<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 
     For the fiscal year ended July 31, 1997

     OR
 
[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 
     For the transition period from __________ to __________

                        Commission file number 0-27286
                    ------------------------------------  

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

                Delaware                                 95-4552813
     (State or other jurisdiction           (I.R.S. Employer Identification No.)
   of 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 [_]  NO [X]

          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 $14,046,907

          As of November 14, 1997, 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 $2,918,805.80

    4,025,251 shares of Common Stock were outstanding at November 14, 1997.

                      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.
<PAGE>
 
                                     PART I

ITEM 1.  BUSINESS

The Company

Overview

     Helisys, Inc. (the "Company") designs, develops, manufactures and markets
rapid prototyping systems and the materials and supplies used with them.  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 and
prototypes directly from CAD designs.  They significantly reduce the time and
effort needed to produce complex models and prototypes, 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.

     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 or 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 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 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 rapid prototyping systems utilizing sheet materials
in the world. The Company believes that 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 
<PAGE>
 
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. ("Wohlers"), that there were over 2,243 rapid
prototyping systems installed worldwide as of December 31, 1996.  Approximately
35% of these were sold by 3D Systems, 21% by Stratasys, 11% by the Company and
the balance by smaller producers.  As of July 31, 1997, the Company had shipped
over 260 rapid prototyping systems globally.  Wohlers estimates that 1996
industry-wide revenue was approximately $420 million, with about $245 million
attributable to service and $175 million derived from product sales.  Overall
revenue growth was approximately 43% for 1996 and Wohlers forecasts unit sales
growth of 40% and 42% for 1997 and 1998 respectively.

     The Company believes that the rapid prototyping industry will eventually be
divided into two distinct segments.  One segment will consist of rapid
prototyping systems which are compact, inexpensive, clean and easy to operate,
and are, therefore, compatible with the office environment.  The other segment
is expected to consist of more expensive manufacturing-based rapid prototyping
systems which will address the need for high throughput, high precision and
sophisticated industrial equipment-line machine tools.  The Company believes
that its LOM technology enables the Company to compete with rapid prototyping
manufacturers in both industry segments.

Current Applications of Rapid Prototyping

     Rapid prototyping systems are currently being used in each stage of the
product development process.

     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.

     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.

     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 
<PAGE>
 
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.

     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.

LOM Technology

     The Company's rapid prototyping systems are used after the user has
prepared a 3-D CAD design of a desired object.  The Company's proprietary
software does the analysis and automatic conversion of the CAD design into a
format which drives the LOM systems; this is done by dividing the CAD
replication of the object into fine, horizontal "slices" where each layer has a
thickness equal to that of the sheet material to be used.

     The Company's LOM process then builds the object by cutting each of these
layer-thin cross sections on a gradually growing stack of sheet material
supported by an elevator platform in the working chamber of the LOM system.  A
roll of sheet material is mounted on a reel; the material is fed into the
working chamber to the cutting station, where 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 excess material from the object when the process is
complete.  After each layer's cross-section is cut by the laser beam, a new
layer is bonded on top with heat and pressure; then the laser cuts the next
cross-section.

     The process continues until all cross sections are bonded and cut and the
object is contained inside what appears to be a solid block of the sheet-form
material used.  The excess material is then removed from the object at the
parting lines to reveal a physical rendering of the 3-D CAD design.  The
majority of materials currently used in connection with the LOM systems are
specially developed papers and plastics.  The finished models or other objects
constructed from papers have the look and feel of lightweight wood.  The Company
intends to introduce a high-strength composite in the near future.

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 the fiscal year ended July 31, 1997.  The Company believes
that the second generation LOM systems (the 1015Plus and the 2030H) has
significant improvements in terms of reliability and ease of use as compared
with the first generation models.  Through July 31, 1997, the Company had
shipped over 260 LOM systems.
<PAGE>
 
     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
 
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

SYSTEM DIMENSIONS:                    3 units requiring 4.88m L x        1.226m W x 0.743m D x 1.308m H;
                                      3.66m W x 140cm H; 1404kg          454kg

CURRENT DOMESTIC LIST PRICE:          $254,000                           $92,600

MAXIMUM PART SIZE:                    813mm L x 559mm W x 508mmH;        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 systems.

     The Company also 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 
<PAGE>
 
departments within the Company; however, to fully utilize the LOM systems when
they are not being used for these other purposes, the TRC also offers LOM
services to outside entities on a limited basis.

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.

     The Company's sustaining engineering efforts continually have resulted in
improvements to 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 both major changes
to the 1015 and 2030 platforms, as well as 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 LOM
systems.

     The Company continues to pursue government and industry sponsored research
grants to provide funds for continued research and development.  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.

New Products

     During the fiscal year ending July 31, 1998, the Company hopes to introduce
a new LOM system with a working volume between that of the 1015 and 2030
systems.  This new system will incorporate the Company's next-generation
software and laser cutting systems.  It is expected to be faster, easier to use
and more reliable than the Company's current LOM systems.

New Materials

     The Company plans to dedicate much of its research and development efforts
to the testing and development of new materials to be used with its LOM systems,
including moisture resistant papers, plastics, ceramics and ceramic composites,
high performance polymer composites and metals.  It is also continuously
improving the process feedback systems and software to improve heat and pressure
consistency during object construction for each type of material.  The Company
is testing various improved sealants to minimize swelling and edge delamination
of newly produced objects.

Manufacturing

     The Company's in-house manufacturing efforts consist 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 considers its relationships with its suppliers to be good.  Procurement
lead times for the components range from four to 12 weeks.  
<PAGE>
 
The Company performs numerous diagnostic tests and quality control procedures
throughout the assembly process, which takes approximately six weeks.

     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, if necessary, of
such items.  The Company currently maintains an inventory of most of its
necessary supplies, which facilitates the assembly of products required for
near-term production.

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.  In September 1997, the Company hired a new Marketing
Director, who reports to the Vice President, Worldwide Sales and Marketing.

     The market for the Company's LOM systems and related materials and supplies
is largely comprised of entities that design and manufacture 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 sales personnel who
manage a developing global network of independent distributors, representatives
and agents.  Distributors obtain customer leads from the Company and from trade
shows, referral agents and direct inquiries.

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

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 
<PAGE>
 
Prototype, Inc., BPM Inc., 3D Systems, Inc., and Z Systems use ink-jet
technology to deposit material layer by layer.

     The Company believes that no competitive rapid prototyping systems similar
to its LOM 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
also sold rapid prototyping systems to universities and governmental and private
research laboratories for various uses, including 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, President,
Chief Executive Officer 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, including the
apparatus and method for forming an integral three-dimensional object out of
laminations of the same or gradually-varying shapes and the bi-material (i.e.,
adhesive) nature of the materials used in the LOM process. This patent was one
of the early United States patents relating to rapid automatic prototyping
systems which described, in detail, an apparatus capable of building three-
dimensional objects by means of lamination. 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 and cross-hatch such material to allow for
the easy removal of the material at the end of the LOM process. In June 1997,
Mr. Feygin was granted a third patent which extended the claims under the first
two patents with respect to the systems' design. Mr. Feygin was also issued a
European patent and a Canadian patent covering various aspects of the LOM
technology and the associated modeling process. All of the foregoing patents
have been assigned to the Company by Mr. Feygin. Kira Corporation has filed an
opposition to the European patent which is currently pending the European Patent
Office. In addition, the Company is negotiating for patent rights to certain
other related technology.
<PAGE>
 
     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. The Company has been advised that there is significant "prior art"
with respect to the LOM process utilized in the Company's 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.

     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(R) and the LOM logo.
There can be no assurance that the registered or unregistered trademarks or
trade names of the Company may not infringe upon third party rights.

     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 in the course of their
employment with the Company 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 will be able to protect its
trade secrets or that others will not independently develop substantially
equivalent proprietary information and techniques.
<PAGE>
 
Employees

     As of September 30, 1997, the Company had a total of 82 employees, of which
19 were involved in production, shipping, receiving, purchasing, quality and
manufacturing administration, 19 in engineering and research and development, 15
in sales and marketing, 16 in customer support and 13 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.


Certain Factors That May Affect The Company's Business and Future Results


     Operating Losses; Future Profitability and Liquidity Uncertain.  The
Company has experienced significant losses from operations in the most recent
fiscal year and anticipates experiencing further losses in fiscal 1998.
Although the Company anticipates achieving profitable operations in the future,
there can be no assurance that profitable operations will ever be achieved. The
Company's ability to achieve profitable operations in the future will depend in
large part on achieving significant sales of its latest-generation LOM system
machines.  There can be no assurance that, even if the Company generates
anticipated product and service sales, the Company will not continue to incur
losses from operations.  The likelihood of the long-term success of the Company
must be considered in light of the expenses, difficulties and delays frequently
encountered in the development and commercialization of new products and
competitive factors in the marketplace.  Additionally, the Company used cash of
approximately $1.8 million in operations during fiscal 1997.  While the Company
expects sales of its existing products and its latest-generation LOM systems to
support current and future levels of research and development and other
expenses, there can be no assurance that the Company will achieve such sales
levels.  Although the Company has secured $1.0 million line of credit with
Comerica Bank, if the Company is unable to generate sufficient sales or to
reduce expenses to match its sales levels, 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.

