<PAGE>
 
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549
                      __________________________________

                                  FORM 10-KSB
(Mark One) 
[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
        EXCHANGE ACT OF 1934 [FEE REQUIRED]
             For the fiscal year ended July 31, 1998

                                       OR

[_]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
             For the transition period from __________ to __________

                        Commission file number 0-27286
                      __________________________________

                                 HELISYS, INC.
                (Name of Small Business Issuer in its charter)

                Delaware                                 95-4552813
     (State or other jurisdiction of        (I.R.S. Employer Identification No.)
      incorporation or organization)        

24015 Garnier Street, Torrance, California                  90505
 (Address of principal executive offices)                 (Zip Code)

                                 (310) 891-0600
                (Issuer's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:     None
Securities registered pursuant to Section 12(g) of the Act:  Common Stock
                                                           (Title of class)

     Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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 [_] 

     Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not 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 its most recent fiscal year were $8,450,066

     As of November 13, 1998, the aggregate market value of the voting stock
held by non-affiliates, computed by reference to the price at which the stock
was sold on such date, was approximately $323,000.

     4,042,760 shares of Common Stock were outstanding at November 13, 1998.

                      Documents Incorporated by Reference

                                      None
<PAGE>
 
                               INTRODUCTORY NOTE

     This Annual Report on Form 10-KSB contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 and the Registrant intends
that such forward-looking statements be subject to the safe harbors created
thereby. These forward-looking statements relate to (i) the introduction of the
Registrant's upgraded technology and the achievement of commercial levels of its
production and sales, (ii) the future development of the Registrant's
technology, and (iii) the need for, and availability of, additional financing.

     The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties. These forward-
looking statements are based on assumptions that the Registrant will be able to
generate sufficient funds from operations or to obtain sufficient financing to
continue operations, that the Registrant's technology will continue to be
developed, and will not be replaced by new technology, that Registrant will
retain key technical and management personnel, and that there will be no
material adverse change in the Registrant's operations or business. Assumptions
relating to the foregoing involve judgments with respect to, among other things,
future technology, economic, competitive and market conditions, and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Registrant. Although
the Registrant believes that the assumptions underlying the forward-looking
statements are reasonable, any of the assumptions could prove inaccurate and,
therefore, there can be no assurance that the results contemplated in forward-
looking statements will be realized. In addition, the business and operations
of the Registrant are subject to substantial risks which increase the
uncertainty inherent in such forward-looking statements. See "Business--Certain
Factors That May Affect The Company's Business and Future Results" as well as
the Section entitled "Risk Factors" in the Registrant's Registration Statement
on Form SB-2, as declared effective by the Securities and Exchange Commission on
March 7, 1996 for a more detailed discussion of certain of these risks. In
light of the significant uncertainties inherent in the forward-looking
information included herein, the inclusion of such information should not be
regarded as a representation by the Registrant or any other person that the
objectives or plans of the Registrant will be achieved.

                                       2
<PAGE>
 
                                    PART I

ITEM 1.  BUSINESS

The Company

Overview

     Helisys, Inc., a Delaware corporation (the "Company") designs, develops,
manufactures and markets rapid prototyping systems and the materials and
supplies used with them. The Company's predecessor, Hydronetics, Inc., was
incorporated in Illinois in 1985. The Company was incorporated in California in
1990 and reincorporated as a Delaware corporation in 1995. It is the worldwide
market leader in sales and installations for rapid prototyping systems which use
sheet materials to build physical objects.

     Rapid prototyping systems are used in conjunction with three-dimensional
computer-aided design ("3-D CAD") workstations to let manufacturers, design
engineering firms and others create physical models, industrial patterns, molds
and prototypes directly from CAD designs. They significantly reduce the time and
effort needed to produce complex models, prototypes and molds, and thus
substantially lower the cost of many product design processes. The Company's
rapid prototyping systems, for instance, have been used in the design and
development of products ranging from golf club heads to automobile engine blocks
to shoe soles.

     The time it takes to bring new products to market (i.e., "time-to-market")
is a critical success factor for manufacturers who need to introduce new
products to the marketplace faster than their competitors. Not only competitive
sales advantages but also cost reduction and price leadership can accrue to
these manufacturers. The model building, prototyping and industrial pattern
making that often accompany new product development account for a significant
part of this time-to-market. Models or prototypes that might take weeks or
months to make with traditional machining or carving techniques can be made in
hours or days with rapid prototyping systems, usually at significant cost
savings. The 3-D designer can view the object soon after the design is complete
and therefore spot problems with the design, fix them and make the next
generation model very quickly.

     The Company's rapid prototyping systems utilize the Company's Laminated
Object Manufacturing ("LOM") technology. In the LOM process, a computer image of
the solid object is sliced into scores, hundreds, or thousands of parallel, two-
dimensional cross-sections. The LOM system then uses a laser beam to
sequentially cut these cross-sections out of layers of sheet material, such as
paper or plastic film. Each successive layer of material is bonded to the stack
of previously cut layers. At the end of the LOM process, the excess material is
removed ("decubed") to reveal the physical model of the object. The models
produced are used to test the form, fit or function of a part; or to become
patterns or molds for secondary processes such as sand casting, vacuum forming,
rotational molding and rubber molding; or for industrial pattern making
applications; or for analysis by researchers looking at anything from a virus to
a subsurface coastal topographic map.

     The Company believes that its LOM technology is the only commercial rapid
prototyping technology currently marketed in the United States, and one of the
very few anywhere, that can produce three-dimensional objects through the use of
readily available sheet materials. The Company believes that it has sold over
80% of the installed base of such systems in the world. The Company believes
that 

                                       3
<PAGE>
 
the use of these materials offers certain advantages over the other rapid
prototyping technologies, particularly in the production of large objects.

Market Opportunity

Industry Background

     As a new product progresses from concept to mass production, it typically
moves through four major stages of the product development process: (i) initial
product design (often using computer-aided design); (ii) functional performance
testing; (iii) low-volume production; and (iv) high-volume production. By
incorporating rapid prototyping at various stages in the product development
process, manufacturers can significantly reduce the time-to-market of new
products. In addition, rapid prototyping can improve product quality and reduce
overall product development costs. Some models or prototypes that take weeks or
months to create with traditional machining or carving techniques can be
produced in a matter of hours with rapid prototyping systems, often at a
substantially lower cost.

     Because rapid prototyping systems run directly from the computer-generated
output of 3-D CAD workstations and software, a designer may begin creating the
prototype, model or pattern as soon as the design is complete. Since rapid
prototyping often provides greater detail and precision than can be obtained
with traditional methods, rapid prototyping can also be used to generate complex
models, industrial patterns and prototypes which cannot be produced with
traditional methods.

     The Company believes, based on estimates provided by the leading industry
expert (Wohlers Associates, Inc.), that there were over 3,289 rapid prototyping
systems installed worldwide by the end of December 1997.  Approximately 33% of
these were sold by 3D Systems, 22% by Stratasys, 9% by the Company and the
balance by smaller producers. As of July 31, 1998, the Company had shipped over
300 rapid prototyping systems globally into 32 countries. Wohlers estimates that
1997 industry-wide revenue was approximately $453 million, with about $258
million attributable to service and $195 million derived from product sales.
Overall revenue growth was approximately 7.5% for 1997 and Wohlers forecasts
unit sales growth of 23% and 26% for 1998 and 1999 respectively.

     The Company believes that the rapid prototyping industry is dividing into
two distinct segments. One segment consists of rapid prototyping systems which
are compact, inexpensive, and easy to operate, therefore, compatible with the
office ("desk top") environment. The other segment has more expensive and larger
systems which address the need for production manufacturing environments.

Current Applications of Rapid Prototyping

     LOM systems are currently being used in various stages of the product
development process. These include the following:

     First Stage--Initial Product Design: Model Making for Form, Fit and
Function Verification. During the initial stage of the product development
process, rapid prototyping technology offers industrial designers and
manufacturing engineers the ability to produce full-scale physical models at a
lower cost than conventional prototyping methods, such as machining and hand-
carving. Physical models of products such as toys, furniture, shoes and other
consumer products can be produced to allow manufacturers to evaluate the form,
fit and function and other aesthetic properties of a new product.

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     The so-called desktop systems, selling for around $50,000, are currently
dominating this segment of the rapid prototyping market. The primary
requirements in this segment of the industry are user friendliness of the
process, and speed. The Company's product participation in this market
is through the production of large visualization parts which cannot be produced
by the smaller envelope, desk top systems. The primary companies participating
in this segment are 3D Systems, Stratasys, Z Systems and Sanders.

     Second Stage--Functional Performance Testing: Production of Patterns,
Masters and Molds for Prototype Tooling. During the functional performance
testing stage, rapid prototyping technology is used to create three-dimensional
objects, positive versions of which can be used for patterns or masters in a
variety of secondary tooling applications such as sand casting, direct
investment casting, silicone rubber molding, rotational molding, vacuum forming
and plaster casting. Negative versions of such three-dimensional objects can
also be produced for use as molds for the injection of wax in the indirect
investment casting process. Examples of prototypes produced by rapid prototyping
technology include automotive engine components, manufacturing fixtures,
military hardware and medical prosthetics. Examples of the applications of
industrial patterns produced by rapid prototyping systems include motor
housings, exhaust manifolds, pumps and consumer products.

     This stage of the rapid prototyping process focuses on the creation of a
simulated part, preferably out of the material which is used in the eventual
manufacturing of the product. The desired qualities of rapid prototyping systems
serving this market segment are their ability to use industrial plastic or metal
materials, the precision and strength of the manufactured objects and user
friendliness. Stratasys currently dominates this segment of the market but 3D
Systems and DTM also compete effectively. When the Company is able to produce
systems that can produce parts out of industrial plastic or metal materials it
could have a significant impact on this market segment. At the present time, the
Company serves this market primarily through the production of metal casted or
rubber molded patterns.

     Third Stage--Low-Volume Production: Production of Patterns and Masters for
Low-Volume Production Tooling. Before committing a new product to mass
production, many manufacturers plan low-volume production runs which simulate
the production process and help identify potential problems with the part's
design or production process. During this stage, objects produced by means of
rapid prototyping can be used as industrial patterns or masters in secondary
applications such as sand casting, investment casting, spray metal tooling and
EDM (electro discharge machining) abrading to create near production quality
molds. By replacing more time-consuming conventional industrial pattern-making
methods, rapid prototyping technology offers manufacturers the ability to move
more quickly through the low-volume production stage and into high-volume
production. The properties required in this market segment are precision,
surface finish, strength and heat resistance. Metal molds from DTM, Keltool (3D
Systems) and sand casting LOM patterns of the Company are examples of
participation in this market. If and when the Company would introduce additional
advanced composites for tooling applications for mold making and metal forming,
its role in this market could expand significantly.

     Fourth Stage--High-Volume Production: Production of Patterns and Masters
for High-Volume Production Tooling. In certain instances, rapid prototyping
technology currently is used to create patterns or masters in the development of
final high-volume production tooling. Due to the high cost and time required to
generate production tooling using conventional methods, there may be a
substantial future market for rapid prototyping technology if it can be applied
successfully to address more high-volume production tooling requirements. When
and if the Company could develop a metal lamination process, its participation
in this market may become significant.

                                       5
<PAGE>
 
Business Strategy

     The Company's business strategy is to solidify its position as the leading
supplier in the world of sheet material rapid prototyping systems. The Company
is implementing this strategy by: (i) becoming a marketing-focused business with
a disciplined sales approach directed toward niche markets that favor the
strengths of LOM; (ii) concentrating on new LOM materials and software products
to optimize the existing LOM systems performance and developing new systems with
advanced beam positioning and material handling capabilities; (iii) increasing
sales of LOM systems, materials and supplies through its global network of sales
channels; (iv) maintaining the quality of customer service; and (vi) pursuing
strategic alliances with a small number of specific organizations to assist with
all of the above.

     Next Generation of Materials and Systems. The Company's immediate focus is
on optimizing the use of existing LOM systems by developing new materials
tailored for specific applications. The Company believes that new materials
could open a totally new, large segment of the rapid prototyping market for its
systems and help to fully utilize the advantages of it LOM systems.

     However, it is also making significant investments in the design of its
next-generation LOM systems, which the Company expects will exhibit major
improvements and innovations in software, hardware and materials. The Company
believes its next generation LOM systems will deliver significant improvements
in speed, user friendliness, reliability while being able to process most of the
advanced materials currently being developed. The Company intends to continue to
differentiate its systems from competitors which use alternative technologies.
The Company is also dedicating substantial time and effort to improved LOM
system accuracy.

     Increase Selling and Marketing Efforts: The Company believes that its
success depends on sales and marketing. In the short run the Company has
recruited a new senior sales executive to direct its established worldwide
system of direct sales, independent distributors and representatives. The
Company has begun a significant and highly disciplined program to manage the
stream of new sales leads it receives. The Company has also recently signed a
contract with one of the industry's leading rapid prototyping marketing experts
to provide both a long term strategy and short-run tactical focus on marketing
programs to augment the sales process.

     The Company's experience in selling, installing and servicing LOM systems
in dozens of nations around the world has convinced it that it must have an
effective local presence in every major manufacturing market in the world.

     Materials and  Supplies:  The Company's customers continually need rolls of
materials and other consumable supplies to operate their LOM systems. New
plastic and composite materials have joined specially designed papers in the
Company's catalog of available standard sheet materials.  New materials are
under development. Other companies and researchers have used LOM systems to
experiment with metals, ceramics, and unique materials for special applications.

     Quality and Customer Service:  The Company continues to improve the
quality, reliability and performance of its LOM technology. This is required by
marketplace demand; in a few short years users have satisfied themselves that
this is no longer an experimental technology but rather has become robust
additions to on-line manufacturing processes. The effort builds on the major
step in late 1996 and early 1997 when the Company's second generation systems
were introduced. The Company believes that future LOM systems will provide
enhanced accuracy, ease of use, speed and reliability.

                                       6
<PAGE>
 
     The Company will continue to offer service programs under which customers
can buy upgrade kits for earlier systems, to protect investments already made.
The Company offers service contracts through its network of Company-trained
distributors, augmented by a direct customer service workforce positioned around
the world.

     Strategic Alliances:  The Company continues to pursue strategic alliances
that, through the addition of development, manufacturing, marketing and
financial resources, allow the Company to develop new materials for use in the
LOM process. The Company's successful agreement with Toyoda Machine Works, Ltd.
(TMW), under which TMW distributes the Company's products in Japan, is a model
for forming other arrangements in both domestic and overseas distribution. 

     The Company continues to review new developments in the industry and the
expressed needs of its customers to guide future marketing developments. The
recent investment in a disciplined approach to managing new sales leads, when
combined with the resources of it new marketing directions, is also expected to
feed back to the development of new strategic alliances.

