<PAGE>

                     U.S. SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D. C. 20549

                                   FORM 1O-KSB

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

                    For the fiscal year ended January, 1 2000

             / / TRANSITION REPORT UNDER SECTION 13 OF 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

               For the transition period from ________ to ________

                        Commission File Number : 0-26226

                            MICROFIELD GRAPHICS, INC.

                 (Name of small business issuer in its charter)

         OREGON                                          93-0935149
(State or other jurisdiction                        (I. R. S. Employer
of incorporation or organization)                    Identification No.)

                                  16112 SW 72nd
                             PORTLAND, OREGON 97224
              (Address of principal executive offices and zip code)
                                 (503) 620-4000
                           (Issuer's telephone number)

       SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE
         SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
                                  COMMON STOCK

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days:
Yes /X/ No / /

Check if disclosure of delinquent filers in response 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 the Form 10-KSB or any amendment to
this Form 10-KSB. / /

Issuer's revenues for its most recent fiscal year were $ 3,492,238.

The aggregate market value of voting stock held by non-affiliates of the
registrant at March 10, 2000 was $1,163,528 computed by reference to the average
bid and asked prices as reported on the OTC Bulletin Board.

The number of shares outstanding of the Registrant's Common Stock as of March
10, 2000 was 4,132,185 shares.

The index to exhibits appears on page 14 of this document.

Transitional Small Business Disclosure Format (check one): Yes / / No /X/.



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

                            MICROFIELD GRAPHICS, INC.
                                FORM 10-KSB INDEX

                          PART I

<TABLE>
<CAPTION>
                                                                               Page
<S>                                                                              <C>
Item 1. Description of Business                                                   3

Item 2. Description of Property                                                   9

Item 3. Legal Proceedings                                                         9

Item 4. Submission of Matters to a Vote of Security Holders                       9

                                    PART II

Item 5. Market for Common Equity and Related Stockholder Matters                  9

Item 6. Management's Discussion and Analysis of Financial Condition or
         Plan of Operation                                                       10

Item 7. Financial Statements                                                     13

Item 8. Changes in and Disagreements with Accountants on Accounting
         and Financial Disclosure                                                13

                                    PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons;
         Compliance with Section 16(a) of the Exchange Act                       14

Item 10. Executive Compensation                                                  14

Item 11. Security Ownership of Certain Beneficial Owners and Management          14

Item 12. Certain Relationships and Related Transactions                          14

Item 13. Exhibits and Reports on Form 8-K                                        14
</TABLE>



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

                                      PART I

ITEM 1. BUSINESS

INTRODUCTION

Microfield Graphics, Inc. (the "Company") develops, manufactures and markets
computer conferencing and telecommunications products to facilitate group
communications. The principal purpose of these products is to make meetings more
productive and cost effective by capturing ideas from all meeting members
(whether they are located locally or linked remotely through a computer and an
audio hookup) and making the information available to all of the linked systems,
where everyone involved can see and interact with the information produced and
presented. The Company's product lines incorporate a series of digital
whiteboards, interactive rear projection systems, and interactive plasma display
systems under the brand name SoftBoard, along with a variety of application
software packages, supplies and accessories. Information written or drawn on the
SoftBoard surface is recorded and displayed on a personal computer
simultaneously and in color using the Company's proprietary technology. The
information is recorded in a computer file that can be replayed, printed, faxed,
e-mailed or saved for future applications. Optional proprietary software allows
the information to be communicated in real time to remote computers over
standard telephone lines, networks and the Internet.

The Company was incorporated in Oregon in 1986. The Company's executive offices
are located at 16112 SW 72nd, Portland, OR 97224.

PRODUCTS

The Company currently offers five product lines: the SoftBoard Series 200
Digital Whiteboards, the SoftBoard System 300 In-Wall Interactive Rear
Projection Systems, the SoftBoard System 400 Mobile Interactive Rear Projection
Systems, the SoftBoard System 500 Interactive Plasma Display Systems, and the
SoftBoard Series 500K Interactive Enhancement Kits for Plasma Displays.

The SoftBoard Series 200 Digital Whiteboards includes three models, the Model
201, a 67" diagonal writing surface, the Model 203, a 58.5" diagonal writing
surface, and the Model 205, a 42.5" diagonal writing surface. Each SoftBoard can
be purchased for use with either an IBM-compatible personal computer (PC) or a
Macintosh computer. Each SoftBoard includes the Company's proprietary bundled
application software that stores the information written on SoftBoard surface in
a computer file and provides capabilities for playback, printing, distribution
and use in other applications. The playback feature uses a VCR-like interface
and allows the user to review information recorded on the SoftBoard,
stroke-by-stroke,page-by-page, or to move rapidly between multiple pages of a
session. The writing surface of each SoftBoard is high-quality,
porcelain-on-steel.

The SoftBoard System 300 product line includes the Model 301 and the Model 303.
The SoftBoard System 300 is a SoftBoard with a translucent writing surface in
place of the porcelain writing surface. Designed for group presentations and
interaction, the SoftBoard System 300 is either built into a false wall, behind
which the projector is placed, or is designed into a custom cabinet that also
houses the projector. The SoftBoard interactive technology then enables the user
to interact with the application and the data displayed on the screen.

The SoftBoard System 400 product line integrates a SoftBoard into a mobile
rear-projection system. In this application, the porcelain-on-steel SoftBoard
writing surface is replaced with a translucent writing surface. Integrated into
the unit is an LCD projector which projects the output of a connected PC onto
the rear surface of the translucent screen of the SoftBoard. Pen strokes on the
SoftBoard surface (using an electronic pen) are then captured and transmitted
through the PC to the LCD projector and then onto the rear of the SoftBoard
surface, in electronic ink. The electronic pen also acts as a mouse and allows
the user to interact with the software that is displayed on the SoftBoard
surface. This product creates a room-sized interactive multimedia computer
screen, allowing a user to combine information already in a computer file with
new information created during a collaborative session. The data can be shared
with a computer hooked up directly in the



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

room, with a computer somewhere else on the network, or over the Internet with
one or more remote sites. The SoftBoard System 400 enhances both single-site and
multiple-site meetings due to the interactivity of the rear-projection system.
The SoftBoard System 400 allows groups of people either in one location or in
multiple locations to view the information in a room-sized setting and to
interact with the information in the computer file in all locations.

The SoftBoard System 500 product line currently consists of seven different
models. The SoftBoard System 500 models integrate the SoftBoard proprietary
laser scanning data acquisition technology with a gas plasma display. The plasma
displays are large flat panel monitors that can be hung on walls, mounted on
mobile carts or stands, and connected to a personal computer. Through use of the
SoftBoard laser scanning technology, and SoftBoard's electronic pen, the user
interacts with the software on the surface of the plasma display in the same
manner as he would by using a mouse. The user can interact with any software
program, presentation, or conferencing software and allow a room full of meeting
participants to see the product of his work as he is creating it.

This interactive plasma display and its local computer can be connected to other
remotely located computers and plasma displays anywhere in the world. These
attached systems allow the remote users to interact with each other by sharing
each others' files and manipulating the data from any of the locations as the
work sessions dictate. The benefit of this technology is that one can have a
meeting with groups of people located anywhere in the world, where the
participants can interact with each other, share and manipulate each others'
data, without the cost and time involved with bringing each meeting participant
to one location.

The SoftBoard Series 500K Interactive Enhancement Kit product line currently
consists of seven models which enable a user to integrate the SoftBoard
interactive technology with the gas plasma display of their choice. Kits are
currently available for Pioneer, Fujitsu, NEC, and Sony plasma displays. Once
assembled, the integrated system has the full interactive display capabilities
of the System 500 product line.

SoftBoard System 300, 400, 500 and 500K products are marketed under the
trademark Group Desktop-TM- Products.

PRODUCT DEVELOPMENT

During 1999, the Company's engineering efforts were primarily focused on new
product development of advanced versions of 200 Series products, additional
System 500K interactive plasma display kits for new plasma display models and
System 400 upgrades for new projector models.


MARKETING, SALES AND DISTRIBUTION

The Company markets its SoftBoard products to resellers, OEMs, and end users in
the United States and to distributors, resellers, and end users outside the
United States.

In July 1997, the Company entered into a two-year general purchase and
development agreement with 3M through which 3M marketed, on a global basis,
advanced versions of the Company's SoftBoard products under the 3M brand name
"Ideaboard." Shipments to 3M began in the fourth quarter of 1997, and totaled
1422 units through the end of 1998. 3M has not purchased any significant
quantities of SoftBoard products since June 1998. The agreement between 3M and
the Company expired in July 1999. SEE MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION OR PLAN OF OPERATIONS.