     Quarterly Fluctuations.  The Company's quarterly operating results may
fluctuate significantly due to a variety of factors, including changes in the
Company's sales and customer mix, delays in shipping new systems, the
introduction of new products and new product enhancements by the Company or its
competitors, pricing pressures, increases in expenditures relating to pursuing
the Company's business strategies, general economic conditions and other
factors.  For example, because prospective customers may defer purchasing a LOM
system in anticipation of the release of an improved system, the Company
believes that sales of its existing rapid prototyping systems may decrease in
the periods immediately preceding the introduction of new LOM systems.  In this
respect, the Company believes that sales of its earlier-generation LOM-2030 have
been adversely affected in recent periods because of the recent introduction of
its latest-generation LOM-2030H and expects that its net sales will continue to
be adversely affected during the transition to sales of its latest-generation
LOM-2030H.  In addition, the Company used a portion of the proceeds of its
initial public offering to accelerate certain product development activities.
The Company believes that the timing of these expenditures affected the
Company's results of operations in 
<PAGE>
 
the last six quarters. The decline in sales of earlier-generation LOM-2030
during this transition period, together with increased product development
expenditures, have resulted in net losses for the Company during this transition
period, including the quarter ending July 31, 1997. The Company may continue to
experience net losses in future quarters until sales of commercial quantities of
the Company's latest-generation LOM systems are achieved, and, even once such
sales levels are achieved, net losses may continue to be experienced for the
reasons previously cited. Accordingly, there can be no assurance that the
Company will be profitable in any quarter.

     Emerging Nature of Rapid Prototyping Industry; Reliance on Single Product
Line.  The rapid prototyping industry is an emerging industry, and the Company
believes that the development and future growth of the rapid prototyping
industry will relate to the general trend toward increased automation of produce
design and manufacturing processes, including the expanded use of 3-D CAD.
There can be no assurance that the use of 3-D CAD will continue to expand or
that the rapid prototyping industry otherwise will continue to develop or grow.
See "Industry Background."

     The Company has developed and markets a single product line of rapid
prototyping systems which utilize LOM technology.  The immediate prospects of
the Company will be dependent upon market acceptance of the Company's LOM
technology and systems, including the Company's latest-generation LOM systems.
There can be no assurance that the Company's LOM systems will gain significant
market acceptance or that the introduction of products embodying new or
alternate technologies or the emergence of new industry standards will not
render the Company's systems obsolete and unmarketable.  See "LOM Technology."

     Product Reliability; Ongoing Technical Challenges. Although the LOM
technology utilized in the Company's systems has been in development since 1985,
until recently there has been only limited commercial use of LOM technology in
rapid prototyping applications. In this respect, certain of the Company's
customers have experienced performance problems with the Company's first-
generation LOM systems, which from time to time have not performed to the
Company's specifications. The Company believes that it has identified all of
these problems and that the LOM systems currently being marketed by the Company
meet applicable product specifications. Until there is sufficient customer
experience with the LOM systems sold most recently by the Company, however, the
Company will be unable to determine whether its LOM systems are consistently
performing to specifications. Furthermore, no assurance can be given that new
problems will not be identified by customers or that any such problems could be
adequately addressed by the Company in a timely manner. There can be no
assurance, therefore, that the Company's customers will not make claims against
the Company arising from dissatisfaction with the performance of the Company's
LOM systems. In the first quarter of the fiscal year ending July 31, 1997, the
Company commenced sales of the latest-generation LOM-2030 system, which the
Company believes adequately addresses certain performance problems associated
with its first-generation LOM systems and represents significant improvements in
overall product performance and reliability. There can be no assurance, however,
that the Company's latest-generation LOM systems will not experience similar
performance or reliability problems. In addition, the Company is unable to
predict what effect the problems associated with its first-generation LOM
systems will have on the Company's efforts to market and sell its latest-
generation LOM systems. The immediate prospects for future growth of the Company
are dependent upon market acceptance of its latest-generation rapid prototyping
systems.

     Dependence on Proprietary Technology.  The Company's ability to compete in
the market for rapid prototyping products may depend significantly on its
ability to protect its proprietary technology.  The Company seeks to protect its
technology through a combination of patents, copyrights, trade secrets,
proprietary know-how, confidentiality agreements and ongoing development of new
products, features and designs.  Any finding that the patent claims with respect
to the Company's LOM process are invalid could 
<PAGE>
 
have a material adverse effect on the business and prospects of the Company. An
invalidation of the patent claims relating to the Company's LOM process would
not, however, affect the other claims in the United States patents relating to
the Company's LOM systems. The laws of some foreign countries do not protect the
Company's proprietary rights to the same extent as do the laws of the United
States. The Company could incur substantial costs in seeking enforcement of its
proprietary rights against infringement or the unauthorized use of its
proprietary technology by others or in defending itself against similar claims
of others. Insofar as the Company relies on trade secrets and proprietary know-
how to maintain its competitive position, there can be no assurance that others
may not independently develop similar or superior technologies or gain access to
the Company trade secrets or know-how. See "Patents and Proprietary Rights."

     Competition.  The Company's LOM systems compete with traditional
prototyping methods, such as machining, which are currently more widely used
than rapid prototyping systems.  Rapid prototyping systems are designed to be
used primarily with 3-D CAD systems, and there can be no assurance that rapid
prototyping will ever become the predominant method of producing prototypes and
other three-dimensional objects.  Within the rapid prototyping industry, the
Company is not aware of any other companies engaged in the commercial production
of rapid prototyping products using the LOM process.  However, various companies
currently offer, or are developing, rapid prototyping equipment which utilize
alternative technologies, some of which are superior in certain respects to the
Company's LOM technology.  Certain of these companies have significantly greater
financial, product development, manufacturing and marketing resources than the
Company.  Furthermore, the products introduced by any of these companies could
emerge as the industry standard or otherwise render the Company's products
obsolete or unmarketable.  In addition, the Company faces competition with
respect to the sale of sheet materials and other supplies used with its LOM
systems.  There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that the competitive
pressures faced by the Company will not adversely affect its profitability or
results of operations.  See "Competition."

ITEM 2.  PROPERTIES

     The Company's 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 is subject to two loans which aggregated $1,907,597 and $1,875,266 at
July 31, 1996 and July 31, 1997, respectively.  The Company believes that, in
general, its facility is adequately maintained, is in good condition and is
adequate for the Company's needs in the foreseeable future.  The Company may
expand its manufacturing operations within this facility in the near future, and
if it does so, it will 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 also currently leases 4,800 square feet of office space in
Auburn Hills, Michigan, which serves as a sales office and warehouse.  The
annual rent payment under the lease is $34,800, subject to certain adjustments,
and the lease expires on November 30, 1998.

ITEM 3.  LEGAL PROCEEDINGS

     The Company is not a party to any material 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.
<PAGE>
 
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, 1997.
<PAGE>
 
                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Since March 8, 1996, the Company's Common Stock has traded on the Nasdaq
National Market.  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.

<TABLE>
<CAPTION>
                                          High                 Low
                                          ----                 --- 
<S>                                      <C>                 <C>
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 July 31, 1997, 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 OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

General

     The Company designs, develops, manufactures and 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 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 
<PAGE>
 
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
began to implement cost-cutting programs in an effort to return to
profitablility. The Company has experienced significant losses from operations
in its two most recent fiscal years and anticipates experiencing further losses
in fiscal 1998. Although the Company anticipates achieving profitable operations
in the future, there can be no assurance that profitable operations will ever be
achieved. The Company's ability to achieve profitable operations in the future
will depend in large part on achieving significant sales of its latest
generation LOM system machines. Moreover, there an be no assurance that even if
the Company generates anticipated product and service sales, the Company will
not continue to incur losses from operations. The likelihood of the long-term
success of the Company must be considered in light of the expenses, difficulties
and delays frequently encountered in the development and commercialization of
new products and competitive factors in the marketplace.

     Because of these and other factors affecting the Company's operating
results, past financial performance should not be considered a reliable
indicator of future performance, and investors should not use historical trends
to anticipate results or tends in future periods.