LOM Technology

     LOM systems have proprietary software that takes the users 3-CAD design of
a desired object and performs analysis and automatic conversion of the design.
The result is a program that drives the LOM systems. The CAD replication of the
object is divided into fine, horizontal "slices" where each layer equals the
thickness of the sheet material to be used.

     The LOM system then builds the object by cutting each of these layer-thin
cross sections on the top of a gradually growing stack of sheet material
supported by an elevator platform in the working chamber of the LOM system.
Each layer is bonded to the stack with heat and pressure before it is cut.

     Sheet material (in the form of large rolls in the standard format) is fed
into the working chamber to the cutting station. There, a low-power laser beam
cuts the exact cross-section of the object for that layer, as well as parting
lines to allow for separation of the excess material.  When the entire stack
containing the object has been built, the excess material is removed from the
object at the parting lines to reveal the desired object.

     While the Company is far and away the market leader for the type of
technology that laminates sheet-form materials such as paper, plastic and
composites, there are some smaller firms in other countries such as Singapore
and China, that have similar technologies. Japan's Kira Corporation sells
systems which use a knife instead of a laser beam to cut sheets of material.

     3D Systems, Inc., Aaroflex, Inc., Cubital, Ltd., CMET, D-MEC, Mitsui and
Teijin Seiki Company, use a technology based on the solidification of the top of
a pool or vat of liquid polymers. DTM Corporation uses lasers to harden powders
to form models. Stratasys, Inc. uses nozzle extrusion technology to build
objects by melting and resolidifying filaments fed from a coil into the working
area. Sanders Prototype, Inc., 3D Systems, BPM, Z-Systems and other
manufacturers use a modification of ink-jet technology to deposit droplets of
material to form objects.

     These competing technologies have certain advantages over the Company's LOM
technology (as currently embodied) for some applications, such as the ability to
operate in an office environment or 

                                       7
<PAGE>
 
the ability to produce smaller objects with less effort in removing excess
material at the end of the build process. The Company, however, believes that
its LOM technology provides clear competitive advantages over the long run:

     Material Variety:  In theory, any sheet-formed material that can be cut and
  bonded to itself can be used in the LOM process. These materials currently
  include paper, plastic film and composite laminates. Ceramic tapes and metal
  foils have been and continue to be tested for use with the Company's rapid
  prototyping systems. The Company believes that no other rapid prototyping
  technology currently on the market allows for the potential use of such a
  variety of raw materials. Most sheet materials now used with the Company's
  systems are less expensive than the liquids or powders used by certain of the
  Company's competitors. The majority of objects currently being produced by
  the Company's LOM systems have the look and feel of lightweight wood; they can
  be finished and painted to give customers the ability to evaluate the proposed
  product's aesthetic properties and can be easily machined or modified to
  obtain the exact fit and form desired.

     Precision:  In the competing rapid prototyping technologies, raw materials
  undergo a phase-change step (e.g., liquid-to-solid or powder-to-liquid-to-
  solid or solid-to-liquid-to-solid) that imposes a distorting change in volume
  as the raw material solidifies. This makes it hard to maintain precision.
  Management believes that the LOM process is inherently least affected by this
  problem. Since the raw materials used in the LOM process are solid sheets,
  practically no phase change occurs during object formation, except for the
  reaction of the adhesive. To take full advantage of this feature, the Company
  is presently developing post-processing processes and sealants to prevent the
  produced objects from absorbing atmospheric moisture which can cause object
  growth after production.

     Speed:  Most other rapid prototyping processes require time-consuming
  point-by-point material solidification over an entire area, either by means of
  laser scanning or droplet deposition. The Company's LOM systems, on the other
  hand, trace or cut the periphery of the object's cross section out of raw
  sheet material. As a result, the Company's LOM technology is faster than that
  of most competing rapid prototyping technologies.

     Environmental Safety:  The Company's consumable sheet materials are
  generally inert and non-toxic. Therefore, the LOM process does not raise the
  same concerns of possible exposure to toxic chemicals that arise with some
  competitive technologies.

     The Company believes that the foregoing characteristics make the Company's
LOM systems particularly well suited to the production of large, bulky patterns
in the prototype tooling process. The Company also believes that its current
systems are capable of producing larger objects than any other commercial rapid
prototyping system currently on the market. On the other hand, at the present
time the Company has utilized very few of the available materials for their
products, with paper being the main production material. The Company's goal is
to introduce new materials for the process to fully realize its potential.

     Several of the Company's most demanding customers experienced performance
problems with the Company's first-generation LOM systems. While many of these
systems continue to be productive for their owners, a significant portion of
this early population has gradually been upgraded or replaced by current
products. Current generation LOM systems, sold in the last few years, continue
to perform with high levels of reliability.

                                       8
<PAGE>
 
     In the past, the Company is aware of instances of fires occurring within
the cabinets of its LOM systems, which the Company believes resulted from the
cutting laser beam accidentally coming in contact with a loose, unbonded piece
of paper which should not have been where it was; the Company offers fire
suppression systems as well as flame-retardant or flame-resistant materials. The
design of the Company's current products reduces the risk of damages from this
cause.


Products and Related Services

     The Company's LOM systems are designed by the Company and incorporate
numerous hardware and software components. The Company's LOM systems, together
with a variety of sheet materials, can be used in all stages of the product
development process. The Company believes that the applications of its LOM
technology will increase as additional materials are developed for use in the
LOM process.

     The current systems sold by the Company are the LOM-1015Plus and the LOM-
2030H. The LOM-1015 series was developed for the production of medium-size
objects, such as are often found in appliance components, shoes or spring
models; the Company's LOM-2030 series was developed for the production of large-
size objects, such as automobile parts or heavy machinery components. Each LOM
series first shipped in 1992. The second generation of each LOM series was
introduced in FY 1997; the Company believes that the second generation equipment
(the 1015Plus and the 2030H) represent significant improvements in reliability
and ease of use as compared with the first generation models. Through July 31,
1998, the Company had shipped over 300 LOM systems.

     The following table sets forth certain information with respect to the
components and characteristics of the Company's current LOM systems:

<TABLE>
<CAPTION>
                                       LOM-2030H                               LOM-1015Plus
<S>                                <C>                                      <C>
LASER:                             50 Watt CO                               25 Watt CO
LASER BEAM DIAMETER:               0.203mm-0.254mm                          0.203mm-0.254mm
POSITIONING SYSTEM:                X-Y Positioning Table moves the          X-Y Positioning Table moves the
                                   laser beam                               laser beam
CUTTING SPEED:                     Up to 457mm/second                       Up to 508mm/second
SHEET MATERIAL TYPES:              Paper, plastic and other                 Paper, plastic and other
                                   materials coated with heat seal          materials coated with heat seal
                                   adhesives in roll form                   adhesives in roll form
COMPUTER:                          Pentium-based PC                         Pentium-based PC
OPERATING SYSTEM:                  MS-Windows NT, MS-DOS                    MS-Windows NT, MS-DOS
SOFTWARE:                          LOMSlice(TM) software                    LOMSlice(TM) software
NETWORK:                           Ethernet compatible                      Ethernet compatible
</TABLE> 

                                       9
<PAGE>
 
<TABLE> 
<S>                                <C>                                      <C> 
SYSTEM DIMENSIONS:                 4.88m L x 3.66m W x 140cm H;             1.226m W x 0.743m D x 1.308m H;
                                   1404kg                                   454kg
CURRENT DOMESTIC LIST PRICE:       $275,000                                 $99,500
MAXIMUM PART SIZE:                 813mm L x 559mm W x 508mm H;             381mm L x 254mm W x 356mm H;
                                   204kg                                    32kg
</TABLE>                                                                  
                                                                          
     The Company also sells rolls of sheet-form materials used with its LOM
systems, including standard performance LOM paper ("LPS"), high performance LOM
paper ("LPH"), LOM composite ("LGF"), flame-retardant paper ("LPF"), and
polyester plastic ("LXP"), each in various widths and lengths.

    The Company offers its customers service contracts directly or though its
distributors for the periods following the expiration of the one-year warranty.
A typical service contract includes labor and parts for preventative
maintenance, technical support and repairs. The Company offers programs under
which customers may elect to obtain upgrade kits as part of regular service
contracts, as well as outright sale of upgrade kits for older system systems.
                                                                          
     The Company also occasionally produces prototypes and models for industrial
designers and engineers on a per-order basis. The prototypes and models are
produced at the Company's Technical Resource Center ("TRC") located at the
Company's headquarters, which is equipped with several of the Company's LOM
systems. The TRC is mainly used to provide internal technical training and
testing support to other departments within the Company. The TRC also
manufacturers sample parts to potential customers in the pre-sales phase of the
selling process.


Research and Development

     The Company's research and development department was formally established
in January 1994. Since then much of its activity has been (i) to develop new
materials for the LOM process and (ii) to improve the LOM system processing
speeds and user friendliness.

     The Company's sustaining engineering efforts continually improve the LOM-
1015 and LOM-2030 systems, based on customer feedback as well as internal
analyses. Developmental engineering's objective is next generation technology
(hardware, software, and materials) for not only major changes to the 1015 and
2030 platforms, but also for introduction of a new LOM system series. In both
sustaining and developmental engineering, the Company seeks improved system
precision and reliability, greater accuracy in the produced objects, faster
object production speeds and easier operation of the systems.

     The Company continues to pursue government and industry sponsored research
grants to provide funds for continued research and development only in areas
that are commercially useful to the Company. The Company has performed research
under government research contracts to examine ceramics and ceramic matrix
composites, polymer composites and metals with its LOM systems. It has entered
into research alliances with certain corporations as well, both domestically and
overseas.

     The Company's expenditures for research and development for the fiscal
years ended July 31, 1997 and July 31, 1998 were, respectively, $2,609,000 and
$1,381,000.

                                       10
<PAGE>
 
New Products

     In 1998 and 1999 the Company expects to develop several new product
enhancements and LOM subsystems, including new software, materials, subsystems
and mechanical subassemblies. Based on the Company's prior performance, it is
possible that new generations of LOM systems could be introduced in the next few
years. Developmental work is directed at producing LOM systems which are
substantially faster, easier to use and more reliable than previous systems.
Another aspect of development is to simplify decubing or the removal of the
support material surrounding the manufactured LOM object.

New Materials

     The Company is dedicating much of its research and development efforts to
the testing and development of new materials to be used with its LOM systems.
These will include nearly homogeneous plastics, ceramics and ceramic composites,
high performance polymer composites and metals. The Company expects to be able
to introduce the best of these into the marketplace, where they will command a
premium price.

     The Company has been and expects to continue to improve its process
feedback systems and software in order to improve heat and pressure consistency
during object construction for each type of material. The Company is also
testing various improved sealants to minimize swelling and edge delamination of
newly produced paper objects.

Manufacturing

     The Company's in-house manufacturing consists of manually assembling LOM
system components on a build-to-forecast basis to minimize both inventory costs
and delivery lead times. Sales and shipment forecasts are determined by a
committee comprised of sales, finance, manufacturing and engineering personnel,
which meets weekly.

     The Company buys major component parts from outside vendors, subcontractors
and other sources, and assembles them at the Company's operating facility.  The
Company's major suppliers are Premier Metal, Inc. (metal cabinets), N.A. Darcy,
Inc. (step-motors, amplifiers and clutches), Galil, Inc. (circuit boards), and
Seiberco, Inc. (motors). The Company considers its relationships with its
suppliers to be good. Procurement lead times for the components range from four
to twelve weeks. The Company performs numerous diagnostic tests and quality
control procedures throughout the assembly process, which takes approximately
six weeks.

     With the exception of the LOM paper supplier, the Company does not believe
it is dependent on any single source for any of its purchases, but it could take
six to 12 weeks for the Company to locate other suppliers of the lasers, machine
enclosures and motion-control components (including the time it would take to
test and change the design). The Company currently maintains an inventory of
most of its necessary supplies, which facilitates the assembly of products
required for near-term production.

     It is possible that the Company could outsource more of its assembly
operations and it is actively reviewing its options in this area.

                                       11
<PAGE>
 
Sales and Marketing

     The Company's sales and marketing efforts include press releases, trade
magazine articles, customer studies, brochures, direct mailings, trade show
demonstrations and videos. The Company has recruited a new senior executive for
sales and has contracted with a well known industry expert to assist the Company
with its marketing plans. It has also begun a new system for receiving and
organizing sales leads obtained from various sources.

     The market for the Company's LOM systems and related materials and supplies
is concentrated in entities that design and make mechanical products, including
service bureaus that produce models and prototypes on a per-order basis.
Potential customers typically have 3-D CAD capability and need to produce at
least one object per week to justify the cost of purchasing a LOM system. The
Company's rapid prototyping systems and related materials are substantially less
expensive than rapid prototyping products and materials sold by certain of the
Company's competitors. The Company believes that this allows its customers to
recapture their investment in the Company's rapid prototyping systems more
quickly than for such competitive systems, which is attractive to entities with
comparatively low production needs.

     The Company's sales efforts are conducted by a staff of regionally based
sales personnel who manage a developing global network of independent
distributors, representatives and agents. Some of these organizations are
developing into strategic partners of the Company. Distributors obtain customer
leads from the Company and from trade shows, referral agents and direct
inquiries; the Company has recently introduced a disciplined new approach for
such lead management. Support of the distribution channel is a major focus of
the Company.

     The Company's products are distributed from its Torrance, California
facility to customers throughout North America, as well as Japan, Korea, China,
Australia, Russia, South America, Germany, the United Kingdom, France, Italy and
Sweden and elsewhere.

Competition

     Most models and prototypes are made by machinists and engineers working
from blueprints or CAD designs using traditional machining methods. To compete
with these methods, the Company must effectively educate the consumer on the
advantages of rapid prototyping in general and the Company's LOM system
technology in particular.

     A number of different technologies are employed in commercial rapid
prototyping devices marketed by the Company's competitors. Stereolithography is
used in the products of 3D Systems, Inc., Aaroflex, Inc., Cubital, Ltd., CMET,
D-MEC, Mitsui and Teijin Seiki Company.  3D Systems, Inc. sold the first
commercial rapid prototyping product, and the Company believes that it may have
accounted for over a third of the total worldwide rapid prototyping sales to
date. In addition, DTM Corporation and EOS GmbH produce rapid prototyping
systems that use lasers to sinter or harden powdered material. Wax, plastic and
other polymer filament nozzle extrusion technology is used by Stratasys, Inc.,
which the Company believes may have now sold more than a fifth of all installed
rapid prototyping systems. Sanders Prototype, Inc., 3D Systems, Inc., and Z
Systems use ink-jet technology to deposit material layer by layer.