In April 1999, the Company was informed by 3M of its decision to exit the
Advanced Meeting Solutions (AMS) Project under which the SoftBoard family of
products was marketed by 3M. The Company reached an agreement with 3M under
which the Company assumed responsibility for 3M's global distribution network of
whiteboard products. In this role, the Company will support digital whiteboard
product sales, service and warranty obligations for all of 3M's installed base
and dealer network affected by their withdrawal from the AMS Project. The
reduced level of sales to 3M and their announced exit from the AMS program has
had a material adverse effect on the Company's business. The Company believes
that 3M's


SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

liquidation of its inventory of Ideaboard products negatively impacted
sales of its SoftBoard digital whiteboard products during the first half of
1999. Unit sales in this product line have been strengthening, reflecting
completion of the 3M liquidation program, the recent expansion of the Company's
dealer base as previously announced, and new product pricing strategies which
the Company introduced in mid-1999.


MANUFACTURING AND SUPPLY

The principal components of the various SoftBoard models consist of lasers,
scanners, electronic subassemblies, the porcelain-on-steel and translucent glass
writing surfaces, metal housing and frame parts, LCD projectors, and plasma
display monitors. The Company buys and tests parts manufactured to its
specifications and delivers certain electronic components to subcontractors for
subassembly. The Company assembles the final product. Final assembly includes
precise alignment of the lasers and scanners and final testing. The Company
generally ships products from its facility within one day after receipt of an
order.

Certain components of the Company's products are purchased from single sources.
The Company believes alternative sources are available and could be located and
qualified for all components. The Company does not, however, have any long-term
supply contracts with any vendors. Although a component may be available from
more than one supplier, the Company could incur delays in switching suppliers,
which could have an adverse effect on the Company's sales and results of
operations.


COMPETITION

The Company believes the ability to compete effectively in the market for
computer-assisted conferencing and presentation products generally, and
electronic whiteboards particularly, depends upon price and key product
characteristics, including ease of use, positional accuracy, reliability,
durability and applications software.

There are a small number of competitors selling electronic whiteboards. Most of
the competitors that manufacture electronic whiteboards with capabilities
somewhat similar to those of SoftBoard use pressure-sensitive surfaces, which
the Company believes are generally awkward to use because of the pressure
required to register the writing and which the Company believes are less durable
than SoftBoard's porcelain-on-steel writing surface. Additionally, the Company
believes SoftBoard's functionality and long-term reliability is significantly
greater than current competitors.

The Company also competes with manufacturers of simple electronic copyboards,
conferencing software and front- and rear-projection systems. Electronic copy
boards, which generally range in price from approximately $1,500 to
approximately $4,500, provide only black and white printouts on thermal paper,
may or may not be connected to a computer and offer limited ability to store the
screen image for subsequent playback and review or transmission to remote
locations. In addition, the meeting or presentation process is typically
interrupted and delayed while participants wait for the written information to
be scanned and copied.

Certain software products provide conferencing and "shared whiteboard"
capabilities in software. The users run an application on the PC that allows
them to mark up documents on computer screens and share them with other users on
a network. Input is limited to keyboard, mouse or graphics tablet; few of these
products have the capability to draw or write on a whiteboard surface. These
software-only products do not allow for a group of people in the same room to
share and interact with the information. The Company believes these software
"shared whiteboard" products are complementary to SoftBoard because SoftBoard
provides an input device that can be used directly with many of these software
products.

The Company is aware of several competitors that offer a rear-projection


SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

system. The competitive systems use a pressure sensitive surface. With pressure
sensitive technology a limited amount of light can be projected through the
writing surface making it more difficult for the user and any other participants
to view the image on the display, thereby requiring the lights in the meeting
room to be turned off. Their product is also subject to alignment problems if
moved even slightly, and is not supplied with an integrated LCD projector. The
Company believes that the System 400 is superior to this product because of the
greater amount of light that is delivered through the System 400 writing
surface, it can be moved across the room or around the world with minimal, and
often no, alignment problems and it is complete and ready to connect to a
personal computer for immediate use.

The Company is aware of several competitors that offer an interactive kit for
plasma displays with the same or similar functionality that the System 500K
models possess. These competitive products typically utilize pressure sensitive
technology with its inherent disadvantages of diminished brightness, smudging,
and reduced viewing angle.

Many of the Company's competitors are more established, benefit from greater
name recognition and have significantly greater financial, technological,
production and marketing resources than the Company. In addition, many of these
companies have large and established sales forces and have been selling their
products to the same customers targeted by the Company for a substantial period
of time. The market acceptance of certain competing products that are based on
different technologies or approaches could have the effect of reducing the size
of the market for the Company's products, resulting in lower prices and erosion
of the Company's gross profit.

INTELLECTUAL PROPERTY

The Company was issued United States Patent No. 5,248,856 in September 1993
for the main graphic data-acquisition technology incorporated in Softboard.
Canadian Patent No. 2100624 covering this technology was issued to the
Company in July 1997. European patent No. 0600576 covering the system
technology was issued to the Company in October 1998. In April 1997, the
Company was issued U. S. Patent No. 5,623,129 covering the code-based,
electromagnetic-field-responsive graphic data-acquisition system. In
September 1997, the Company was issued U. S. Patent No. 5,665,942 for the
optical scanning system employing laser and laser safety control.

The Company currently holds eight separate patents on various technology
incorporated in the SoftBoard products. In addition, the Company will file
other patent applications for new SoftBoard product features and technology.
The Company relies on copyright protection for its proprietary software.
Additionally, SoftBoard-TM- and Microfield Graphics-TM- are registered
trademarks of the Company in the United States, and trademark applications
have been filed for the phrases "See What I'm Saying," and "Group Desktop."

The Company protects its intellectual property rights through a combination of
patents, copyrights, trade secret and other intellectual property law,
nondisclosure agreements and other measures. The Company believes, however, that
its financial performance will depend more upon the innovation, technological
expertise and marketing abilities of its employees than upon such protection.



GOVERNMENT REGULATION

SoftBoard uses low-powered infrared lasers, similar to those used in compact
disc players and laser printers. The Company has independently tested its
products and believes they comply with the applicable industry and governmental
safety requirements for lasers.

EMPLOYEES

As of March 10, 2000 the Company employed 20 persons. None of the



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

Company's employees are covered by collective bargaining agreements, and the
Company believes its relations with its employees are good.

ITEM 2. PROPERTIES

The Company's facilities in Portland, Oregon, consist of approximately 12,000
square feet of office and manufacturing space. The Company occupies this
facility pursuant to a lease, commencing April 1, 2000 and expiring on June 30,
2003, at a base rent of $6,720 per month.


ITEM 3. LEGAL PROCEEDINGS

During February 2000, the company was named in a class action lawsuit, Adair v.
Microfield Graphics, Inc. Et ano., 00 CIV. 0629 (MBM), UNITED STATES DISTRICT
COURT SOUTHERN DISTRICT OF NEW YORK. The complaint alleges that the Company and
its Chief Executive Officer issued a series of false and misleading statements
concerning, among other things, the Company's purchase agreement with 3M. The
complaint alleges that, as a result of these allegedly material misstatements
and omissions, the Company's stock price was artificially inflated during the
period from July 23, 1998 through April 2, 1999 and requests that damages be
determined at trial. The Company denies the allegations and intends to
vigorously defend itself. However, the ultimate outcome of the litigation is
presently undeterminable.

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

No matters were submitted to a vote of the Company's shareholders during the
Quarter ended January 1, 2000.


PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Since October 30, 1999, the Company's common stock has been quoted on the OTC
Bulletin Board under the symbol "MICG." Prior to that date the Company's common
stock was quoted on the Nasdaq SmallCap Market under the same symbol. The
following table sets forth the high and low sales prices as reported by the OTC
Bulletin Board or the Nasdaq SmallCap Market,as appropriate, for the periods
indicated.

<TABLE>
<CAPTION>
                         LOW               HIGH
                         ---               ----
<S>                     <C>              <C>
FISCAL 1998
First Quarter           $ 3 5/8          $ 8 3/4
Second Quarter            4 1/16           9 3/16
Third Quarter             2                4 15/16
Fourth Quarter            1 3/8            2 7/8

FISCAL 1999
First Quarter           $ 1 7/8          $ 2 3/8
Second Quarter             15/16           2 1/16
Third Quarter               9/16           1 1/16
Fourth Quarter              1/4              5/8
</TABLE>

There were 143 shareholders of record and the Company believes approximately
1600 beneficial shareholders at April 10, 2000. There were no cash dividends
declared or paid in fiscal years 1999 or 1998. The Company does not anticipate
declaring such dividends in the foreseeable future.