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,
                                                      -----------------
                                                        1996     1997
                                                       ------   ------ 
<S>                                                    <C>      <C>
Net sales.......................................        100.0%   100.0%
Cost of sales...................................         53.7     59.9
                                                        -----    ----- 
Gross profit....................................         46.3     40.1
Selling, general and administrative expense.....         39.4     41.6
Research and development expense................         16.4     18.6
                                                        -----    ----- 
Loss from operations............................         (9.5)   (20.1)
Other income (expense)..........................         (1.4)    (1.9)
                                                        -----    ----- 
Loss before income tax benefit..................        (10.9)   (22.0)
Income tax benefit..............................         (3.7)     (.4)
                                                        -----    ----- 
Net loss........................................         (7.2)%  (21.6)%
                                                        =====    ===== 
</TABLE>
<PAGE>
 
Comparison of Fiscal Years Ended July 31, 1997 and July 31, 1996

     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 July 31, 1997 were approximately $14,047,000, an increase of
approximately $1,725,000 or 14%, compared to net sales of approximately
$12,322,000 for the fiscal year ended July 31, 1996. The Company sold 23 and 25
LOM-1015 systems in fiscal years 1996 and 1997, respectively, while also selling
38 and 51 LOM-2030 systems in fiscal years 1996 and 1997, respectively. The
sales increase was primarily due to the revenues generated from the increased
unit sales of the 2030H-LOM system, the first of which was shipped in October
1996. The increase took place even though there was a decrease of approximately
22% in the list price of the next generation LOM-1015 systems which began
shipping in March 1997. Foreign system shipments accounted for approximately
76.3% of units shipped as opposed to 57.9% for the fiscal year ended July 31,
1996. In addition, 67.1% of the Company's LOM system sales in fiscal 1997 were
sales of LOM-2030 systems, as compared to 62.3% of sales in fiscal 1996, and the
LOM-2030 system sells for a substantially higher price than the LOM-1015. As of
July 31, 1997, the Company had deferred gross profit in the amount of
approximately $264,000, relating to shipment of LOM systems subject to
agreements providing the customer the right to exchange such systems for
upgraded versions. The amount of deferred gross profit decreased from the
$446,000 as of July 31, 1996, as the Company fulfilled provisions of some
agreements by delivering upgraded systems during the fiscal year ended July 31,
1997.

<PAGE>
 
Information with respect to the product mix of the Company's sales in the fiscal
years ended July 31, 1997 and July 31, 1996, respectively, is as follows:

<TABLE>
<CAPTION>
Product Mix Percentage:                         Fiscal Year Ended
------------------------                        ------------------
                                      July 31, 1997           July 31, 1996
                                      -------------           ------------- 
<S>                                   <C>                     <C>
LOM Systems                                    79.1%                   77.3%
Materials and Service                          20.9%                   22.7%
LOM System Units Sold During
----------------------------
the Periods Indicated:
---------------------- 
                                         LOM-1015s                LOM-2030s
                                         ---------                ---------
Fiscal Year ended July 31, 1996                  23                      38
Fiscal Year ended July 31, 1997                  25                      51
</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, 1997 was approximately
$5,634,000, a decrease of approximately $76,000 or 1.3%, compared to gross
profit of approximately $5,710,000 for the fiscal year ended July 31, 1996.
Gross profit as a percentage of sales decreased from 46.3% in the fiscal year
ended July 31, 1996, to 40.1% in the fiscal year ended July 31, 1997.

     The decrease in gross profit as a percentage of sales was attributable
primarily to higher costs of material and labor for the LOM-2030 systems in 1997
as well as lower margins attributable to the LOM-1015 systems, whose domestic
list price had been decreased by approximately 22%.  The decrease was partly
offset by decreased sales of materials and services, which have lower margins
than systems.  Materials and service sales decreased to 20.9% of net sales
during the fiscal year ended July 31, 1997, compared to 22.7% of net sales
during the fiscal year ended July 31, 1996.  To the extent that the Company's
sales continue to consist of a greater percentage of LOM-2030s, including the
LOM-2030H, along with the reduced pricing of the LOM-1015s, the Company's gross
profit margins are unlikely to increase.  Further, there can be no assurance the
Company will be able to maintain current levels of gross profit on sales of its
LOM-2030H and LOM-1015Plus systems as compared to the LOM-2030s and LOM-1015s.

     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, 1997 were
approximately $5,848,000, an increase of approximately $991,000 or 20.4%,
compared to approximately $4,857,000 for the fiscal year ended July 31, 1996.

     The increase resulted primarily from increased spending in the areas of
advertising, trade shows, outside services, travel, hiring costs of new sales
representatives and costs related to strengthening the sales and marketing
presences of the Company.  Such additional hirings and increased expenditures
were made to facilitate the introduction and market acceptance of the LOM-2030H
and to adequately support and increase sales to existing customers with
installed LOM systems.  The Company incurred increased auditing and tax
services, outside services, and administrative-related expenses attributable to
being a public company for its first full reporting year in fiscal 1997.
However, should sales of the LOM systems, 
<PAGE>
 
materials, and services fail to match such levels of expenditures, management
anticipates re-evaluating the Company's expenditure levels.

     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, 1997 was approximately $2,609,000, an increase of
approximately $579,000, or 28.5% compared to approximately $2,030,000 for the
fiscal year ended July 31, 1996.  The increase was primarily due to development
costs (materials and personnel) related to the LOM-2030H and LOM-1015Plus and
the testing of new sheet form raw materials to be used with the Company's LOM
systems.  In addition, during the fiscal year ended July 31, 1997, the Company
realized the first full year impact of the salary and benefit expenses related
to the hiring of a highly qualified engineering staff during the latter part of
fiscal 1996.

     Increased spending on research and development expenses related to the LOM-
2030H and LOM-1015Plus was incurred during fiscal 1997 to complete these
products which were released in October 1996 and March 1997, respectively.
Significant amounts were also expended on continuing software upgrades to the
LOM operating system as well as sustaining engineering support of existing
products.  The development and testing of new materials such as plastic, which
was released in March 1996, and composite material, which the Company
anticipates will be released by the end of calendar 1997, also required
significant expenditures.  As commercial levels of production of the LOM-2030H
and LOM-1015 have been achieved, the Company expects a slight decrease in
research and development expenses in the fiscal year ending July 31, 1998.
However, there can be no assurance that increases in such expenditures will not
become necessary for unanticipated engineering or future development projects.

     Other Income (Expense).   Net other expense for the fiscal year ended July
31, 1997, was approximately $265,000, compared to other expense of approximately
$167,000 for the fiscal year ended July 31, 1996.  The change was primarily due
to the recording of $104,000 of expenses related to the 50,000 warrants issued
to Cruttenden Roth in exchange for their issuance of a $1,500,000 credit line to
the Company.  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.

     Income Tax Benefit.  The income tax benefit for the fiscal year ended July
31, 1997, was approximately $56,000 as compared to approximately $457,000 for
the fiscal year ended July 31, 1996, resulting in effective tax rates of (1.8)%
and (34.0)%, respectively.  The change was primarily due to the establishment of
a valuation account for net deferred tax assets.

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 $2,438,000 and $1,827,000 in
operations during the fiscal years ended July 31,1996, and July 31, 1997,
respectively, even though net loss increased by
<PAGE>
 
$2,145,000. The decrease in cash used in operations is primarily the result of
decreases in accounts receivable, deferred income taxes and a reduced rate of
increase in inventories.

     Working capital was approximately $2,565,000 at July 31, 1997, compared to
approximately $5,338,000 at July 31, 1996.  The decrease from July 31, 1996 to
July 31, 1997 was due primarily to the increased net loss experienced in 1997.

     Cash used in investing activities, which includes purchases of property,
plant and equipment, was approximately $664,000 and $161,000 for the fiscal
years ended July 31, 1996 and 1997, respectively. The decrease during the fiscal
year ended July 31, 1997 was primarily attributable to reduced spending for the
purchase of engineering hardware and software, information systems network
hardware and office equipment, as compared to the prior year. The Company
anticipates that its capital expenditures for the fiscal year ending July 31,
1998 will be approximately $115,000, which will be used primarily to upgrade the
facility in Torrance for such things as new roofing , air conditioning and
lighting.

     In addition to negative operating cash flow, the Company reported a net 
loss of approximately $887,000 and $3,032,000 for the years ended July 31, 1996 
and 1997, respectively. These conditions raise substantial doubt about the 
Company's ability to continue as a going concern. Management's plans to overcome
these conditions include continuing cost-cutting programs implemented in 1997
and raising additional debt and equity capital to fund operations.

     As of July 31, 1997, the Company had a revolving line of credit facility 
(the "Primary Facility") with Comerica Bank, which would have expired on May 1, 
1998, that provided for maximum borrowings of $1,500,000, subject to borrowing 
base limitations for eligible accounts receivables and inventory. Borrowings 
under the Primary Facility bore interest at the Company's option, at either 
the bank's base rate (8.5% at July 31, 1997) less .75%, or the London Inter-Bank
Market Offered Rate ("LIBOR") plus 3.00%. At July 31, 1997 there were no amounts
outstanding under the Primary Facility.