     The Company believes that it has sold and installed more systems than any
competitor except for 3D Systems and Stratasys, which use different
technologies. No competitive systems similar to its LOM

                                       12
<PAGE>
 
systems have been sold in the United States. The Japanese company Kira
Corporation has sold a limited number of sheet-material systems in Asia, mostly
in Japan, which use a knife to cut the sheet material and a xerographic
technique to apply adhesive. The Company believes that the necessity to deposit
glue xerographically limits the number of adhesives and core materials
applicable for use with Kira's machines. In addition, the Singapore company
Kinergy Pte. Ltd. has introduced rapid prototyping machines that are
technologically similar to the Company's LOM systems, and a university-based
Chinese joint venture has developed a similar system.

Customers

     The Company's rapid prototyping systems are used by corporations,
universities, government laboratories and service bureaus that regularly employ
3-D CAD systems in their internal product design and development activities. The
Company's list of major corporation customers includes Boeing Aircraft Company,
Cobra Golf Incorporated, Chrysler Corporation, Daimler-Benz, BMW, Ford Motor
Company, General Motors Corporation, Hughes Electro-Optical Systems, Raytheon,
Bombardier, Rubbermaid and Toyota Motor Corporation. The Company has
substantial sales to universities and governmental and private research
laboratories as well as to universities for research, student training and
educational applications.

     The Company also sells its LOM systems to independent service bureaus that
produce prototypes and models for manufacturers and others on a per-order basis,
and to independent design and engineering firms that produce models and
prototypes. For these customers, the decision to convert to rapid prototyping
systems is based primarily upon cost considerations and the time required to
recoup their investment in rapid prototyping equipment.

Patents and Proprietary Rights

     The Company considers the protection of its technology to be material to
its business. In June 1988, Michael Feygin, the Company's co-founder, Chairman
and Chief Technical Officer, was issued a United States patent with 80 claims
covering the Company's LOM systems, various aspects of the Company's LOM
technology and the associated modeling process. These original claims describe
the basic LOM apparatus and the LOM methodology. This patent was one of the
early United States patents in the field. In October 1994, a second United
States patent with 24 claims was issued to Mr. Feygin covering additional
aspects of the LOM technology, including several selective bonding techniques
and the method by which the Company's LOM systems leave the support material
around the three-dimensional object while cross-hatching it for the removal of
the material at the end of the LOM process. In June 1997, Mr. Feygin was granted
a third patent which extended the teachings of the first two patents and created
more concepts for the machine design. In March 1998, still another LOM
improvement patent was issued. European, Canadian and Japanese patents covering
various aspects of the LOM technology also have been issued.

     There can be no assurance that any patents or claims which are included in
future patent applications will be issued, that any issued patents will provide
the Company with competitive advantages or will not be challenged by third
parties, or that the existing or future patents of third parties will not have
an adverse effect on the ability of the Company to continue to commercialize its
products. Kira Corporation has filed an opposition to the European and Japanese
patents and, at the present time, the companies are exchanging patent court
motions in Europe to reach a conclusion in this matter. Kira's opposition to the
Company's Japanese patent was recently defeated. The Company has also been
advised that there is significant "prior art" in the United States with respect
to the LOM process utilized in the Company's

                                       13
<PAGE>
 
LOM systems, and it is possible that claims in the United States patents
relating to the LOM process could be invalidated or restricted if challenged.

     Any finding that the patent claims with respect to the Company's LOM
process are invalid could have a material adverse effect on the business and
prospects of the Company. Furthermore, there can be no assurance that other
companies will not independently develop similar products, duplicate any of the
Company's products or design around patents that may be issued to the Company.
Litigation may be necessary to enforce any patents issued to the Company or to
determine the scope and validity of others' proprietary rights in court or
administrative proceedings. Any litigation could result in substantial costs to
the Company and distraction of the Company's management.  An adverse ruling in
any litigation could have a material adverse effect on the Company's business,
financial condition and results of operations. An invalidation of the patent
claims relating to the Company's LOM process would, however, affect the other
claims in the United States patents relating to the Company's LOM systems.

     The future success of the Company may also depend in part on the Company
not infringing upon patents it does not own. Accordingly, it has engaged in
negotiations concerning patents it considers of the greatest potential
importance. There can be no assurance that patents belonging to competitors
will not require the Company to alter its products or processes, pay licensing
fees or cease development of its current or future products. Any litigation
regarding infringement could result in substantial costs to the Company and
distraction of the Company's management, and any adverse ruling in any
litigation could have a material adverse effect on the Company's business,
financial condition and results of operations. Further, there can be no
assurance that the Company will be able to license other technology that it may
require at a reasonable cost or at all. Failure by the Company to obtain a
license to any technology that it may require to commercialize its products
would have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, to determine the priority of
inventions, the Company may have to participate in interference proceedings
declared by the United States Patent and Trademark Office or in proceedings
before foreign agencies with respect to any of its existing patents or patent
applications or any future patents or applications, any of which could result in
substantial costs to the Company and distraction of the Company's management.

     The Company also relies upon trade secrets, know-how and continuing
technological innovations to develop and maintain its competitive position.  The
Company has not obtained registered trademarks for its corporate name, nor any
other trademark other than Laminated Object Manufacturing and LOM and Design.
There can be no assurance that the registered or unregistered trademarks or
trade names of the Company may not infringe upon third party rights; if so, the
Company believes that while required changes could entail significant expenses,
they would not have a material adverse effect on the Company's business,
financial condition and operations.

     The Company also seeks to protect its unpatented trade secrets, know-how
and continuing technological innovation, in part, by confidentiality agreements
with its corporate partners, collaborators, employees and consultants.  These
agreements typically provide that all confidential information developed or made
known to the individual or entity during the course of the individual's or
entity's relationship with the Company is to be kept confidential and not
disclosed to third parties except in specific circumstances. In the case of
employees, the agreements provide that, to the extent permitted by applicable
law, all inventions conceived by the individual are the exclusive property of
the Company. There can be no assurance that these agreements will not be
breached, that the Company would have adequate remedies for any breach, or that
the Company's trade secrets will not otherwise become known or be independently
discovered by competitors. Further, there can be no assurance that the Company

                                       14
<PAGE>
 
will be able to protect its trade secrets or that others will not independently
develop substantially equivalent proprietary information and techniques.

Employees

     As of September 30, 1998, the Company had a total of 44 employees, of which
11 were involved in production, shipping, receiving, purchasing, quality and
manufacturing administration, 6 in engineering and research and development, 9
in sales and marketing, 9 in customer support and 9 in general administration.
None of the Company's employees is covered by a collective bargaining agreement.
The Company considers its relationship with its employees to be good.

Government Regulation

     The Company is subject to various local, state and federal laws and
regulations that affect businesses generally in the countries in which it does
business and sells its products, including regulations promulgated by federal
and state environmental, health and safety agencies, as well as to various laws
pertaining to the hiring, treatment, safety and discharge of employees.
Historically, regulatory compliance has not had a material adverse effect on the
Company's sales or operations. The Company believes it is in compliance with
material applicable laws.

ITEM 2.      PROPERTIES

     The Company's original headquarters and operating facilities are located in
a 43,600 square foot facility in Torrance, California. The Company moved into
the facility in August 1994 and purchased the facility in November 1994. The
facility has been sold with escrow closing during July 1998. The Company
entered into a three year leaseback of approximately one-half of the building
that expires in July 2001 which it believes is adequate for the Company's needs
in the foreseeable future. The Company may need to store its inventory of
materials and supplies at another location. The Company believes that it will
be able to secure adequate space for this purpose, if necessary.

     The Company terminated its lease in March 1998 on 4,800 square feet of
office space in Auburn Hills, Michigan which served as a sales office and
warehouse.

ITEM 3.      LEGAL PROCEEDINGS

     The Company is not a party to any legal proceedings and does not know of
any pending litigation affecting it or its property, other than the
aforementioned opposition proceeding in the European Patent Office and routine
litigation which is incidental to the Company and its business.

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

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended July 31, 1998.

                                       15
<PAGE>
 
                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Since March 8, 1996, the Company's Common Stock had been traded on the
Nasdaq National Market. In February 1998 the Company's shares were delisted
from Nasdaq due to the failure to meet the continuing listing requirements.
Subsequently the Company stock began trading on the Over The Counter Bulletin
Board (OTC-BB). The following table presents quarterly information on the high
and low closing sales prices of the Company's Common Stock, as reported on the
Nasdaq National Market and OTC-BB.

<TABLE>
<CAPTION>
                                               High         Low
                                               ----         ---
    <S>                                       <C>         <C>
     Fiscal Year ended July 31, 1998                    
     First Quarter                            $3.00       $1.125
     Second Quarter                           $2.125      $ .375
     Third Quarter                            $1.00       $ .375
     Fourth Quarter                           $ .5937     $ .3437
                                                        
     Fiscal Year ended July 31, 1997                    
     First Quarter                            $4.25       $2.00
     Second Quarter                           $3.375      $1.625
     Third Quarter                            $2.75       $1.375
     Fourth Quarter                           $2.25       $1.25
                                                        
     Fiscal Year ended July 31, 1996                    
     First Quarter                               N/A         N/A
     Second Quarter                              N/A         N/A
     Third Quarter                            $7.75       $4.50
     Fourth Quarter                           $5.25       $1.75
</TABLE>                                                                   
                                                                           
     As of November 13, 1998, there were approximately 900 stockholders of
record of the Company's Common Stock.  The Company has not paid any dividends on
its Common Stock since its inception and does not contemplate or anticipate
paying any dividends upon its Common Stock in the foreseeable future.  It is
currently anticipated that earnings, if any, will be used to finance the
development and expansion of the Company's business.   
                                                       
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
         OPERATION               
                                                       
General                                                
                                                       
     The Company designs, develops, manufactures and m markets rapid prototyping
systems used by manufacturers, design engineering firms, universities and others
to make physical models, industrial patterns and prototypes directly from 3-D
CAD files. The Company's systems use the Company's LOM technology to produce
physical models and other three-dimensional objects used as models, or in the
preliminary testing of the form, fit or function of a part, or the conversion of
patterns into usable parts through secondary processes, such as sand casting and
rubber molding, or in industrial pattern making

                                       16
<PAGE>
 
and similar applications. The Company also sells sheet-form materials and other
supplies used with its LOM systems.

     From inception until 1992, the Company was engaged primarily in the
research and development of its LOM systems and related materials. The Company
commenced shipping its LOM systems in early 1992 and as product
commercialization and acceptance of the Company's products developed, the need
arose to establish a supporting infrastructure. This process began in the
fiscal year ended July 31, 1994, as the number of employees increased from 25 to
57 by the end of that fiscal year. Growth continued during the following three
fiscal years as the employee base was expanded. The additional staffing and
accompanying overhead costs added significant expenses that impacted gross
profits, operating expenses and earnings. In addition, better financial
reporting methods (standard cost, inventory control, allocation of expenses by
department) were implemented, new benefits programs were added, more
sophisticated information systems were installed and the Company purchased and
expanded its facilities. During the fiscal year ended July 31, 1997 the Company
introduced its second generation LOM systems (2030H and 1015Plus). The
shipments of these products contributed to the growth in revenues from fiscal
1996 to fiscal 1997. The LOM 2030H system is more costly to manufacture and the
reduction of the selling price of the 1015Plus of approximately 22% from its
prior LOM 1015 system reduced overall margins. At the same time the Company
began to implement cost-cutting programs in an effort to return to
profitability. These actions included a staff reduction of approximately 10%
effective January 31, 1997 and concentrated efforts to reduce the manufacturing
costs of the LOM systems. Subsequent to fiscal 1997 year end another staff
reduction of approximately 10% was instituted at the end of August 1997.
Additional staff reductions were instituted in January 1998 and once again in
March 1998. The staff reductions and attrition have resulted in the current
level of 44 employees.

Annual Results of Operations

     The following table sets forth certain statement of income data as a
percentage of net sales for the periods indicated:


<TABLE>
<CAPTION>                                                                Fiscal Year Ended
                                                                             July 31,
                                                                       ---------------------
                                                                         1997           1998
                                                                       ----------   --------
<S>                                                                    <C>            <C>
Net sales.....................................................         100.0%         100.0%
Cost of sales.................................................          59.9           75.1
                                                                      ------         ------
Gross profit..................................................          40.1           24.9
Selling, general and administrative expense...................          41.6           50.2
Research and development expense..............................          18.6           16.4
                                                                      ------         ------
Loss from operations..........................................         (20.1)         (41.7)
Other income (expense)........................................          (1.9)          (1.3)
                                                                      ------         ------
Loss before income tax benefit................................         (22.0)         (43.0)
Income tax benefit............................................           (.4)            (0)
                                                                      ------         ------
Net Loss......................................................         (21.6)%        (43.0)%
                                                                      ======         ======
</TABLE>
                                                                                
Comparison of Fiscal Years Ended July 31, 1998 and July 31, 1997

     Net Sales. The Company's gross sales include sales of LOM systems,
materials used in the LOM process and services which consist primarily of
contracts for repair and maintenance of installed LOM systems. Net sales
consist of gross sales less the amount of discounts, returns and allowances,
plus any income in excess of costs incurred on research and grants. Net sales
for the fiscal year ended

                                       17
<PAGE>
 
July 31, 1998 were approximately $8,450,000, a decrease of approximately
$5,597,000 or 39.8%, compared to net sales of approximately $14,047,000 for the
fiscal year ended July 31, 1997. The Company sold 25 and 24 LOM-1015 systems in
fiscal years 1997 and 1998, respectively while also selling 51 and 26 LOM-2030
systems in fiscal years 1997 and 1998, respectively. The sales decrease was
primarily due to the decrease in revenues generated from the reduced unit sales
of the 2030H-LOM systems. The Asian financial crisis and the strength of the
dollar adversely affected sales and systems pricing which contributed to the
reduction in revenues. Foreign sales continue to dominate sales as system
shipments offshore accounted for approximately 84.0% of units shipped as opposed
to 76.3% for the fiscal year ended July 31, 1997. In addition, 52.0% of the
Company's LOM system sales in fiscal 1998 were sales of LOM-2030 systems, as
compared to 67.1% of sales in fiscal 1997, and the LOM-2030 system sells for a
substantially higher price than the LOM-1015. As of July 31, 1998 and 1997, the
Company had deferred gross profit in the amount of approximately $0 and
$264,000, respectively, relating to shipment of LOM systems subject to
agreements providing the customer the right to exchange such systems for
upgraded versions. This amount was reduced to zero as the Company fulfilled all
provisions of the outstanding agreements as all the remaining upgraded systems
were delivered during the fiscal year ended July 31, 1998.