On October 5, 1999, the Company issued to its bank a warrant to purchase 20,000
shares of the Company's common stock at a purchase price of $0.75 per share. The
warrant was issued in connection with the Forebearance Agreement dated October
15, 1999 between the Company and the bank. The Company received no cash
consideration for the warrant. The warrant



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

expires in October 2003. The issuance was exempt from registration under Section
4(2) of the Securities Act of 1933, as amended (the "Act), because the bank is
an accredited investor, as that term is defined in Rule 501 of the Act, and the
transaction fell within the parameters of Rule 506 of the Act.

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

OVERVIEW

The Company develops, manufactures and markets computer conferencing and
telecommunications products to facilitate group communications. The principal
purpose of these products is to make meetings more productive and cost effective
by capturing ideas from all meeting members (whether they are located locally or
linked remotely through a computer and an audio hookup) and making the
information available to all of the linked systems, where everyone involved can
see and interact with the information produced and presented. The Company's
product lines incorporate a series of digital whiteboards, interactive rear
projection systems, interactive plasma display systems, and interactive
enhancement kits for plasma displays under the brand name SoftBoard, along with
a variety of application software packages, supplies and accessories.
Information written or drawn on the SoftBoard surface is recorded and displayed
on a personal computer simultaneously and in color using the Company's
proprietary technology. The information is recorded in a computer file that can
be replayed, printed, faxed, e-mailed or saved for future applications. Optional
proprietary software allows the information to be communicated in real time to
remote computers over standard telephone lines, networks and the Internet.

In July 1997 the Company entered into a General Purchase and Development
Agreement with Minnesota Mining and Manufacturing Company (3M), under which 3M
globally marketed advanced versions of the Company's SoftBoard family of
products. Under the terms of the two year agreement, the Company developed
specialized versions of the SoftBoard product line exclusively for 3M. Shipments
from the Company to 3M began in the fourth quarter of 1997 and continued through
the second quarter of 1998. For the year ended January 1, 2000 and January 2,
1999, approximately 0% and 38%, respectively, of the Company's sales were
attributable to 3M.

In April 1999, the Company was informed by 3M of its decision to exit the
Advanced Meeting Solutions (AMS) Project under which the SoftBoard family of
products was marketed. The Company reached an agreement with 3M under which the
Company assumed responsibility for 3M's global distribution network of
whiteboard products. In this role, the Company will support digital whiteboard
product sales, service, and warranty obligations for all of 3M's installed base
and dealer network affected by their withdrawal from the AMS Project. The
reduced level of sales to 3M and their announced exit from the AMS program has
had a material adverse effect on the Company's business. The Company believes
that 3M's liquidation of its inventory of Ideaboard products negatively impacted
sales of its SoftBoard digital whiteboard products during 1999. Unit sales in
this product line have been strengthening, reflecting completion of the 3M
liquidation program, the recent expansion of the Company's dealer base as
previously announced, and new product pricing strategies which the Company
introduced in mid 1999.

In March 1998 the Company signed a Common Stock Purchase Agreement with
Steelcase Inc. (Steelcase), pursuant to which Steelcase purchased 350,000 shares
of the Company's common stock and a warrant for a total of $2,012,500 in cash.
The warrant gives Steelcase the right to purchase an additional 260,000 shares
of the Company's common stock at $6.75 per share. The warrant is exercisable
starting on March 16, 1999 and expires on March 16, 2001. In March 1999,
Steelcase purchased an additional 444,445 shares for a total of $1,000,001 in
cash. As of January 1, 2000 Steelcase owned 19% of the outstanding common stock
of the Company.

At the end of the second quarter of 1999, the Company introduced a major
restructuring to realign operating expenses with sales levels while retaining
critical functions in key operational areas. Total overhead expense was reduced
by approximately 50% through a combination of staff reductions, workweek
reductions, temporary executive salary reductions, and reductions in general
expense spending levels, including negotiating a satisfactory termination of the
company's existing facilities lease in January 2000 and entering into a lease
for a new facility with a lower lease cost. As a result, the



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

Company has delayed the previously reported Joint Development Agreement with
Steelcase Inc. entered into in the first quarter of 1999. In the near term, the
Company is focusing efforts on expanding product offerings based on its current
technology. It is the Company's intention to resume the joint product
development program with Steelcase when the Company achieves profitability on a
sustainable basis. There is no assurance that the development program will be
resumed or that the restructuring will return the Company to profitability. Also
at the end of the second quarter of 1999, the Company introduced a product price
reduction in its 200 Series digital whiteboard product line. Prices were
adjusted to achieve closer parity with competing products in the marketplace.

The Company's ongoing results will depend on continued and increased market
acceptance of the Company's products and the Company's ability to modify them to
meet the needs of its customers. Any reduction in demand for, or increasing
competition with respect to, these products would have a material adverse effect
on the Company's financial condition and results of operations.

RESULTS OF OPERATIONS

The following table sets forth, as a percentage of sales, certain consolidated
statement of operations data relating to the SoftBoard business for the periods
indicated.


<TABLE>
                                            FISCAL         FISCAL
                                            1999           1998
                                            ------         ------
<S>                                         <C>            <C>
Net sales                                    100 %          100 %
Cost of goods sold                            65             59
                                            ----           ----
         Gross profit                         35             41
Research and development expenses            (18)           (15)
Marketing and sales expenses                 (47)           (40)
General and administrative expenses          (25)           (14)
                                            ----           ----
Loss from operations                         (55)           (28)
Other expense, net                            (3)            (1)
                                            ----           ----
Loss before income taxes                     (58)           (29)
Benefit from income taxes                      -              -
                                            ----           ----
Net loss                                     (58)%          (29)%
                                            ----           ----
                                            ----           ----
</TABLE>
SALES. Total sales decreased $3,153,910 (48%) to $3,492,238 in 1999 from
$6,646,148 in 1998. In fiscal 1999, export sales aggregated $665,000 (19% of net
sales), compared to $1,826,703 (27% of net sales) in 1998. The decline in sales,
including export sales, was due primarily to 3M's decision to exit the Advanced
Meeting Solutions (AMS) Project under which the SoftBoard family of products was
marketed. Sales to 3M accounted for $2,551,000 in 1998. There were no sales to
3M in 1999.

GROSS PROFIT. Cost of goods sold includes the cost of raw materials needed to
assemble the product, assembly and preparation by vendors and direct and
indirect costs associated with the procurement, testing, scheduling and quality
assurance functions performed by the Company. The Company's gross margin was 35%
in 1999, down from 41% in 1998. The decrease in gross margin was primarily the
result of lower sales volumes resulting in decreased manufacturing overhead
absorption in 1999 compared to 1998.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development costs are expensed
as incurred. Research and development expenses decreased $363,000 (36%) to
$635,000 in 1999 from $998,000 in 1998. The decrease was due primarily to the
Company restructuring implemented at the end of the second quarter. Research and
development expenses, as a percentage of sales, were 18% and 15% in 1999 and
1998, respectively.



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

MARKETING AND SALES EXPENSES. Marketing and sales expenses decreased $1,003,000
(38%) to $1,655,000 in 1999 from $2,658,000 in 1998. The decreases were due
primarily to significantly lower advertising and trade show expense during 1999.
The Company undertook changes in the methods it used to generate sales leads
during the current year. Marketing and sales expenses increased as a percentage
of sales to 47% in 1999 from 40% in 1998.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased $93,000 (10%) to $867,000 in 1999 from $960,000 in 1998. The
restructuring efforts were the primary cause of the decrease in general and
administrative expenses. General and administrative expenses, as a percentage of
sales, were 25% in 1999 compared to 14% in 1998. The increase in percentage
compared to sales was due to the lower total sales in 1999.

OTHER INCOME (EXPENSE). Other income (expense) includes interest income,
interest expense and miscellaneous income. Other expense increased by $57,000 to
107,000 in 1999, from $50,000 in 1998. The increase was primarily due to a legal
settlement and related expenses of approximately $23,000 and a one time
non-recurring charge of $26,000 related to the restructuring. (See Overview)

INCOME TAXES. As of January 1, 2000 the Company had available net operating loss
carryforwards of approximately $14 million for federal income tax purposes. Such
carryforwards may be used to reduce consolidated taxable income, if any, in
future years through their expiration in 2003 to 2020. Utilization of net
operating loss carryforwards may be limited due to the ownership changes
resulting from the Company's initial public offering in 1995 and other stock
transactions. In addition, the Company has research and development credits
aggregating approximately $285,000 for income tax purposes at January 1, 2000.
Such credits may be used to reduce taxes payable, if any, on a consolidated
basis in future years through their expiration in 2001 to 2020. SEE NOTE 7 OF
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, the Company has financed its operations and capital
expenditures through public and private sales of equity securities, cash from
operations, and borrowings under bank lines of credit. At January 1, 2000 the
Company had working capital of approximately $4,000 and its principal sources
of liquidity consisted of $113,000 in cash and cash equivalents. Accounts
receivable decreased $532,000 to $266,000 at January 1, 2000 from $798,000 at
January 2, 1999. This was due to decreased sales in the fourth quarter of 1999
compared to fourth quarter sales in 1998 and to improved account collection
policies implemented as part of the restructuring and cost reduction plan.
Inventories decreased $449,000 to $497,000 at January 1, 2000 from $946,000 at
January 2, 1999. This decrease was due primarily to the lowering of inventory
levels implemented as part of the restructuring and cost reduction plan, and to
the lower level of sales in the fourth quarter of 1999. Accounts payable
decreased $194,000 to 338,000 at January 1, 2000 compared to 532,000 at January
2, 1999 as a result of the improved purchasing policies implemented as part of
the restructuring and cost reduction plan.