     Under the Primary Facility, the Company was subject to certain financial
covenants, including requirements for maintaining defined levels of tangible net
worth and quarterly profitability, as well as certain financial ratios. As a
result of the $3,032,000 loss reported in 1997, the Company did not comply with
certain of these covenants. In November 1997, to cure the covenant defaults, the
Company amended its existing Primary Facility and obtained an additional line of
credit facility (the "Secondary Facility") with Comerica Bank. These facilities
provide for aggregate maximum borrowings of $1,000,000.

     The amended Primary Facility, which expires February 28, 1998, provides for
maximum borrowings of $500,000, subject to borrowing base limitations for
eligible accounts receivables and inventory. Borrowings under the amended
Primary Facility bear interest, at the Company's option, at either the bank's
base rate plus 1.25%, or LIBOR plus 3.00%.

     The Secondary Facility, which expires August 1, 1998, provides for maximum 
borrowings of $500,000. Borrowings under the Secondary Facility bear interest,
at the Company's option, at either the bank's base rate, or LIBOR plus 2.75%.

     Both credit facilities are collateralized by substantially all assets of 
the Company, except for land and the building, which serves as a warehouse 
facility and corporate offices. Under the Primary Facility, the Company is
subject to certain covenants, including requirements for maintaining defined
levels of tangible net worth and quarterly profitability, as well as various
financial ratios.

     In addition to amending its existing line of credit with the bank, the
Company issued 80,000 shares of the Company's convertible Series A Preferred
Stock, $.001 par value, to an investment banker for $500,000 in November 1997.
The shares are convertible into common stock at the rate of five shares of
common stock per share of preferred stock. In connection with the issuance of
preferred stock, the investment banker agreed to guarantee the $500,000
secondary line of credit facility with the bank in exchange for a five year
warrant 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. Additional consideration of 10,000 five year warrants to
purchase the Company's common stock at $1.75 per share will be granted to the
investment banker for each $100,000 that the Company borrows under the secondary
line of credit facility. Under the terms of the preferred stock purchase
agreement, the Company is obligated to pay the investment banker a commission on
the purchase 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.

     There can be no assurance that the Company will be successful in returning 
to profitability or obtaining additional capital or that the 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.

     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 is effective for interim periods and fiscal years ending 
after December 15, 1997.  The Company does not expect that the statement will 
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.

ITEM 7.  FINANCIAL STATEMENTS

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

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

     On June 18, 1997, the Board of Directors of Helisys, Inc., a Delaware
corporation (the "Company") dismissed Arthur Andersen LLP as the Company's
auditors.  On July 10, 1997 the Company engaged Deloitte & Touche LLP as its
auditors.

     In connection with its audit for the fiscal years ended July 31, 1995 and
July 31, 1996, Arthur Andersen LLP advised the Company, including the Company's
Audit Committee of its Board of Directors, that it disagreed with the Company's
recognition of revenue with respect to sales of four rapid prototyping systems
made during each such year. Arthur Andersen LLP advised the Company as to the
requirements for revenue recognition under generally accepted accounting
principles and, consequently, the Company did not reflect such sales in the
audited financial statements for the fiscal years ended July 31, 1995 and July
31, 1996, respectively. If such sales had been reflected on the Company's
financial statements for the fiscal years ended July 31, 1995 and July 31, 1996,
respectively, then Arthur Andersen LLP would have made reference to such matters
in connection with its reports relating to such audited financial statements.
Arthur Andersen LLP's reports on the financial statements for the fiscal years
ending July 31, 1995 and July 31, 1996, respectively, contained no adverse
opinions or disclaimer of opinion, nor were they qualified or modified as to
uncertainty, audit scope or accounting principles.


                                   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 Chairman of the Board, Chief Executive Officer and Chief Technical
Officer since the Company's inception in 1990. Mr. Feygin developed the
Laminated Object Manufacturing technology ("LOM") on behalf of the Company. Mr.
Feygin completed his Bachelor of Science 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.

     Robert D. Crangle, 54, co-founded the Company's predecessor in 1985 and
served as a Director and Vice President of the predecessor until the Company was
formed in 1990. He served as Senior Vice President and Secretary of the Company
from 1990 until October 1995, and has served as a Director of the Company since
its inception in 1990. Mr. Crangle earned the Certified Management Consultant
designation in 1980 and is also an attorney admitted to the bar in
Massachusetts, Illinois, and Kansas. Mr. Crangle has been President of Rose &
Crangle, Ltd., a Kansas corporation and management consulting firm, since 1984,
emphasizing science policy as well as manufacturing operations and
entrepreneurship. He has been a practicing attorney, emphasizing business law,
with the firm of Metz and Crangle since 1987, and has been the Lincoln County,
Kansas County Attorney since 1997. Mr. Crangle received a degree in Nuclear
Engineering from Kansas State University and a law degree from Harvard Law
School.

     Dave T. Okazaki, 49, has been Chief Financial Officer, Secretary and a
Director of the Company since October 1995, 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 to raise capital to fund the manufacturing of a desktop digital film
recorder, and from December 1988 to April 1992, Mr. Okazaki 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 currently enrolled in a masters degree program.

     B. Allen Lay, 63, has been a Director of the Company since January 1997.
Mr. Lay has been Chief Executive Officer of Westbrae Natural Foods, Inc.
("Westbrae") since January 1995, and has been a director of Westbrae since 1987.
Mr. Lay was the Chief Executive Officer of Meridian Data, Inc. from July 1993 to
December 1994.  Since 1982 he has been a General Partner of Southern California
Ventures.  Mr. Lay is a director of ViaSat, Inc. and PairGain Technologies, Inc.
Mr. Lay received a degree in Industrial Management from the University of
Kansas.

     Frederick M. Haney, 56, has been a Director of the Company since March
1996.  Since May 1991, Mr. Haney has been President of The Venture Management
Company, a management consulting firm specializing in strategic growth,
technology transfer and the formation of new businesses, and has served as a
member of the Board of Directors of Adaptive Solutions, Inc., a publicly traded
developer and manufacturer of neural network and imaging processing computers.
Since September 1996, Mr. Haney has served as a member of the Board of Directors
of CAM Data Systems, Inc., a publicly traded provider of software systems for
retail establishments.  From January 1984 until March 1991, Mr. Haney was Senior
Vice President and Manager of West Coast Activities for 3i Ventures, a venture
capital firm.  Mr. Haney also currently serves on the Board of Directors of
several privately held companies, as well as Rainbow Technologies, Inc., a
publicly traded developer and manufacturer of security software.  Mr. Haney
received a Bachelor of Arts degree in Mathematics from Ohio Wesleyan University,
a Masters of Science in Mathematics from Colorado State University and a Ph.D.
in Computer Sciences from Carnegie-Mellon University.

     Jack Andersen, 59 has been Vice President-Worldwide Sales of the Company
since June 1996.  Mr. Andersen served as Director of Worldwide Sales and Service
at Industrial Electronic Engineers Inc. from June 1994 until May 1996.  From
July 1992 until May 1994, Mr. Andersen served as Vice President-Worldwide Sales
and Support of Sanyo Icon, Inc. and from January 1990 until June 1992.  Mr.
Andersen served as President of Supreme Connection, Inc., a private consulting
firm.  Mr. Andersen received a Bachelor of Science degree in Business
Administration from the University of California, Los Angeles.

<PAGE>
 
ITEM 10.  EXECUTIVE COMPENSATION.

          The following table sets forth summary information concerning
          compensation paid or accrued by the Company for services rendered
          during the two fiscal years ended July 31, 1997, to the Company's
          Chief Executive Officer and to the other executive officers employed
          by the Company as of July 31, 1997.

                           Summary Compensation Table

<TABLE>
<CAPTION>
                                                                             Long Term
                                                                           Compensation
                                        Fiscal Year                         Securities
                                           Ended                            Underlying      Other Annual
                                         July 31,      Salary     Bonus     Options (#)    Compensation(1)
 
<S>                                     <C>           <C>        <C>       <C>             <C>
Michael Feygin
 Chief Financial Officer, President
 and Chief Technical Officer.........      1997       $225,000   $ 2,647         --              --
                                           1996       $159,614   $91,942         --              --
Dave T. Okazaki
 Chief Financial Officer.............      1997       $105,000      --         16,300            --
                                           1996       $ 88,308   $15,619       22,600            --
Jack Andersen
 Vice President-Worldwide Sales......      1997       $125,000      --         20,000         $35,117
                                           1996       $ 20,708      --         30,000            --
</TABLE>
______________
(1)  Represents commissions earned.

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, 1997.

                       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        --            --               --                 --
Dave T. Okazaki     11,300          4.6%           $2.375            9/18/06
                     5,000          2.0%           $1.875             2/4/07
Jack Andersen       15,000          6.1%           $2.375            9/18/06
                     5,000          2.0%           $1.875             2/4/07
</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, 1997.