<TABLE>
<CAPTION>
Product Mix Percentage:                     Fiscal Year Ended
----------------------                      ------------------
                                     July 31, 1998    July 31, 1997
                                     --------------   -------------
<S>                                  <C>              <C>
LOM Systems                               60.4%             79.1%
Materials and Service                     39.6%             20.9%

LOM System Units Sold During
----------------------------
the Periods Indicated:
---------------------

<CAPTION> 
 
                                       LOM-1015s        LOM-2030s
                                     --------------   ------------
Fiscal Year ended July 31, 1997           25                51
Fiscal Year ended July 31, 1998           24                26
</TABLE>

     Gross Profit.  Cost of sales consists primarily of the costs of labor, raw
materials and overhead used in the production of the Company's rapid prototyping
systems. Gross profit for the fiscal year ended July 31, 1998 was approximately
$2,104,000, a decrease of approximately $3,530,000 or 62.7%, compared to gross
profit of approximately $5,634,000 for the fiscal year ended July 31, 1997.
Gross profit as a percentage of sales decreased from 40.1% in the fiscal year
ended July 31, 1997, to 24.9% in the fiscal year ended July 31, 1998.

     The decrease in gross profit as a percentage of sales was attributable
primarily to the product mix of LOM-2030 systems as compared to 1015 systems
which provide lower margins. During the year ending July 31, 1998 twenty-six
(26) LOM-2030 systems were shipped as compared to fifty-one (51) in the fiscal
year ended July 31, 1997, a decrease of 25 units or 49.0%. The decrease was
also due to lower margins normally experienced on sales of materials and
services, which increased to 39.6% of net sales during the fiscal year ended
July 31, 1998, compared to 20.9% of net sales during the fiscal year ended July
31, 1997. To the extent that the Company's sales continue to consist of a
greater percentage of LOM-1015s, including the LOM-1015Plus and as the sales
rate of materials and services continues to grow, the Company's gross profit
margins are unlikely to increase. Further, there can be no assurance the

                                       18
<PAGE>
 
Company will be able to maintain current levels of gross profit on sales of its
LOM-2030H and LOM-1015Plus systems.

     Selling, General and Administrative Expense. Selling, general and
administrative expense consists primarily of commissions, sales and
administrative salaries, office expenses and general overhead. Selling, general
and administrative expenses for the fiscal year ended July 31, 1998 were
approximately $4,249,000, a decrease of approximately $1,599,000 or 27.3%,
compared to approximately $5,848,000 for the fiscal year ended July 31, 1997.

     The decrease is mainly attributable to the cost reduction efforts of the
Company instituted beginning in January 1997. The savings resulted primarily
from reductions in staff and related expenses implemented during the fiscal year
ended July 31, 1998. The most recent reductions between January 1998 and March
1998 resulted in the termination of 5 employees at an estimated annual savings
of approximately $200,000.

     Research and Development Expense. Research and development expense
consists of engineering costs incurred in the development and enhancement of LOM
systems and new materials research. Research and development expense also
includes costs expended to secure government grants which the Company uses to
subsidize certain research activities. Research and development expense for the
fiscal year ended July 31, 1998 was approximately $1,381,000, a decrease of
approximately $1,228,000, or 47.1% compared to approximately $2,609,000 for the
fiscal year ended July 31, 1997. The reduction and elimination of the
development costs of the latest generation 2030H, which began shipment in
October 1996, and the 1015Plus which was introduced in March 1997 were mainly
responsible for the cost savings. The decrease was also impacted by the
reduction in personnel and the focus on sustaining engineering versus
development projects.

     Though these expenditures are unlikely to continue to be incurred since
commercial levels of production of the LOM-2030H  and LOM-1015 are achieved,
there can be no assurance that such expenditures will cease to be necessary or
that additional, similar expenditures will not become necessary for other
reasons or future development projects.

     Other Income (Expense). Net other expense for the fiscal year ended July
31, 1998 was approximately $110,000, compared to other expense of approximately
$265,000 for the fiscal year ended July 31, 1997. The change was primarily due
to the recording of $144,000 of expenses related to the 100,000 warrants issued
to Walter Cruttenden in exchange for their issuance of a bank guarantee. The
expense was determined in accordance with Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" which requires that
these instruments be accounted for based on the fair market value at the date of
grant.

     The expense for warrants was offset by the recording of a gain of
approximately $280,000 on the sale of its corporate headquarters in Torrance,
California.

     Income Tax Benefit.  The income tax benefit for the fiscal year ended July
31, 1998, was approximately $0 as compared to approximately $56,000 for the
fiscal year ended July 31, 1997, resulting in effective tax rates of (0)% and
(1.8)%, respectively.

                                       19
<PAGE>
 
Liquidity and Capital Resources

     During its early years, the Company obtained government funding to conduct
research and development activities relating to the LOM process. Commencing in
1991, commercial operations were funded through the receipt of advance deposits
from customers to cover the costs of manufacturing the LOM systems. More
recently, the Company has funded its cash requirements primarily from cash flow
from operations and from short term borrowings under its revolving credit
facility. In addition, the Company has continued to actively pursue government
funding to subsidize research and development projects.

     The Company used cash of approximately $1,927,000 and $1,827,000 in
operations during the fiscal years ended July 31, 1998 and July 31, 1997
respectively. These operating cash flows are consistent with the decrease in
sales and decrease in inventories during the fiscal years ended July 31, 1997 
and July 31, 1998 respectively.

     Working capital was approximately $82,000 at July 31, 1998, compared to
approximately $2,565,000 at July 31, 1997. The decrease from July 31, 1997 to
July 31, 1998 was due primarily to the increased net loss experienced in 1998.

     Cash (used in) provided by investing activities, which includes purchases
and sales of property, plant and equipment, was approximately $2,249,000 and
($161,000) for the fiscal years ended July 31, 1998 and 1997, respectively. The
decrease during the fiscal year ended July 31, 1998 was attributable to the
limited need to purchase equipment. The Company anticipates that its capital
expenditures for the fiscal year ending July 31, 1999 will be minimal, if
anything at all.

     In November 1997, the Company issued 80,000 shares of the Company's
convertible Series A Preferred Stock, $.001 par value ("Preferred Stock"), to an
investment banker for $500,000. The shares were convertible into common stock
at the rate of 5 shares of common stock per share of preferred stock, and are
now convertible (along with all of the Company's Series A preferred stock) at
the rate of 25 shares of common stock per share of preferred stock.

     Also, in November 1997 the Company amended its existing credit facility
(the "Primary Facility") and obtained an additional credit facility (the
"Secondary Facility") from Comerica Bank (the "Bank"). These facilities provide
for aggregate maximum borrowings of $1,000,000. The Primary Facility was
extended to June 1998, and provided for maximum borrowings of $500,000, subject
to borrowing base limitations for eligible accounts receivable. The Secondary
Facility, which expired in August 1998, provided for maximum borrowings of
$500,000. Both credit facilities are collateralized by substantially all the
company assets except the land and building.

     In January 1998 the Company was notified by the Bank that it was in default
on its obligations with the Bank due to violations of certain financial
covenants. As of July 31, 1998, the Company had aggregate borrowings of $369,552
outstanding under the Secondary Facility (the Primary Facility was repaid in
July 1998 upon the sale of the Company's building). All amounts outstanding
under the credit facilities are classified as current at July 31, 1998. The
Bank has currently entered into a forbearance agreement with the Company that
extends the Secondary Facility through January 15, 1999. There can be no
assurance that the Bank will continue to extend such accommodations. If the
Company is unable to generate sufficient cash flow from operations, the Company
will require additional debt or equity financing to continue operations. There
can be no assurance that the Company will be able to obtain such financing or
obtain such financing on terms acceptable to the Company.

     

                                       20
<PAGE>
 
     In  September 1998, the Company issued 64,000 shares of The Company's
Preferred Stock to investors for $400,000. Purchasers of the Preferred Stock in
this transaction received warrants to purchase 800,000 shares of the Company's
Common Stock at a purchase price of $0.35 per share. Pursuant to this
transaction, each share of the Preferred Stock issued (including the 80,000
shares of Series A Preferred Stock issued to the investment banker in November
1997) is convertible into 25 shares of the Company's Common Stock, as set forth
in the Company's Certificate of Designation of Rights, Preferences & Privileges
of Series A Preferred Stock ("Certificate"). The certificate also sets forth
the voting rights of holders of the company's Preferred Stock, which entitled
them to that number of votes equal to five times the number of shares of Common
Stock into which each share of the Preferred Stock is convertible. The number
of votes that the holders of the Preferred Stock are entitled to decreases as
the share price of the Company's Common Stock increases. The documents
evidencing this transaction, including the Certificate which details the voting
rights of the holders of the Preferred Stock, are attached to the Schedule 13D
filed by Telantis Venture Partners V, Inc. and Robert F. Meyerson on September
24, 1998. This transaction was disclosed on the Company's 8K filed October 9,
1998, which is incorporated by reference herein.

     The Company, as noted above, received $400,000 for the 64,000 shares of
Preferred Stock. In order to obtain bridge financing pending the closing of the
above-referenced transaction, the Company issued two $100,000 notes payable
(each at an interest rate of 10%, both secured by all assets of the Company) to
one investor group purchasing Preferred Stock in the transaction. One of these
notes was issued in July 1998 and one in September 1998. These two notes were
paid off in their entirety in September 1998 out of proceeds from the financing.
As additional consideration for the September 1998 bridge loan of $100,000, the
investor group was issued a warrant to purchase 100,000 shares of the Company's
common stock.

     There can be no assurance that the Company will be successful in returning
to profitability or obtaining additional capital or that capital raised will be
sufficient to fund the Company's operations until such time as the Company is
able to operate profitably. If the Company is unsuccessful in returning to
profitable operations or in raising additional capital it may be unable to
continue as a going concern.

     The Company believes that funds from operations and equity investments will
be sufficient to meet its capital needs for existing operations and future
anticipated growth of the Company for the next 3-6 months. To the extent that
such amounts are insufficient to finance the Company's working capital
requirements, the Company will be required to raise additional funds through
public or private equity or debt financing. There can be no assurance that such
additional financing will be available, if needed, or, if available, will be on
terms satisfactory to the Company. Significant additional dilution may be
incurred by investors in this offering as a result of additional financing.

Impact of Recently Issued Accounting Standards

     In February, 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per
Share". The statement was effective for interim periods and fiscal years ending
after December 15, 1997. The implementation of this statement by the Company
during the year ended July 31, 1998 did not have a material effect on the
Company's financial statements.

     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting for Comprehensive Income" and
No. 131, "Disclosure about Segments of an Enterprise and Related Information."
These statements are effective for financial statements issued for

                                       21
<PAGE>
 
periods beginning after December 15, 1997. The Company has not yet analyzed the
impact of adopting these statements.

Year 2000 Issue

     The Company is currently in the process of addressing a potential problem
that is facing all users of automated information systems. This problem is
commonly known as the "Year 2000" or "Y2K" problem and results from the use of
two digits rather than four digits to identify a year in the date field in many
computer software and hardware systems. As a result, certain date-sensitive
software does not recognize "00" as 2000, and may produce errors in information
or systems failures. The Company relies on its internal computer systems in
operating and monitoring many significant aspects of its business, including
financial systems (such as general ledger, accounts payable, accounts
receivable, inventory and order management), customer services, infrastructure
and network and telecommunications equipment. The Company is currently in the
process of conducting a comprehensive review of its internal systems and, at the
present time does not believe that the Year 2000 problem will pose significant
operational problems for the Company. The Company currently estimates that its
costs associated with Year 2000 compliance, including any costs associated with
the consequences of incomplete or untimely resolution of Year 2000 compliance
issues, are not material to the Company's business, financial condition or
results of operations. However, the Company cannot be sure that it has fully
identified the impact of the Year 2000 problem on the Company's internal systems
and has not concluded that it can resolve all of the issues that may arise in
connection with the Year 2000 problem without disruption of its business or
without incurring significant expense. At a minimum, the Company estimates that
software necessary to resolve certain Year 2000 problems associated with the
Company's internal systems will cost at least $80,000 to $100,000.

     Even if the Company's internal systems are not materially affected by the
Year 2000 problem, the Company could be affected through disruption in the
operation of the enterprises with which the Company interacts. The Company is
therefore in the process of assessing the possible effects on the Company's
operations with respect to the Year 2000 readiness of the customers, suppliers,
creditors, financial organizations and domestic and international governments on
which the Company directly and indirectly relies. The Company's reliance on
these enterprises, and therefore, on the proper functioning of their information
and computer systems, means that failure by these enterprises to address their
potential Year 2000 problems could have a material adverse impact on the
Company's operations. The potential impact and related costs of such failures
are not known at this time.

ITEM 7.  FINANCIAL STATEMENTS

     The financial statements of the Company required by this Item begin on Page
F-1 of this Report.

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

     On September 23, 1998, the Board of Directors of Helisys, Inc. filed a Form
8-K acknowledging its acceptance of the resignation of Deloitte & Touche LLP as
its auditors. On October 16, 1998, Helisys, Inc. engaged Stonefield Josephson,
Inc. as its auditors and filed the respective Form 8-K on October 19, 1998.

     Deloitte & Touche LLP's report on the financial statements for the year
ended July 31, 1997 contained no adverse opinion or disclaimer of opinion, nor
was it qualified or modified as to audit scope or accounting principles.
Deloitte & Touche LLP did add explanatory language to its unqualified report to

                                       22
<PAGE>
 
indicate that the financial statements were affected by uncertainties about the
entity's ability to continue as a going concern.


                                    PART III

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

     Michael Feygin, 44, co-founded the Company's predecessor in 1985 and has
served as Director and Chairman of the Board, and Chief Technical Officer since
the Company's inception. Mr. Feygin invented the Laminated Object Manufacturing
technology ("LOM") and has assigned his patents to the Company. He is considered
one of the pioneers in the rapid prototyping industry. Mr. Feygin completed his
degree in Mechanical Engineering in Moscow at the Technological Institute of
Food Industry and earned a Master of Science degree at the Illinois Institute of
Technology in Chicago. He is a registered Professional Engineer in Illinois.

     Gary Moskovitz, 51, has been President, Chief Executive Officer since July
1998 and Director since March 1998. Mr. Moskovitz served as Executive Vice
President and Chief Operating Officer of Quintar Company in the color hard copy
and desktop publishing industry from 1992 until January 1998. From 1991 until
1992, Mr. Moskovitz served as President, Chief Executive Officer and Director of
Personanfile Incorporated, a document processing company and from 1989 until
1991, Mr. Moskovitz served as President, Chief Executive Officer and Director of
Genesis Electronics Corporation, a voice mail systems company. Mr. Moskovitz
received a Bachelor of Science degree in Electrical Engineering from Carnegie
Mellon University and an MBA in Marketing from the University of Pittsburgh.

