrating  on increasing its sales and improving its gross
  margins.  Management  believes  that,  as a result of its recent  mergers with
  I-PAC  and  MGM,  combined  with  its  relocation  and  consolidation  of  its
  operations into the I-PAC facility, the Company will have sufficient cash from
  operations and other resources (including the availability under the Company's
  line of credit) to fund operations of the combined company for the next twelve
  months.

                                    Year 2000

  The  Company  recognizes  the need to ensure that its  operations  will not be
  adversely impacted by Year 2000 software and hardware failures. The Company is
  in process of reviewing its information technology systems and non-information
  technology systems with embedded technology applications, addressing Year 2000
  risks,  and  believes it will  resolve any such risks in a timely  manner.  In
  addition,  during the quarter  ended  December 31, 1998,  the Company plans to
  begin a process of  contacting  its critical  business  partners to reasonably
  assure that they are adequately prepared.  The Company has determined that its
  products are fully Year 2000 compliant.

  Although the Company has not yet completed its  assessment of the scope of the
  Year 2000 issues  facing its  systems and  programs,  in  connection  with the
  recent merger it is currently developing plans to convert much of its in-house
  software. Year 2000 issues will be considered in connection with this software
  conversion project. In addition, the

                                       12

<PAGE>



  Company  plans  to  evaluate  every  piece  of  equipment  in its  facilities.
  Equipment that is non-compliant  will be brought into compliance,  replaced or
  taken out of service.

  The Company plans on developing  contingency plans to address Year 2000 issues
  that do arise. As part of its Year 2000 compliance program,  the Company plans
  to  identify  alternate  vendor  sources for vendors who do not respond to our
  questionnaires  or who appear to not be in  compliance.  Although no assurance
  can be made,  given the nature of its major  customers,  the Company  does not
  expect that it will  encounter  significant  problems with respect to customer
  compliance with Year 2000 issues.

  The currently the Company does not have an estimate of costs  associated  with
  these  efforts,  but does not believe  them to be  significant.  However,  the
  Company could be adversely  impacted if its suppliers or customers do not make
  the necessary changes to their own systems and products  successfully and in a
  timely manner, or if regional  infrastructure  failures occur as a consequence
  of Year 2000 problems.

  The SEC's recent  guidance for Year 2000 disclosure also calls on companies to
  describe their most likely worst case Year 2000 scenario. The Company believes
  that the most likely worst case  scenario is that the Company will have to add
  additional  staff and/or  reassign  existing staff and/or  acquire  additional
  equipment  or software  during the time period  leading up to and  immediately
  following  December  31,  1999,  in order to  address  Year 2000  issues  that
  unexpectedly arise.

                          New Accounting Pronouncements

  In September 1997, the Financial  Accounting  Standards Board issued SFAS 131,
  DISCLOSURE  ABOUT  SEGMENTS OF AN  ENTERPRISE  AND RELATED  INFORMATION.  This
  accounting  statement  established  standards for the way that public business
  enterprises  report  information about operating  segments in annual financial
  statements and requires that  enterprises  report selected  information  about
  operating  segments in interim financial reports issued to shareholders.  This
  accounting  statement  shall be  effective  for fiscal years  beginning  after
  December 15, 1997. In the initial year of application, comparative information
  for  earlier  years is to be  restated.  At this time,  the  Company  does not
  believe that this accounting  statement will have a significant  impact on its
  financial  position or results of  operations  for the year  ending  March 31,
  1999.


  THIS  10-QSB  CONTAINS  FORWARD-LOOKING  STATEMENTS  THAT  INVOLVE  RISKS  AND
  UNCERTAINTIES.   THESE  STATEMENTS  INCLUDE,  WITHOUT  LIMITATION,  STATEMENTS
  RELATING TO THE COMPANY'S PLANS AND OBJECTIVES FOR FUTURE OPERATIONS INCLUDING
  ACQUIRING  OTHER   BUSINESSES,   INCREASING   SALES  AND  IMPROVING   MARGINS,
  ASSUMPTIONS  AND  STATEMENTS   RELATING  TO  THE  COMPANY'S   FUTURE  ECONOMIC
  PERFORMANCE AND OTHER NON-HISTORICAL INFORMATION. THE COMPANY'S ACTUAL RESULTS
  COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HEREIN.  FACTORS THAT COULD CAUSE
  OR CONTRIBUTE TO SUCH DIFFERENCES  INCLUDE,  WITHOUT  LIMITATION,  THOSE RISKS
  DISCUSSED UNDER THE HEADING "ADDITIONAL RISK FACTORS" AS WELL AS OTHER FACTORS
  AS DISCUSSED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB FOR THE FISCAL YEAR
  ENDED MARCH 31, 1998.







                                       13

<PAGE>



  PART II: OTHER INFORMATION

  Item 4.

      Submission of Matters to a Vote of Security Holders

         None

  Item 5.

      Other Information

        None



   Item 6.   Exhibits and Reports on Form 8-K

   a.   Reports on Form 8-K

        There  were no  reports  on Form 8-K  filed  during  the  quarter  ended
September 30, 1998.

   b.   Exhibits


   10.44                   Stock Option Agreement-Patrick W. Moore
   10.45                   Stock Option Agreement-William L. Grivas
   10.46                   Employee Stock Purchase Plan
   10.47                   MGM TechRep Asset Transfer Agreement
   27                      Financial Data Schedule






















                                       14

<PAGE>


                                   SIGNATURES


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




                                            PHOTOMATRIX  INC.



   Date: November 3, 1998                   by  /s/ William L. Grivas
                                               -------------------------------
                                               William L. Grivas
                                               Chairman of the Board

   Date: November 3, 1998                   by  /s/ Patrick W. Moore
                                               -------------------------------
                                               Patrick W. Moore
                                               Chief Executive Officer

   Date: November 3, 1998                   by  /s/ Roy L. Gayhart
                                               -------------------------------
                                               Roy L. Gayhart
                                               Chief Financial Officer

   Date: November 3, 1998                   by  /s/ Charles H. Frady
                                               -------------------------------
                                               Charles H. Frady
                                               Controller










                                       15