  The following table includes the number of shares covered by both exercisable
and unexercisable stock options as of July 31, 1997.  None of the options
reflected below were "in the money" at July 31, 1997 (i.e., with a positive
spread between the closing sales price as reported by NASDAQ/NMS of $1.25 per
share of Common Stock as of July 31, 1997, and the exercise price of such stock
options).

                    Aggregate Fiscal Year-End Option Values
<TABLE> 
<CAPTION> 

                             Number of Unexercised
                                   Options at
                                Fiscal Year-End
                                ---------------
                         Exercisable      Unexercisable
                         -----------      -------------
<S>                      <C>              <C>
Michael Feygin               --                  --
Dave T. Okazaki            14,255              24,645
Jack Andersen              12,250              37,750
</TABLE>


<PAGE>
 
Consulting Agreements

  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.

Director Compensation

  Each non-employee director is paid $10,000 annually for serving on the Board.
The Company has and will continue to pay the expenses of its non-employee
directors incurred in attending Board meetings.  In addition, 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 15,000 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 become 25% exercisable on the date of grant
and 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, to the knowledge of the Company, certain
information regarding the beneficial ownership of the Company's Common Stock as
of November 15, 1997, by (i) each person known by the Company to be the
beneficial owner of more than 5% of the outstanding Common Stock, (ii) each of
the Company's directors and nominees, (iii) each of the named executive officers
in the Summary Compensation Table and (iv) all of the Company's executive
officers and directors as a group.  Except as indicated in the footnotes to this
table, the Company believes that the persons named in this table have sole
voting and investment power with respect to the shares of Common Stock
indicated.

<TABLE>
<CAPTION>
                                                    Shares
        Name and Address of                      Beneficially
          Beneficial Owner                        Owned (1)
----------------------------------------------------------------------
                                            Number          Percent
                                    -------------------  --------------
<S>                                 <C>                  <C>
Michael Feygin (2)(3)                     1,993,260            49.5%

Robert D. Crangle (4)(5)                    355,178             8.8%
 102 E. Lincoln Avenue
Lincoln, Kansas  67455

Dave T. Okazaki (2)(6)                       17,255              *
</TABLE>
<PAGE>
 
<TABLE>
<S>                                          <C>                  <C>
B. Allen Lay (7)                                  5,250              *
  19 Caballeros Road
  Rolling Hills, California 90274

Jack Andersen (2)(8)                             15,174              *

Frederick M. Haney (9)                            5,250              *
  3433 Paseo del Campo
  Palos Verdes Estates, California  90274

All directors and officers as a group (10)    2,391,367            58.9%
</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 15, 1997, 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 irrevocable trust for the
     benefit of Mr. Feygin's children, over which Mr. Feygin disclaims
     beneficial ownership.

(4)  Includes 342,928 shares owned of record by Rose & Crangle, Ltd., a Kansas
     corporation ("Rose & Crangle") and management consulting firm. Robert D.
     Crangle, a Director of the Company, owns 50% of the shares of Rose &
     Crangle, and Mr. Crangle's spouse owns the remaining 50% of the shares of
     Rose & Crangle.  However, pursuant to an arrangement entered into between
     Mr. Crangle and Rose & Crangle, Ltd., Mr. Crangle is entitled to vote 100%
     of the shares of the Company owned of record by Rose & Crangle, Ltd.

(5)  Includes 3,750 shares subject to options exercisable within 60 days of
     November 15, 1997.

(6)  Includes 14,255 shares subject to options exercisable within 60 days of
     November 15, 1997.

(7)  Includes 3,750 shares subject to options exercisable within 60 days of
     November 15, 1997.

(8)  Includes 12,250 shares subject to options exercisable within 60 days of
     November 15, 1997.

(9)  Includes 3,750 shares subject to options exercisable within 60 days of
     November 15, 1997.

(10) Includes directors' and executive officers' shares listed above, including
     37,755 shares subject to options exercisable within 60 days of November 15,
     1997.
<PAGE>
 
The Company is not aware of any arrangements that may at a subsequent date
result in a change of control of the Company.


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 provides a
professional consulting services to the Company.  Such services include the
administration of research grants, preparation of business plans and other
documents, and certain contractual and other matters.  The Company paid Rose &
Crangle, Ltd. aggregate fees and reimbursed expenses of $106,935 in the fiscal
year ended July 31, 1996 and $92,460 in the fiscal year ended July 31, 1997, for
such services, the majority of which were performed by Mr. Crangle.

  In connection with the acquisition of its facility in Torrance, California,
the Company entered into a loan agreement with Bank of America in the aggregate
amount of $1,930,500, which amount is collateralized by the facility and
personally guaranteed by Michael Feygin.

  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.

  The Company's Restated Certificate of Incorporation provides that, pursuant to
Delaware Law, directors of the Company shall not be liable for monetary damages
for breach of the directors' fiduciary duty of care to the Company and its
stockholders.  This provision does not eliminate the duty of care, and in
appropriate circumstances equitable remedies such as injunctions or other forms
of non-monetary relief remain available under Delaware Law.  In addition, each
director will continue to be subject to liability for breach of the director's
duty of loyalty to the Company, for acts or omissions not in good faith or
involving intentional misconduct, for knowing violations of law, for actions
leading to improper personal benefit to the director and for payment of
dividends or approval of stock repurchases or redemptions that are unlawful
under Delaware Law.  The provision also does not affect a director's
responsibility under any other law, such as the federal securities laws.  The
Company has entered into Indemnification Agreements with each of its officers
and directors that obligate the Company to indemnify them as permitted by
applicable law.
<PAGE>
 
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:
          --------------------

     The Registrant filed a Form 8-K on June 25, 1997, as amended on July 3,
     1997 and on August 1, 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.
<PAGE>
 
                               Index to Exhibits
                               -----------------
<TABLE>
<CAPTION>
   Exhibit
    Number                                       Description of Document
   -------                                       -----------------------
 
<C>              <S>
      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 BDO Seidman, LLP on changes in certifying accountant./(1)/
     16.2        Letter from Arthur Andersen LLP on changes in certifying accountant./(4)/
     16.3        Letter from Arthur Andersen LLP on changes in certifying accountant./(5)/
     21.1        Subsidiaries of the Registrant./(1)/
     23.1        Consent of Deloitte & Touche LLP
     24.1        Power of Attorney (included on signature page hereto).
     27.1        Financial Data Schedule
</TABLE>
 
(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 ending July 31, 1996, as
     filed with the Securities and Exchange Commission.
(4)  Incorporated by reference to exhibit 16.1 of the Company's Current Report
     on Form 8-K, as filed with the Securities and Exchange Commission on June
     25, 1997, as amended on July 3, 1997 and on August 1, 1997.
<PAGE>
 
(5)  Incorporated by reference to exhibit 16.2 of the Company's Current Report
     on Form 8-K, as filed with the Securities and Exchange Commission on June
     25, 1997, as amended on July 3, 1997 and on August 1, 1997.
<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 December 3, 1997.

                                  HELISYS, INC.


Dated:  December 3, 1997        By:  /s/ Michael Feygin
                                       -----------------------------------------
                                       Michael Feygin
                                       Chairman, President, Chief Executive 
                                       Officer and Director


     We, the undersigned directors and officers of Helisys, Inc., do hereby
constitute and appoint Michael Feygin 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>
<S>                           <C>                             <C>
/s/ Michael Feygin            Chairman, President, Chief      December 3, 1997
-------------------------     Executive Officer and Director
Michael Feygin                (Principal Executive Officer)  
                              
/s/ Dave T. Okazaki           Chief Financial Officer,        December 3, 1997
-------------------------     Secretary and Director       
Dave T. Okazaki               (Principal Financial and     
                              Principal Accounting Officer) 
                              
/s/ Jack Andersen             Vice President, Worldwide       December 3, 1997
-------------------------     Sales & Marketing 
                              
/s/ Robert Crangle            Director                        December 3, 1997
-------------------------
Robert Crangle
 
/s/ B. Allen Lay              Director                        December 3, 1997
-------------------------
B. Allen Lay
 
/s/ Frederick M. Haney        Director                        December 3, 1997
-------------------------
Frederick M. Haney
</TABLE>
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS


                                                                      Page
                                                                      ----

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

Balance Sheet as of July 31, 1997....................................  F-2

Statements of Operations for the years ended July 31, 1996 and 1997..  F-3

Statements of Stockholders' Equity for the years ended July 31, 1996
  and 1997...........................................................  F-4

Statements of Cash Flows for the years ended July 31, 1996 and 1997..  F-5

Notes to Financial Statements........................................  F-6
<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, 1997, and the related statements of operations, stockholders' equity, and
cash flows for each of the two years in the period 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 audits.

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

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Helisys, Inc., at July 31,
1997, and the results of its operations and its cash flows for each of the two
years in the period 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-1
<PAGE>
 
                                 HELISYS, INC.