     Dave T. Okazaki, 50, has been Chief Financial Officer and Secretary of the
Company since October 1995.  He was a Director of the Company from October 1995
through February 1998 and from March 1994 to October 1995 was Controller of the
Company.  Mr. Okazaki was Vice President of Finance and Administration at
Superior Engineered Products from July 1993 to March 1994.  From May 1992 to
June 1993, Mr. Okazaki concentrated on a private business venture and from
December 1988 to April 1992, he served as Vice President of Finance and
Administration at Cymbolic Sciences International, a manufacturer of automated
inspection equipment, photoplotters and digital film recorders.  Mr. Okazaki
received a Bachelor of Science degree in Accounting from the University of
Denver and is presently enrolled in a Masters in Management program.

     Robert D. Crangle, 55, co-founded the Company's predecessor in 1985 and has
served as Director of the Company since its inception.  Mr. Crangle became a
Certified Management Consultant in 1980.  He has been President of Rose &
Crangle Ltd., a management consulting firm, since 1984.  He is admitted to
practice law in Massachusetts, Illinois, and Kansas, where he has been a
practicing attorney with Metz and Crangle since 1987, and the Lincoln County
(KS) Attorney since 1997.  Mr. Crangle earned a degree in nuclear engineering
from Kansas State University and a law degree from Harvard Law School.  He once
was a faculty member, responsible for entrepreneurial studies, at the business
school of the Illinois Institute of Technology.  He is a fellow of the American
Association for the Advancement of Science.

     Gregory J. Chambers, 53, is President of Telantis Research, Inc., a
Management Consulting Firm specializing in technology research, legal and human
resource strategy research, and development of joint venture opportunities in
the Pacific rim areas, and has served as a Director of the Company since

                                       23
<PAGE>
 
September 1998.  Mr. Chambers was Senior Vice President of Corporate Affairs of
Telxon Corporation from October 1995 through December 1997.  Prior to that
assignment he was Director of Planning for Employee Benefits and Compensation
for Reliance Electric Company. Mr. Chambers received a Bachelor of Arts degree
from Western Reserve University and a Juris Doctor degree from Cleveland
Marshall College of Law.  Mr. Chambers is member of the Ohio Bar.

ITEM 10.  EXECUTIVE COMPENSATION

     The following table sets forth information regarding compensation for
services in all capacities paid or accrued for the fiscal year indicated by the
Company to the Chief Executive Officer and the other executive officers whose
current compensation exceeds $100,000  (collectively, the "Named Executive
Officers"):

                           Summary Compensation Table

<TABLE>
<CAPTION>
                                                                                Long Term                  
                                                                               Compensation                 
                                                 Fiscal                         Securities        Other     
                                               Ended Year                       Underlying        Annual    
                                                July 31,   Salary     Bonus      Options #     Compensation  
                                                -------   --------   -------   -------------   ------------  
<S>                                             <C>       <C>         <C>       <C>             <C>  
Michael Feygin
 Chairman of the Board, Founder and Chief
 Technical Officer                                 1998   $202,933        --              --             --
                                                   1997   $225,000   $ 2,647              --             --
                                                   1996   $159,614   $91,942              --             --
 
Gary Moskovitz
 President and Chief Executive Officer             1998   $ 77,022   $ 8,500         350,000             --
 
Dave Okazaki
 Chief Financial Officer                           1998   $101,365        --          21,000             --
                                                   1997   $105,000        --          16,300             --
                                                   1996   $ 88,308   $15,619          22,600             --
</TABLE>

Option Matters


     Option Grants.  The following table sets forth certain information
concerning grants of stock options to each of the Company's executive officers
named in the Summary Compensation Table during the fiscal year ended July 31,
1998.

                                       24
<PAGE>
 
                       Option Grants in Last Fiscal Year

<TABLE>
<CAPTION>
                                                   % of
                                              Total Options
                                                Granted to
                           Options             Employees in             Exercise
       Name                Granted             Fiscal Year            Price ($/Sh)         Expiration Date
<S>                  <C>                   <C>                    <C>                    <C> 
Michael Feygin               --                     --                     --                    --
Gary Moskovitz             350,000                     44.9%                 $0.48                  3/8/08
Dave Okazaki                21,000                      2.7%                 $0.78                 12/4/07
</TABLE>

     Option Exercises.  No options were exercised by any of the Company's
executive officers named in the Summary Compensation Table during the fiscal
year ended July 31, 1998

     The following table includes the number of shares covered by both
exercisable and unexercisable stock options as of July 31, 1998.  None of the
options reflected below were "in the money" at July 31, 1998 (i.e., with a
positive spread between the closing sales price as reported by OTC/BB of $0.375
per share of Common Stock as of July 31, 1998, and the exercise price of such
stock options).

                    Aggregate Fiscal Year-End Option Values

<TABLE>
<CAPTION>
                                               Number of Unexercised    
                                                    Options at          
                                                  Fiscal Year-End       
                                           -----------------------------
         Name                              Exercisable     Unexercisable       
         --------------                    -----------     -------------       
         <S>                               <C>             <C>                 
         Michael Feygin                             --                --     
         Gary Moskovitz                         36,458           313,542     
         Dave Okazaki                           18,755            41,145 
</TABLE>

Consulting Agreement


     On April 1, 1996 the Company entered into a Professional Services Agreement
with Mr. Crangle and Rose & Crangle, Ltd., a Kansas corporation of which Mr.
Crangle is a 50% shareholder.  Under the terms of this Agreement, Rose & Crangle
is paid $6,600 per month for consulting services performed on behalf of the
Company and the Company reimburses Rose & Crangle's expenses incurred in
connection with performing such consulting services.  The monthly fee was
amended to $5,610 in January 1998.  In addition, the Company exercised its right
to terminate the consulting agreement, effective December 31, 1998.

Director Compensation

     Each non-employee, non-investor director is paid $10,000 annually except
for Robert D. Crangle, who is compensated by Rose & Crangle, Ltd., pursuant to a
consulting agreement between the Company and Rose & Crangle, Ltd. This
consulting agreement has been terminated effective December 31, 1998. Each non-
employee director was granted options to purchase a total of 15,000 shares of
Common Stock

                                       25
<PAGE>
 
on January 16, 1997. The Company has and will continue to pay the expenses of
its non-employee directors incurred in attending Board meetings. Pursuant to the
terms of the Company's 1995 Stock Incentive Plan, each non-employee director of
the Company, so long as they beneficially own less than 1% of the outstanding
Common Stock of the Company, including any outstanding options to purchase
Common Stock which are exercisable within 60 days of the date of grant, will be
granted nonstatutory options to purchase 6,000 shares of Common Stock, at fair
market value on the date of commencement of service on the Company's Board of
Directors and every four years thereafter, provided that all unvested options
shall terminate upon the termination of the non-employee director's service on
the Board of Directors. All options granted to non-employee directors under the
Company's 1995 Stock Incentive Plan will become 25% exercisable on the date of
grant and will become exercisable at the rate of 25% every 12 months thereafter.

ITEM 11.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of November 13, 1998 by each
director, director nominee and Named Executive Officer of the Company, each
person known to the Company to be the beneficial owner of more than 5% of the
outstanding Common Stock, and all directors and executive officers of the
Company as a group. Except as otherwise indicated below, the Company believes
that each person listed below has sole voting and investment power with respect
to the shares owned, subject to applicable community property laws.

<TABLE>
<CAPTION>
                                                                Shares Beneficially
                                                                       Owned
                   Name and address of
                    Beneficial owner                          Number          Percent
                    ----------------                       -------------   --------------
 
<S>                                                        <C>             <C>
Michael Feygin (2)(3)...................................       1,993,260            22.0%
Gary Moskovitz (2)(5)...................................          72,917               *
Rose & Crangle, Ltd (4).................................         337,928             3.7%
Robert D. Crangle (4)(7)................................          19,750               *
Dave T. Okazaki (2)(6)..................................          28,720               *
Gregory Chambers (7)....................................           3,750               *
All directors and officers as a group (5 persons)(7)....       2,456,325            27.2%
Walter W. Cruttenden III (8)............................       2,150,000            23.8%
Robert F. Meyerson (9)..................................       1,630,000            18.0%
Reed Harman (10)........................................         900,000            9.95%
</TABLE>
                                                                               
_____________________
*    Less than one percent.

(1)  Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission and generally includes voting or
     investment power with respect to securities. Shares of Common Stock subject
     to options or warrants currently exercisable or convertible, or exercisable
     or convertible within 60 days of November 13, 1998, are deemed outstanding
     for computing the percentage of the persons holding such options but are
     not deemed outstanding for computing the percentage of any other person.

(2)  The address of such stockholder is c/o Helisys, Inc., 24015 Garnier Street,
     Torrance, California 90505.

(3)  Does not include 120,000 shares held in an irrevocable trust for the
     benefit of Mr. Feygin's children, over which Mr. Feygin disclaims
     beneficial ownership.

                                       26
<PAGE>
 
(4)  The shares shown owned of record by Rose & Crangle, Ltd., a Kansas
     corporation ("Rose & Crangle") and management consulting firm, are
     beneficially owned by Robert Crangle, a Director of the Company.  Mr.
     Crangle owns 50% of the shares of Rose & Crangle and his spouse owns the
     remaining 50%.  Pursuant to an arrangement entered into between Mr. Crangle
     and Rose & Crangle, Mr. Crangle is entitled to vote 100% of the shares of
     the Company owned of record by Rose & Crangle.  In addition, Mr. Crangle's
     IRA owns 8,500 shares and he personally has vested options in 7,500 shares.

(5)  Consists of 14,583 shares subject to options exercisable within 60 days of
     November 15, 1998.

(6)  Includes directors' and executive officers' shares listed above, including
     9,965 shares subject to options exercisable within 60 days of November 15,
     1998.

(7)  Includes directors' and executive officers' shares listed above, including
     3,750 shares subject to options exercisable within 60 days of November 15,
     1998.

(8)  Includes 2,000,000 shares of Common Stock issuable upon the conversion of
     80,000 shares of the Company's Series A Preferred Stock, $.001 par value
     ("Preferred Stock") and 150,000 shares of Common Stock issuable upon the
     exercise of stock subscription warrants.

(9)  Includes 1,000,000 shares of Common Stock issuable upon the conversion of
     40,000 shares of the Company's Preferred Stock beneficially owned by Mr.
     Meyerson and 600,000 shares of Common Stock issuable upon the exercise of
     stock subscription warrants beneficially owned by Mr. Meyerson.

(10) Includes 600,000 shares of Common Stock issuable upon the conversion of
     40,000 shares of the Company's Preferred Stock beneficially owned by Mr.
     Harman and 300,000 shares of Common Stock issuable upon the exercise of
     stock subscription warrants beneficially owned by Mr. Harman.

ITEM 12.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Robert D. Crangle, a director of the Company, owns 50% of the outstanding
equity of Rose & Crangle, Ltd., a management consulting firm that has provided
professional consulting services to the Company since 1985.  Services include
advice on Company and departmental operations and personnel, business plans and
strategies, document review and preparation, marketing and other research,
contract negotiations, contract management, and other matters.  The Company paid
Rose & Crangle, Ltd. aggregate fees and reimbursed expenses of $92,460 and
$81,190 in the fiscal years ended July 31, 1997 and 1998, respectively, for such
services, the majority of which were performed by Mr. Crangle.  As part of an
agreement between the Company and Rose & Crangle, Ltd., Mr. Crangle is neither
compensated directly by the Company for serving in any capacity, or reimbursed
directly by the Company for his expenses in providing services to the Company.
The agreement with Rose & Crangle Ltd., scheduled to terminate on December 31,
1998, has a reduced fee schedule for calendar 1998 as compared with earlier
years.

     The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could otherwise be obtained from
unaffiliated third parties.  In the future, the Company will not enter into any
transaction with its officers and directors unless such transaction is approved
by the independent directors of the Company.

ITEM 13.    EXHIBITS AND REPORTS ON FORM 8-K

     The following documents are filed as part of this Form 10-KSB:

     (a)  Exhibits:
          -------- 

     See Index to Exhibits on Page II-2 of this Annual Report on Form 10-KSB.

     (b)  Reports on Form 8-K:
          --------------------

                                       27
<PAGE>
 
     The Registrant filed a Form 8-K on June 25, 1997 which was during the last
quarter of the period covered by this report, reporting a change of auditors
from Arthur Andersen LLP to Deloitte & Touche LLP.

                                       28
<PAGE>
 
                               Index to Exhibits
                               -----------------

Exhibit
Number      Description of Document
------      -----------------------

 2.1        Agreement and Plan of Merger between the Registrant and Helisys,
            Inc., a California corporation, effective November 22, 1995./(1)/

 3.1        Certificate of Incorporation of Registrant./(1)/

 3.2        Bylaws of Registrant./(1)/

 4.1        Form of Representative's Warrant Agreement by and between the
            Registrant and Cruttenden Roth Incorporated./(1)/

 10.1       1995 Stock Incentive Plan./(1)/, /(2)/

 10.2       Employee Stock Purchase Plan./(1)/, /(2)/

 10.3       Form of Directors' and Officers' Indemnification Agreement./(1)/

 10.4       Agreement dated February 28, 1995, between the Aviation Applied
            Technology Directorate and the Registrant./(1)/

 10.5       Agreement dated August 31, 1994, between the University of Dayton
            Research Institute and the Registrant./(1)/

 10.6       Intentionally Omitted.

 10.7       Joint Development and Distribution Agreement for EX85Z Adhesive,
            dated March, 1995, between Brown-Bridge Industries, Inc. and the
            Registrant./(1)/

 10.8       Consulting Agreement dated November 1, 1995 between L.A. Delmonico
            Consulting, Inc. and the Registrant./(3)/

 10.9       Professional Services Contract dated March 7, 1996 among Rose &
            Crangle, Ltd., the Registrant, Robert D. Crangle and Michael
            Feygin./(3)/

 16.1       Letter from Deloitte & Touche, LLP on changes in certifying
            accountant./(1)/

 21.1       Subsidiaries of the Registrant./(1)/

 23.1       Consent of Deloitte & Touche, LLP

 23.2       Consent of Stonefield Josephson, Inc.

 24.1       Power of Attorney (included on signature page hereto)./(1)/

 27.1       Financial Data Schedule

__________________

(1) Incorporated by reference to the same numbered exhibit of the Company's
    Registration Statement on Form SB-2, No. 33-99244-LA.

(2) These exhibits are identified as management contracts or compensatory plans
    or arrangements of the Company pursuant to item 13(a) of Form 10-KSB.

(3) Incorporated by reference to the same numbered exhibit of the Company's
    Annual Report on Form 10-KSB for the fiscal year ended July 31, 1996, as
    filed with the Securities and Exchange Commission.

(4) Incorporated by reference to the same numbered exhibit of the Company's
    Current Report on Form 8-K, as filed with the Securities and Exchange
    Commission on September 23, 1998.

                                       29
<PAGE>
 
                                   SIGNATURES
                                   ----------

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized, in the City of
Torrance, State of California, on November 13, 1998.