The Company has a line of credit with its bank using its accounts receivable and
certain of its inventory as collateral. The Loan Agreement for the line of
credit expired on September 8, 1999, at which time $524,000 was outstanding
under the line of credit. The Company and the bank continued to operate under
the terms of the Loan Agreement until new terms were formalized on October 25,
1999. At September 8, 1999 and at October 2, 1999, the Company was not in
compliance with the minimum tangible net worth financial covenant of its Loan
Agreement with the bank. On October 15, 1999, the bank delivered a notice of
default and the Company subsequently entered into a Forbearance Agreement which
provides for a reduction in the line of credit to $650,000, the elimination of
inventory from the collateral base over a 14 month period, an interest rate
increase, and certain financial covenants with which the Company must comply.
The Forbearance Agreement period is through April 30, 2000. The operating line
bears interest monthly at prime plus 2.5% under terms of the Forbearance
Agreement. At January 1, 2000 $296,000 was available on the line of credit. The
interest rate in effect on January 1, 2000 was 11%. In the event that the
Forbearance Agreement is not extended or the Loan Agreement is not renewed, and
the



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

company is unable to obtain substitute financing at acceptable terms, the
Company's business and financial condition will be materially and adversely
affected.

During 1999, the Company experienced significantly reduced sales and negative
cash flows from operations. The reduction was due primarily to the loss of
sales from 3M, a major OEM customer. At the end of the second quarter of
1999, the Company concluded that it might not have sufficient funds to
operate for at least twelve months. Management based such conclusions on the
reduction in sales and resulting losses that occurred during the first six
months of 1999, coupled with diminishing cash resources (cash and cash
equivalents, and cash available under its operating line of credit). In
response, management restructured its operations through a combination of
staff reductions, workweek reductions, temporary executive salary reductions
and reductions in general expense spending levels. The company anticipates
spending levels to continue to decline over the next several months as the
effect of the implemented restructuring stabilize. However, there can be no
assurance that the Company will achieve profitability.

In March 1998 the Company signed a Common Stock Purchase Agreement with
Steelcase Inc. (Steelcase), pursuant to which Steelcase purchased 350,000 shares
of the Company's common stock and a warrant for a total of $2,012,500 in cash.
The warrant gives Steelcase the right to purchase an additional 260,000 shares
of the Company's common stock at $6.75 per share. The warrant is exercisable
starting on March 16, 1999 and expires on March 16, 2001. In March 1999,
Steelcase purchased an additional 444,445 shares for a total of $1,000,001 in
cash. As of January 1, 2000 Steelcase owned 19% of the outstanding common stock
of the Company.

The Company has no commitments for capital expenditures in material amounts.

IMPACT OF THE YEAR 2000 ISSUE

Many computer systems have been expected to experience problems distinguishing
between dates in different centuries because such systems were developed using
two digits rather than four digits to determine the applicable year.
Consequently, there was concern that these systems would be unable to
distinguish between dates in different centuries and could have experienced
errors resulting in system failures or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities. To
date, we have not experienced any problems complying with the Year 2000 issues
and have not been informed of any failures of our products from customers. These
problems, however, may not be discovered until months after January 1, 2000.

ITEM 7. FINANCIAL STATEMENTS

The Consolidated Financial Statements, together with the report thereon of
PricewaterhouseCoopers LLP are included in this report as follows:

<TABLE>
Microfield Graphics, Inc.:                                         Page

<S>                                                                <C>
Report of Independent Accountants                                  F-1

Consolidated Balance Sheets
         January 1, 2000 and January 2, 1999                       F-2

Consolidated Statements of Operations for the years
         ended January 1, 2000 and January 2, 1999                 F-3

Consolidated Statements of Shareholders' Equity for the
         years ended January 1, 2000 and January 2, 1999           F-4

Consolidated Statements of Cash Flows for the years ended
         January 1, 2000 and January 2, 1999                       F-5

Notes to Consolidated Financial Statements                         F-6
</TABLE>


SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

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

         None.


                                    PART III

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

         The names, ages and positions of the Company's executive officers and
directors are as follows:

<TABLE>
NAME                     AGE         CURRENT POSITION(S) WITH COMPANY
-------------------------------------------------------------------------------------------------
<S>                      <C>         <C>
John B. Conroy           61          Chairman of the Board, President and Chief Executive Officer
Michael W. Stansell      57          Vice President, Operations and Sales
William P. Cargile       58          Director
Herbert S. Shaw          64          Director
</TABLE>



JOHN B. CONROY joined the Company in May 1986 and was appointed
President and elected a Director that same month. Mr. Conroy was designated
Chief Executive Officer by the Board of Directors in January 1987, and
appointed Chairman of the Board of Directors in June 1996. Mr. Conroy
previously held executive management positions with a number of computer
industry companies, has served as a Director of several, and holds a BSEE
from New York University.

MICHAEL W. STANSELL joined the Company in November 1985 as Director of
Manufacturing and was appointed Vice President, Operations, in January 1987.
Mr. Stansell was a division manufacturing manager, among other positions, at
Tektronix Corporation from August 1965 through October 1985.

WILLIAM P. CARGILE was elected to the Board of Directors in February 1989. Mr
Cargile was a General Partner of Crosspoint Venture Partners from April 1983
until December 1995, at which time he became a Venture Partner of Crosspoint
Venture Partners.

HERBERT S. SHAW was elected to the Board of Directors in June 1997. Mr. Shaw has
been the Managing Partner of NorCrest Ltd. and Chairman of NorCrest Capital
Management LLC, an investment banking company, since January 1996. From February
1992 to December 1995 Mr. Shaw was the President and CEO of The Laughlin Group,
a financial services and investment group of companies.

ITEM 10. EXECUTIVE COMPENSATION

The following table provides certain summary information concerning compensation
awarded to, earned by or paid to the Company's Chief Executive Officer and other
executive officers of the Company whose total annual salary and bonus exceeded
$100,000 (collectively, the "named officers") for fiscal years 1999, 1998 and
1997.

<TABLE>
<CAPTION>
                                      SUMMARY COMPENSATION TABLE
                                                                                     LONG TERM
                                                                                 COMPENSATION
                                                                                      AWARDS
                                             ANNUAL COMPENSATION                 ----------------
                                   -----------------------------------------        SECURITIES
                                                                                    UNDERLYING          ALL OTHER
                                    FISCAL                                            OPTIONS          COMPENSATION
                                     YEAR       SALARY($)        BONUS($)               (#)               ($)(1)
                                   ------- ------------------ --------------     ----------------    ---------------
<S>                                  <C>        <C>                <C>               <C>                   <C>
John B. Conroy                       1999       185,192            --                100,000                --
  Chairman of the Board of           1998       219,154            --                 75,000                --
  Director, President, and           1997       206,451            --                 60,000                --
  Chief Executive Officer
</TABLE>



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

    (1) The aggregate amount of perquisites and other personal benefits was less
        than either $50,000 or 10% of the total of the annual salary and bonus
        reported for each of the names officers.

    ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of Common Stock of the Company as of March 10, 2000 as to (i) each
person who is known by the Company to own beneficially more than 5% of the
outstanding shares of Common Stock, (ii) each director or nominee for director
of the Company, (iii) each of the executive officers named in the Summary
Compensation Table below and (iv) all directors and executive officers as a
group. Except as otherwise noted, the Company believes the persons listed below
have sole investment and voting power with respect to the Common Stock owned by
them. As of March 10, 2000 John B. Conroy, William P. Cargile, Michael W.
Stansell (collectively, the "Executives"), Steelcase Inc. and the Company were
parties to a Share Ownership, Voting and Right of First Refusal Agreement dated
March 19, 1998 (the "Voting Agreement"). On the date of the Voting Agreement,
the Executives were directors and executives of the Company. Pursuant to the
Voting Agreement, Steelcase and the Executives are obligated to vote their
shares of Common Stock to elect certain individuals to the Board of Directors of
the Company, including one individual designated by Steelcase (James B. Keane,
Steelcase's original designee, resigned on February 17, 2000 and Steelcase has
not identified a replacement for his seat.), Mr. Conroy and three independent
directors as directed by majority of the Board of Directors (currently only
Messrs. Shaw and Cargile have been designated). With regard to matters other
than the election of directors, Steelcase has agreed to vote all of its shares
of Common Stock that it may own in excess of 610,000 shares in direct proportion
of the votes of all outstanding shares of Common Stock. Each party to the Voting
Agreement is deemed the beneficial owner of the shares of Common Stock
beneficially owned by each other party to the Voting Agreement.