                                 BALANCE SHEET

                                                                   July 31, 1997
<TABLE>
<S>                                                                                                     <C>
ASSETS
Current assets:
     Cash and cash equivalents                                                                           $   626,976
     Accounts receivable, net of allowance for doubtful accounts of $357,000                               2,047,480
     Inventories                                                                                           2,544,235
     Income taxes receivable                                                                                 578,537
     Prepaid expenses                                                                                         60,619
                                                                                                         -----------
            Total current assets                                                                           5,857,847
                                                                                                         -----------
Property, plant and equipment:
     Land                                                                                                    838,000
     Building and improvements                                                                             1,344,122
     Office furniture and equipment                                                                          582,314
     Machinery and equipment                                                                                 869,252
                                                                                                         -----------
                                                                                                           3,633,688
     Less - accumulated depreciation                                                                         851,251
                                                                                                         -----------
       Property, plant and equipment, net                                                                  2,782,437
                                                                                                         -----------
Other assets                                                                                                  26,131
                                                                                                         -----------
Total                                                                                                    $ 8,666,415
                                                                                                         ===========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
     Current portion of long-term debt and
        capital lease obligation                                                                         $    42,176
     Accounts payable                                                                                      1,188,806
     Accrued liabilities                                                                                     796,496
     Customer deposits                                                                                        37,497
     Deferred maintenance revenues                                                                           963,718
     Deferred gross profits                                                                                  263,860
                                                                                                         -----------
            Total current liabilities                                                                      3,292,553
                                                                                                         -----------
Long-term debt and capital lease obligation, net of current portion                                        1,836,995
                                                                                                         -----------
Commitments and contingencies    
Stockholders' equity:
     Preferred stock, $.001 par value
       1,000,000 shares authorized, none issued
       or outstanding                                                                                             -
     Common stock, $.001 par value
       Authorized 20,000,000 shares
       Issued and outstanding 4,025,251 shares                                                                 4,026
     Additional paid-in capital                                                                            6,008,570
     Accumulated deficit                                                                                  (2,445,442)
     Deferred compensation                                                                                   (30,287)
                                                                                                         -----------
            Total stockholders' equity                                                                     3,536,867
                                                                                                         -----------

Total                                                                                                    $ 8,666,415
                                                                                                         ===========
</TABLE> 

                See accompanying notes to financial statements.


                                      F-2
<PAGE>
 
                                  HELISYS, INC.
                                        
                            STATEMENTS OF OPERATIONS


<TABLE> 
<CAPTION> 
                                                                            FOR THE YEAR ENDED
                                                                  JULY 31, 1996             JULY 31, 1997
                                                               -----------------          -----------------
<S>                                                            <C>                        <C>
Net sales..................................................        $12,322,291                $14,046,907 
Cost of sales..............................................          6,612,206                  8,413,098
                                                                   -----------                -----------
Gross profit...............................................          5,710,085                  5,633,809  
                                                                   -----------                -----------

Operating Expenses:
   Selling, general and administrative....................           4,857,033                  5,847,578 
   Research and development...............................           2,029,849                  2,608,527
                                                                   -----------                ----------- 
   Total operating expenses...............................           6,886,882                  8,456,105 
                                                                   -----------                -----------
Loss from operations......................................          (1,176,797)                (2,822,296)
                                                                   -----------                -----------

Other income (expense):
   Interest and other income..............................              62,733                     70,722 
   Interest and other expense.............................            (229,631)                  (335,899) 
                                                                   -----------                -----------
                                                                      (166,898)                  (265,177)
                                                                   -----------                -----------

Loss before income tax benefit............................          (1,343,695)                (3,087,473) 
Income tax benefit........................................            (457,000)                   (55,802)
                                                                   -----------                -----------

Net loss..................................................         $  (886,695)               $(3,031,671)
                                                                   ===========                ===========
                                                                           
Net loss per share........................................         $     (0.28)               $      (.76)
                                                                   ===========                ===========
                                                                           
Weighted average number of common shares outstanding......           3,200,000                  4,002,134
                                                                   ===========                ===========
</TABLE>

                See accompanying notes to financial statements.

                                      F-3
<PAGE>
 
                                 HELISYS, INC.

                       STATEMENTS OF STOCKHOLDERS' EQUITY

                   FOR THE YEARS ENDED JULY 31, 1996 AND 1997


<TABLE>
<CAPTION>                                                                                           

                                                      COMMON STOCK 
                                  COMMON STOCK         SUBSCRIBED       ADDITIONAL  RETAINED     ADVANCE   
                                -----------------    ---------------     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, 1995       2,645,304   $2,645    54,696    $ 55    $   32,945 $ 1,472,924        -            -    $ 1,508,569 
   Net Loss                                                                          (886,695)                            (886,695)
   Common stock issued in
     connection with initial
     public offering, net      1,266,111    1,267                       5,674,728                                        5,675,995
   Issuance of subscribed 
     shares                       54,696       55   (54,696)    (55)                                                           -
   Common stock issued to
     employees under stock
     purchase plan                25,543       25                          75,965                                           75,990
   Advance to shareholder                                                  18,750                (40,536)                  (21,786)
   Deferred compensation on
     stock options awarded
     to employee                                                           68,695                             (68,695)         -
   Amortization of deferred
     compensation on stock
     options awarded to 
     employees                                                                                                 18,216       18,216
                              -----------------------------------------------------------------------------------------------------

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

</TABLE>

                See accompanying notes to financial statements.


                                      F-4
<PAGE>
 
                                 HELISYS, INC.
                           STATEMENTS OF CASH FLOWS
<TABLE> 
<CAPTION> 
                                                                                    FOR THE YEAR ENDED
                                                                                  JULY 31,      JULY 31, 
                                                                                    1996          1997
<S>                                                                            <C>            <C> 
Cash flows from operating activities:                                        
  Net loss...................................................................  $  (886,695)   $(3,031,671)
  Adjustments to reconcile net loss to net cash used in operating activities:
   Depreciation..............................................................      313,255        431,852
   Deferred income taxes.....................................................       (6,878)       545,553
   Amortization of deferred compensation.....................................       18,216         20,192
   Impairment loss realized on advance to shareholder........................                       8,453
   Amortization of net commitment fee paid with warrants.....................           --        104,000
   Noncash compensation to shareholder.......................................       18,750             --
   Loss on disposition of property, plant and equipment......................       24,099         29,167
   Changes in operating assets and liabilities:                              
     Accounts receivable, net................................................      (67,878)       360,835
     Inventories.............................................................     (882,596)      (450,372)
     Income tax receivable...................................................     (894,670)       316,133
     Prepaid expenses........................................................      (88,085)        85,442
     Other assets............................................................         (141)         4,970
     Accounts payable........................................................      119,861       (213,765)
     Accrued liabilities.....................................................       67,352       (106,871)
     Customer deposits.......................................................     (433,820)       (12,503)
     Deferred maintenance revenues...........................................      198,571        264,019
     Deferred gross profits..................................................       62,418       (182,298)
                                                                               -----------     -----------
       Net cash used in operating activities.................................   (2,438,241)    (1,826,864)

Cash flows from investing activities:
 Purchases of property, plant and equipment..................................     (663,750)      (161,410)
                                                                               -----------     -----------
Cash flows from financing activities:
 Payments on long-term debt and capital lease obligation.....................      (54,044)       (50,603)
 Proceeds from initial public offering of common stock, net..................    5,675,995             --
Proceeds from issuance of common stock under employee stock purchase
  plan.......................................................................       75,990         65,604
 Net advance to shareholder secured by common stock..........................      (40,536)            --
                                                                               -----------    -----------
       Net cash provided by financing activities.............................    5,657,405         15,001
                                                                               -----------    -----------
Net increase (decrease) in cash..............................................    2,555,414     (1,973,273)
Cash and cash equivalents, beginning of period...............................       44,835      2,600,249
                                                                               -----------    -----------
Cash and cash equivalents, end of period.....................................  $ 2,600,249    $   626,976
                                                                               ===========    ===========
Supplemental disclosures of cash flow information:
 Cash paid during the period for interest....................................  $   229,631    $   144,670
 Cash paid during the period for income taxes................................      387,242             --
Supplemental disclosures of noncash financing and investing activities:
 Warrants issued as commitment fee to secure line of credit..................                     104,000
 Inventory transfers to property, plant & equipment..........................                     193,334
 Retirement of 6,110 shares of common stock used as collateral for
   advance to shareholder/employee that became uncollectible.................  $        --    $    32,083
                                                                               -----------    -----------
---------------------------------------------------------------------------------------------------------
</TABLE>

See accompanying notes to financial statements.

                                      F-5
<PAGE>
 
                                 HELISYS, INC.