                                 HELISYS, INC.


Dated:  November 13, 1998        By:  /s/ Gary Moskovitz
                                      ------------------------------
                                      Gary Moskovitz
                                      President, Chief Executive Officer and 
                                      Director

     We, the undersigned directors and officers of Helisys, Inc., do hereby
constitute and appoint Gary Moskovitz and Dave T. Okazaki our true and lawful
attorneys and agents, with full powers of substitution to do any and all acts
and things in our name and behalf in our capacities as directors and officers
and to execute any and all instruments for us and in our names in the capacities
indicated below, which said attorneys and agents may deem necessary or advisable
to enable said corporation to comply with the Securities Exchange Act of 1934,
as amended, and any rules, regulations and requirements of the Securities and
Exchange Commission, in connection with this Annual Report on Form 10-KSB,
including specifically but without limitation, power and authority to sign for
us or any of us in our names in the capacities indicated below, any and all
amendments hereto; and we do hereby ratify and confirm all that said attorneys
and agents, shall do or cause to be done by virtue hereof.

     Pursuant to the requirements of the Securities Exchange Act of 1934, 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>

<S>                       <C>                                        <C> 
/s/ Gary Moskovitz        President, Chief Executive Officer and     November 13, 1998
-----------------------   Director (Principal Executive Officer)

 
/s/ Michael Feygin        Chairman, Chief Technical Officer and      November 13, 1998
-----------------------   Director
Michael Feygin            
 
/s/ Dave T. Okazaki       Chief Financial Officer and                November 13, 1998
-----------------------   Secretary (Principal Financial and
Dave T. Okazaki           Principal Accounting Officer)     
                          
 
/s/ Robert Crangle        Director                                   November 13, 1998
-----------------------
Robert Crangle
 
/s/ Gregory Chambers      Director                                   November 13, 1998
-----------------------
Gregory Chambers
</TABLE>

                                       30
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS


                                                                          Page
                                                                          ----

Report of Independent Public Accountants................................   F-1

Report of Independent Public Accountants................................   F-2

Balance Sheet as of July 31, 1998.......................................   F-3

Statements of Operations for the years ended July 31, 1997 and 1998.....   F-4

Statements of Stockholders' Equity for the years ended July 31, 1997
  and 1998..............................................................   F-5

Statements of Cash Flows for the years ended July 31, 1997 and 1998.....   F-6

Notes to Financial Statements...........................................   F-7

                                       31
<PAGE>
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To the Board of Directors and Stockholders of
Helisys, Inc.:

     We have audited the accompanying balance sheet of Helisys, Inc., as of July
31, 1998, and the related statements of operations, stockholders' equity and
cash flows for the year ended July 31, 1998. 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 audit.

     We conducted our audit 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 audit provides a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Helisys, Inc., at July 31,
1998, and the results of its operations and its cash flows for the year then
ended, in conformity with generally accepted accounting principles.

     The accompanying financial statements have been prepared assuming the
Company will continue as a going concern.  As discussed in Note 1 to the
financial statements, the Company's operating losses and negative cash flow from
operating activities raise substantial doubt about its ability to continue as a
going concern.  Management's plans concerning these matters are also described
in Note 1.  The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

                                 STONEFIELD JOSEPHSON, INC.

Santa Monica, California
October 29, 1998

                                      F-1
<PAGE>
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Board of Directors and Stockholders of
Helisys, Inc.:

     We have audited the accompanying statements of operations, stockholders'
equity and cash flows of Helisys, Inc., for the year ended July 31, 1997.  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 audit.

     We conducted our audit 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 audit provides a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of Helisys,
Inc. for the year ended July 31, 1997, in conformity with generally accepted
accounting principles.

     The accompanying financial statements have been prepared assuming the
Company will continue as a going concern.  As discussed in Note 1 to the
financial statements, the Company's operating losses and negative cash flow from
operating activities raise substantial doubt about its ability to continue as a
going concern.  Management's plans concerning these matters are also described
in Note 1.  The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.


                              DELOITTE & TOUCHE LLP


Los Angeles, California
November 21, 1997

                                      F-2

<PAGE>

                                 HELISYS, INC.
                                 BALANCE SHEET

<TABLE>
<CAPTION>
                                                                                                                July 31, 1998
ASSETS
Current assets:
<S>                                                                                                     <C>
     Cash and cash equivalents                                                                                      $    45,766
     Accounts receivable, net of allowance for doubtful accounts of $140,840                                          1,414,254
     Inventories                                                                                                      1,417,379
     Prepaid expenses                                                                                                    62,426
     Other current assets                                                                                                17,950
                                                                                                        -----------------------
            Total current assets                                                                                      2,957,775
                                                                                                        -----------------------
Property, plant and equipment:                                                                          
     Office furniture and equipment                                                                                     583,308
     Machinery and equipment                                                                                            669,270
                                                                                                        -----------------------
                                                                                                                      1,252,578
     Less - accumulated depreciation                                                                                    791,412
                                                                                                        -----------------------
     Property, plant and equipment, net                                                                                 461,166
                                                                                                        -----------------------
Other assets                                                                                                             27,365
                                                                                                        -----------------------
Total                                                                                                               $ 3,446,306
                                                                                                        =======================
                                                                                                        
LIABILITIES AND STOCKHOLDERS' EQUITY                                                                    
Current liabilities:                                                                                    
     Accounts payable                                                                                               $ 1,136,992
     Accrued liabilities                                                                                                659,956
     Customer deposits                                                                                                   43,722
     Deferred maintenance revenues                                                                                      565,545
     Line of credit                                                                                                     369,552
     Note payable                                                                                                       100,000
                                                                                                        -----------------------
            Total current liabilities                                                                                 2,875,767
Commitments and contingencies (Note 9)                                                                  
Stockholders' equity:                                                                                   
     Preferred stock, $.001 par value                                                                   
         5,000,000 shares authorized, 80,000 issued                                                     
         and outstanding                                                                                                     80
     Common stock, $.001 par value                                                                      
         Authorized 20,000,000 shares                                                                   
         Issued and outstanding 4,042,760 shares                                                                          4,043
     Additional paid-in capital                                                                                       6,646,990
     Accumulated deficit                                                                                             (6,080,574)
                                                                                                        -----------------------
             Total stockholders' equity                                                                                 570,539
                                                                                                        -----------------------
                                                                                                        
Total                                                                                                               $ 3,446,306
                                                                                                        =======================
</TABLE>

                See accompanying notes to financial statements.

                                      F-3 
<PAGE>
 
                                 HELISYS, INC.

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                              FOR THE YEAR ENDED
                                                                                JULY 31, 1997                   JULY 31, 1998
                                                                           --------------------            --------------------
 
<S>                                                                           <C>                             <C>
Net sales..................................................................         $14,046,907                     $ 8,450,066
Cost of sales..............................................................           8,413,098                       6,345,667
                                                                           --------------------            --------------------
 
Gross profit...............................................................           5,633,809                       2,104,399
                                                                           --------------------            --------------------
 
Operating Expenses:
   Selling, general and administrative.....................................           5,847,578                       4,248,502
   Research and development................................................           2,608,527                       1,380,670
   Total operating expenses................................................           8,456,105                       5,629,171
                                                                           --------------------            --------------------
 
   Loss from operations....................................................          (2,822,296)                     (3,524,773)
                                                                           --------------------            --------------------
 
Other income (expense):
   Interest and other income...............................................              70,722                         344,460
   Interest and other expense..............................................            (335,899)                       (454,819)
                                                                                       (265,177)                       (110,359)
                                                                           --------------------            --------------------
 
Loss before income tax benefit.............................................          (3,087,473)                     (3,635,132)
Income tax benefit.........................................................             (55,802)                              0
                                                                           --------------------            --------------------
 
Net loss...................................................................         $(3,031,671)                    $(3,635,132)
                                                                           ====================            ====================
 
Net loss per share.........................................................               $(.76)                          $(.90)
                                                                           ====================            ====================
 
Weighted average number of common shares outstanding.......................
basic and diluted                                                                     4,002,134                       4,033,934
                                                                           ====================            ====================
</TABLE>

See accompanying notes to financial statements.

                                      F-4

<PAGE>

                                 HELISYS, INC.

                       STATEMENTS OF STOCKHOLDERS' EQUITY

                   FOR THE YEARS ENDED JULY 31, 1997 AND 1998

<TABLE>
<CAPTION>
                                                         PREFERRED     ADDITIONAL    RETAINED     ADVANCE   
                                       COMMON STOCK        STOCK         PAID-IN     EARNINGS       TO       DEFERRED
                                      SHARES  AMOUNT   SHARES  AMOUNT    CAPITAL     (DEFICIT)  STOCKHOLDER COMPENSATION    TOTAL
                                   -------------------------------------------------------------------------------------------------

                                                                                                            
<S>                                <C>        <C>      <C>      <C>    <C>          <C>         <C>         <C>          <C>
Balance at July 31, 1996           3,991,654  $3,992        -       -  $5,871,083   $   586,229    ($40,536)   ($50,479) $6,370,289
   Net Loss                                                                          (3,031,671)                         (3,031,671)

   Common stock issued to                                                                                   
      employees under stock                                                                                 
      purchase plan                   39,707      40                       65,564                                            65,604
   Retirement of stock used as                                                                              
      collateral for advance to                                                                             
      shareholder/employee            (6,110)     (6)                     (32,077)                   40,536                   8,453
   Value of 50,000 warrants issued                                                                          
      as commitment fee to secure                                                                           
      line of credit                                                      104,000                                           104,000
   Amortization of deferred                                                                                 
      compensation on stock                                                                                 
      options awarded to employees                                                                               20,192      20,192
                                   -------------------------------------------------------------------------------------------------

                                                                                                            
Balance at July 31, 1997           4,025,251  $4,026        -       -  $6,008,570   ($2,445,442)          -    ($30,287) $3,536,867

                                   =================================================================================================

Balance at July 31, 1997           4,025,251  $4,026         -      -  $6,008,570   ($2,445,442)               ($30,287) $3,536,867 
   Net Loss                                                                          (3,635,132)                         (3,635,132)
   Common stock issued to                                                                                               
      employees under stock                                                                                             
      purchase plan                   17,509      17                        6,500                                             6,517
   Preferred stock issued to                                                                                            
      Walter Cruttenden for                                                                                             
      private investment                               80,000      80     499,920                                           500,000
   Value of 100,000 warrants issued                                                                                     
      as commitment fee to secure                                                                                       
      line of credit                                                      132,000                                           132,000
   Amortization of deferred                                                                                             
      compensation on stock                                                                                             
      options awarded to employees                                                                               30,287      30,287
                                   -------------------------------------------------------------------------------------------------

Balance at July 31, 1998           4,042,760  $4,043    80,000    $80  $6,646,990   ($6,080,574)          -           -  $  570,539
                                   =================================================================================================

</TABLE>
See accompanying notes to financial statements.

                                      F-5
 
<PAGE>

                                 HELISYS, INC.

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                            FOR THE YEAR ENDED
                                                                                    ---------------------------------
                                                                                    JULY 31, 1997       JULY 31, 1998
                                                                                    -------------       -------------
<S>                                                                                 <C>                 <C>
Cash flows from operating activities:
   Net loss                                                                           $(3,031,671)        $(3,635,132)
     Adjustments to reconcile net loss to net cash used in operating activities:
     Depreciation..................................................................       431,852             347,008
     Deferred income taxes.........................................................       545,553                  --
     Amortization of credit facility commitment fee paid with warrants...                 104,000             114,050
     Amortization of deferred compensation.........................................        20,192              30,287
     Net book value of equipment sold to customers.................................            --              72,548
     Impairment loss realized on advance to shareholder............................         8,453                  --
     Loss on disposition of property, plant and equipment..........................        29,167                  --
     Gain on sale of property......................................................            --            (279,634)
     Changes in operating assets and liabilities:
     Accounts receivable.........................................................         360,835             633,226
     Inventories.................................................................        (450,372)          1,059,435
     Income tax receivable.......................................................         316,133             578,537
     Prepaid expenses............................................................          85,442              (1,808)
     Other assets................................................................           4,970              (1,234)
     Accounts payable............................................................        (213,765)            (51,812)
     Accrued liabilities.........................................................        (106,871)           (136,538)
     Customer deposits...........................................................         (12,503)              6,225
     Deferred maintenance revenues...............................................         264,019            (398,173)
     Deferred gross profits......................................................        (182,298)           (263,860)
                                                                                      -----------         -----------
       Net cash used in operating activities.....................................      (1,826,864)         (1,926,875)
                                                                                      -----------         -----------
Cash flows from investing activities:
 Purchases of property, plant and equipment......................................        (161,410)            (45,036)
 Proceeds from sale of building..................................................              --           2,293,805
                                                                                      -----------         -----------
       Net cash (used in) provided by investment activities......................        (161,410)          2,248,769
                                                                                      -----------         -----------
Cash flows from financing activities:
 Payments on long-term debt and capital lease obligation.........................         (50,603)         (1,879,171)
 Proceeds from issuance of common stock under employee stock purchase
  plan...........................................................................          65,604               6,517
 Proceeds from issuance of preferred stock.......................................              --             500,000
 Net borrowings on bank credit line..............................................              --             369,550
 Proceeds from issuance of note payable..........................................              --             100,000
                                                                                      -----------         -----------
       Net cash (used in) provided by financing activities.......................          15,001            (903,104)
                                                                                      -----------         -----------
Net (decrease) increase in cash..................................................      (1,973,273)           (581,210)
Cash and cash equivalents, beginning of period...................................       2,600,249             626,976
                                                                                      -----------         -----------
Cash and cash equivalents, end of period.........................................     $   626,976         $    45,766
                                                                                      ===========         ===========
Supplemental disclosures of cash flow information:                                   
 Cash paid during the period for interest........................................     $   144,670         $   245,845
 Cash paid during the period for income taxes....................................     $        --         $        --
Supplemental disclosures of noncash financing and investing activities:
 Warrants issued as commitment fee to secure line of credit......................     $   104,000         $   114,050
 Inventory transfers to property, plant & equipment..............................     $   193,334         $    67,422
 Retirement of 6,110 shares of common stock used as collateral for
   Advance to shareholder/employee that became uncollectible - net...............     $    32,083         $        --
</TABLE>

                See accompanying notes to financial statements.

                                      F-6
 
<PAGE>

                                 HELISYS, INC.