<TABLE>
                                                                                COMMON STOCK
----------------------------------------------------------         ----------------------------------------

        FIVE PERCENT SHAREHOLDERS, DIRECTORS, DIRECTOR                  SHARES          APPROXIMATE
            NOMINEES AND CERTAIN EXECUTIVE                           BENEFICIALLY        PERCENTAGE
                         OFFICERS                                      OWNED (1)           OWNED
----------------------------------------------------------         ----------------------------------------

           <S>                                                      <C>                 <C>
           Steelcase Inc.(6)                                              1,459,228               35.3  %
             P. O. Box 1967
             Grand Rapids, MI  49501-1967

           John. B. Conroy (2) (3)                                        1,459,228               35.3  %

           William P. Cargile (2) (4)                                     1,459,228               35.3  %

           Herbert S. Shaw (2) (5)                                           13,000                  *


           All  directors  and  executive  officers  as a                 1,459,228               35.3  %
           group (5 persons) (7)
------------------------
</TABLE>

        *Less than 1%

    (1) Shares to which the person or group has the right to acquire within 60
        days after March 2, 2000 are deemed to be outstanding in calculating the
        percentage ownership of the person or group but are not deemed to be
        outstanding as to any other person or group.

    (2) The address of Messrs. Conroy, Cargile, and Shaw, is c/o Microfield
        Graphics, Inc., 16112 SW 72nd, Portland, Oregon 97224.

    (3) Includes 45,000 shares held by Mr. Conroy, 91,033 shares held by Mr.
        Conroy's wife, and 49,750 shares subject to options exercisable within
        60 days after March 10, 2000.

    (4) Includes 190,000 shares held by Mr. Cargile and 16,000 shares subject to
        options exercisable within 60 days after March 10, 2000.



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

    (5) Includes 13,000 shares subject to options exercisable within 60 days
        after March 10, 2000.

    (6) Includes 794,445 shares held by Steelcase Inc. and 260,000 shares
        subject to warrants exercisable by Steelcase within 60 days after March
        10, 2000.

    (7) Includes 78,750 shares subject to options and 260,000 shares subject to
        warrants exercisable within 60 days after March 10, 2000.



    ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    On March 19, 1998 the Company signed a common stock purchase agreement with
Steelcase under which Steelcase purchased 350,000 shares of the Company's common
stock and a warrant for $2,012,500 in cash. The warrant gives Steelcase the
right to purchase an additional 260,000 shares of the Company's common stock at
$6.75 per share. The warrant is exercisable starting on March 19, 1999 and
expires on March 19, 2001. As a part of the transaction Steelcase was granted a
seat on the Board of Directors. James P. Keane was appointed as their
representative on the board in March 1998. Mr. Keane resigned in March 2000. No
Steelcase representative has been appointed to replace him. In addition, the
Company, Steelcase and certain directors and executives of the Company entered a
Share Ownership, Voting and Right of First Refusal Agreement ("Voting
Agreement") pursuant to which the parties agreed to vote their shares of common
stock to elect certain individuals to the Board of Directors. See "Security
Ownership of Certain Beneficial Owners and Management." On March 26, 1999 the
Company sold Steelcase on additional 444,445 shares of the Company's common
stock for $1,000,001. The Company also granted Steelcase registration rights for
its shares of the Company's common stock in connection with these two stock
sales. Steelcase has the right, at any time after March 19, 2000, to require the
Company to effect the registration under the Securities Act of 1933 of the
common stock owned by Steelcase, subject to certain limitations.

    On October 22, 1998, pursuant to an executive loan program authorized by the
    Board of Directors, John B. Conroy borrowed money from the Company in order
    to exercise options for 45,000 shares of the Company's Common Stock. The
    transaction resulted in a note due the Company from Mr. Conroy in the amount
    of $75,000, with interest at 6% per year, due on October 22, 2003.

    ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

    (a) Exhibits included herein:


        Exhibit No.
        -----------

    *3.1             Articles of Incorporation, as amended
    *3.2             Bylaws, as amended
    *4.1             See Article III of Exhibit 3.1 and Articles I and VI of
                     Exhibit 3.2
    #*10.1           1986 Stock Option Plan, as amended
    *10.3            Form of Incentive Stock Option Agreement
    *10.7            Form of Representative's Warrants (1)
    (1)*10.8         Japanese Marketing License Agreement (1)
    (1)**10.9        General Purchase and Development Agreement dated
                     July 14, 1997 between the Registrant and 3M Company
    (1)***10.10      Common Stock Purchase Agreement dated March 19, 1998
                     between the Registrant and Steelcase Inc., Registration
                     Rights Agreement dated March 19, 1998 between the
                     Registrant and Steelcase Inc., Stock Purchase Warrant to
                     Purchase Shares of Common Stock of Microfield Graphics,
                     Inc. dated March 19, 1998 issued by the Registrant to
                     Steelcase Inc., and Share Ownership, Voting and Right of
                     First Refusal Agreement dated March 19, 1998 between the
                     Registrant, Steelcase Inc., John B. Conroy, Scott D. McVay,
                     Randall R. Reed, Michael W. Stansell, Peter F. Zinsli,
                     Donald H. Zurstadt, and William P. Cargile.
    ****10.11        Restated 1995 Stock Incentive Plan dated May 11, 1998.



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

    *****10.12        Form of Lease between Microfield Graphics and Pacific
                      Realty Associates, LLP, dated January 24, 2000.
    *****10.13        Form of Forbearance Agreement between Silicon Valley Bank
                      and Microfield Graphics, Inc. dated November 3, 1999.
    *****23           Consent of PricewaterhouseCoopers
    *****27           Financial Data Schedule
    ------------
    *  Incorporated by reference to Exhibits 3.1, 3.2, 4.1, 10.1, 10.3, 10.7,
       10.8, as applicable, to Registrant's Registration Statement on Form SB-2
       (Registration No. 33-91890).

    ** Incorporated by reference to Exhibit 10.9 to Registrants Quarterly Report
    on Form 10-QSB for the three month period ended September 27, 1997.

    *** Incorporated by reference to Exhibit 10.10 to Registrants Quarterly
    Report on Form 10-QSB for the three month period ended April 4, 1998.

    **** Incorporated by reference to Exhibits 10.11 to Registrants Quarterly
    Report on Form 10-QSB for the three month period ended July 3, 1999.

    ***** Exhibits 10.12, 10.13, 23, 27 filed herewith.

    # This exhibit constitutes a management contract, or compensatory plan or
    arrangement.

    (1) Portions of Exhibit 10.8, 10.9, and 10.10 have been omitted and filed
    separately with the Securities and Exchange Commission pursuant to a request
    for confidential treatment.

    (b) Reports on Form 8-K

    No reports on Form 8-K were filed by the Company during the quarter ended
    January 1, 2000.



SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

Dated: April 10, 2000

                                MICROFIELD GRAPHICS, INC.

                                By: /s/ JOHN B. CONROY
                                -----------------------
                                John B. Conroy
                                Chairman of the Board, President,
                                and Chief Executive Officer


         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:

Signature                        Title
---------                        -----
/s/ JOHN B. CONROY               Chairman of the Board, President, and Chief
----------------------           Executive Officer (Principal Executive Officer)
John B. Conroy                   Date: April 10, 2000


/s/ HERBERT S. SHAW              Director
----------------------           Date: April 10, 2000
Herbert S. Shaw



SoftBoard and Microfield are registered trademarks and SBRecord, SBRemote,
SBView, and SBProjection are trademarks of Microfield Graphics, Inc. All other
trademarks and registered trademarks are the property of their respective
owners. All prices and specifications are subject to change without notice.
Prices may be higher outside the continental United States.
<PAGE>

/s/ WILLIAM P. CARGILE           Director
----------------------           Date: April 10, 2000
William P. Cargile


<PAGE>

MICROFIELD GRAPHICS, INC.
(d.b.a. SOFTBOARD)
CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 1, 2000 AND JANUARY 2, 1999



<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders of
Microfield Graphics, Inc. (d.b.a. Softboard)


In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Microfield
Graphics, Inc. (d.b.a. Softboard) and its subsidiary at January 1, 2000 and
January 2, 1999 and the results of their operations and their cash flows for the
years then ended, in conformity with accounting principles generally accepted in
the United States. 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 of these
statements in accordance with auditing standards generally accepted in the
United States, which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 12 to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency at January 1, 2000. In addition, as discussed
in Note 6, the Company during 1999 was not in compliance with certain covenants
related to its line of credit and, as a result, received a notice of default
from its bank and entered into a forbearance agreement with the bank. Such
factors raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Notes 6 and 12. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.