                         NOTES TO FINANCIAL STATEMENTS
                   FOR THE YEARS ENDED JULY 31, 1996 AND 1997


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.   Going Concern

     The accompanying financial statements have been prepared assuming the
Company will continue as a going concern.  For the years ended July 31, 1996 and
1997 the Company reported a net loss of $886,695 and $3,031,671 and negative
cash flows from operations of $2,438,241 and $1,826,864, respectively.  These
conditions raise substantial doubt about the Company's ability to continue as a
going concern.  Management's plans to overcome these conditions include
continuing cost-cutting programs implemented in 1997 and raising additional debt
and equity capital to fund operations. As described in Notes 3 and 17, in
November 1997, the Company successfully amended its existing credit facility and
secured a $500,000 infusion of cash in exchange for issuing 80,000 shares of
convertible preferred stock to an investment banker. There can be no assurance
that the Company will be successful in returning to profitability, obtaining
additional capital or that the 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.

     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 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.

                                      F-6
<PAGE>
 
     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 estimates 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. Revenue from annual
product maintenance and warranty contracts is recognized ratably over the
contract period (generally, 12 months).

     Deferred gross profits consisted of the following at July 31, 1997:

<TABLE>
         <S>                                                <C> 

         Deferred revenues...............................   $350,967
         Deferred cost...................................    (87,107)
                                                            --------
                                                            $263,860
                                                            ========
</TABLE>

     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.

     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.  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 

                                      F-7
<PAGE>
 
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, 1996 and
1997, 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:

<TABLE>
<CAPTION>
                                          JULY 31,    JULY 31,
                                            1996        1997
                                          --------    --------
     <S>                                  <C>        <C>
 
     Cost incurred to date                $809,000   $1,264,000
     Gross profit recognized to date      $ 73,000   $  115,000
</TABLE>

     i.   Income Taxes

     Income taxes are accounted for by the asset and liability approach.
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 Standards

     In February, 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per
Share". The statement is effective for interim periods and fiscal years ending
after December 15, 1997.  The Company does not expect that the statement will
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.   Stock Split

     As described in Note 14, in November 1995, the Company effected a 
2,486.188-for-one split of its common stock. All share and per share amounts
included in the accompanying financial statements and footnotes have been
restated to reflect the stock split and the corresponding change in par value.

     m.   Net Income (Loss) Per Common Share

     Net income (loss) per share of common stock 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 effect has been given to options outstanding under the Company's
stock incentive plans as no material dilutive effect would result from the
exercise of these options.

                                      F-8
<PAGE>
 
2.   INVENTORIES

     Inventories consist of the following at July 31, 1997:
<TABLE>
 
       <S>                                       <C>

       Raw materials and component parts.......  $1,200,434
       Work-in-process.........................     584,070
       Finished systems........................     759,731
                                                 ----------
                                                 $2,544,235
                                                 ==========
</TABLE> 

3.   LINE OF CREDIT

     As of July 31, 1997, the Company had a revolving line of credit facility 
(the "Primary Facility") with a bank, which would have expired on May 1, 1998, 
that provided for maximum borrowings of $1,500,000, subject to borrowing base 
limitations for eligible accounts receivable and inventories. Borrowings under 
the Primary Facility bore interest, at the Company's option, at either the 
bank's base rate (8.5% at July 31, 1997) less .75%, or the London Inter-Bank 
Market Offered Rate ("LIBOR") plus 3.00%. At July 31, 1997, there were no
amounts outstanding under the Primary Facility.

     Under the Primary Facility, the Company was subject to certain financial 
covenants, including requirements for maintaining defined levels of tangible net
worth and quarterly profitability, as well as certain financial ratios. As a 
result of the $3,031,671 loss reported in 1997, the Company did not comply with 
certain of these covenants. In November 1997, to cure the covenant default, the
Company amended its existing Primary Facility and obtained an additional line of
credit facility (the "Secondary Facility") with the bank. These facilities
provide for maximum aggregate borrowings of $1,000,000.

     The amended Primary Facility, which expires February 28, 1998, provides for
maximum borrowings of $500,000, subject to borrowing base limitations for
eligible accounts receivables and inventory. Borrowings under the amended
Primary Facility bear interest, at the Company's option, at either the bank's
base rate plus 1.25%, or LIBOR plus 3.00%.

     The Secondary Facility, which expires August 1, 1998, provides for maximum 
borrowings of $500,000. Borrowings under the Secondary Facility bear interest,
at the Company's option, at either the bank's base rate, or LIBOR plus 2.75%.

     Both credit facilities are collateralized by substantially all assets of 
the Company, except for land and the building, which serves as a warehouse 
facility and corporate offices. The Secondary Facility is guaranteed by an 
investment banker (see Note 17). Under the Primary Facility, the Company is 
subject to certain financial covenants, including requirements for maintaining 
defined levels of tangible net worth and quarterly profitability, as well as 
various financial ratios.

                                      F-9
<PAGE>
 
4.   ACCRUED LIABILITIES

     Accrued liabilities consist of the following at July 31, 1997:

<TABLE>
         <S>                                             <C>
         Accrued commissions.........................    $124,714
         Accrued salaries and bonuses................      77,884
         Accrued vacation............................     142,106
         Accrued warranty............................     300,000
         Other accrued liabilities...................     151,792
                                                         --------
                                                         $796,496
                                                         ========
</TABLE>


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.

     Additionally, the Company leases certain equipment under a noncancellable
capital lease. Below is a summary of the equipment which have been capitalized
and included in property, plant and equipment in the accompanying balance sheet
at July 31, 1997:

<TABLE>
         <S>                                             <C>
         Cost........................................    $60,642
         Less:  Accumulated depreciation.............     58,958
                                                         -------
                                                         $ 1,684
                                                         =======
</TABLE>

Long-term debt and the capital lease obligation consist of the following as of
July 31, 1997:

Note payable to bank, due November 1, 2009. The note bears interest at an annual
rate of 9.47 percent with principal and interest payments of $9,484 per month
through November 1, 2009, and all unpaid principal balance due at maturity.

<TABLE> 

<S>                                                                 <C> 

Collateralized by deed of trust and other assets, as defined 
  by the note, and guaranteed by the majority stockholder........   $1,040,201
Note payable to U.S. Small Business Administration, due February 
  1, 2015. Interest accrues at 8.224 percent per year. Monthly 
  principal and interest payments are $7,955. Collateralized by 
  second trust deed..............................................      835,065
Capital lease obligation, maturing in November 1997. 
  Collateralized by certain equipment.  Payable in quarterly
  installments, including principal and interest, of $5,940.
  The loan bears interest at 11.47 percent per year..............        3,961
                                                                    ----------
                                                                     1,879,227

  Less:  Amount representing interest included in capital lease 
    obligation...................................................           56
                                                                    ----------
                                                                     1,879,171
  Less:  Current portion.........................................       42,176
                                                                    ----------
                                                                    $1,836,995
                                                                    ==========
</TABLE> 

                                      F-10
<PAGE>
 
     Future minimum principal payments for long-term debt and the capital lease
obligation at July 31, 1997, are as follows:

<TABLE>
               <S>                             <C>

               1998..........................  $   42,176
               1999..........................      41,756
               2000..........................      45,560
               2001..........................      49,711
               2002..........................      54,243
               Thereafter....................   1,645,725
                                               ----------
                                               $1,879,171
                                               ==========
</TABLE>

     The note payable to the U.S. Small Business Administration provides for a
prepayment penalty in the event the note is prepaid before the maturity date, as
defined under the agreement.

6.   INCOME TAXES

     The components of the provision (benefit) for income taxes are as follows:
<TABLE>
<CAPTION>
 
                                                 JULY 31,     JULY 31,
                                                   1996         1997
                                                ---------    ---------
         <S>                                    <C>          <C>
 
         Current:
             Federal.........................   $(450,122)   $(504,223)
             State...........................          --      (97,132)
                                                ---------    ---------
                                                 (450,122)    (601,355)
                                                ---------    ---------

         Deferred:
             Federal.........................      (6,878)    (454,013) 
             State...........................     (13,312)      50,325
             Valuation Allowance.............      13,312      949,241
                                                ---------    ---------
                
                                                   (6,878)    (545,553)
                                                ---------    ---------

         Income tax benefit..................   $(457,000)   $ (55,802)
                                                =========    =========
</TABLE> 

     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, 1997.  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, 1997, the Company has a $962,553 net deferred tax asset; however, the
Company provided a valuation allowance to offset the full amount of the net
deferred tax asset.

                                      F-11
<PAGE>
 
<TABLE>
<CAPTION>
 
                                                               JULY 31, 1997
        <S>                                                    <C> 
        Allowance for doubtful account........................  $   127,634
        Inventory adjustments.................................      103,937
        Depreciation..........................................       28,684
        Accrued expenses......................................      205,268
        Deferred gross margins................................       94,335
        Federal operating loss carryforward...................    1,084,545
        State net operating loss carryforward.................       53,606
                                                                -----------
                                                                    962,553
        Less valuation allowance..............................     (962,553)
                                                                -----------
                                                                         --
                                                                ===========
</TABLE>

      The federal and state net operating loss carryforwards, which can be 
carried to future years for possible utilization, expire through July 31, 2003 
and 2013, respectively.