                         NOTES TO FINANCIAL STATEMENTS
                   FOR THE YEARS ENDED JULY 31, 1997 AND 1998


1.   DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     a.  Organization

     Helisys, Inc.'s predecessor, Hydronetics, Inc., was incorporated in
Illinois in 1985 to engage in Laminated Object Manufacturing research and
development activities. Helisys, Inc. (the Company) was reincorporated in
California in 1990. The Company designs, develops, manufactures and markets
rapid prototyping machines that are used by design engineers and manufacturers
to make physical models, industrial patterns, and prototypes directly from an
engineer's or industrial designer's three-dimensional computer-aided design (3-D
CAD). The Company's rapid prototyping equipment utilizes the Company's
proprietary Laminated Object Manufacturing (LOM) technology. The Company's LOM
technology is a rapid prototyping technology that produces physical models,
industrial patterns, and prototypes through the lamination of sheet-formed
materials such as paper and plastic. The Company also sells the consumable
materials used with its LOM systems.  The principal markets for the Company's
products are industrial manufacturing companies, custom prototype shops, and
educational institutions worldwide.

     b.  Significant Risk Factor

     The Company's operating losses and negative cash flow from operating
activities raise substantial doubt about the Company's ability to continue as a
going concern. The Company incurred net losses of $3,031,671 and $3,635,132 for
the fiscal years ended July 31, 1997 and July 31, 1998, respectively. The
Company has also had recurring negative cash flows from operations of $1,826,864
and $1,926,875 for the years ended July 31, 1997 and 1998, respectively. The
Company was notified that it was in default on its obligations with its Bank due
to violations of certain financial covenants. As of July 31, 1998, the Company
had aggregate borrowings from the Bank of $369,552. The Bank has currently
entered into an agreement forbearing from exercising its rights and remedies
under the Loan Documents and Guaranty with respect to the existing defaults
until subsequent to the forbearance termination date of January 1999.

     The ability of the Company to attain profitability is dependent, in part,
upon market acceptance of its latest generation rapid prototyping machines (the
LOM 1015Plus and 2030H), as well as continued sales of materials and services,
maintaining gross profit levels, controlling operating costs and the securing of
an additional working capital bank credit facility as needed.  If these matters
are not successful, the Company will be required to scale back efforts in
research and development and reduce certain selling, general and administrative
expenses. In addition, the Company may be required to raise additional funds
through public or private equity or debt financing. There can be no assurance
that the Company's cash and cash equivalents will be sufficient to meet future
operating requirements, or, if required, that additional financing will be
available.

     c.  Accounting Estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of

                                      F-7
 
<PAGE>

assets and liabilities and disclosures of contingencies at the date of the
financial statements and the reported amounts of revenues and expenses during
the reported period. Actual results could differ from estimated amounts.

     d.  Inventories

     Inventories are stated at lower of cost (determined by first-in, first-out
method) or market. Inventory costs include the cost of material, labor, and
manufacturing overhead.

     e.  Property, Plant and Equipment

     Property, plant and equipment are recorded at cost. Additions and
betterments are capitalized. Maintenance and repairs are charged directly to
expense as incurred. When assets are disposed, the related cost and accumulated
depreciation are removed from the accounts and any resulting gains or losses are
included in the statements of operations. Depreciation is provided using the
straight-line method over the following estimated useful lives:

        Building and improvements..............    30 years
        Office furniture and equipment.........    3 to 5 years
        Machinery and equipment................    3 to 5 years

     The Company records depreciation on property, plant and equipment based on
estimated useful lives. The actual useful lives and recoverability of values of
property, plant and equipment may vary from the Company's estimates. In the
event that future facts and circumstances indicate that the cost of property,
plant and equipment may be impaired, an evaluation of recoverability would be
performed. If an evaluation is required, the estimated future undiscounted cash
flows associated with the asset would be compared to the asset's carrying amount
to determine if a write-down to market value or discounted cash flow value is
required.

     f.   Revenue Recognition

     Revenue from the sale of rapid prototyping systems and related products is
recognized upon shipment and satisfaction of significant customer requirements.
During fiscal years ended July 31, 1995, and prior, the Company shipped certain
rapid prototyping systems to customers, subject to agreements providing the
rights to exchange the systems for upgraded versions. In instances where units
are shipped subject to such exchanges, gross profits are deferred until the
exchange is completed or the right to exchange has expired. During fiscal 1998
the Company had met all its exchange and upgrade obligations; therefore there
were no deferred gross profits remaining at July 31, 1998.  Revenue from annual
product maintenance and warranty contracts is recognized ratably over the
contract period (generally, 12 months).

     g.  Concentration of Credit Risk

     Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents and trade
receivables.

     The Company maintains its cash and cash equivalents in bank accounts which,
at times, may exceed federally insured limits.  The Company has not experienced
any losses in such accounts.  The Company does not believe it is exposed to any
significant credit risk on cash and equivalents.

                                      F-8
 
<PAGE>
 
     The Company grants credit to domestic and foreign customers.  Credit is
extended based on an evaluation of each customer's financial condition. To
reduce credit risk in connection with sales of LOM systems, the Company may,
depending upon the circumstances, require deposits prior to shipment and may
retain a security interest in the LOM equipment until fully paid.  The Company
often requires international customers to furnish letters of credit. To date,
the Company has not incurred any significant credit related losses.  Exposure to
losses on receivables is principally dependent on each customer's financial
condition.  The Company monitors its exposure for credit losses and maintains
allowances for anticipated losses. The actual credit losses experienced by the
Company may vary from its allowances for anticipated losses.

     The Company's customers are dispersed across various geographic areas. The
Company does not believe there is significant credit risk concentration in any
single geographic area (see Notes 10 and 16).

     h.  Research and Development Costs

     Research and development costs are expensed as incurred except for those
costs that are reimbursable under specific contracts. As of July 31, 1997 and
1998, the Company had one significant research and development contract in
process. The contract provides for cost reimbursement plus a fixed fee and is
performed on a best efforts basis with no guarantee of ultimate success. Costs
related to research and development contracts are included in inventory and
charged to cost of sales upon recognition of the related revenues. Revenues on
research and development contracts are recognized as work is performed and is
estimated based on the relationship of cost incurred to date to total estimated
costs to be incurred on the contract. These estimates are subject to the
Company's progress and could materially vary from time to time. Costs incurred
and gross profit recognized on research and development contracts are as
follows:

                                            JULY 31, 1997     JULY 31, 1998 
                                            -------------     -------------
         Cost incurred to date               $1,264,000        $1,352,000
         Gross profit recognized to date     $  115,000        $  119,000

     i.  Income Taxes

     Income taxes are accounted for by the asset and liability approach in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes."  Deferred taxes represent the expected future tax
consequences when the reported amounts of assets and liabilities are recovered
or paid.  They arise from differences between the financial reporting and tax
basis of assets and liabilities and are adjusted for changes in tax laws and tax
rates if and when those changes are enacted.  The provision (benefit) for income
taxes represents the total of income taxes paid or payable (receivable) for the
current year, plus the change in deferred taxes during the year.

     j.  Cash and Cash Equivalents

     The Company considers all short-term deposits with an original maturity of
three months or less to be cash equivalents.  This caption includes cash and
short-term money funds.

     k.  Impact of Recently Issued Accounting Statements

                                     F-9

<PAGE>

     In February, 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per
Share". The statement was effective for interim periods and fiscal years ending
after December 15, 1997.  The implementation of this statement by the Company
during the year ended July 31, 1998 did not have a material effect on the
Company's financial statements.

     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting for Comprehensive Income" and
No. 131, "Disclosure about Segments of an Enterprise and Related Information."
These statements are effective for financial statements issued for periods
beginning after December 15, 1997.  The Company has not yet analyzed the impact
of adopting these statements.

     l.  Net Income (Loss) Per Common Share

     Net income (loss) per share of common stock (basic and dilutive) is
computed based upon the number of shares of common stock outstanding. All shares
are treated as outstanding in determining earnings (losses) per share for all
periods presented.  No material dilutive effect would result from the exercise
of outstanding options, warrants or common equivalent shares outstanding.

2.   INVENTORIES

     Inventories consist of the following at July 31, 1998:

       Raw materials..............................   $  689,829
       Work-in-process............................      162,501
       Finished systems...........................      565,049
                                                     ----------
                                                     $1,417,379
                                                     ==========

3.   LINE OF CREDIT

     In November 1997, to cure the covenant defaults with its Bank, the Company
amended its existing Primary Facility (from $1,500,000 to $500,000) and obtained
an additional line of credit facility for $500,000 (the "Secondary Facility")
with the Bank.  These facilities provided for maximum aggregate borrowings of
$1,000,000 and were guaranteed, in part, by an investment banker (see Note 17).
The Primary Facility was repaid in July 1998 upon the sale of the Company's
building.

     At July 31, 1998, the Company's borrowings under the Secondary Facility
with the bank, bearing interest at prime plus one-half of one percent (8.5% at
July 31, 1998) amounted to $369,552. This revolving credit facility is subject
to a forbearance agreement with the Bank that expires on January 15, 1999.
Monthly payments of $6,500, plus interest, were commenced effective August 1,
1998.

     The Secondary Facility is collateralized by substantially all assets of the
Company, except for land and the building (sold July 1998).  Under the Facility,
the Company is subject to certain financial covenants.  The major financial
covenants include requirements for maintaining defined levels of tangible net
worth and working capital, as well as various ratios, including the current
ratio and the senior liabilities to tangible net worth ratio.

     The Company did not comply with certain financial covenants at July 31,
1998, and accordingly, is subject to a forbearance agreement with its bank for
periods up to and including January 15, 1999.

                                     F-10
 
<PAGE>

4.   ACCRUED LIABILITIES

     Accrued liabilities consist of the following at July 31, 1998:

       Accrued commissions.....................................      $ 39,158  
       Accrued salaries and bonuses............................        58,335
       Accrued vacation........................................        93,976
       Accrued warranty........................................       250,000
       Other accrued liabilities...............................       218,487
                                                                     --------
                                                                     $659,956
                                                                     ========
5.   LONG-TERM DEBT AND CAPITAL LEASE OBLIGATION

     During October 1994 the Company exercised an option to purchase land and
the building which serves as a warehouse facility and corporate offices. The
total purchase price aggregated $2,095,000, of which $1,930,500 was funded by
bank borrowings evidenced by two notes payable secured by a first and second
trust deed. Subsequent to the purchase, one of the notes aggregating $858,000
was refinanced by the Company with funds received from the United States Small
Business Administration.  The land and building were sold in July 1998 and all
long-term debt has been retired, resulting in a gain of $279,634.  The Company
has entered into a three year operating sub-lease of half of the facility,
approximately 21,800 square feet, from Quinstar Technology, the occupant of the
other half of the building.

     Additionally, the Company leases certain equipment under a noncancellable
capital lease. Below is a summary of the equipment which has been capitalized
and included in property, plant and equipment in the accompanying balance sheet
at July 31, 1998:

     Cost............................................      $60,642
     Less:  Accumulated depreciation................        60,642
                                                           -------
                                                           $    --
                                                           =======
6.   INCOME TAXES

     The components of the provision (benefit) for income taxes are as follows:

                                               JULY 31, 1997   JULY 31, 1998
                                               -------------   -------------
        Current:
           Federal........................      $(504,223)     $        --
           State..........................      $ (97,132)     $        --
                                                ---------      -----------
                                                $(601,355)     $        --
 
        Deferred:
           Federal........................      $(454,013)     $(1,785,476)
           State..........................         50,325         (315,084)
           Valuation allowance............        949,241        2,100,560
                                                ---------      -----------
                                                 (545,553)              --
 
        Provision (benefit) for
           income taxes...................      $ (55,802)     $   
                                                =========      ===========

                                     F-11
 
<PAGE>

     Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and (b)
operating loss and tax credit carryforwards.  The following represents the tax
effects of significant items comprising the Company's deferred income taxes as
of July 31, 1998.  A valuation allowance is provided when it is more likely than
not that some or all of the deferred tax assets will not be realized.  As of
July 31, 1998, the Company provided a valuation allowance to offset the net
deferred tax asset since the future benefit of these assets is not assured.

                                          JULY 31, 1998
                                          -------------
     Allowance for doubtful account          $   56,336
     Inventory adjustments                       65,583
     Depreciation                                 1,829
     Accrued expenses                           137,590
     Net operating loss carryforward          1,839,222
                                             ----------

                                              2,100,560
     Less valuation allowance                (2,100,560)
                                             ----------

                                             $       --
                                             ==========

     Federal and state net operating loss carryforwards, which can be carried
forward to future years for possible utilization, expire through the year ending
July 31, 2013.

     The reconciliations of the overall effective tax rate to the Federal
statutory rate of 34% are as follows:

<TABLE>
<CAPTION>
                                                                                JULY 31,   JULY 31,          
                                                                                 1997        1998           
                                                                               --------    -------          
<S>                                                                            <C>         <C>              
     Federal income tax provision (benefit)..................................   (34.0)%     (34.0)%          
     State income tax provision (benefit), net of federal benefit............    (1.0)%      (6.0)%          
     Valuation allowance.....................................................     34.3%       40.0%          
     Other (including permanent differences).................................    (1.1)%         --          
                                                                               -------      ------          
     Effective income tax provision (benefit)................................    (1.8)%         --          
                                                                               =======      ======           
</TABLE>

7.   FAIR VALUE OF FINANCIAL INSTRUMENTS

     The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable, and accrued expenses approximate fair value because of the
short maturity of these items.


8.   RELATED PARTY TRANSACTIONS

     A stockholder of the Company owns 50% of a firm that provided consulting
services to the Company during the fiscal years ended July 31, 1997 and 1998.
The Company paid such firm aggregate fees and reimbursed expenses of $92,460 and
$81,190 in each of the fiscal years ended July 31, 1997 and July 31, 1998,
respectively.

                                     F-12
 
<PAGE>

     Former directors of the Company provided consulting services to the Company
during the fiscal year ended July 31, 1997 and 1998.  The fees paid to the
director totaled $5,400 and $1,000 during the fiscal years ended July 31, 1997
and 1998.

9.   COMMITMENTS AND CONTINGENCIES

     a.  Operating Leases

     The Company leases certain facilities and certain equipment under
noncancellable operating lease agreements which expire at various dates through
the year ending July 2003.

     A schedule of future minimum lease payments under noncancellable operating
leases at July 31, 1998, is as follows:

            1999.............................    $238,772
            2000.............................     207,657
            2001.............................     165,609
            2002.............................       5,284
            2003.............................       1,184
                                                 --------
                                                 $618,506
                                                 ========

     Rental expense for the years ended July 31, 1997 and 1998 amounted to
$81,391 and $168,226, respectively.

     b.  Legal Proceedings

     The Company is subject to various legal actions arising out of the conduct
of its business, including those actions related to patent infringement.  No
amounts were accrued for these actions at July 31, 1998.  An opposition has been
filed against the Company's European patent. However, the Company expects that
the European patent will be upheld.  The Company has also been advised that
there is significant "prior art" in the United States relating to the LOM
process.  Any finding that patent claims with respect to Company's LOM process
are invalid could have a material adverse effect on the Company's operations.
However, the Company believes that the results of any pending legal proceedings
will not have a material adverse effect on the Company's operations.

     c.  Internal Revenue Service Examination

     The Company has undergone an examination by the Internal Revenue Service
(IRS) for the tax years 1993, 1994 and 1995.  The initial report of the
examination, dated July 1998, showed adjustments which would increase the
taxable income of the Company, resulting in an assessment for taxes, interest
and penalties approximating $394,000.  The IRS report did not take into
consideration net operating loss carrybacks generated in the years 1996 and 1997
which would eliminate the tax assessments in their entirety. The IRS has
indicated that it is going to extend its examination to the years ended 1996 and
1997 in order to determine the cause of the large losses reported in those
years.