March 10, 2000


                                      F-1
<PAGE>

CONSOLIDATED BALANCE SHEETS
JANUARY 1, 2000 AND JANUARY 2, 1999

<TABLE>
<CAPTION>
                                                        1999             1998
                             ASSETS
<S>                                               <C>              <C>
Current assets:
   Cash and cash equivalents                         $  113,041       $  739,628
   Accounts receivable, net (Note 3)                    265,524          797,543
   Inventories (Note 4)                                 496,696          946,103
   Prepaid expenses and other                           120,969          156,627
                                                     ----------       ----------

     Total current assets                               996,230        2,639,901

Property and equipment, net (Note 5)                    244,714          379,457
Other assets                                             76,915          226,140
                                                     ----------       ----------

                                                     $1,317,859       $3,245,498
                                                     ----------       ----------

         LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
   Line of credit (Note 6)                           $  353,528       $  655,000
   Current portion of long-term debt (Note 6)             6,945           83,333
   Accounts payable                                     338,325          532,308
   Accrued payroll and payroll taxes                    133,650          255,698
   Unearned income                                       77,687           56,101
   Other accrued liabilities                             82,048          186,403
                                                     ----------       ----------

     Total current liabilities                          992,183        1,768,843

Long-term debt, net of current portion (Note 6)               -            6,945
Other long-term liabilities                              52,455           77,220
                                                     ----------       ----------

     Total liabilities                                1,044,638        1,853,008
                                                     ==========       ==========

Commitments and contingencies (Note 8)

Shareholders' equity (Notes 9 and 11):
   Common stock, 25,000,000 shares authorized,
     4,132,185 and 3,686,775 shares issued and
     outstanding, respectively                       15,273,912       14,362,698
   Accumulated deficit                              (15,000,691)     (12,970,208)
                                                     ----------       ----------
     Total shareholders' equity                         273,221        1,392,490
                                                     ----------       ----------

                                                     $1,317,859       $3,245,498
                                                     ==========       ==========
</TABLE>

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


                                      F-2
<PAGE>

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JANUARY 1, 2000 AND JANUARY 2, 1999


<TABLE>
<CAPTION>
                                                       1999            1998

<S>                                               <C>             <C>
Net sales (Note 10)                               $  3,492,238    $  6,646,148
Cost of goods sold                                   2,258,204       3,893,541
                                                  ------------    ------------

     Gross profit                                    1,234,034       2,752,607
                                                  ------------    ------------

Operating expenses:
   Research and development                            635,020         997,929
   Marketing and sales                               1,655,452       2,657,581
   General and administrative                          867,001         960,498
                                                  ------------    ------------

                                                     3,157,473       4,616,008
                                                  ------------    ------------

     Loss from operations                           (1,923,439)     (1,863,401)

Other income:
   Interest expense, net                               (58,099)        (50,176)
   Other (expense) income, net                         (48,945)            346
                                                  ------------    ------------

     Loss before income taxes                       (2,030,483)     (1,913,231)

Provision for income taxes (Note 7)                          -          (1,506)
                                                  ------------    ------------

     Net loss                                     $ (2,030,483)   $ (1,914,737)
                                                  ============    ============

Basic and diluted net loss per share              $       (.50)   $       (.54)
                                                  ============    ============

Shares used in calculation                           4,029,489       3,552,706
                                                  ============    ============
</TABLE>

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


                                      F-3
<PAGE>

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JANUARY 1, 2000 AND JANUARY 2, 1999


<TABLE>
<CAPTION>
                                                            COMMON STOCK
                                                  -----------------------------   ACCUMULATED
                                                    SHARES         AMOUNT            DEFICIT
                                                  -----------  ---------------  ----------------

<S>                                                <C>           <C>              <C>
Balance at January 3, 1998                         3,211,813     $ 12,185,527     $ (11,055,471)

Stock options exercised                              124,962          187,643                 -

Issuance of common stock and warrants                350,000        1,989,528                 -

Net loss                                                   -                -        (1,914,737)
                                                  -----------  ---------------  ----------------

Balance at January 2, 1999                         3,686,775       14,362,698       (12,970,208)

Stock options exercised                                  965            1,210                 -

Issuance of common stock and warrants, net of
   issuance costs                                    444,445          910,004                 -

Net loss                                                   -                -        (2,030,483)
                                                  -----------  ---------------  ----------------

Balance at January 1, 2000                         4,132,185     $ 15,273,912    $  (15,000,691)
                                                  ===========  ===============  ================
</TABLE>

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


                                      F-4
<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JANUARY 1, 2000 AND JANUARY 2, 1999


<TABLE>
<CAPTION>
                                                                            1999             1998
<S>                                                                       <C>               <C>
Cash flows from operating activities:
   Net loss                                                               $(2,030,483)      $(1,914,737)
   Adjustments to reconcile loss from continuing operations to operating
     cash flows:
       Depreciation and amortization                                          280,271           209,990
       Changes in assets and liabilites:
         Accounts receivable                                                  532,019           230,359
         Inventories                                                          449,407          (234,103)
         Prepaid expenses and other                                            35,658           (34,692)
         Accounts payable                                                    (193,983)          (74,248)
         Accrued payroll and payroll taxes                                   (122,048)           61,941
         Unearned income                                                       21,586             2,356
         Other accrued liabilities                                           (104,355)           99,140
                                                                          ------------      ------------
     Net cash used in operating activities                                 (1,131,928)       (1,653,994)
                                                                          ------------      ------------

Cash flows from investing activities:
   Acquisition of property and equipment, net                                 (75,053)         (185,650)
   Loan to employee                                                                 -           (78,750)
                                                                          ------------      ------------
     Net cash used in investing activities                                    (75,053)         (264,400)
                                                                          ------------      ------------
Cash flows from financing activities:
   Net borrowings (payments) under line of credit and term loan
     agreement                                                               (301,472)         (345,000)
   Net payments on long-term debt                                            (108,098)          (83,333)
   Proceeds from exercise of common stock options                               1,210           187,643
   Proceeds from issuance of common stock                                     988,754         1,989,528
                                                                          ------------      ------------
     Net cash provided by financing activities                                580,394         1,748,838
                                                                          ------------      ------------
     Net decrease in cash and cash equivalents                               (626,587)         (169,556)

Cash and cash equivalents, beginning of year                                  739,628           909,184
                                                                          ------------      ------------
Cash and cash equivalents, end of year                                    $   113,041       $   739,628
                                                                          ============      ============

Cash paid for:
   Interest                                                               $    67,898       $    94,804
                                                                          ============      ============
   Income taxes                                                           $         -       $     1,506
                                                                          ============      ============
</TABLE>

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


                                      F-5
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   THE COMPANY AND BASIS OF PRESENTATION

     Microfield Graphics, Inc. (the Company), an Oregon corporation incorporated
     in October 1986, develops, manufactures and markets computer conferencing
     and telecommunications products to facilitate group communications. The
     Company's product lines incorporate a series of digital whiteboards,
     digital whiteboard rear projection systems, and interactive plasma display
     systems under the brand name Softboard, along with a variety of application
     software packages, supplies and accessories. Information written or drawn
     on the Softboard surface is recorded and displayed on a personal computer
     simultaneously and in color using the Company's proprietary technology.

     The Company has a wholly-owned foreign sales corporation in Barbados.
     Hereafter in these consolidated financial statements, the term "Company"
     refers to Microfield Graphics, Inc. and its subsidiary. The Company's
     primary market is in the United States; however, there are export sales to
     the United Kingdom, China, Japan and other countries (see Note 10).


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     FISCAL YEAR
     The Company operates on a 52-53 week fiscal year ending on the Saturday
     closest to the last day of December.

     PRINCIPLES OF CONSOLIDATION
     The consolidated financial statements include the accounts of the Company
     and its wholly-owned subsidiary. All significant intercompany transactions
     and balances have been eliminated in consolidation.

     CONSOLIDATED STATEMENT OF CASH FLOWS
     For purposes of the statement of cash flows, the Company considers all
     highly liquid debt instruments purchased with an original maturity of three
     months or less to be cash equivalents.

     ACCOUNTS RECEIVABLE
     Accounts receivable at January 1, 2000 and January 2, 1999 are recorded net
     of allowances for uncollectible accounts of $27,153 and $44,553,
     respectively.

     INVENTORIES
     Inventories are stated at the lower of standard cost or market value.
     Standard costs approximate the first-in, first-out method. Inventory costs
     include raw materials, direct labor and allocated overhead.