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

<TABLE>
<CAPTION>
                                                      JULY 31,      JULY 31,
                                                        1996          1997
                                                      --------      --------
<S>                                                   <C>           <C>
Federal income tax provision (benefit)............      (34.0)%      (34.0)%
State income tax provision (benefit), net of 
   federal benefit................................         --         (1.0)%
Valuation allowance...............................         --         34.3%
Other (including permanent differences)...........         --         (1.1)%
                                                        -----        -----
Effective income tax provision (benefit)..........      (34.0)%       (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.  The Company believes that the fair value of
long-term debt and capital lease obligations approximates recorded value because
there have not been any significant changes in market conditions or specific
circumstances since the instruments were negotiated.

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, 1996 and 1997.
The Company paid such firm aggregate fees and reimbursed expenses of $106,935
and $92,460 in each of the fiscal years ended July 31, 1996 and July 31, 1997,
respectively.

     A director of the Company provided consulting services to the Company
during the fiscal years ended July 31, 1996 and July 31, 1997.  The fees paid to
the director totaled $32,128 and $5,400 during the fiscal years ended July 31,
1996 and 1997, respectively.

     A stockholder of the Company was the president of a sales agency which
represented the Company prior to the stockholder's joining the Company as an
employee. The total fees paid to this sales agency totaled $60,036 during the
year ended July 31, 1996. No fees were paid to this sales agency during the year
ended July 31, 1997.

                                      F-12
<PAGE>
 
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
April 2002.


      A schedule of future minimum lease payments under noncancellable operating
leases at July 31, 1997, is as follows:


<TABLE>
            <S>                            <C>

            1998.......................    $ 91,013
            1999.......................      62,587
            2000.......................      36,752
            2001.......................       8,749
            2002.......................       2,916
                                           --------
                                           $202,017
                                           ========
</TABLE>

     Rental expense for the years ended July 31, 1996 and 1997, amounted to
$64,797 and $81,391, 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, 1997. 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, financial position or 
cash flows.

10.  MAJOR CUSTOMERS

     During the years ended July 31, 1996 and 1997, $1,878,575 (15%) and
$4,303,173 (31%) of the Company's revenues resulted from sales to one customer.
At July 31, 1997, accounts receivable included balances of $290,123 from this
major customer, of which $199,900 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 10 percent of total accounts receivable at July 31, 1997.

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.

                                      F-13
<PAGE>
 
12.  COMPENSATION PLANS

     a.  1995 Stock Incentive Plan

     The Company adopted a Stock Incentive Plan (the Plan) in October 1995, and
has reserved 200,000 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).

     Options expire 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, 1996 and 1997:

<TABLE>
<CAPTION>
                                                                 Option Price
                                                           ---------------------
                                              Number of    Weighted
                                               Options     Average       Total
                                              ---------    --------    ---------
     <S>                                      <C>          <C>         <C> 
     Outstanding, August 1, 1995...........         --         --      $      --
     Granted...............................    159,670       4.20        670,815
     Cancelled.............................     (7,150)      4.34        (31,036)
                                               -------                 ---------
     Outstanding, July 31, 1996............    152,520       4.20        639,779
     Granted...............................    244,550       2.28        556,785
     Cancelled.............................   (134,620)      3.65       (491,907)
                                              --------                 ---------
     Outstanding, July 31, 1997............    262,450       2.68      $ 704,657
                                              ========                 =========
</TABLE>


     The following summarizes pricing and term information for options
outstanding as of July 31, 1997:

<TABLE>
<CAPTION>
                                         Options Outstanding                    Options Exercisable
                             ------------------------------------------      ------------------------
                                                Weighted                                  
                                Number          Average        Weighted                      Weighted
                             Outstanding       Remaining       Average       Exercisable     Average 
                             at July 31,      Contractual      Exercise      at July 31,     Exercise
                                 1997             Life          Price            1997         Price
                             -----------      -----------      --------      -----------     --------
<S>                          <C>              <C>              <C>           <C>             <C>
$1.50 to $2.25.............     92,850         9.5 years        $1.87           24,000        $1.96
2.38 to 2.50...............    116,000         9.2               2.38            2,800         2.42
4.09 to 5.50...............     53,600         8.7               4.75           15,040         4.73
                               -------                                          ------
                               262,450         9.2              $2.68           41,840        $2.99
                               =======                                          ======
</TABLE>


                                      F-14
<PAGE>
 

     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
100,000 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, 1997, 65,251 shares had been purchased, and 34,749 shares were
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 1996 and 1997 pursuant to 
SFAS 123 was approximately $273,954 and $367,662 respectively. The estimated 
fair value of stock offered to employees under the 1995 Employee Stock Purchase 
Plan during 1996 and 1997 pursuant to SFAS 123 was approximately $57,237 and 
$13,327 respectively. Had the Company adopted SFAS 123, pro forma net loss would
have been $979,815 and $3,209,470 and pro forma net loss per share would have 
been $0.31 and $0.80 for 1996 and 1997, respectively. 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:

<TABLE> 
<CAPTION> 

                                         Stock              Employee Stock
                                     Incentive Plan         Purchase Plan
                                     --------------         --------------
<S>                                  <C>                    <C> 
Dividend yield                            Zero                   Zero
Volatility                                  95%                    95%
Risk-free interest rate                    5.9%                   5.5%
Expect lives (years)                         7                    0.5
</TABLE> 

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.

14.  STOCKHOLDERS' EQUITY

     On October 30, 1995, the Board of Directors of the Company approved a
2,486.188-for-one split of the Company's common stock, which took effect in
November 1995. The stockholders approved a proposal to amend the Company's
articles of incorporation to increase the number of authorized shares from
1,000,000 to 20,000,000, of which 2,700,000 were issued and outstanding at July
31, 1995, and 300,000 were reserved for issuance under the Company's employee
stock purchase and incentive plans (see Note 11). The stated par value of each
share was changed from no par value to $.001 in connection with the stock split.
The Company reincorporated in the State of Delaware effective in November 1995.
In connection with the reincorporation, the Board of Directors and shareholders
approved an amendment to the articles of incorporation to authorize 1,000,000
shares of $.001 par value preferred stock. The Board of Directors is authorized
to issue preferred stock in one or more series and to fix the powers,
designations, preferences and rights of each series. All references to preferred
stock in the accompanying financial statements reflect the November 1995
authorization for this class of stock.

     On March 12, 1996, the Company consummated its initial public offering of
1,200,000 shares of common stock and received net proceeds of approximately
$6,000,000 prior to the payment of legal, accounting and other fees in the
aggregate amount of approximately $660,000 incurred in connection therewith.

     In connection with the initial public offering, the Company and a
stockholder of the Company granted the Company's underwriters a 45-day option to
purchase up to 170,000 and 10,000 additional shares of common stock,
respectively, to cover over-allotments, if any, on the terms and conditions as
set forth in the Company's prospectus. On April 23, 1996, the Company issued
66,111 shares to its underwriters upon their exercise of this option, and
received net proceeds of approximately $330,000 after deduction of associated
expenses.

     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, 1997.

     On November 12, 1996, the Company issued 50,000 warrants to a lender in
connection with a credit facility 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. 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
credit facility.

15.  PRODUCT RELIABILITY MATTERS

                                      F-15
<PAGE>
 
     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 and is testing flame resistant
paper and has changed the design of its LOM 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, 1997. 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
                                      ----------   ----------   ----------   ----------   -----------
     <S>                               <C>          <C>          <C>          <C>          <C>
     For the year ended July 31,
      1996
 
         Products..................   $3,383,136   $3,440,716   $1,652,823   $1,053,763   $ 9,530,438
         Supplies and services.....    1,600,439      860,803      124,792      205,819     2,791,853
                                      ----------   ----------   ----------   ----------   -----------
                                      $4,983,575   $4,301,519   $1,777,615   $1,259,582   $12,322,291
                                      ==========   ==========   ==========   ==========   ===========
 
     For the year ended July 31,
      1997
 
         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
                                      ==========   ==========   ==========   ==========   ===========
</TABLE>

17.  SUBSEQUENT EVENT

     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 five shares of common 
stock per share of preferred stock.

     In connection with the issuance of preferred stock, the investment banker 
agreed to guarantee a $500,000 secondary line of credit facility (see Note 3) 
with the bank in exchange for a five year warrant 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. Additional 
consideration of 10,000 five year warrants to purchase the Company's common 
stock at $1.75 per share will be granted to the investment banker for each 
$100,000 that the Company borrows under the secondary line of credit facility. 
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.

                                      F-16