     The Company expects the 1996 and 1997 losses to hold up under IRS
examination, and for the additional taxes to be eliminated.

                                     F-13
 
<PAGE>

10.  MAJOR CUSTOMERS

     During the years ended July 31, 1997 and 1998, $4,303,173 (31%) and
$1,262,300 (15%) of the Company's revenues were from one customer. At July 31,
1998, accounts receivable included balances of $216,113 from this major
customer, of which $72,442 was secured by a Letter of Credit through a major
bank.

     The Company sells a significant portion of its products through third-party
resellers and, as a result, maintains individually significant receivable
balances with major distributors. If the financial condition and operations of
these distributors deteriorate below critical levels, the Company's operating
results could be adversely affected.  One distributor's unsecured receivable
balance represented 14 percent of total accounts receivable at July 31, 1998.

11.  MAJOR SUPPLIER

     Certain paper products used in the Company's LOM systems are purchased from
a sole vendor under an exclusive arrangement.  Although the Company believes
that other sources of supply of paper with attributes similar to the paper
exists, the Company believes that it would not be able to secure an alternate
supply in the short-term.  The unanticipated loss of the Company's sole source
of supply of paper would have a material adverse effect on the Company's results
of operations unless and until an alternate source of supply of paper with
similar attributes could be obtained.

12.  COMPENSATION PLANS

     a.  1995 Stock Incentive Plan

     The Company adopted a Stock Incentive Plan (the Plan) in October 1995, and
has reserved 900,000 shares of the Company's common stock for issuance pursuant
to the plan.

     Under the Plan, the Executive Committee is authorized to grant options to
purchase shares of common stock, including options qualifying as "incentive
stock options" under Section 422 of the Internal Revenue Code of 1986, as
amended, and options that do not so qualify (Nonstatutory Options).

     No stock option may be exercised after ten years from the date of grant and
all incentive stock options granted to a 10% stockholder shall expire within
five years from the date of grant. Options vest ratably over four years.  The
purchase price of common stock subject to an incentive stock option shall not be
less than 100% of the fair market value of such common stock on the date of
grant unless such incentive stock option is granted to a 10% stockholder, in
which case, the purchase price shall not be less than 110% of the fair market
value of such common stock on the date of grant. Non statutory Options will have
an exercise price determined by the Executive Committee, but shall not be less
than 85% of the fair market value of such common stock on the date of grant.

     The following table summarizes stock option activity for the years ended
July 31, 1997 and 1998:

<TABLE>
<CAPTION>

                                                           Option Price     
                                                        --------------------
                                          Number of     Weighted     Actual
                                           Options      Average      Total  
                                          ---------     --------   ---------
<S>                                       <C>           <C>        <C>        
Outstanding, August 1, 1996..............  152,400         4.20    $ 639,882
Granted..................................  244,550         2.27      556,125
</TABLE> 

                                     F-14
 
<PAGE>

<TABLE> 
<CAPTION> 
<S>                                        <C>          <C>        <C>        
Cancelled................................   (55,300)       3.45     (190,733) 
Outstanding, July 31, 1997...............   341,650        2.94    1,005,275  
Granted..................................   779,151         .62      486,337  
Cancelled................................  (413,450)        .88     (363,836) 
Outstanding, July 31, 1998...............   707,351         .53      375,788  
                                           ========                =========  
</TABLE>
 
     The following summarizes pricing and term information for options
outstanding as of July 31, 1998:

<TABLE>
<CAPTION>
                                      Options Outstanding                          Options Exercisable        
                              ---------------------------------------------     -------------------------
                                                  Weighted         Weighted                      Weighted
                                   Number          Average          Average                       Average
                              Outstanding at      Remaining        Exercise     Exercisable at   Exercise
                              July 31, 1998    Contractual Life     Price        July 31, 1998    Price         
                              --------------   ----------------    --------     --------------   --------
<S>                           <C>              <C>                 <C>          <C>              <C>            
$.34 to .38................      169,151          9.4 years          $0.36          59,251         $0.36         
 .48 to .59.................      351,500          9.7                 0.48          36,458          0.48         
 .78........................      186,700          8.7                 0.78          47,386          0.78         
                              --------------                                    --------------                  
$0.34 to $.78..............      707,351          9.8                $ .53         143,095         $0.53         
                              ==============                                    ==============                   
</TABLE>

     b.  1995 Employee Stock Purchase Plan

     The Company's Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in October 1995, covering an aggregate of
150,000 shares of common stock. The Purchase Plan, which is intended to qualify
as an "employee stock purchase plan" under Section 423 of the Internal Revenue
Code, will be implemented by six-month offering periods with purchases occurring
at six-month intervals. The Purchase Plan will be administered by the Executive
Committee of the Board of Directors of the Company. The Purchase Plan permits
eligible employees to purchase common stock through payroll deductions, which
may not exceed 15% of an employee's compensation. The price of common stock
purchased under the Purchase Plan will be 85% of the lower of the fair market
value of the common stock at the beginning of the six-month offering period or
the applicable purchase date. The Purchase Plan will terminate in December 2005.
At July 31, 1998, 82,760 shares had been purchased, with the balance available
for purchase under the Purchase Plan.

     c.  Stock Based Compensation

     The Company has adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation." The estimated fair value of options
granted under the 1995 Stock Incentive Plan during 1997 pursuant to SFAS 123 was
approximately $367,662. The estimated fair value of stock offered to employees
under the 1995 Employee Stock Purchase Plan during 1997 pursuant to SFAS 123 was
approximately $13,327. Had the Company adopted SFAS 123, pro forma net loss
would have been $3,209,470 and pro forma net loss per share would have been
$0.80 for 1997. The fair value of each option grant and stock offering was
estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions depending on the compensation plan:


                                    Stock                Employee Stock
                                Incentive Plan           Purchase Plan
                                --------------           --------------

Dividend yield                       Zero                     Zero
Volatility                            95%                      95%
Risk-free interest rate              5.9%                     5.5%
Expect lives (years)                   7                      0.5


The pro forma results of operations as of July 31, 1998, as if the Company had 
adopted the fair value method of SFAS No. 123, have not been presented as the 
amounts reported in the financial statements and the amounts obtained under 
adoption of the method would not be material.

13.  EMPLOYEE BENEFIT PLAN

     In July 1995, the Company adopted a 401(k) profit sharing plan (the Plan)
for its employees. To be eligible, full time employees must be at least 21 years
of age. Participants may contribute up to 15% of compensation, as defined by the
Plan. Participants' contributions are fully and immediately vested and non-
forfeitable.

                                     F-15
 
<PAGE>

14.  STOCKHOLDERS' EQUITY

     Pursuant to the Company's initial public offering in March 1996, the
Company issued 84,000 warrants to its underwriters at an exercise price of $6.60
per share, exercisable in March 1997 and expiring in March 2001.  None of these
warrants have been exercised as of July 31, 1998.

     On November 12, 1996, the Company entered into an unsecured $1,500,000 line
of credit facility with an investment banker. In consideration for the
commitment, the Company issued 50,000 warrants to the lender at an exercise
price of $2.75 per share, exercisable immediately and expiring in November 2001.
The warrants were recorded as additional paid in capital at their estimated fair
market value of $104,000.  For each $500,000 increment advanced to the Company,
an additional 50,000 warrants at an exercise price of $2.75 per share,
exercisable immediately and expiring five years from the date of issuance, were
issuable to the lender.  The credit facility expired in 1997 upon the Company
obtaining a new bank revolving credit facility (see Note 3).  No amounts were
borrowed under the line of credit with an investment banker.

     In November 1997, the Company amended its existing line of credit with a
bank (see Note 3) and issued 80,000 shares of the Company's convertible Series A
Preferred Stock, $.001 par value, to an investment banker for $500,000.  The
shares are convertible into common stock at the rate of 25 shares of common
stock per share of preferred stock.  (See Note 17 - Subsequent Events).

     In connection with the issuance of preferred stock, the investment banker
agreed to guarantee a $500,000 secondary line of credit facility with the bank
in exchange for a five year warrant (expiring November 2002) to purchase 100,000
shares of the Company's common stock at an exercise price of $1.75 per share
(which exercise price is subject to adjustment), plus $10,000 in cash. The
Company agreed that as additional consideration to the investment banker with
respect to the line of credit, the investment banker would earn a warrant to
purchase 10,000 shares of the Company's common stock at $1.75 per share (or the
lowest average of the nearer of the closing bid and asked prices over a
consecutive seven-day period, if lower) for each $100,000 that the Company
borrowed under the secondary line of credit facility.  As the Company borrowed
$500,000 under this facility, the investment banker earned warrants to purchase
50,000 shares of the Company's common stock.  The additional 50,000 warrant 
obligation is included in accrued liabilities in the accompanying balance sheet
at an estimated fair value of $39,000. Under the terms of the preferred stock
purchase agreement, the Company is obligated to pay the investment banker a
commission on the purchase price paid for additional shares of Series A
Preferred Stock purchased by investors who are introduced to the Company by the
investment banker, at a rate of 6.0% of the aggregate purchase price paid by
such investors.

     In addition to the consideration noted above, an indemnification, pledge
and security agreement was entered into between the investment banker and a
majority stockholder of the Company.  The majority stockholder indemnified the
investment banker from losses that may occur under the guaranty and secured the
indemnification obligation by pledging 750,000 shares of the majority
stockholder's stock in the Company.

15.  PRODUCT RELIABILITY MATTERS

     Since 1992 when the Company commenced production of its first-generation
LOM 2030's, there have been reported instances of fires occurring within the
cabinets of these systems. The Company believes that such fires may have
resulted when the cutting laser beam accidentally came in contact with a loose,
unbonded piece of paper which had been improperly fed into the LOM system. To
address this problem, the Company has developed flame resistant paper and has
changed the design of its LOM

                                     F-16

<PAGE>

systems to decrease the likelihood that paper material will become loose and
ignite during the LOM process. Since the development of the new product, no
cases of fire have been reported.

     The Company determined that it will modify its first-generation LOM 2030's
to substantially reduce the likelihood that burning material will be pulled
outside of the LOM cabinet.  The Company estimates the costs of performing the
modifications to be approximately $200,000 and has accrued this amount as of
July 31, 1998.  The ultimate costs of modifying the machines to adequately
address the aforementioned problem may vary materially from the Company's
estimate.

     The Company has not taken any specific actions or expended any of the
amounts accrued to perform the necessary modifications because not one customer
has requested the modifications.  Although the Company carries product liability
insurance coverage, if the Company fails to perform the necessary modifications,
the insurance carrier may assert certain defenses over the extent of such
coverage in the event the Company experiences product liability claims resulting
from the occurrence of fires in the systems.  No amount has been accrued for
this contingency.

16.  GEOGRAPHICAL SALES INFORMATION

     All of the Company's assets are devoted to the manufacture and sale of LOM
systems, together with related supplies and services.

     Summarized sales data for the Company are as follows:

<TABLE>
<CAPTION>
                                   UNITED                                                                                    
                                   STATES       EUROPE       JAPAN        OTHER        TOTAL                                 
                                                                                                                             
For the year ended July 31,                                                                                                  
1997                                                                                                                         
<S>                               <C>          <C>          <C>          <C>         <C>                                     
 Products.....................    $2,305,182   $3,416,853   $3,801,942   $1,591,681  $11,115,658                             
 Supplies and services........     1,479,342      737,516      501,231      213,160    2,931,249                             
                                  ----------   ----------   ----------   ----------  -----------                             
                                                                                                                             
                                  $3,784,524   $4,154,369   $4,303,173   $1,804,841  $14,046,907                             
                                  ==========   ==========   ==========   ==========  ===========              
 
For the year ended July 31,
1998
 
 Products.....................    $  929,245   $2,166,298   $  466,500   $1,542,763  $ 5,104,806                             
 Supplies and services........     1,522,841      861,685      537,037      423,697    3,345,260                             
                                  ----------   ----------   ----------   ----------  -----------                             
                                                                                                                             
                                  $2,452,086   $3,027,983   $1,003,537   $1,966,460  $ 8,450,066                             
                                  ==========   ==========   ==========   ==========  ===========                          
</TABLE>

17.  SUBSEQUENT EVENTS

     On September 3, 1998 the Company issued a 10% note payable to an investor
for $100,000, due and payable December 31, 1998.  The note was secured by
substantially all assets of the Company, and as additional consideration for the
monies lent, the investor received a warrant to purchase 100,000 shares of the
Company's common stock for $.35 per share.  The warrant is exercisable through
September 2003.

                                     F-17
 
<PAGE>

     During September 1998, the Company issued 64,000 shares of convertible
Series A Preferred Stock to two private investors for $400,000.  With respect to
the proceeds received, $200,000 was used to pay off the $100,000 note payable
shown on the balance sheet of the Company as of July 31, 1998 (10% interest
rate, secured by substantially all assets of the Company) as well as the
$100,000 note payable related to the September 3, 1998 transaction referred to
above.

     On September 17, 1998, the Company filed a Certificate of Designation of
Rights, Preferences & Privileges of Series A Preferred Stock ("Certificate")
with the secretary of state of the State of Delaware.  In so doing, the Company
created, out of the 5,000,000 shares of preferred stock authorized, a series of
preferred stock consisting of 144,000 shares to be designated Series A
Convertible Preferred Stock ("Series A Stock").  In the event of a liquidation,
dissolution or winding up of the Company, each holder of Series A Stock shall be
entitled to receive, prior and in preference to any holders of common stock or
any other series of preferred stock of the Company, an amount per share of the
Series A Stock equal to $6.25, plus any accrued and unpaid dividends.  Upon the
consolidation or merger of the Company with or into another corporation or a
conveyance of all or substantially all of the assets of the Company, the holders
of the Series A stock shall have the right to elect the buyout provisions noted
above.  Additionally, pursuant to the Certificate, holders of Series A Stock may
convert their Series A Stock to Common Stock of the Company at a conversion rate
of 25 shares of Common Stock for each share of Series A Stock (subject to
certain adjustments).  The holders of Series A Stock retain their right to
convert their shares into convertible promissory notes.