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


                                      F-6
<PAGE>

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

     PROPERTY AND EQUIPMENT
     Property and equipment are stated at cost and are depreciated using
     accelerated methods over their estimated useful lives of five years.
     Repairs and maintenance are charged to expense as incurred; improvements
     are capitalized. When the Company sells or disposes of assets, the accounts
     are relieved of the related costs and accumulated depreciation and
     resulting gains and losses are reflected in operations.

     RESEARCH AND DEVELOPMENT
     Research and development expenditures are charged to operations as
     incurred.

     REVENUE RECOGNITION
     Revenue is recognized upon shipment of products. Revenue on warranty
     contracts is recognized over the life of the contract.

     INCOME TAXES
     The Company accounts for income taxes using the asset and liability
     approach in accordance with Statement of Financial Accounting Standards
     (SFAS) No. 109, ACCOUNTING FOR INCOME TAXES. The asset and liability
     approach requires the recognition of deferred tax liabilities and assets
     for the expected future tax consequences of temporary differences between
     the carrying amounts and the tax basis of assets and liabilities. The
     effect on deferred taxes of a change in tax rates is recognized in
     operations in the period that includes the enactment date.

     BASIC AND DILUTED NET LOSS PER SHARE
     Basic earnings (loss) per common share is computed using the
     weighted-average number of common shares outstanding during the period.
     Diluted earnings per common share is computed using the combination of
     dilutive common share equivalents and the weighted-average number of common
     shares outstanding during the period. Diluted loss per common share for
     1999 and 1998 is based only on the weighted-average number of common shares
     outstanding during the period, as the inclusion of 481,881 and 442,413
     common share equivalents would have been antidilutive.

     USE OF ESTIMATES
     The preparation of financial statements in conformity with accounting
     principles generally accepted in the United States requires management to
     make estimates and assumptions that affect the reported amounts of assets
     and liabilities and disclosure of contingent assets and liabilities at the
     date of the financial statements and the reported amounts of revenues and
     expenses during the reporting period. Actual results could differ from
     those estimates.

     FAIR VALUE OF FINANCIAL INSTRUMENTS
     The recorded amounts of cash and cash equivalents, accounts receivable,
     accounts payable, line of credit and accrued liabilities as presented in
     the consolidated financial statements approximate fair value because of the
     short-term maturity of these instruments. The recorded amount of long-term
     debt approximates fair value since the imputed interest or stated interest
     approximates currently competitive rates.

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


                                      F-7
<PAGE>


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

     COMPREHENSIVE INCOME (LOSS)
     The Company has adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME, as of
     January 4, 1998. Comprehensive loss equals net loss for all periods
     presented.


3.   CONCENTRATION OF CREDIT RISK

     During the year ended January 1, 2000 no customers accounted for 10% or
     more of total net sales. During the year ended January 2, 1999 one customer
     accounted for approximately 38% of net sales. Accounts receivable from one
     customer totaled approximately $210,000 at January 2, 1999.


4.   INVENTORIES

     Inventories consist of the following:
<TABLE>
<CAPTION>

                                                                   JANUARY 1,   JANUARY 2,
                                                                     2000         1999
                                                                  ----------   ----------
<S>                                                               <C>          <C>
       Raw materials                                              $  368,498   $  607,140
       Finished goods                                                128,198      338,963
                                                                  ----------   ----------

                                                                  $  496,696   $  946,103
                                                                  ==========   ==========
</TABLE>


5.   PROPERTY AND EQUIPMENT

     Property and equipment consist of the following:
<TABLE>
<CAPTION>

                                                                   JANUARY 1    JANUARY 2,
                                                                     2000         1999
                                                                  ----------   ----------
<S>                                                               <C>          <C>
       Furniture, machinery and equipment                         $1,196,585   $1,223,014

       Less accumulated depreciation and amortization                951,871      843,557
                                                                  ----------   ----------

                                                                  $  244,714   $  379,457
                                                                  ==========   ==========
</TABLE>

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


                                      F-8
<PAGE>


6.   DEBT

     At January 1, 2000, the Company had a $650,000 line of credit with a bank.
     Borrowings under the line of credit are due on demand, bear interest
     payable monthly at prime plus 2.5% (11% at January 1, 2000), and are
     collateralized by accounts receivable and a portion of inventory. As of
     January 1, 2000, borrowings of $353,528 were outstanding under the line.
     Pursuant to the line of credit agreement, the Company is required to comply
     with certain financial covenants, including ratios and minimum net worth.
     During 1999, the Company was not in compliance with the minimum tangible
     net worth financial covenant of its Loan Agreement with its bank. As a
     result, on October 15, 1999 the bank delivered a notice of default and the
     Company subsequently entered into a Forbearance Agreement with the bank.
     The Forbearance Agreement provides for a reduction in the line of credit to
     $650,000, the elimination of inventory from the collateral base over a
     fourteen-month period, an increase in the interest rate from prime to prime
     plus 2.5% and certain financial covenants with which the Company must
     apply. The Forbearance Agreement period is through April 30, 2000.

     Pursuant to the Forbearance Agreement, the Company must maintain a balance
     of accounts receivable not less than (i) 125% of the outstanding advances
     under the line of credit, minus (ii) 50% of the value of the Company's
     inventory, capped at $220,000 (the Inventory Cap Amount) at January 1,
     2000. To the extent the Company obtains initial deposits on contracts that
     reduce overall accounts receivable, the Bank may elect to include such
     deposits, as reflected in the balance sheet category of unearned income, as
     accounts receivable. The Inventory Cap Amount will reduced by $10,000 each
     month through March 31, 2000 and further reduced by $25,000 each month
     ending thereafter.

     In the event that the Forbearance Agreement is not extended or the Loan
     Agreement is not renewed, the Company's business and financial condition
     could be materially and adversely affected. Under such circumstances the
     Company believes that it would not have resources sufficient to fund its
     operations for the next twelve months unless it is able to obtain
     alternative financing on terms acceptable to the Company.

     The Company is exploring alternative means of financing the business.
     However, there can be no assurance that the Company can obtain such
     financing, or that such financing will be on terms acceptable to the
     Company.

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


                                      F-9
<PAGE>


6.   DEBT (CONTINUED)

     The Company's long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                                                    JANUARY 1,      JANUARY 2,
                                                                                      2000            1999
                                                                                   -----------     -----------
<S>                                                                                 <C>             <C>
       Term loan payable to bank in monthly installments of $7,988, including
         interest at the prime rate plus 2.5% (11.5% at January 1, 2000), from
         February 1997 through January 2000; all assets purchased with the
         proceeds of this loan are pledged
         as collateral                                                              $  6,945        $ 90,278
       Less principal amounts due within one year                                     (6,945)        (83,333)
                                                                                    ---------       ---------

           Long-term debt                                                           $      -        $  6,945
                                                                                    =========       =========
</TABLE>


7.   INCOME TAXES

     The provision for income taxes of $1,506 for fiscal year 1998 consists of
     minimum payments due and paid to various state tax authorities.

     The provision for income taxes for the years ended January 1, 2000 and
     January 2, 1999 differs from the amount which would be expected as a result
     of applying the statutory tax rates to the losses before income taxes due
     primarily to changes in the valuation allowance to fully reserve net
     deferred tax assets.

     Deferred tax assets are comprised of the following components:

<TABLE>
<CAPTION>

                                                  JANUARY 1,     JANUARY 2,
                                                     2000           1999
                                                 -----------    -----------
<S>                                             <C>            <C>
   Current:
     Allowances for uncollectible accounts       $     7,588    $    18,560
     Employee benefits                                20,281         31,125
     Inventory, warranty, and other allowances        29,837         59,266
     Unearned revenues                                29,801         21,520
                                                 -----------    -----------
                                                      87,507        130,471
                                                 -----------    -----------
   Non-current:
     Intangible assets                                19,331         15,368
     Net operating loss carryforwards              5,525,432      4,702,432
     Research and development credits                284,854        272,471
                                                 -----------    -----------
                                                   5,829,617      4,990,271
                                                 -----------    -----------

       Total deferred tax asset                    5,917,124      5,120,742

   Deferred tax asset valuation allowance         (5,917,124)    (5,120,742)
                                                 -----------    -----------

       Net deferred tax assets                   $         -    $         -
                                                 ===========    ===========
</TABLE>

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


                                      F-10
<PAGE>

7.   INCOME TAXES (CONTINUED)

     At January 1, 2000, the Company had available net operating loss
     carryforwards of approximately $14,404,155 for federal income tax purposes.
     Such carryforwards may be used to reduce consolidated taxable income, if
     any, in future years through their expiration in 2003 to 2020. Utilization
     of net operating loss carryforwards may be limited due to the ownership
     changes resulting from the Company's initial public offering in 1995. In
     addition, the Company has research and development credits aggregating
     $284,854 for income tax purposes at January 1, 2000. Such credits may be
     used to reduce taxes payable, if any, in future years through their
     expiration in 2001 to 2020.


8.   LEASE COMMITMENTS AND CONTINGENCIES

     The Company leases office space under operating leases. Subsequent to
     January 1, 2000, the Company entered into a new lease agreement for
     different office space. At the same time, the Company was discharged from
     its existing lease arrangement. Under the terms of the new lease agreement,
     the Company has a future minimum lease commitment equivalent to six months
     of lease payments. Total future minimum lease commitments under the new
     lease agreement are $40,320.

     Rent expense totaled $328,459 and $355,246 for fiscal years ended 1999 and
     1998, respectively.


9.   SHAREHOLDERS' EQUITY

     INCENTIVE STOCK OPTION PLAN
     The Company has Stock Option Plans (the Plans). At January 1, 2000 and
     January 2, 1999, 1,305,162 and 1,005,162 shares, respectively, of common
     stock were reserved for issuance to employees, officers, directors and
     consultants. Under the Plans, the options may be granted to purchase shares
     of the Company's common stock at fair market value, as determined by the
     Company's Board of Directors, at the date of grant. The options are
     exercisable over a period of up to five years from the date of grant. The
     options become exercisable over four years.

     The Company adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION,
     in 1996. SFAS No. 123 allows companies to choose whether to account for
     stock-based compensation on a fair value method or to continue to account
     for stock-based compensation under the current intrinsic value method as
     prescribed by APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES.
     The Company has elected to continue to follow the provisions of APB Opinion
     No. 25.

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


                                      F-11
<PAGE>


9.   SHAREHOLDERS' EQUITY (CONTINUED)

     INCENTIVE STOCK OPTION PLAN (CONTINUED)
     A summary of the status of the Company's Stock Option Plans as of January
     1, 2000 and January 2, 1999 and for the years then ended is presented
     below:

<TABLE>
<CAPTION>
                                                  JANUARY 1, 2000            JANUARY 2, 1999
                                              -------------------------  ------------------------
                                                            WEIGHTED-                 WEIGHTED-
                                                             AVERAGE                   AVERAGE
                                                            EXERCISE                   EXERCISE
                PERFORMANCE OPTIONS             SHARES        PRICE        SHARES       PRICE
           ------------------------------     ------------ ------------  -----------  -----------
<S>                                            <C>          <C>           <C>         <C>
           Outstanding at beginning of year       442,413      $  4.66      402,868      $  3.69
           Granted                                344,100          .93      212,500         4.04
           Exercised                                 (965)        1.25     (124,962)        1.50
           Forfeited                             (303,667)        2.39      (47,993)        2.07
                                              ------------ ------------  -----------

                                                  481,881      $   .22      442,413
                                              ============ ============  ===========

           Options exercisable at year-end        174,987                   144,046
                                              ============               ===========
</TABLE>


     Effective December 20, 1999, the Company decreased the exercise price for
     all outstanding common stock options to $0.22 per share. As a result, the
     exercise price for all of the outstanding options (to purchase an aggregate
     of 481,881 shares of common stock) has been repriced to $0.22 per share as
     shown in the above table, as of January 1, 2000. Pursuant to the provisions
     of a proposed financial intepretation to existing accounting
     pronouncements, the Company may be required to account for its repriced
     options as variable rather than fixed options. Accordingly, the Company
     may be required to record compensation expense to the extent that the
     quoted market price of the Company's common stock exceeds the related
     quoted market price as of June 30, 2000, the proposed effective date of
     the proposed interpretation. Such compensation expense would be
     recognized over the period from June 30, 2000 through the dates of
     exercise of the repriced options.

     The weighted-average contractual remaining life is 8.7 years for all
     outstanding common stock options as of January 1, 2000.

     The Company has computed for pro forma disclosure purposes the value of all
     options and warrants granted during 1999 and 1998 using the Black-Scholes
     pricing model as prescribed by SFAS No. 123 and the following assumptions:

<TABLE>
<CAPTION>
                                              1999           1998

<S>                                         <C>            <C>
       Risk-free interest rate                   6.36%          4.31%
       Expected dividend yield                      0%             0%
       Expected lives                        4.5 years      4.5 years
       Expected volatility                        117%           102%
</TABLE>

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


                                      F-12
<PAGE>

9.   SHAREHOLDERS' EQUITY (CONTINUED)

     INCENTIVE STOCK OPTION PLAN (CONTINUED)
     Had compensation cost for the Company's Plans been determined based on the
     fair value at the grant dates consistent with the method of SFAS No. 123,
     the total value of options and warrants granted would be computed as
     follows:

       Year ended January  1, 2000                                  $ 292,462
       Year ended January  2, 1999                                    642,370



     Such amounts would be amortized over the vesting period of the options.

     Accordingly, under SFAS No. 123, the Company's net loss and loss per share
     would have been changed to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                                     1999           1998

<S>                                                <C>           <C>            <C>
       Net loss                                    As reported   $(2,030,483)   $(1,914,737)
                                                   Pro forma      (2,173,162)    (2,243,091)

       Basic and diluted net loss per share        As reported          (.50)          (.54)
                                                   Pro forma            (.54)          (.63)
</TABLE>



     The effects of applying SFAS No. 123 for providing pro forma disclosures
     for 1999 and 1998 are not likely to be representative of the effects on
     reported net loss and net loss per share for future years, because options
     vest over several years and additional awards generally are made each year.

     COMMON STOCK WARRANTS
     In connection with its initial public offering in 1995, the Company issued
     110,000 warrants to purchase shares of Common Stock at an exercise price of
     $7.20 per share; such warrants expire in 2000. In addition, in connection
     with the common stock purchase agreement on March 16, 1998 the Company
     issued 260,000 warrants to purchase shares of common stock at an exercise
     price of $6.75 per share. Such warrants may be exercised beginning March
     1999 and expire in March 2001.

     In connection with a forbearance agreement entered into on October 15, 1999
     with the Company's debt holders (see Note 6), the Company issued a warrant
     to purchase 20,000 shares of the Company's Common Stock at an exercise
     price of $0.75 per share. In accordance with the terms of the warrant, the
     holder, in lieu of exercising the warrant, has the option to convert the
     warrant into a number of shares to be determined based on a formula which
     considers the difference between the fair market value of the Company's
     Common Stock at the time of conversion and the exercise price of the
     warrant. The fair value of the warrants determined utilizing the
     Black-Scholes pricing model at the time of issuance is immaterial. The
     warrant expires in October 2003.

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


                                      F-13
<PAGE>

10.  EXPORT SALES

     Export sales aggregated $665,000 and $1,826,703 in 1999 and 1998,
     respectively. Such export sales were made to customers in the following
     countries:

<TABLE>
<CAPTION>
                                             1999            1998

<S>                                       <C>              <C>
       China                              $   150,000      $     4,703
       Japan                                  111,000          114,000
       United Kingdom                         182,000          520,000
       France                                       -          854,000
       Other                                  222,000          334,000
                                          ------------     ------------

                                             $665,000       $1,826,703
                                          ============     ============
</TABLE>


11.  SUBSEQUENT EVENTS

     During February 2000, the Company was named in a class action lawsuit. The
     complaint alleges that the Company and its Chief Executive Officer issued a
     series of false and misleading statements concerning, among other things,
     the Company's purchase agreement with Minnesota Mining and Manufacturing
     Company. The complaint alleges that, as a result of these allegedly
     material misstatements and omissions, the Company's stock price was
     artificially inflated during the period from July 23, 1998 through April 2,
     1999. The Company denies the allegations and intends to vigorously defend
     itself. However, the ultimate outcome of the litigation is presently
     undeterminable.


12.  GOING CONCERN

     During 1999, the Company experienced significantly reduced sales and
     negative cash flows from operations. Such reduction was due primarily to
     the loss of sales from Minnesota Mining and Manufacturing Company, a major
     OEM customer. At the end of the second quarter of 1999, the Company
     concluded that it might not have sufficient funds to operate for at least
     the next twelve months. Management based such conclusions on the reduction
     in sales and resulting losses that occurred during the first six months of
     1999, coupled with diminishing cash resources (cash and cash equivalents,
     and cash available under its operating line of credit). In response,
     management restructured its operations through a combination of staff
     reductions, workweek reductions, temporary executive salary reductions and
     reductions in general expense spending levels. As a result, the Company
     delayed certain product development programs and focused its efforts on
     expanding product offerings based on its current technology. It is the
     Company's intention to resume its product development programs when and if
     it achieves profitability on a sustainable basis. However, there can be no
     assurance that the Company will achieve profitability or resume its
     development programs.

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


                                      F-14